Chapter 10

A $5 million deposit outflow from a bank has the immediate effect of A) reducing deposits and reserves by $5 million. B) reducing deposits and loans by $5 million. C) reducing deposits and securities by $5 million. D) reducing deposits and capital by $5 million.

A

A bank failure occurs whenever A) a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements. B) a bank suffers a large deposit outflow. C) a bank has to call in a large volume of loans. D) a bank is not allowed to borrow from the Fed.

A

A bank is insolvent when A) its liabilities exceed its assets. B) its assets exceed its liabilities. C) its capital exceeds its liabilities. D) its assets increase in value.

A

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. A) reduces; reduces B) increases; increases C) reduces; increases D) increases; reduces

A

Bank capital is equal to ________ minus ________. A) total assets; total liabilities B) total liabilities; total assets C) total assets; total reserves D) total liabilities; total borrowings

A

Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans. A) adverse selection B) moral hazard C) moral suasion D) intentional fraud

A

Banksʹ asset portfolios include state and local government securities because A) their interest payments are tax deductible for federal income taxes. B) banks consider them helpful in attracting accounts of Federal employees. C) the Federal Reserve requires member banks to buy securities from state and local governments located within their respective Federal Reserve districts. D) there is no default-risk with state and local government securities.

A

Conditions that likely contributed to a credit crunch in 2008 include: A) capital shortfalls caused in part by falling real estate prices. B) regulated hikes in bank capital requirements. C) falling interest rates that raised interest rate risk, causing banks to choose to hold more capital. D) increases in reserve requirements.

A

Holding all else constant, when a bank receives the funds for a deposited check, A) cash items in the process of collection fall by the amount of the check. B) bank assets increase by the amount of the check. C) bank liabilities decrease by the amount of the check. D) bank reserves increase by the amount of required reserves.

A

If a bank has $10 million of checkable deposits, a required reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of A) $1.2 million. B) $1.1 million. C) $1 million. D) $900,000.

A

If a bank has $200,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is A) $50,000. B) $40,000. C) $30,000. D) $25,000.

A

If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in A) deposits and reserves. B) deposits and loans. C) capital and reserves. D) capital and loans.

A

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. A) specialization in lending; diversifying B) specialization in lending; rationing C) credit rationing; diversifying D) screening; rationing

A

Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks. A) reduce; screen B) increase; screen C) reduce; increase D) increase; increase

A

Modern liability management has resulted in A) increased sales of certificates of deposits to raise funds. B) increase importance of deposits as a source of funds. C) reduced borrowing by banks in the overnight loan market. D) failure by banks to coordinate management of assets and liabilities.

A

Net profit after taxes per dollar of assets is a basic measure of bank profitability called A) return on assets. B) return on capital. C) return on equity. D) return on investment.

A

Property promised to the lender as compensation if the borrower defaults is called ________. A) collateral B) deductibles C) restrictive covenants D) contingencies

A

Secondary reserves are so called because A) they can be converted into cash with low transactions costs. B) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms. C) 50% of these assets count toward meeting required reserves. D) they rank second to bank vault cash in importance of bank holdings.

A

The largest percentage of banksʹ holdings of securities consist of A) Treasury and government agency securities. B) tax-exempt municipal securities. C) state and local government securities. D) corporate securities.

A

To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also A) monitor and enforce them. B) be willing to rewrite the contract if the borrower cannot comply with the restrictions. C) trust the borrower to do the right thing. D) be prepared to extend the deadline when the borrower needs more time to comply.

A

When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserves instead, then, in the bankʹs final balance sheet, A) the assets at the bank increase by $1 million. B) the liabilities of the bank decrease by $1 million. C) reserves increase by $200,000. D) liabilities increase by $200,000.

A

When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then A) the liabilities of the First National Bank decrease by $10. B) the reserves of the First National Bank increase by $10. C) the liabilities of Citibank decrease by $10. D) the assets of Citibank decrease by $10.

A

When a new depositor opens a checking account at the First National Bank, the bankʹs assets ________ and its liabilities ________. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

A

Which of the following are bank assets? A) the building owned by the bank B) a discount loan C) a negotiable CD D) a customerʹs checking account

A

Which of the following are primary concerns of the bank manager? A) Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows B) Extending loans to borrowers who will pay low interest rates, but who are poor credit risks C) Acquiring funds at a relatively high cost, so that profitable lending opportunities can be realized D) Maintaining high levels of capital and thus maximizing the returns to the owners.

A

Which of the following are reported as liabilities on a bankʹs balance sheet? A) Discount loans B) Reserves C) U.S. Treasury securities D) Loans

A

Which of the following has not resulted from more active liability management on the part of banks? A) Increased bank holdings of cash items B) Aggressive targeting of goals for asset growth by banks C) Increased use of negotiable CDs to raise funds D) An increased proportion of bank assets held in loans

A

Which of the following statements are true? A) Checkable deposits are payable on demand. B) Checkable deposits do not include NOW accounts. C) Checkable deposits are the primary source of bank funds. D) Demand deposits are checkable deposits that pay interest.

A

Which of the following statements most accurately describes the task of bank asset management? A) Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity. B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return on their operations. C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity needs supersede the desire for profits. D) Banks seek to acquire funds in the least costly way.

A

With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is A) $90. B) $100. C) $10. D) $110.

A

A bank will want to hold more excess reserves (everything else equal) when A) it expects to have deposit inflows in the near future. B) brokerage commissions on selling bonds increase. C) the cost of selling loans falls. D) the discount rate decreases.

B

A bank with insufficient reserves can increase its reserves by A) lending federal funds. B) calling in loans. C) buying short-term Treasury securities. D) buying municipal bonds

B

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. A) an increase; increase B) an increase; reduce C) a decline; reduce D) a decline; not affect

B

Asset transformation can be described as A) borrowing long and lending short. B) borrowing short and lending long. C) borrowing and lending only for the short term. D) borrowing and lending for the long term.

B

Bank capital is listed on the ________ side of the bankʹs balance sheet because it represents a ________ of funds. A) liability; use B) liability; source C) asset; use D) asset; source

B

Bank loans from the Federal Reserve are called ________ and represent a ________ of funds. A) discount loans; use B) discount loans; source C) fed funds; use D) fed funds; source

B

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 A) liability management. B) liquidity management. C) managing interest rate risk. D) managing credit risk.

B

Banks acquire the funds that they use to purchase income-earning assets from such sources as A) cash items in the process of collection B) savings accounts. C) reserves. D) deposits at other banks.

B

Banks hold excess and secondary reserves to A) reduce the interest-rate risk problem. B) provide for deposit outflows. C) satisfy margin requirements. D) achieve higher earnings than they can with loans.

B

Banks that actively manage liabilities will most likely meet a reserve shortfall by A) calling in loans. B) borrowing federal funds. C) selling municipal bonds. D) seeking new deposits.

B

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. A) money market deposit accounts; time deposits B) checkable deposits; passbook savings C) passbook savings; checkable deposits D) passbook savings; time deposits

B

Credit risk management tools include A) deductibles. B) collateral. C) interest rate swaps. D) duration analysis.

B

For a given return on assets, the lower is bank capital, A) the lower is the return for the owners of the bank. B) the higher is the return for the owners of the bank. C) the lower is the credit risk for the owners of the bank. D) the lower the possibility of bank failure.

B

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 A) $30,000. B) $25,000. C) $20,000. D) $10,000.

B

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 A) adverse credit risk. B) adverse selection. C) moral hazard. D) lemon lenders.

B

In general, banks make profits by selling ________ liabilities and buying ________ assets. A) long-term; shorter-term B) short-term; longer-term C) illiquid; liquid D) risky; risk-free

B

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. A) moral hazard B) adverse selection C) moral suasion D) adverse lending

B

Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the A) requirement that firms keep compensating balances at the banks from which they obtain their loans. B) requirement that firms place on their board of directors an officer from the bank. C) inclusion of restrictive covenants in loan contracts. D) requirement that individuals provide detailed credit histories to bank loan officers.

B

Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called A) proscription bonds. B) restrictive covenants. C) due-on-sale clauses. D) liens.

B

Risk that is related to the uncertainty about interest rate movements is called A) default risk. B) interest-rate risk. C) the problem of moral hazard. D) security risk

B

The fraction of checkable deposits that banks are required by regulation to hold are A) excess reserves. B) required reserves. C) vault cash. D) total reserves.

B

Through correspondent banking, large banks provide services to small banks, including A) loan guarantees. B) foreign exchange transactions. C) issuing stock. D) debt reduction.

B

Unanticipated moral hazard contingencies can be reduced by A) screening. B) long-term customer relationships. C) specialization in lending. D) credit rationing.

B

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, A) the assets at the bank increase by $800,000. B) the liabilities of the bank increase by $1,000,000. C) the liabilities of the bank increase by $800,000. D) reserves increase by $160,000.

B

When you deposit a $50 bill in the Security Pacific National Bank, A) its liabilities decrease by $50. B) its assets increase by $50. C) its reserves decrease by $50. D) its cash items in the process of collection increase by $50.

B

Which of the following are reported as assets on a bankʹs balance sheet? A) Borrowings B) Reserves C) Savings deposits D) Bank capital

B

Which of the following are reported as liabilities on a bankʹs balance sheet? A) Reserves B) Checkable deposits C) Loans D) Deposits with other banks

B

Which of the following bank assets is the most liquid? A) Consumer loans B) Reserves C) Cash items in process of collection D) U.S. government securities

B

Which of the following statements is false? A) Checkable deposits are usually the lowest cost source of bank funds. B) Checkable deposits are the primary source of bank funds. C) Checkable deposits are payable on demand. D) Checkable deposits include NOW accounts.

B

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 A) place a bank officer on their board of directors. B) place a corporate officer on the bankʹs board of directors. C) keep compensating balances in a checking account at the bank. D) purchase the bankʹs CDs.

C

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 A) an adjustable gap loan. B) an adjustable portfolio loan. C) loan commitment. D) pre-credit loan line.

C

As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________. A) decrease; increase B) increase; decrease C) increase; increase D) decrease; not be affected

C

Bank reserves include A) deposits at the Fed and short-term treasury securities. B) vault cash and short-term Treasury securities. C) vault cash and deposits at the Fed. D) deposits at other banks and deposits at the Fed.

C

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. A) loans; deposits B) securities; deposits C) liabilities; assets D) assets; liabilities

C

Banks that suffered significant losses in the 1980s made the mistake of A) holding too many liquid assets. B) minimizing default risk. C) failing to diversify their loan portfolio. D) holding only safe securities.

C

Bankʹs make their profits primarily by issuing ________. A) equity B) negotiable CDs C) loans D) NOW accounts

C

Because of their ________ liquidity, ________ U.S. government securities are called secondary reserves. A) low; short-term B) low; long-term C) high; short-term D) high; long-term

C

Holding large amounts of bank capital helps prevent bank failures because A) it means that the bank has a higher income. B) it makes loans easier to sell. C) it can be used to absorb the losses resulting from bad loans. D) it makes it easier to call in loans.

C

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to A) buy back bank stock. B) pay higher dividends. C) shrink the size of the bank. D) sell securities the bank owns and put the funds into the reserve account.

C

If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A) reduce deposits by $3 million. B) increase loans by $3 million. C) sell $3 million of securities. D) repay its discount loans from the Fed.

C

In general, banks would prefer to acquire funds quickly by ________ rather than ________. A) reducing loans; selling securities B) reducing loans; borrowing from the Fed C) borrowing from the Fed; reducing loans D) ʺcalling inʺ loans; selling securities

C

In 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. A) 45 percent; 55 percent B) 55 percent; 4 percent C) 25 percent; 50 percent D) 50 percent; 30 percent

C

In the absence of regulation, banks would probably hold A) too much capital, reducing the efficiency of the payments system. B) too much capital, reducing the profitability of banks. C) too little capital. D) too much capital, making it more difficult to obtain loans.

C

Large-denomination CDs are ________, so that like a bond they can be resold in a ________ market before they mature. A) nonnegotiable; secondary B) nonnegotiable; primary C) negotiable; secondary D) negotiable; primary

C

Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called A) return on assets. B) return on capital. C) return on equity. D) return on investment.

C

Secondary reserves include A) deposits at Federal Reserve Banks. B) deposits at other large banks. C) short-term Treasury securities. D) state and local government securities.

C

The amount of assets per dollar of equity capital is called the A) asset ratio. B) equity ratio. C) equity multiplier. D) asset multiplier.

C

The most important category of assets on a bankʹs balance sheet is A) discount loans. B) securities. C) loans. D) cash items in the process of collection.

C

The share of checkable deposits in total bank liabilities has A) expanded moderately over time. B) expanded dramatically over time. C) shrunk over time. D) remained virtually unchanged since 1960.

C

When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then A) the liabilities of the First National Bank increase by $10. B) the reserves of the First National Bank increase by $ 10. C) the liabilities of Citibank increase by $10. D) the assets of Citibank fall by $10.

C

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 A) coercive bargaining. B) strategic holding out. C) credit rationing. D) collusive behavior.

C

When you deposit $50 in currency at Old National Bank, A) its assets increase by less than $50 because of reserve requirements. B) its reserves increase by less than $50 because of reserve requirements. C) its liabilities increase by $50. D) its liabilities decrease by $50.

C

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 A) the assets of First National rise by $50. B) the assets of Chemical Bank rise by $50. C) the reserves at First National fall by $50. D) the liabilities at Chemical Bank rise by $50.

C

Which of the following are transaction deposits? A) Savings accounts B) Small-denomination time deposits C) Negotiable order of withdraw accounts D) Certificates of deposit

C

Which of the following is not a nontransaction deposit? A) Savings accounts B) Small-denomination time deposits C) Negotiable order of withdrawal accounts D) Certificate of deposit

C

Which of the following is not a source of borrowings for a bank? A) Federal funds B) Eurodollars C) Transaction deposits D) Discount loans

C

Which of the following statements are true? A) A bankʹs assets are its sources of funds. B) A bankʹs liabilities are its uses of funds. C) A bankʹs balance sheet shows that total assets equal total liabilities plus equity capital. D) A bankʹs balance sheet indicates whether or not the bank is profitable.

C

________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow. A) Selling securities B) Selling loans C) Calling in loans D) Selling negotiable CDs

C

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. A) passbook savings; time deposits B) money market deposit accounts; time deposits C) money market deposit accounts; passbook savings D) time deposits; passbook savings

D

Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the A) adverse selection problem. B) lemon problem. C) adverse credit risk problem. D) moral hazard problem.

D

Because checking accounts are ________ liquid for the depositor than passbook savings, they earn ________ interest rates. A) less; higher B) less; lower C) more; higher D) more; lower

D

From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem. A) moral hazard; diversification B) diversification; moral hazard C) adverse selection; diversification D) diversification; adverse selection

D

Of the following, which would be the first choice for a bank facing a reserve deficiency? A) Call in loans B) Borrow from the Fed C) Sell securities D) Borrow from other banks

D

The goals of bank asset management include A) maximizing risk. B) minimizing liquidity. C) lending at high interest rates regardless of risk. D) purchasing securities with high returns and low risk.

D

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. A) gains; gains B) gains; loses C) loses; gains D) loses; loses

D

When banks offer borrowers smaller loans than they have requested, banks are said to A) shave credit. B) rediscount the loan. C) raze credit. D) ration credit.

D

Which of the following are not reported as assets on a bankʹs balance sheet? A) Cash items in the process of collection B) Deposits with other banks C) U.S. Treasury securities D) Checkable deposits

D

Which of the following statements is false? A) A bankʹs assets are its uses of funds. B) A bank issues liabilities to acquire funds. C) The bankʹs assets provide the bank with income. D) Bank capital is recorded as an asset on the bank balance sheet.

D

Which of the following would a bank not hold as insurance against the highest cost of deposit outflow-bank failure? A) Excess reserves B) Secondary reserves C) Bank capital D) Mortgages

D

Which of the following would not be a way to increase the return on equity? A) Buy back bank stock B) Pay higher dividends C) Acquire new funds by selling negotiable CDs and increase assets with them D) Sell more bank stock

D