Red Brick Bank plans to launch a new deposit campaign next week in hopes of bringing in from $100 million to $600 million in new deposit money, which it expects to invest at a 5.5 percent yield. Management believes that an offer rate on new deposits of 2.75 percent would attract $100 million in new

Question

Red Brick Bank plans to launch a new deposit campaign next week in hopes of bringing in from $100 million to $600 million in new deposit money, which it expects to invest at a 5.5 percent yield. Management believes that an offer rate on new deposits of 2.75 percent would attract $100 million in new deposits and rollover funds. To attract $200 million, the bank would probably be forced to offer 3.25 percent. Red Brick’s forecast suggests that $300 million might be available at 3.75 percent, $400 million at 4.00 percent, $500 million at 4.25 percent, and $600 million at 4.5 percent. What volume of deposits should the institution try to attract to ensure that marginal cost does not exceed marginal revenue?

Accepted Answer

Expected	Rate	Total	Marginal	Marginal	Marginal	Exp. Diff. In	Total
Inflows	Offered on	Interest	Interest	Cost Rate	Revenue	Marg. Rev	Profits
	New	Cost	Cost		Rate	and Costs	Earned
	Funds
$100	2.75%	2.75	2.75	2.75%	5.50%	2.75%	$2.75
$200	3.25%	6.5	3.75	3.75%	5.50%	1.75%	$4.50
$300	3.25%	11.25	4.75	4.75%	5.50%	0.75%	$5.25
$400	4%	16	4.75	4.75%	5.50%	0.75%	$6.00
$500	4.25%	21.25	5.25	5.25%	5.50%	0.25%	$6.25
$600	4.50%	27	5.75	5.75%	5.50%	-0.25%	$6.00

The marginal revenue rate is greater than the marginal cost rate up to $500 million in new deposits. At $600 million, the marginal cost rate of 5.75% is greater than the marginal revenue rate of 5.50%. Therefore, Red Brick Bank should try and attract $500 million in new deposits.

Question 12.P.5: Red Brick Bank plans to launch a new deposit campaign next w...

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