ECON 330 EXAM 2 CHAPTER 10
n recent years the interest paid on checkable and time deposits has accounted for around ________ of total bank operating expenses, while the costs involved in servicing accounts have been approximately ________ of operating expenses.
25 percent, 50 percent
If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is
25,000
With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is
90
Which of the following statements are true about the bank balance sheet?
A bankʹs balance sheet shows that total assets equal total liabilities plus equity capital.
Which of the following statements is false about the bank balance sheet?
Bank capital is recorded as an asset on the bank balance sheet.
Which of the following statements most accurately describes the task of bank asset management?
Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity.
which statement is true about checkable deposits?
Checkable deposits are payable on demand.
which statement is false about checkable deposits?
Checkable deposits are the primary source of bank funds.
Which of the following are primary concerns of the bank manager?
Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
why do equity holders care more about ROW than about ROA?
ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run
A bank failure occurs whenever
a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements.
A reason why rogue traders have bankrupt their banks is due to
a failure to maintain proper internal controls
Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans.
adverse selection
If borrowers with the most risky investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, banks are said to face the problem of
adverse selection
In order to reduce the ________ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones.
adverse selection
If a bankʹs liabilities are more sensitive to interest rate movements than are its assets, then
an increase in interest rates will reduce bank profits
All else the same, if a bankʹs liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits.
an increase, reduce
Duration analysis involves comparing the average duration of the bankʹs ________ to the average duration of its ________.
assets, liabilities
Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called
basic gap analysis
Of the following, which would be the first choice for a bank facing a reserve deficiency?
borrow from other banks
Banks that actively manage liabilities will most likely meet a reserve shortfall by
borrowing federal funds
why might a bank be willing to borrow funds from other banks at a higher rate rather than borrow from the Fed?
borrowing from the Fed might invite greater supervisory scrutiny from the central bank
In general, banks would prefer to acquire funds quickly by ________ rather than ________.
borrowing from the fed, reducing loans
Asset transformation can be described as
borrowing short and lending long
A bank will want to hold more excess reserves (everything else equal) when
brokerage commissions on selling bonds increase.
Because of an expected rise in interest rates in the future, a banker will likely
buy short-term rather than long-term bonds.
A bank with insufficient reserves can increase its reserves by
calling in loans
________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow.
calling in loans
Conditions that likely contributed to a credit crunch in 2008 include:
capital shortfalls caused in part by falling real estate prices.
Holding all else constant, when a bank receives the funds for a deposited check,
cash items in the process of collection fall by the amount of the check.
Which of the following are not reported as assets on a bankʹs balance sheet?
checkable deposits
Which of the following are reported as liabilities on a bankʹs balance sheet?
checkable deposits and discount loans
Credit risk management tools include
collateral
Property promised to the lender as compensation if the borrower defaults is called ________.
collateral
The principal-agent problem that exists for bank trading activities can be reduced through
creation of internal controls that separate trading activities from bookkeeping.
When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in
credit rationing
If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to
decline by 1.5 million
the volume of checkable deposits relative to total bank liabilities has:
declined over time
If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in
deposits and reserves
Bank loans from the Federal Reserve are called ________ and represent a ________ of funds.
discount loans, source
From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem.
diversification, adverse selection
The amount of assets per dollar of equity capital is called the
equity multiplier
Banks that suffered significant losses in the 1980s made the mistake of
failing to diversify their loan portfolio
One of the problems in conducting a duration gap analysis is that the duration gap is calculated assuming that interest rates for all maturities are the same. That means that the yield curve is
flat
Through correspondent banking, large banks provide services to small banks, including
foreign exchange transactions
The difference of rate-sensitive liabilities and rate-sensitive assets is known as the
gap
Because of their ________ liquidity, ________ U.S. government securities are called secondary reserves.
high, short-term
Off-balance sheet activities involving guarantees of securities and back-up credit lines
increase the risk a bank faces
As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________.
increase, increase
When a new depositor opens a checking account at the First National Bank, the bankʹs assets ________ and its liabilities ________.
increase, increase
Which of the following has not resulted from more active liability management on the part of banks?
increased bank holdings of cash items
Modern liability management has resulted in
increased sales of certificates of deposits to raise funds.
Most of a bankʹs operating income results from
interest on assets
Risk that is related to the uncertainty about interest rate movements is called
interest-rate risk
Holding large amounts of bank capital helps prevent bank failures because
it can be used to absorb the losses resulting from bad loans.
When you deposit a $50 bill in the Security Pacific National Bank,
its assets increase by 50
A bank is insolvent when
its liabilities exceed its assets
When you deposit $50 in currency at Old National Bank,
its liabilities increase by 50
A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be prevented, will require borrowers to
keep compensating balances in a checking account at the bank.
A bank with excess reserves can economize on these reserves by
lending reserves in the federal funds market
Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy ________ with a different set of characteristics.
liabilities, assets
Bank capital is listed on the ________ side of the bankʹs balance sheet because it represents a ________ of funds.
liability, source
Bankersʹ concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Fed, and borrowings from other banks to deal with deposit outflows is an example of
liquidity management
A bankʹs commitment to provide a firm with loans up to pre-specified limit at an interest rate that is tied to a market interest rate is called
loan commitment
Examples of off-balance-sheet activities include
loan sales
Bankʹs make their profits primarily by issuing ________.
loans
The most important category of assets on a bankʹs balance sheet is
loans
Unanticipated moral hazard contingencies can be reduced by
long-term costumer relationships
When Jane Brown writes a $100 check to her nephew (who lives in another state), Ms. Brownʹs bank ________ assets of $100 and ________ liabilities of $100.
loses, loses
To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also
monitor and enforce them
Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the
moral hazard problem
If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits.
more, an increase
If a bank has ________ rate-sensitive assets than liabilities, a ________ in interest rates will reduce bank profits, while a ________ in interest rates will raise bank profits.
more, decline, rise
Because checking accounts are ________ liquid for the depositor than passbook savings, they earn ________ interest rates.
more, lower
Which of the following is not an example of a backup line of credit?
mortgages
Which of the following would a bank not hold as insurance against the highest cost of deposit outflow-bank failure?
mortgages
Which of the following are transaction deposits?
negotiable order of withdraw accounts
Which of the following is not a nontransaction deposit?
negotiable order of withdrawal accounts
Large-denomination CDs are ________, so that like a bond they can be resold in a ________ market before they mature.
negotiable, secondary
The quantity interest income minus interest expenses divided by assets is a measure of bank performance known as
net interest margin
Because ________ are less liquid for the depositor than ________, they earn higher interest rates.
passbook savings, checkable deposits
Banks hold excess and secondary reserves to
provide for deposit outflows
The goals of bank asset management include
purchasing securities with high returns and low risk.
When banks offer borrowers smaller loans than they have requested, banks are said to
ration credit
Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks.
reduce, screen
Bank capital has both benefits and costs for the bank owners. Higher bank capital ________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given return on assets.
reduces, reduces
A $5 million deposit outflow from a bank has the immediate effect of
reducing deposits and reserves by $5 million.
The fraction of checkable deposits that banks are required by regulation to hold are
required reserves
Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the
requirement that firms place on their board of directors an officer from the bank.
Which of the following are reported as assets on a bankʹs balance sheet?
reserves
Which of the following bank assets is the most liquid?
reserves
Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called
restrictive covenants
Net profit after taxes per dollar of assets is a basic measure of bank profitability called
return on assets
Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called
return on equity
Banks acquire the funds that they use to purchase income-earning assets from such sources as
savings accounts
If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can
sell $3 million of securities.
Which of the following would not be a way to increase the return on equity?
sell more bank stock
All of the following are examples of off-balance sheet activities that generate fee income for banks except
selling negotiable CDs
All of the following are operating expenses for a bank except
service charges on deposit accounts
One way for banks to reduce the principal-agent problems associated with trading activities is to
set limits on the total amount of a tradersʹ transactions.
Secondary reserves include
short-term treasury securities
In general, banks make profits by selling ________ liabilities and buying ________ assets.
short-term, longer-term
Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bankʹs assets to increase their rate sensitivity or, alternatively, ________ the duration of the bankʹs liabilities.
shortening, lengthening
If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to
shrink the size of the bank
The share of checkable deposits in total bank liabilities has
shrunk over time
In one sense ________ appears surprising since it means that the bank is not ________ its portfolio of loans and thus is exposing itself to more risk.
specialization in lending, diversifying
When banks involved in trading activities attempt to outguess markets, they are
speculating
When banks calculate the losses the institution would incur if an unusual combination of bad events happened, the bank is using the ________ approach.
stress test
Which of the following are bank assets?
the building owned by the bank
For a given return on assets, the lower is bank capital,
the higher is the return for the owners of the bank.
When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then
the liabilities of citibank increase by 10
When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bankʹs final balance sheet,
the liabilities of the bank increase by $1,000,000.
Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals times the change in the interest rate is called
the maturity bucket approach to gap analysis.
why has the development of overnight loan markets made it more likely that banks will hold fewer excess reserves?
the presence of overnight loan markets reduces the costs associated with deposit outflows
Traders working for banks are subject to the
the principal agent problem
When you deposit $50 in your account at First National Bank and a $100 check you have written on this account is cashed at Chemical Bank, then
the reserves at First National fall by $50.
Banksʹ asset portfolios include state and local government securities because
their interest payments are tax deductible for federal income taxes.
Secondary reserves are so called because
they can be converted to cash with low transaction costs
Because ________ are less liquid for the depositor than ________, they earn higher interest rates.
time deposits, passbook savings
If a banker expects interest rates to fall in the future, her best strategy for the present is
to increase the duration of the banks assets
In the absence of regulation, banks would probably hold
too little capital
Bank capital is equal to ________ minus ________.
total assets, total liabilities
Which of the following is not a source of borrowings for a bank?
transaction deposits
The largest percentage of banksʹ holdings of securities consist of
treasury and government agency securities
Banks develop statistical models to calculate their maximum loss over a given time period. This approach is known as the
value at risk approach
Bank reserves include
vault cash and deposits at the fed
Looking at the Net Interest Margin indicates that the poor bank performance in the late 1980s
was not a result of interest rate movements