Chapter 15 - The Management of Capital

A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of Tier 1 capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above

A) 6.08 percent

Which of the following would be an example of crime risk? A) A bank manager that embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest and principal has been collected in 2 years D) A bank manager predicts that interest rates will rise. However interest rates fall causing the bank 's net income to fall by $250,000 E)All of the above are examples of crime risk

A) A bank manager that embezzles $1,000,000 from the bank

A bank has decided to retain more of their earnings, moving their retention ratio from 40% to 70%. What way of meeting their capital needs is the bank taking? A) Changing their dividend policy B) Issuing common stock C) Issuing preferred stock D) Issuing subordinated notes and debentures E) Selling assets and leasing facilities

A) Changing their dividend policy

The risk that a customer the bank has entered into a contract with will fail to pay or to perform, forcing the bank to find a replacement contract that may be less satisfactory is what form of risk listed below? A) Counterparty risk B) Interest-rate risk C) Operating risk D) Credit risk E) Liquidity risk

A) Counterparty risk

For a bank with deficient capital ratios, which of the following actions could be required by regulators to increase the capital ratios, all else constant? A) Cut the bank's dividend payment B) Increase the bank's leverage C) Reduce the bank's holdings of cash D) Increase the bank's growth rate by making additional commercial loans. E) Reduce the bank's holdings of Treasury securities.

A) Cut the bank's dividend payment

A bank that is 'well-capitalized': A) Faces no significant regulatory restrictions B) Cannot accept broker placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E) None of the above

A) Faces no significant regulatory restrictions

The Second National Bank of Lincoln has decided that to raise funds it is going to issue new common equity through a pre-emptive rights offering so that current owners will not have that ownership diluted. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments

A) Issuing common stock

The revised Basel I rules impose capital requirements for market risk on: A) Only the largest banks B) Only the smallest banks C) Only moderate size banks D) All banks E) No banks

A) Only the largest banks

The Jennings Bank of Texas wants to protect itself from credit risk by making large loans to corporate customers, by making residential mortgages to families, by making agriculture loans to farmers and ranchers in the area, by making small business loans to business along main street and by making automobile loans for the car dealership across the street from the bank. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners' capital E) All of the above

A) Portfolio diversification

Which of the following would be an example of Tier 2 capital? A) Subordinated debt capital instruments with an original maturity of at least 5 years B) Undivided profits C) Minority interest in the equity accounts of consolidated subsidiaries D) Qualifying noncumulative preferred stock E) All of the above

A) Subordinated debt capital instruments with an original maturity of at least 5 years

Even if individual banks are good at forecasting risk using VAR models there may still be problems because losses may occur at several banks at the same time due to the interdependency of the financial system, magnifying each bank's risk exposure and possibly causing a major problem for regulators. The book calls this: A) Systematic risk B) Operational risk C) Credit risk D) Market risk E) Liquidity risk

A) Systematic risk

A bank has capital to risk weighted assets of 11.5%, Tier 1 capital to risk weighted assets of 7.2% and a leverage ratio of 5.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized

A) Well capitalized

Basel II has a different set of rules for different bank size categories and the number of categories is: A) two B) three C) four D) five E) ten

A) two

A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity capital to total assets ratio? A) 7.00 percent B) 14.29 percent C) 28.00 percent D) 16 percent E) None of the above

B) 14.29 percent

A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of Tier 2 capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above

B) 3.04 percent

A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent , an equity multiplier of 12 and a retention ratio of 60 percent. What is this bank's ICGR? A) 6.6 percent B) 3.96 percent C) 7.2 percent D) .33 percent E) None of the above

B) 3.96 percent

A "well capitalized" bank in the United States must have a leverage ratio of at least: A) 5 percent B) 4 percent C) 6 percent D) 8 percent E) None of the above

B) 4 percent

Second National Bank is forecasting a return on equity of 15 percent for this year. The board of directors wants to maintain its current policy of paying the bank's stockholders 40 percent of any net earnings the bank will earn. How fast can the bank's assets grow this year without jeopardizing its ratio of capital to assets? A) 15 percent. B) 9 percent. C) 8 percent. D) 6 percent. E) None of the above

B) 9 percent.

A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 5% and a leverage ratio of 4.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized

B) Adequately capitalized

Which of the following would be an example of operational risk? A) A bank teller manages to steal $250,000 over a period of several months B) An out of date computer system causes the bank to lose $750,000 C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors D) A $500,000 loan the bank has made has been deemed uncollectable E) None of the above are examples of operational risk

B) An out of date computer system causes the bank to lose $750,000

A bank that is adequately capitalized: A) Faces no significant regulatory restrictions B) Cannot accept broker-placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E) None of the above

B) Cannot accept broker-placed deposits without regulatory approval

Which of the following is in the 20 percent risk-weight (low) category? A) Cash B) General obligation municipal bonds C) Residential mortgage loans D) Credit card loans E)None of the above

B) General obligation municipal bonds

The Michelson Bank of Stetson wants to protect itself from risk. It decides to make loans in Florida, Georgia, Texas and Oklahoma as well as invest in municipal bonds from California and Oregon. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners' capital E) All of the above

B) Geographic diversification

The Third State Bank of Denton has decided to issue stock through a trust company and borrow the funds from the trust company. This stock pays a fixed dividend and because of the way the stock has been issued it is tax deductible. What way of meeting their capital needs in the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments

B) Issuing preferred stock

Why do regulators prefer higher capital requirements? A) It justifies the existence of regulatory agencies B) It better protects the deposit insurance fund C) It enhances bank asset quality D) It decreases bank profitability E) It increases bank leverage

B) It better protects the deposit insurance fund

The ratio of core capital to average assets is called the: A) Supplemental Capital ratio B) Leverage ratio C) Long-term capital ratio D) GAAP capital ratio E)None of the above.

B) Leverage ratio

There are three pillars of Basel II. One of them wants to make market discipline a powerful force compelling risky banks to lower their risk exposure. What does Basel II want to do to make this happen? A) Require minimum capital requirement based on the bank's own evaluation of its risk B) Require greater public disclosure of each bank's true financial condition C) Expand the risks to be evaluated to include credit risk, market risk and operational risk D) Require supervisory review of each bank's risk evaluation procedures E) All of the above

B) Require greater public disclosure of each bank's true financial condition

If a bank benefits when a foreign currency declines in value, then the bank must be in a __________ position. The term below that correctly fills in the blank in the preceding sentence is: A) Long B) Short C) Negative D) Credit risk E) None of the above

B) Short

Which of the following would be an example of exchange risk? A) A bank manager embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years D) A bank manager predicts interest rates will rise. However interest rates fall causing the bank's net income to fall by $250,000 E) All of the above are examples of exchange risk

B)A bank that loses $500,000 from trading in foreign currencies

In the United States a 'well capitalized' bank must have a ratio of capital to risk-weighted assets of at least: A) 6 percent B) 8 percent C) 10 percent. D) 5 percent. E) None of the above

C) 10 percent

A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent and has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this bank's internal capital growth rate? A) 28.35 percent B) 2.36 percent C) 11.34 percent D) 4.8 percent E) None of the above

C) 11.34 percent

A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of total capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above

C) 9.11 percent

Which of the following would be an example of credit risk? A) A bank manager embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years D) A bank manager predicts interest rates will rise. However interest rates fall causing the bank's net income to fall by $250,000 E) All of the above are examples of credit risk

C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years

Which of the following would be an example of liquidity risk? A) A bank teller manages to steal $250,000 over a period of several months B) An out of date computer system causes the bank to lose $750,000 C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors D) A $500,000 loan the bank has made has been deemed uncollectable E) None of the above are examples of liquidity risk

C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors

The following are the advantages of Basel II over Basel I except: A) Uses "bifurcated" system that takes into consideration differences in risk exposures by bank size B) Provides for greater sensitivity to arbitrage and financial innovations C) Applies the same minimum capital requirements to all banks D) Broadens the types of risk considered E) All of the above are the advantages of using Basel II

C) Applies the same minimum capital requirements to all banks

The Northwest Bank of Charlotte has decided to issue new securities that have five years to maturity that have claims to assets that follow the claims of depositors. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E)Swapping stock for debt instruments

C) Issuing subordinated notes and debentrues

Which of the following would be an example of Tier 1 capital? A) Subordinated debt capital instruments with an original maturity of at least 5 years B) Allowance for loan and lease losses C) Minority interest in the equity accounts of consolidated subsidiaries D) Intermediate term preferred stock E) All of the above

C) Minority interest in the equity accounts of consolidated subsidiaries

The Perdue Bank of Houston has just hired a new manager who has a reputation of anticipating potential problems and acting quickly to prevent those problems so that the bank stays healthy and profitable. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners' capital E) All of the above

C) Quality management

Which of the following is in the 50 percent risk-weight (moderate) category? A) Cash B) General Obligation Municipal Bonds C) Residential Mortgage Loans D) Credit Card Loans E) None of the above

C) Residential Mortgage Loans

The issue of correctly adding up all of the different types of bank risk exposure is known as: A) Risk tallying B) Summing risk C) Risk aggregation D) Risk accumulation E) Risk totality

C) Risk aggregation

Measured by dollar volume the largest category of capital at U.S. banks is: A) Par value of common stock B) Subordinated notes and debentures C) Surplus D) Undivided profits and capital reserves E)None of the above.

C) Surplus

Why do banks generally prefer lower capital requirements? A) To minimize the impact shareholders have on management decisions B) To increase the influence of bank regulators C) To increase a bank's return on equity D) To increase depositor protection E) To maximize operating leverage

C) To increase a bank's return on equity

A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 4.5% and a leverage ratio of 3.7%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized

C) Undercapitalized

In the United States a bank to be considered 'adequately capitalized' must have a ratio of Tier 1 (or core) capital to risk-weighted assets of at least: A) 8 percent B) 6 percent C) 10 percent D) 4 percent E) None of the above

D) 4 percent

A bank has $100 million in assets in the 0 percent risk weight category, $200 million in assets in the 20 percent risk weight category, $500 million in assets in the 50 percent risk weight category and $750 million in assets in the 100 percent risk weight category. This bank has $57 million in core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to risk-weighted assets? A) 3.68 percent B) 7.6 percent C) 18.25 percent D) 5.48 percent E)None of the above

D) 5.48 percent

61. Which of the following would be an example of interest rate risk? A) A bank manager embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years D) A bank manager predicts interest rates will rise. However interest rates fall causing the bank's net income to fall by $250,000 E) All of the above are examples of interest rate risk?

D) A bank manager predicts interest rates will rise. However interest rates fall causing the bank's net income to fall by $250,000

Which of the following would not be an example of operational risk? A) A bank on the coast of Louisiana is hit by a hurricane and is flooded for 6 weeks B) A bank employee acting as a derivatives trader is also the one who writes the reports on profits and losses in derivatives trading at the end of each day C) The banks older computer system breaks down causing a loss of service to customers for 2 weeks D) A bank robber robs a teller at gun point and gets away before police can get to the bank E) All of the above are examples of operational risk

D) A bank robber robs a teller at gun point and gets away before police can get to the bank

Which of the following are the reasons for having the government set capital standards for financial institutions as opposed to letting the private marketplace set those standards? A) To preserve public confidence B) To alleviate market imperfections arising from the mispriced effect of systemic failures C) To limit losses to the federal government arising from deposit insurance claims D) All of the above E) None of the above

D) All of the above

The fundamental purposes of regulating bank capital cited in the textbook include which of the following? A) To limit the risk of bank failures. B) To preserve public confidence in banks. C) To limit losses to the federal government arising from insurance claims. D) All of the above. E)A and B only

D) All of the above.

Which of the following is in the 100 percent risk-weight category? A) Cash B) General obligation municipal bonds C) Residential mortgage loans D) Credit card loans E)None of the above

D) Credit card loans

The Norton Bank of Illinois has just issued trust preferred stock. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners' capital E) All of the above

D) Increasing owners' capital

Possible breakdowns in quality control, inefficiencies in producing and delivering financial services, weather damage, aging or faulty computer systems and simple errors in judgment by bank management illustrate what form of risk faced by banks? A) Credit risk B) Liquidity risk C) Interest-rate risk D) Operational risk E) None of the above

D) Operational risk

The First National Bank of Tucson has determined that the value of their property in Tucson has tripled in the last three years. They decide that they would like to use this property to raise funds and will rent space from the new owners of the building. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments

D) Selling assets and leasing facilities

A bank has capital to risk weighted assets of 5.5%, Tier 1 capital to risk weighted assets of 2.8% and a leverage ratio of 2.6%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized

D) Significantly undercapitalized

Bank debt which appears to be highly sensitive to the market perception of the bank's risk is which of the following? A) Deposits B) Fed funds C) Repos D) Subordinated debt capital E) Preferred stock

D) Subordinated debt capital

Which of the following is not a weakness of Basel I risk-based capital standards? A) They ignore interest rate risk B) They ignore changes in value due to currency value changes C) They ignore changes in value due to commodity price changes D) They ignore credit risk E) They ignore the market value

D) They ignore credit risk

What type of preferred stock has become popular among large banks in recent years, partly because dividends paid are tax deductible for the issuing institution? A) Cumulative preferred stock B) Noncumulative preferred stock C) Convertible preferred stock D) Trust preferred stock E) All of the above

D) Trust preferred stock

A bank that is 'critically undercapitalized': A) Faces no significant regulatory restrictions B) Cannot accept broker-placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E)None of the above

D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit.

Bank operational risk includes: A) Employee fraud B) Account errors C) Computer breakdowns D) Natural disasters

E) All of the above

Which of the following assets fits into the 0 percent risk weight category? A) Cash B) Deposits at the Federal Reserve C) Treasury Bills D) GNMA mortgage-backed securities E) All of the above fit into the 0 percent risk weight category

E) All of the above fit into the 0 percent risk weight category

According to the textbook the role of capital is to: A) Provide a cushion against failure risk. B) Provide funds needed to organize, open, and operate a bank. C) Promote public confidence D) Support growth and the development of new services E) All of the above.

E) All of the above.

The Internal Capital Growth Rate for a bank is a function of which of the following factors? A) Profit margin. B) Asset utilization. C) Equity multiplier. D) Earnings retention ratio. E) All of the above.

E) All of the above.

The textbook discusses several alternative defenses banks have against risk. These defenses include: A) Quality management B) Portfolio diversification C) Geographic diversification D) Deposit insurance E) All of the above.

E) All of the above.

A bank has capital to risk weighted assets of 1.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E)Critically undercapitalized

E) Critically undercapitalized

A bank has issued $5,000,000 in long term debt and since that time interest rates have risen so that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides to issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments

E) Swapping stock for debt instruments