Banking T2

Deposit insurance has not worked well in countries with 1. A) a weak institutional environment. 2. B) strong supervision and regulation. 3. C) a tradition of the rule of law. 4. D) few opportunities for corruption.

A 10

The Federal Reserve Banks are ________ institutions since they are owned by the ________. 1. A) quasi-public; private commercial banks in the district where the Reserve Bank is located 2. B) public; private commercial banks in the district where the Reserve Bank is located 3. C) quasi-public; Board of Governors 4. D) public; Board of Governors

A 10

When asset prices rise above their fundamental economic values, a(n) ________ occurs. 1. A) asset-price bubble 2. B) liability war 3. C) decline in lending 4. D) decrease in moral hazard

A 10

Property promised to the lender as compensation if the borrower defaults is called 1. A) collateral. 2. B) deductibles. 3. C) restrictive covenants. 4. D) contingencies.

A 101

Collateral requirements lessen the consequences of ________ because the collateral reduces the lender's losses in the case of a loan default and it reduces ________ because the borrower has more to lose from a default. 1. A) adverse selection; moral hazard 2. B) moral hazard; adverse selection 3. C) adverse selection; diversification 4. D) diversification; moral hazard

A 102

Critics of nationwide banking fear 1. A) an elimination of community banks. 2. B) increased lending to small businesses. 3. C) cutthroat competition. 4. D) banks with economies of scale problems.

A 105

One of the concerns of increased bank consolidation is the reduction in community banks which could result in 1. A) less lending to small businesses. 2. B) loss of cultural identity. 3. C) higher interest rates. 4. D) more bank regulation.

A 106

Most U.S. financial crises have started during periods of ________ either after the start of a recession, a stock market crash, or the failure of a major financial institution. 1. A) high uncertainty 2. B) low interest rates 3. C) low asset prices 4. D) high financial regulation

A 11

When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of 1. A) moral hazard. 2. B) split incentives. 3. C) ex ante shirking. 4. D) pre-contractual opportunism.

A 11

Under the Gramm-Leach-Bliley Act the oversight of the securities activities of bank holding companies belongs to 1. A) the SEC. 2. B) the Comptroller of the Currency. 3. C) the U.S. Treasury. 4. D) the Federal Reserve.

A 111

As a result of the global financial crisis several of the large, free-standing investment banking firms chose to become bank holding companies. This means that they will now be regulated by 1. A) the Federal Reserve. 2. B) the FDIC. 3. C) the state banking authorities. 4. D) the Treasury.

A 112

If a bank's liabilities are more sensitive to interest rate movements than are its assets, then 1. A) an increase in interest rates will reduce bank profits. 2. B) a decrease in interest rates will reduce bank profits. 3. C) interest rates changes will not impact bank profits. 4. D) an increase in interest rates will increase bank profits.

A 113

In a ________ banking system, commercial banks provide a full range of banking, securities, and insurance services, all within a single legal entity. 1. A) universal 2. B) severable 3. C) barrier-free 4. D) dividerless

A 113

Like the dual banking system for commercial banks, thrifts can have either ________ or ________ charters. 1. A) state; federal 2. B) state; local 3. C) local; federal 4. D) municipal; federal

A 116

Unlike banks, ________ have been allowed to branch statewide since 1980. 1. A) federally-chartered S&Ls 2. B) state-chartered S&Ls 3. C) financially troubled S&Ls 4. D) technically insolvent S&Ls

A 117

The FHLBS gives loans to S&Ls and thus performs a function similar to the ________ for commercial banks. 1. A) Federal Reserve 2. B) U.S. Treasury 3. C) Office of the Comptroller of the Currency 4. D) U.S. Mint

A 119

If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) 1. A) banking crisis. 2. B) financial recovery. 3. C) reduction of the adverse selection and moral hazard problems. 4. D) increase in information available to investors.

A 12

Moral hazard is an important concern of insurance arrangements because the existence of insurance 1. A) provides increased incentives for risk taking. 2. B) is a hindrance to efficient risk taking. 3. C) causes the private cost of the insured activity to increase. 4. D) creates an adverse selection problem but no moral hazard problem.

A 12

All of the following are operating expenses for a bank EXCEPT 1. A) service charges on deposit accounts. 2. B) salaries and employee benefits. 3. C) rent on buildings. 4. D) servicing costs of equipment such as computers.

A 145

First National Bank Assets Liabilities Rate-Sensitive $40M $50M Fixed-Rate $60M $50M If interest rates rise by 5 percentage points, say from 10 to 15%, bank profits (measured using gap analysis) will 1. A) decline by $0.5 million. 2. B) decline by $1.5 million. 3. C) decline by $2.5 million. 4. D) increase by $2.0 million.

A 121

Mutual savings banks are primarily regulated by 1. A) the states in which they are located. 2. B) the Federal Reserve. 3. C) the FDIC. 4. D) the National Credit Union Administration.

A 121

Assuming that the average duration of its assets is four years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to ________ by ________ of the total original asset value. 1. A) decline; 5 percent 2. B) decline; 10 percent 3. C) decline; 15 percent 4. D) increase; 20 percent

A 122

The spectacular growth in international banking can be explained by 1. A) the rapid growth in international trade. 2. B) the 1988 Basel Agreement. 3. C) the collapse of the Bretton Woods system. 4. D) the creation of the World Trade Organization.

A 124

Bruce the Bank Manager can reduce interest rate risk by ________ the duration of the bank's assets to increase their rate sensitivity or, alternatively, ________ the duration of the bank's liabilities. 1. A) shortening; lengthening 2. B) shortening; shortening 3. C) lengthening; lengthening 4. D) lengthening; shortening

A 126

Deposits in European banks denominated in dollars for the purpose of international transactions are known as 1. A) Eurodollars. 2. B) European Currency Units. 3. C) European Monetary Units. 4. D) International Monetary Units.

A 126

The main center of the Eurodollar market is 1. A) London. 2. B) Basel. 3. C) Paris. 4. D) New York.

A 127

Eurodollars are 1. A) dollar-dominated deposits held in banks outside the United States. 2. B) deposits held by U.S. banks in Europe. 3. C) deposits held by U.S. banks in foreign countries. 4. D) dollar-dominated deposits held in U.S. banks by Europeans.

A 128

Examples of off-balance-sheet activities include 1. A) trading activities. 2. B) extending loans to depositors. 3. C) borrowing from other banks. 4. D) selling negotiable CDs.

A 128

An advantage to American banks from operating foreign branches is that Eurodollar deposits in offshore branches are 1. A) not subject to reserve requirements. 2. B) insured by the FDIC. 3. C) subject to extensive regulatory supervision. 4. D) all demand deposits that pay no interest.

A 130

U.S. banks have most of their branches in 1. A) Latin America, the Far East, the Caribbean, and London. 2. B) Latin America, the Middle East, the Caribbean, and London. 3. C) Mexico, the Middle East, the Caribbean, and London. 4. D) South America, the Middle East, the Caribbean, and Canada.

A 131

A(n) ________ is a subsidiary of a U.S. bank that is engaged primarily in international banking. 1. A) Edge Act corporation 2. B) Eurodollar agency 3. C) universal bank 4. D) McFadden corporation

A 132

Traders working for banks are subject to the 1. A) principal-agent problem. 2. B) free-rider problem. 3. C) double-jeopardy problem. 4. D) exchange-risk problem.

A 134

________ of a foreign bank operates in the U.S. but cannot accept deposits from domestic residents. 1. A) An agency office 2. B) A universal corporation 3. C) A McFadden corporation 4. D) A Basel branch

A 134

If a foreign bank operates a subsidiary bank in the U.S., the subsidiary bank is 1. A) subject to the same regulations as a U.S. owned bank. 2. B) only subject to the regulations of the country in which the foreign bank is chartered. 3. C) restricted to making loans to only foreign citizens in the U.S. 4. D) restricted to accepting deposits from foreign citizens living in the U.S.

A 135

One way for banks to reduce the principal-agent problems associated with trading activities is to 1. A) set limits on the total amount of a traders' transactions. 2. B) make sure that the person conducting the trades is also the person responsible for recording the transactions. 3. C) encourage traders to take on more risk if the potential rewards are higher. 4. D) reduce the regulations on the traders so that they have more flexibility in conducting trades.

A 136

Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by foreign banks in the U.S. has been 1. A) reduced. 2. B) mildly expanded. 3. C) completely eliminated. 4. D) greatly expanded.

A 137

When banks calculate the losses the institution would incur if an unusual combination of bad events happened, the bank is using the ________ approach. 1. A) stress-test 2. B) value-at-risk 3. C) trading-loss 4. D) maximum value

A 139

Debt deflation occurs when 1. A) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness. 2. B) rising interest rates worsen adverse selection and moral hazard problems. 3. C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral. 4. D) corporations pay back their loans before the scheduled maturity date.

A 14

Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions EXCEPT 1. A) forgiving tax debt. 2. B) lending from the central bank. 3. C) lending directly from the government's treasury department. 4. D) nationalizing and guaranteeing that all creditors will be repaid their loans in full.

A 14

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 1. A) flat. 2. B) slightly upward sloping. 3. C) steeply upward sloping. 4. D) downward sloping.

A 143

Most of a bank's operating income results from 1. A) interest on assets. 2. B) service charges on deposit accounts. 3. C) off-balance-sheet activities. 4. D) fees from standby lines of credit.

A 144

When a bank suspects that a $1 million loan might prove to be bad debt that will have to be written off in the future the bank 1. A) can set aside $1 million of its earnings in its loan loss reserves account. 2. B) reduces its reported earnings by $1, even though it has not yet actually lost the $1 million. 3. C) reduces its assets immediately by $1 million, even though it has not yet lost the $1 million. 4. D) reduces its reserves by $1 million, so that they can use those funds later.

A 146

A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called 1. A) debt deflation. 2. B) moral hazard. 3. C) insolvency. 4. D) illiquidity.

A 15

Although the FDIC was created to prevent bank failures, its existence encourages banks to 1. A) take too much risk. 2. B) hold too much capital. 3. C) open too many branches. 4. D) buy too much stock.

A 15

A possible sequence for the three stages of a financial crisis might be ________ leads to ________ leads to ________. 1. A) asset price declines; banking crises; unanticipated decline in price level 2. B) unanticipated decline in price level; banking crises; increase in interest rates 3. C) banking crises; increase in interest rates; unanticipated decline in price level 4. D) banking crises; increase in uncertainty; increase in interest rates

A 16

A system of deposit insurance 1. A) attracts risk-taking entrepreneurs into the banking industry. 2. B) encourages bank managers to decrease risk. 3. C) increases the incentives of depositors to monitor the riskiness of their bank's asset portfolio. 4. D) increases the likelihood of bank runs.

A 16

The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression. 1. A) debt deflation 2. B) illiquidity 3. C) an improvement in banks' balance sheets 4. D) increases in bond prices

A 17

The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry. 1. A) an adverse selection 2. B) a moral hazard 3. C) a lemons 4. D) a revenue

A 17

Acquiring information on a bank's activities in order to determine a bank's risk is difficult for depositors and is another argument for government 1. A) regulation. 2. B) ownership. 3. C) recall. 4. D) forbearance.

A 19

A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a 1. A) financial crisis. 2. B) fiscal imbalance. 3. C) free-rider problem. 4. D) "lemons" problem.

A 2

Depositors lack of information about the quality of bank assets can lead to 1. A) bank panics. 2. B) bank booms. 3. C) sequencing. 4. D) asset transformation.

A 2

The First Bank of the United States 1. A) was disbanded in 1811 when its charter was not renewed. 2. B) had its charter renewal vetoed in 1832. 3. C) was fundamental in helping the Federal Government finance the War of 1812. 4. D) None of the above.

A 2

Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been 1. A) the creation of the FDIC. 2. B) rapid economic growth since 1941. 3. C) the employment of new procedures by the Federal Reserve. 4. D) better bank management.

A 20

The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance 1. A) are likely to take on greater risks than they otherwise would. 2. B) are likely to be too conservative, reducing the probability of turning a profit. 3. C) are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety. 4. D) are placed at a competitive disadvantage in acquiring funds.

A 20

________ is a process of bundling together smaller loans (like mortgages) into standard debt securities. 1. A) Securitization 2. B) Origination 3. C) Debt deflation 4. D) Distribution

A 20

A ________ pays out cash flows from a collection of assets in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there are losses on the underlying assets. 1. A) collateralized debt obligation (CDO) 2. B) adjustable-rate mortgage 3. C) negotiable CD 4. D) discount bond

A 21

The Fed's support of the Depository Institutions Deregulation and Monetary Control Act of 1980 stemmed in part from its 1. A) concern over declining Fed membership. 2. B) belief that all banking regulations should be eliminated. 3. C) belief that interest rate ceilings were too high. 4. D) belief that depositors had to become more knowledgeable of banking operations.

A 21

The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk. 1. A) principal-agent 2. B) debt deflation 3. C) democratization of credit 4. D) collateralized debt

A 22

If mortgage brokers do not make a strong effort to evaluate whether the borrower can pay off a loan, this creates a 1. A) severe adverse selection problem. 2. B) decline in mortgage applications. 3. C) call to deregulate the industry. 4. D) decrease in the demand for houses.

A 23

Agency problems in the subprime mortgage market included all of the following EXCEPT 1. A) homeowners could refinance their houses with larger loans when their homes appreciated in value. 2. B) mortgage originators had little incentives to make sure that the mortgagee is a good credit risk. 3. C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back. 4. D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest.

A 24

A problem with the too-big-to-fail policy is that it ________ the incentives for ________ by big banks. 1. A) increases; moral hazard 2. B) decreases; moral hazard 3. C) decreases; adverse selection 4. D) increases; adverse selection

A 25

The growth of the subprime mortgage market led to 1. A) increased demand for houses and helped fuel the boom in housing prices. 2. B) a decline in the housing industry because of higher default risk. 3. C) a decrease in home ownership as investors chose other assets over housing. 4. D) decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages.

A 25

When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that 1. A) the value of the house fell below the amount of the mortgage. 2. B) the basement flooded since they could not afford to fix the leaky plumbing. 3. C) the roof leaked during a rainstorm. 4. D) the amount that they owed on their mortgage was less than the value of their house.

A 26

Regulators attempt to reduce the riskiness of banks' asset portfolios by 1. A) limiting the amount of loans in particular categories or to individual borrowers. 2. B) encouraging banks to hold risky assets such as common stocks. 3. C) establishing a minimum interest rate floor that banks can earn on certain assets. 4. D) requiring collateral for all loans.

A 28

State banking authorities have sole jurisdiction over state banks 1. A) without FDIC insurance. 2. B) that are not members of the Federal Reserve System. 3. C) operating as bank holding companies. 4. D) chartered in the 21st century.

A 28

Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in 1. A) Europe. 2. B) Australia. 3. C) China. 4. D) South America.

A 29

Financial innovations occur because of financial institutions search for 1. A) profits. 2. B) fame. 3. C) stability. 4. D) recognition.

A 29

Which of the followings is a duty of the Board of Governors of the Federal Reserve System? 1. A) setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash 2. B) setting the maximum interest rates payable on certain types of time deposits under Regulation Q 3. C) regulating credit with the approval of the president under the Credit Control Act of 1969 4. D) All governors advise the president of the United States on economic policy.

A 29

A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system 1. A) causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently. 2. B) allows for a more efficient use of funds. 3. C) increases economic activity. 4. D) reduces uncertainty in the economy and increases market efficiency.

A 3

Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history? 1. A) Lehman Brothers 2. B) Merrill Lynch 3. C) Bear Stearns 4. D) Goldman Sachs

A 30

________ is the process of researching and developing profitable new products and services by financial institutions. 1. A) Financial engineering 2. B) Financial manipulation 3. C) Customer manipulation 4. D) Customer engineering

A 30

In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent; in the 1980s it fluctuated between ________ percent and ________ percent. 1. A) 5; 15 2. B) 4; 11.5 3. C) 4; 18 4. D) 5; 10

A 32

Microprudential supervision focuses on the safety and soundness of 1. A) individual financial institutions. 2. B) the financial system as a whole. 3. C) the shadow banking system. 4. D) government credit agencies.

A 33

Macroprudential supervision policies try to prevent a leverage cycle by changing capital requirements so that they ________ during an expansion and ________ during a downturn. 1. A) increase; decrease 2. B) increase; increase 3. C) decrease; increase 4. D) decrease; decrease

A 35

The Basel Accord, an international agreement, requires banks to hold capital based on 1. A) risk-weighted assets. 2. B) the total value of assets. 3. C) liabilities. 4. D) deposits.

A 35

Adjustable rate mortgages 1. A) reduce the interest-rate risk for financial institutions. 2. B) benefit homeowners when interest rates rise. 3. C) generally have higher initial interest rates than conventional fixed-rate mortgages. 4. D) allow borrowers to avoid paying interest on portions of their mortgage loans.

A 36

The research document given to the Federal Open Market Committee that contains information on the state of the economy in each Federal Reserve district is called the 1. A) beige book. 2. B) green book. 3. C) blue book. 4. D) black book.

A 37

The Basel Committee ruled that regulators in other countries can ________ the operations of a foreign bank if they believe that it lacks effective oversight. 1. A) restrict 2. B) encourage 3. C) renegotiate 4. D) enhance

A 62

Banks engage in regulatory arbitrage by 1. A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement. 2. B) keeping low-risk assets on their books while removing high-risk assets with the same capital requirement. 3. C) hiding risky assets from regulators. 4. D) buying risky assets from arbitragers.

A 39 Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in 1. A) reduced risk taking by banks. 2. B) reduced supervision of banks by regulators. 3. C) increased fraudulent behavior by banks. 4. D) increased risk taking by banks. Answer: D 40

A serious consequence of a financial crisis is 1. A) a contraction in economic activity. 2. B) an increase in asset prices. 3. C) financial engineering. 4. D) financial globalization.

A 4

The government institution that has responsibility for the amount of money and credit supplied in the economy as a whole is the 1. A) central bank. 2. B) commercial bank. 3. C) bank of settlement. 4. D) monetary fund.

A 4

The public's fear of centralized power and distrust of moneyed interests led to the demise of the first two experiments in central banking, otherwise known as 1. A) the First Bank of the United States and the Second Bank of the United States. 2. B) the First Bank of the United States and the Central Bank of the United States. 3. C) the First Central Bank of the United States and the Second Central Bank of the United States. 4. D) the First Bank of North America and the Second Bank of North America.

A 4

The Volcker Rule addresses the off-balance-sheet problem involving 1. A) trading risks. 2. B) selling loans. 3. C) loan guarantees. 4. D) interest rate risks.

A 40

One of the criticisms of Basel 2 is that it is procyclical. That means that 1. A) banks may be required to hold more capital during times when capital is short. 2. B) banks may become professional at a cyclical response to economic conditions. 3. C) banks may be required to hold less capital during times when capital is short. 4. D) banks will not be required to hold capital during an expansion.

A 41

One suggested method of dealing with the too-big-to-fail problem is to reimpose the restrictions that were in place under 1. A) Glass-Steagall. 2. B) McFadden. 3. C) the Edge Act. 4. D) the Federal Reserve Act.

A 42

Overseeing who operates banks and how they are operated is called 1. A) prudential supervision. 2. B) hazard insurance. 3. C) regulatory interference. 4. D) loan loss reserves.

A 42

Credit cards date back to 1. A) prior to the second World War. 2. B) just after the second World War. 3. C) the early 1950s. 4. D) the late 1950s.

A 43

A firm issuing credit cards earns income from 1. A) loans it makes to credit card holders. 2. B) subsidies from the local governments. 3. C) payments made to it by manufacturers of the products sold in stores on credit card purchases. 4. D) sales of the card in foreign countries.

A 44

Goal independence is the ability of ________ to set monetary policy ________. 1. A) the central bank; goals 2. B) Congress; goals 3. C) Congress; instruments 4. D) the central bank; instruments

A 45

The federal agencies that examine banks include 1. A) the Federal Reserve System. 2. B) the Internal Revenue Service. 3. C) the SEC. 4. D) the U.S. Treasury.

A 46

Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth. 1. A) call reports 2. B) balance reports 3. C) regulatory sheets 4. D) examiner updates

A 47

Regulations designed to provide information to the marketplace so that investors can make informed decisions are called 1. A) disclosure requirements. 2. B) efficient market requirements. 3. C) asset restrictions. 4. D) capital requirements.

A 50

So-called fallen angels differ from junk bonds in that 1. A) junk bonds refer to newly issued bonds with low credit ratings, whereas fallen angels refer to previously issued bonds that have had their credit ratings fall below Baa. 2. B) junk bonds refer to previously issued bonds that have had their credit ratings fall below Baa, whereas fallen angels refer to newly issued bonds with low credit ratings. 3. C) junk bonds have ratings below Baa, whereas fallen angels have ratings below C. 4. D) fallen angels have ratings below Baa, whereas junk bonds have ratings below C.

A 51

Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks. 1. A) reduce; screen 2. B) increase; screen 3. C) reduce; increase 4. D) increase; increase

A 98

The strongest argument for an independent Federal Reserve rests on the view that subjecting the Fed to more political pressures would impart 1. A) an inflationary bias to monetary policy. 2. B) a deflationary bias to monetary policy. 3. C) a disinflationary bias to monetary policy. 4. D) a countercyclical bias to monetary policy.

A 51

With ________, firms value assets on their balance sheet at what they would sell for in the market. 1. A) mark-to-market accounting 2. B) book-value accounting 3. C) historical-cost accounting 4. D) off-balance sheet accounting

A 51

Critics of the current system of Fed independence contend that 1. A) the current system is undemocratic. 2. B) voters have too much say about monetary policy. 3. C) the president has too much control over monetary policy on a day-to-day basis. 4. D) the Board of Governors is held responsible for policy missteps.

A 52

During times of financial crisis, mark-to-market accounting 1. A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis. 2. B) leads to an increase in the financial firms' balance sheets since they can now get assets at bargain prices. 3. C) leads to an increase in financial firms' lending. 4. D) results in financial firms' assets increasing in value.

A 52

Consumer protection legislation includes legislation to 1. A) reduce discrimination in credit markets. 2. B) require banks to make loans to everyone who applies. 3. C) reduce the amount of interest that bank's can charge on loans. 4. D) require banks to make periodic reports to the Better Business Bureau.

A 53

In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment-grade status. 1. A) Michael Milken 2. B) Roger Milliken 3. C) Ivan Boesky 4. D) Carl Icahn

A 53

Recent research indicates that inflation performance (low inflation) has been found to be best in countries with 1. A) the most independent central banks. 2. B) political control of monetary policy. 3. C) money financing of budget deficits. 4. D) a policy of always keeping interest rates low.

A 53

An important factor in producing the global financial crisis was 1. A) lax consumer protection regulation. 2. B) onerous rules placed on mortgage originators. 3. C) weak incentives for mortgage brokers to use complicated mortgage products. 4. D) strong incentives for the mortgage brokers to verify income information.

A 54

Competition between banks 1. A) encourages greater risk taking. 2. B) encourages conservative bank management. 3. C) increases bank profitability. 4. D) eliminates the need for government regulation.

A 55

The development of money market mutual funds contributed to the growth of ________ since the money market mutual funds need to hold liquid, high-quality, short-terms assets. 1. A) the commercial paper market 2. B) the municipal bond market 3. C) the corporate bond market 4. D) the junk bond market

A 55

Regulations that reduced competition between banks included 1. A) branching restrictions. 2. B) bank reserve requirements. 3. C) the dual system of granting bank charters. 4. D) interest-rate ceilings.

A 56

The process of transforming otherwise illiquid financial assets into marketable capital market instruments is known as 1. A) securitization. 2. B) internationalization. 3. C) arbitrage. 4. D) program trading.

A 56

Who has regulatory responsibility when a bank operates branches in many countries? 1. A) It is not always clear. 2. B) the WTO 3. C) the U.S. Federal Reserve System 4. D) the first country to submit an application

A 59

The Second Bank of the United States was denied a new charter by 1. A) President Andrew Jackson. 2. B) Vice President John Calhoun. 3. C) President Benjamin Harrison. 4. D) President John Q. Adams.

A 6

The collapse of the Bank of Credit and Commerce International, BCCI, showed the difficulty of international banking regulation. BCCI operated in more than ________ countries and was supervised by the small country of ________. 1. A) 70, Luxembourg 2. B) 100, Monaco 3. C) 70, Monaco 4. D) 100, Luxembourg

A 60

Which of the following is NOT part of the shadow banking system? 1. A) the transformer 2. B) the servicer 3. C) the bundler 4. D) the distributor

A 60

Agreements such as the ________ are attempts to standardize international banking regulations. 1. A) Basel Accord 2. B) UN Bank Accord 3. C) GATT Accord 4. D) WTO Accord

A 61

Which of the following statements comparing the European System of Central Banks and the Federal Reserve System is TRUE? 1. A) The budgets of the Federal Reserve Banks are controlled by the Board of Governors, while the National Central Banks control their own budgets and the budget of the European Central Bank. 2. B) The European Central Bank has similar power over the National Central Banks when compared to the level of power the Board of Governors has over the Federal Reserve Banks. 3. C) Just like the Federal Reserve System, monetary operations are centralized in the European System of Central Banks with the European Central Bank. 4. D) The European Central Bank's involvement in supervision and regulation of financial institutions is comparable to the Board of Governors' involvement.

A 62

Prior to 2008, bank managers looked on reserve requirements 1. A) as a tax on deposits. 2. B) as a subsidy on deposits. 3. C) as a subsidy on loans. 4. D) as a tax on loans.

A 64

During the 1960s, 1970s, and early 1980s, traditional bank profitability declined because of 1. A) financial innovation that increased competition from new financial institutions. 2. B) a decrease in interest rates to fight the inflation problem. 3. C) a decrease in deposit insurance. 4. D) increased regulation that prohibited banks from making risky real estate loans.

A 65

On paper, the Bank of Canada has ________ instrument independence and ________ goal independence when compared to the Federal Reserve System. 1. A) less; less 2. B) less; more 3. C) more; less 4. D) more; more

A 67

Money market mutual funds 1. A) function as interest-earning checking accounts. 2. B) are legally deposits. 3. C) are subject to reserve requirements. 4. D) have an interest-rate ceiling.

A 68

One of the problems experienced by the savings and loan industry during the 1980s was 1. A) managers lack of expertise to manage risk in new lines of business. 2. B) heavy regulations in the new areas open to S&Ls. 3. C) slow growth in lending. 4. D) close monitoring by the FSLIC.

A 68

The oldest central bank, having been founded in 1694, is the 1. A) Bank of England. 2. B) Deutsche Bundesbank. 3. C) Bank of Japan. 4. D) Federal Reserve System.

A 68

In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation know as "breaking the buck." This means that 1. A) they could no longer afford to redeem shares at the par value of $1. 2. B) they required shareholders to contribute a dollar more in fees each month. 3. C) shareholders were able to redeem shares for more than a $1. 4. D) shares earned more than a dollar in interest.

A 69

While legislation enacted in 1998 granted the Bank of Japan new powers and greater autonomy, its critics contend that its independence is 1. A) limited by the Ministry of Finance's veto power over a portion of its budget. 2. B) too great because it need not pursue a policy of price stability even if that is the popular will of the people. 3. C) too great since the Ministry of Finance no longer has veto power over the bank's budget. 4. D) limited since the Ministry of Finance can dismiss senior bank officials.

A 69

When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a 1. A) credit boom. 2. B) credit bust. 3. C) deleveraging. 4. D) market race.

A 7

In this type of arrangement, any balances above a certain amount in a corporation's checking account at the end of the business day are "removed" and invested in overnight securities that pay the corporation interest. This innovation is referred to as a 1. A) sweep account. 2. B) share draft account. 3. C) removed-repo account. 4. D) stockman account.

A 70

When regulators chose to allow insolvent S&Ls to continue to operate rather than to close them, they were pursuing a policy of 1. A) regulatory forbearance. 2. B) regulatory kindness. 3. C) ostrich reasoning. 4. D) ignorance reasoning.

A 70

Savings and loan regulators allowed S&Ls to include in their capital calculations a high value for intangible capital called 1. A) goodwill. 2. B) salvation. 3. C) kindness. 4. D) retribution.

A 71

The trend in recent years is that more and more governments 1. A) have been granting greater independence to their central banks. 2. B) have been reducing the independence of their central banks to make them more accountable for poor economic performance. 3. C) have mandated that their central banks focus on controlling inflation. 4. D) have required their central banks to cooperate more with their Ministers of Finance.

A 71

Sweep accounts 1. A) have made reserve requirements nonbinding for many banks. 2. B) sweep funds out of deposit accounts into long-term securities. 3. C) enable banks to avoid paying interest to corporate customers. 4. D) reduce banks' assets.

A 72

Since 1974, commercial banks importance as a source of funds for nonfinancial borrowers 1. A) has shrunk dramatically, from around 40 percent of total credit advanced to around 25 percent by 2014. 2. B) has shrunk dramatically, from around 70 percent of total credit advanced to below 50 percent by 2014. 3. C) has expanded dramatically, from around 50 percent of total credit advanced to above 70 percent by 2014. 4. D) has expanded dramatically, from around 30 percent of total credit advanced to above 50 percent by 2014.

A 73

The policy of ________ exacerbated ________ problems as savings and loans took on increasingly huge levels of risk on the slim chance of returning to solvency. 1. A) regulatory forbearance; moral hazard 2. B) regulatory forbearance; adverse hazard 3. C) regulatory agnosticism; moral hazard 4. D) regulatory agnosticism; adverse hazard

A 73

Regulatory forbearance 1. A) meant delaying the closing of "zombie S&Ls" as their losses mounted during the 1980s. 2. B) had the advantage of benefiting healthy S&Ls at the expense of "zombie S&Ls," as insolvent institutions lost deposits to health institutions. 3. C) had the advantage of permitting many insolvent S&Ls the opportunity to return to profitability, saving the FSLIC billions of dollars. 4. D) increased adverse selection dramatically.

A 74

The S&L Crisis can be analyzed as a principal-agent problem. The agents in this case, the ________, did not have the same incentive to minimize cost to the economy as the principals, the ________. 1. A) politicians/regulators; taxpayers 2. B) taxpayers; politician/regulators 3. C) taxpayers; bank managers 4. D) bank managers; politicians/regulators

A 76

Disintermediation resulted from 1. A) interest rate ceilings combined with inflation-driven increases in interest rates. 2. B) elimination of Regulation Q (the regulation imposing interest rate ceilings on bank deposits). 3. C) increases in federal income taxes. 4. D) reserve requirements.

A 77

That several hundred S&Ls were not even examined once in the period January 1984 through June 1986 can be explained by 1. A) Congress's unwillingness to allocate the necessary funds to thrift regulators. 2. B) regulators' reluctance to find the specific problem thrifts that they knew existed. 3. C) slower growth in lending meant that less regulation was needed. 4. D) Congress's unwillingness to listen to campaign contributors.

A 78

Banks responded to disintermediation by 1. A) supporting the elimination of interest rate regulations, enabling them to better compete for funds. 2. B) opposing the elimination of interest rate regulations, as this would increase their cost of funds. 3. C) demanding that interest rate regulations be imposed on money market mutual funds. 4. D) supporting the elimination of interest rate regulations, as this would reduce their cost of funds.

A 79

The bailout of the savings and loan industry was much delayed and, therefore, much more costly to taxpayers because 1. A) of regulators' initial attempts to downplay the seriousness of problems within the thrift industry. 2. B) politicians listened to the taxpayers rather than the S&L lobbyists. 3. C) Congress did not wait long enough for many of the problems in the thrift industry to correct themselves. 4. D) regulators could not be fired, therefore, they didn't care if they did a good job or not.

A 79

To eliminate the abuses of the state-chartered banks, the ________ created a new banking system of federally chartered banks, supervised by the ________. 1. A) National Bank Act of 1863; Office of the Comptroller of the Currency 2. B) Federal Reserve Act of 1863; Office of the Comptroller of the Currency 3. C) National Bank Act of 1863; Office of Thrift Supervision 4. D) Federal Reserve Act of 1863; Office of Thrift Supervision

A 8

To prevent bank runs and the consequent bank failures, the United States established the ________ in 1934 to provide deposit insurance. 1. A) FDIC 2. B) SEC 3. C) Federal Reserve 4. D) ATM

A 8

When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending in a process called 1. A) deleveraging. 2. B) releveraging. 3. C) capitulation. 4. D) deflation.

A 8

One factor contributing to the decline in cost advantages that banks once had is the 1. A) decline in the importance of checkable deposits from over 60 percent of banks' liabilities to 2 percent today. 2. B) decline in the importance of savings deposits from over 60 percent of banks' liabilities to under 15 percent today. 3. C) decline in the importance of checkable deposits from over 40 percent of banks' liabilities to 15 percent today. 4. D) decline in the importance of savings deposits from over 40 percent of banks' liabilities to under 20 percent today.

A 80

The Resolution Trust Corporation was created by the FIRREA in order to 1. A) manage and resolve insolvent S&Ls. 2. B) build up trust in government regulation. 3. C) regulate the S&L industry. 4. D) purchase large amounts of government debt.

A 83

FIRREA increased the core-capital leverage requirement for thrift institutions from 3% to 1. A) 8%. 2. B) 5%. 3. C) 10%. 4. D) 25%

A 84

The Federal Deposit Insurance Corporation Improvement Act of 1991 1. A) increased the FDIC's ability to borrow from the Treasury to deal with failed banks. 2. B) increased the FDIC's ability to use the too-big-to-fail doctrine. 3. C) eliminated governmentally-administered deposit insurance. 4. D) eliminated restrictions on nationwide banking.

A 85

The ability to use the too-big-to-fail policy was curtailed by the passage of the FDICIA. To use this action today, the FDIC must get approval of a two-thirds majority of both the Board of Governors of the Federal Reserve and the directors of the FDIC and also the approval of the 1. A) Secretary of the Treasury. 2. B) Senate Finance Committee Chairperson. 3. C) President of the United States. 4. D) governor of the state in which the failed bank is located.

A 86

The McFadden Act of 1927 1. A) effectively prohibited banks from branching across state lines. 2. B) required that banks maintain bank capital equal to at least 6 percent of their assets. 3. C) effectively required that banks maintain a correspondent relationship with large money center banks. 4. D) separated the commercial banks and investment banks.

A 87

The directive of prompt corrective action means that 1. A) the FDIC will intervene earlier and more vigorously when a bank gets into trouble. 2. B) the banks must take actions quickly to resolve reserve disputes. 3. C) bank failures cannot occur. 4. D) there must be an immediate response to an increase in interest rates.

A 87

FDICIA ________ incentives for banks to hold capital and ________ incentives to take on excessive risk. 1. A) increased; decreased 2. B) increased; increased 3. C) decreased; decreased 4. D) decreased; increased

A 88

The legislation that effectively prohibited banks from branching across state lines and forced all national banks to conform to the branching regulations in the state in which they reside is the 1. A) McFadden Act. 2. B) National Bank Act. 3. C) Glass-Steagall Act. 4. D) Garn-St.Germain Act.

A 88

When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in 1. A) a contraction of economic activity. 2. B) an economic boom. 3. C) an increased opportunity for growth. 4. D) a call for government regulation.

A 9

A common element in all of the banking crisis episodes in different countries is 1. A) the existence of a government safety net. 2. B) deposit insurance. 3. C) increased regulation. 4. D) lack of competition.

A 92

ATMs were developed because of breakthroughs in technology and as a 1. A) means of avoiding restrictive branching regulations. 2. B) means of avoiding paying interest to corporate customers. 3. C) way of concealing transactions from the SEC. 4. D) increasing the competition from foreign banks.

A 93

As in the United States, an important factor in the banking crises in Norway, Sweden, and Finland was the 1. A) financial liberalization that occurred in the 1980s. 2. B) decline in real interest rates that occurred in the 1980s. 3. C) high inflation that occurred in the 1980s. 4. D) sluggish economic growth that occurred in the 1980s.

A 93

As in the United States, an important factor in the banking crises in Latin America was the 1. A) financial liberalization that occurred in the 1980s. 2. B) decline in real interest rates that occurred in the 1980s. 3. C) high inflation that occurred in the 1980s. 4. D) sluggish economic growth that occurred in the 1980s.

A 94

Financial innovations that grew out of the bank branching restrictions were 1. A) bank holding companies and automated teller machines. 2. B) bank holding companies and securitization. 3. C) automated teller machines and sweep accounts. 4. D) automated teller machines and bank credit cards.

A 94

The Argentine banking crisis of 2001 resulted from Argentina's banks being required to 1. A) purchase large amounts of government debt. 2. B) pay back the value of failed loans. 3. C) make risky real estate loans. 4. D) make loans to only state-owned businesses.

A 95

When comparing the banking crisis in the United States to the crises in Latin America, cost to the taxpayers of the government bailouts was 1. A) higher in Latin American than in the United States. 2. B) higher in the United States than in Latin America. 3. C) about the same in both Latin America and the United States. 4. D) positive in Latin America but negative in the United States.

A 96

Bank holding companies that rival money center banks in size, but are not located in money center cities are 1. A) superregional banks. 2. B) bank clearing houses. 3. C) international banks. 4. D) local banks.

A 97

The Japanese banking system went through a cycle of ________ in the 1990s similar to the one that occurred in the U.S. in the 1980s. 1. A) regulatory forbearance 2. B) policy antagonism 3. C) regulatory ignorance 4. D) policy renewal

A 97

China is trying to move its banking system from being strictly ________ owned by having them issue shares overseas. 1. A) state 2. B) domestic investor 3. C) depositor 4. D) domestic corporate

A 98

The Second Bank of the United States 1. A) was disbanded in 1811 when its charter was not renewed. 2. B) had its charter renewal vetoed in 1832. 3. C) is considered to be the primary cause of the bank panic of 1907. 4. D) None of the above.

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 1. A) requirement that firms keep compensating balances at the banks from which they obtain their loans. 2. B) requirement that firms place on their board of directors an officer from the bank. 3. C) inclusion of restrictive covenants in loan contracts. 4. D) requirement that individuals provide detailed credit histories to bank loan officers.

B 104

Credit risk management tools include 1. A) deductibles. 2. B) collateral. 3. C) interest rate swaps. 4. D) duration analysis.

B 107

The legislation overturning the Glass-Steagall Act is 1. A) the McFadden Act. 2. B) the Gramm-Leach-Bliley Act. 3. C) the Garn-St. Germain Act 4. D) the Riegle-Neal Act.

B 109

Prior to 1863, all commercial banks in the United States 1. A) were chartered by the U.S. Treasury Department. 2. B) were chartered by the banking commission of the state in which they operated. 3. C) were regulated by the Federal Reserve. 4. D) were regulated by the central bank.

B 11

All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits. 1. A) an increase; increase 2. B) an increase; reduce 3. C) a decline; reduce 4. D) a decline; not affect

B 110

If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits. 1. A) more; a decline 2. B) more; an increase 3. C) fewer; an increase 4. D) fewer; a surge

B 111

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. 1. A) more; rise; decline 2. B) more; decline; rise 3. C) fewer; decline; decline 4. D) fewer; rise; rise

B 112

If a bank has $50 million in rate-sensitive assets and $20 million in rate-sensitive liabilities then 1. A) an increase in interest rates will reduce bank profits. 2. B) a decrease in interest rates will reduce bank profits. 3. C) interest rate changes will not impact bank profits. 4. D) a decrease in interest rates will increase bank profits.

B 114

In a ________ banking system, commercial banks engage in securities underwriting, but legal subsidiaries conduct the different activities. Also, banking and insurance are not typically undertaken together in this system. 1. A) universal 2. B) British-style universal 3. C) short-fence 4. D) compartmentalized

B 114

A major difference between the United States and Japanese banking systems is that 1. A) American banks are allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks cannot. 2. B) Japanese banks are allowed to hold substantial equity stakes in commercial firms, whereas American banks cannot. 3. C) bank holding companies are illegal in the United States. 4. D) Japanese banks are usually organized as bank holding companies.

B 115

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called 1. A) basic duration analysis. 2. B) basic gap analysis. 3. C) interest-exposure analysis. 4. D) gap-exposure analysis.

B 117

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 1. A) basic gap analysis. 2. B) the maturity bucket approach to gap analysis. 3. C) the segmented maturity approach to gap analysis. 4. D) the segmented maturity approach to interest-exposure analysis.

B 118

First National Bank Assets Liabilities Rate-Sensitive $20M $50M Fixed-Rate $80M $50M If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using gap analysis) will 1. A) decline by $0.5 million. 2. B) decline by $1.5 million. 3. C) decline by $2.5 million. 4. D) increase by $1.5 million.

B 119

Assuming that the average duration of its assets is five years, while the average duration of its liabilities is three years, then a 5 percentage point increase in interest rates will cause the net worth of First National to decline by ________ of the total original asset value. 1. A) 5 percent 2. B) 10 percent 3. C) 15 percent 4. D) 25 percent

B 120

Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________. 1. A) securities portfolio; non-deposit liabilities 2. B) assets; liabilities 3. C) loan portfolio; deposit liabilities 4. D) assets; deposit liabilities

B 123

Because of an expected rise in interest rates in the future, a banker will likely 1. A) make long-term rather than short-term loans. 2. B) buy short-term rather than long-term bonds. 3. C) buy long-term rather than short-term bonds. 4. D) make either short or long-term loans; expectations of future interest rates are irrelevant.

B 124

Reasons for holding Eurodollars include 1. A) the fact that Eurodollar deposits are insured by the FDIC. 2. B) the fact that dollars are widely used to conduct international transactions. 3. C) the fact that minimum transaction sizes are very low, making Eurodollars an attractive savings instrument for consumers. 4. D) the fact that Eurodollar deposits are heavily regulated.

B 129

The National Bank Act of 1863, and subsequent amendments to it 1. A) created a banking system of state-chartered banks. 2. B) established the Office of the Comptroller of the Currency. 3. C) broadened the regulatory powers of the Federal Reserve. 4. D) created insurance on deposit accounts.

B 13

When bad drivers line up to purchase collision insurance, automobile insurers are subject to the 1. A) moral hazard problem. 2. B) adverse selection problem. 3. C) assigned risk problem. 4. D) ill queue problem.

B 13

________ within the U.S. can make loans to foreigners but cannot make loans to domestic residents. 1. A) Edge Act corporations 2. B) International Banking Facilities 3. C) Universal banks 4. D) Euro banks

B 133

The principal-agent problem that exists for bank trading activities can be reduced through 1. A) creation of internal controls that combine trading activities with bookkeeping. 2. B) creation of internal controls that separate trading activities from bookkeeping. 3. C) elimination of regulation of banking. 4. D) elimination of internal controls.

B 137

Banks develop statistical models to calculate their maximum loss over a given time period. This approach is known as the 1. A) stress-testing approach. 2. B) value-at-risk approach. 3. C) trading-loss approach. 4. D) doomsday approach.

B 138

The Federal Reserve Bank of ________ houses the open market desk. 1. A) Boston 2. B) New York 3. C) Chicago 4. D) San Francisco

B 14

Interest income minus interest expenses divided by assets is a measure of bank performance known as the 1. A) operating income. 2. B) net interest margin. 3. C) return on assets. 4. D) return on equity.

B 148

An important function of the regional Federal Reserve Banks is 1. A) setting reserve requirements. 2. B) clearing checks. 3. C) determining monetary policy. 4. D) setting margin requirements.

B 16

All ________ are required to be members of the Fed. 1. A) state chartered banks 2. B) national banks chartered by the Office of the Comptroller of the Currency 3. C) banks with assets less than $100 million 4. D) banks with assets less than $500 million

B 18

The ________, the difference between the interest rate on Baa corporate bonds and U.S. Treasury bonds. rose sharply during the Great Depression. 1. A) credit boom 2. B) credit spread 3. C) adjustable-rate 4. D) default swap

B 18

The modern commercial banking system began in America when the 1. A) Bank of United States was chartered in New York in 1801. 2. B) Bank of North America was chartered in Philadelphia in 1782. 3. C) Bank of United States was chartered in Philadelphia in 1801. 4. D) Bank of North America was chartered in New York in 1782.

B 2

Prior to 1980, member banks left the Federal Reserve System due to 1. A) the high cost of discount loans. 2. B) the high cost of required reserves. 3. C) a desire to avoid interest rate regulations. 4. D) a desire to avoid credit controls.

B 20

With the creation of the Federal Deposit Insurance Corporation 1. A) member banks of the Federal Reserve System were given the option to purchase FDIC insurance for their depositors, while non-member commercial banks were required to buy deposit insurance. 2. B) member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors, while non-member commercial banks could choose to buy deposit insurance. 3. C) both member and non-member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors. 4. D) both member and non-member banks of the Federal Reserve System could choose, but were not required, to purchase FDIC insurance for their depositors.

B 22

Federal deposit insurance covers deposits up to $250,000, but as part of a doctrine called "too-big-to-fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does this, it uses the 1. A) "payoff" method. 2. B) "purchase and assumption" method. 3. C) "inequity" method. 4. D) "Basel" method.

B 23

The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks from 1. A) issuing equity to finance bank expansion. 2. B) engaging in underwriting and dealing of corporate securities. 3. C) selling new issues of government securities. 4. D) purchasing any debt securities.

B 23

There are ________ members of the Board of Governors of the Federal Reserve System. 1. A) 5 2. B) 7 3. C) 12 4. D) 19

B 24

Which of the following statements concerning bank regulation in the United States is TRUE? 1. A) The Office of the Comptroller of the Currency has the primary responsibility for state banks that are members of the Federal Reserve System. 2. B) The Federal Reserve and the state banking authorities jointly have responsibility for the state banks that are members of the Federal Reserve System. 3. C) The Office of the Comptroller of the Currency has sole regulatory responsibility over bank holding companies. 4. D) The state banking authorities have sole regulatory responsibility for all state banks.

B 25

Each governor on the Board of Governors can serve 1. A) only one nonrenewable fourteen-year term. 2. B) one full nonrenewable fourteen-year term plus part of another term. 3. C) only one nonrenewable eight-year term. 4. D) one full nonrenewable eight-year term plus part of another term.

B 26

If a borrower takes out a $200 million loan in a repo agreement and is asked to post $220 million of mortgage-backed securities as collateral, the "haircut" is 1. A) 5%. 2. B) 10%. 3. C) 20%. 4. D) 50%.

B 27

State banks that are not members of the Federal Reserve System are most likely to be examined by the 1. A) Federal Reserve System. 2. B) FDIC. 3. C) FHLBS. 4. D) Comptroller of the Currency.

B 27

A well-capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities. 1. A) more; more 2. B) more; less 3. C) less; more 4. D) less; less

B 29

A major controversy involving the banking industry in its early years was 1. A) whether banks should both accept deposits and make loans or whether these functions should be separated into different institutions. 2. B) whether the federal government or the states should charter banks. 3. C) what percent of deposits banks should hold as fractional reserves. 4. D) whether banks should be allowed to issue their own bank notes.

B 3

Which of the followings is NOT a current duty of the Board of Governors of the Federal Reserve System? 1. A) setting margin requirements, the fraction of the purchase price of the securities that has to be paid for with cash 2. B) setting the maximum interest rates payable on certain types of time deposits under Regulation Q 3. C) approving the discount rate "established" by the Federal Reserve banks 4. D) voting on the conduct of open market operations

B 30

The most significant change in the economic environment that changed the demand for financial products in recent years has been 1. A) the aging of the baby-boomer generation. 2. B) the dramatic increase in the volatility of interest rates. 3. C) the dramatic increase in competition from foreign banks. 4. D) the deregulation of financial institutions.

B 31

Rising interest-rate risk 1. A) increased the cost of financial innovation. 2. B) increased the demand for financial innovation. 3. C) reduced the cost of financial innovation. 4. D) reduced the demand for financial innovation.

B 34

The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets. 1. A) 10% 2. B) 8% 3. C) 5% 4. D) 3%

B 36

The new Consumer Financial Protection Bureau is an independent agency but is funded and housed within 1. A) the Treasury Department. 2. B) the Federal Reserve. 3. C) the SEC. 4. D) the IRS.

B 37

Financial instruments whose payoffs are linked to previously issued securities are called 1. A) grandfathered bonds. 2. B) financial derivatives. 3. C) hedge securities. 4. D) reversible bonds.

B 39

Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a 1. A) last-in, first-out constraint. 2. B) sequential service constraint. 3. C) double-coincidence of wants constraint. 4. D) everyone-shares-equally constraint.

B 4

Both ________ and ________ were financial innovations that occurred because of interest rate volatility. 1. A) adjustable-rate mortgages; commercial paper 2. B) adjustable-rate mortgages; financial derivatives 3. C) sweep accounts; financial derivatives 4. D) sweep accounts; commercial paper

B 40

The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem. 1. A) adverse selection; adverse selection 2. B) adverse selection; moral hazard 3. C) moral hazard; adverse selection 4. D) moral hazard; moral hazard

B 43 The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets. 1. A) screening; restrictive covenants 2. B) screening; branching restrictions 3. C) identifying; branching restrictions 4. D) identifying; credit rationing Answer: A 44

Dodd-Frank addressed many of the issues that led to the financial crisis. Which of the following was NOT addressed by Dodd-Frank regulations? 1. A) stricter consumer protection laws 2. B) privately owned, government-sponsored enterprises (GSEs) such as Fannie mae and Freddie Mac 3. C) resolution authority over the large financial institutions 4. D) higher requirements on firms dealing in derivatives

B 44

Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for 1. A) liabilities. 2. B) liquidity. 3. C) loans. 4. D) leverage.

B 45

The entry of AT&T and GM into the credit card business is an indication of 1. A) government's efforts to deregulate the provision of financial services. 2. B) the rising profitability of credit card operations. 3. C) the reduction in costs of credit card operations since 1990. 4. D) the sale of unprofitable operations by Bank of America and Citicorp.

B 45

The ability of a central bank to set monetary policy goals is 1. A) political independence. 2. B) goal independence. 3. C) policy independence. 4. D) instrument independence.

B 46

The ability to use one resource to provide different products and services is 1. A) economies of scale. 2. B) economies of scope. 3. C) diversification. 4. D) vertical integration.

B 99

Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry. 1. A) moral hazard 2. B) adverse selection 3. C) ex post shirking 4. D) post-contractual opportunism

B 48

The political business cycle refers to the phenomenon that just before elections, politicians enact ________ policies. After the elections, the bad effects of these policies (for example, ________ ) have to be counteracted with ________ policies. 1. A) expansionary; higher unemployment; contractionary 2. B) expansionary; a higher inflation rate; contractionary 3. C) contractionary; higher unemployment; expansionary 4. D) contractionary; a higher inflation rate; expansionary

B 50

One factor contributing to the rapid growth of the commercial paper market since 1970 is 1. A) the fact that commercial paper has no default risk. 2. B) improved information technology making it easier to screen credit risks. 3. C) government regulation. 4. D) FDIC insurance for commercial paper.

B 54

The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed 1. A) was supportive of congressional attempts to limit the central bank's autonomy. 2. B) was so secretive about the conduct of future monetary policy. 3. C) sought less control over banks in the 1980s. 4. D) was willing to take on powerful groups that may threaten its autonomy.

B 56

The ________ that required separation of commercial and investment banking was repealed in 1999. 1. A) the Federal Reserve Act. 2. B) the Glass-Steagall Act. 3. C) the Bank Holding Company Act. 4. D) the Monetary Control Act.

B 57

Under the European System of Central Banks, the Governing Council is similar in structure to the ________ of the Federal Reserve System. 1. A) Board of Governors 2. B) Federal Open Market Committee 3. C) Federal Reserve Banks 4. D) Federal Advisory Council

B 59

What makes the Federal Reserve so unique compared to other central banks around the world is its 1. A) centralized structure. 2. B) decentralized structure. 3. C) regulatory functions. 4. D) monetary policy functions.

B 6

Because of securitization, a new class of residential mortgages offered to borrowers with less-than-stellar credit records developed. These mortgages are known as 1. A) risk-enhanced mortgages. 2. B) subprime mortgages. 3. C) bundled mortgages. 4. D) adjustable-rate mortgages.

B 61

Members of the Executive Board of the European System of Central Banks are appointed to ________ year, nonrenewable terms. 1. A) four 2. B) eight 3. C) ten 4. D) fourteen

B 61

Moral hazard and adverse selection problems increased in prominence in the 1980s 1. A) as deregulation required savings and loans and mutual savings banks to be more cautious. 2. B) following a burst of financial innovation in the 1970s and early 1980s that produced new financial instruments and markets, thereby widening the scope for risk taking. 3. C) following a decrease in federal deposit insurance from $100,000 to $40,000. 4. D) as interest rates were sharply decreased to bring down inflation.

B 64

Prior to 1980, the Fed set an interest rate ________, a maximum limit, on the interest rate that could be paid on time deposits. 1. A) floor 2. B) ceiling 3. C) wall 4. D) window

B 66

Prior to the 1980s, S&Ls and mutual savings banks were restricted almost entirely to 1. A) commercial real estate loans. 2. B) home mortgages. 3. C) education loans. 4. D) vacation loans.

B 67

In the early stages of the 1980s banking crisis, financial institutions were especially harmed by 1. A) declining interest rates from late 1979 until 1981. 2. B) the severe recession in 1981-82. 3. C) the disinflation from mid 1980 to early 1983. 4. D) the increase in energy prices in the early 80s.

B 69

Currency circulated by banks that could be redeemed for gold was called 1. A) junk bonds. 2. B) banknotes. 3. C) gold bills. 4. D) state money.

B 7

Which of the following is NOT an entity of the Federal Reserve System? 1. A) Federal Reserve Banks 2. B) the Comptroller of the Currency 3. C) the Board of Governors 4. D) the Federal Open Market Committee

B 7

Unanticipated moral hazard contingencies can be reduced by 1. A) screening. 2. B) long-term customer relationships. 3. C) specialization in lending. 4. D) credit rationing.

B 99

Regarding central bank independence 1. A) the Fed is more independent than the European Central Bank. 2. B) the European Central Bank is more independent than the Fed. 3. C) the trend in industrialized nations has been to reduce central bank independence. 4. D) the Bank of England has the longest tradition of independence of any central bank in the world.

B 70

Sweep accounts which were created to avoid reserve requirements became possible because of a change in 1. A) deposit ceilings. 2. B) technology. 3. C) government rules. 4. D) bank mergers.

B 71

Thrift institutions importance as a source of funds for borrowers 1. A) has shrunk from around 40 percent of total credit advanced in the late 1970s to below 30 percent by 2014. 2. B) has shrunk from over 20 percent of total credit advanced in the late 1970s to around 3 percent by 2014. 3. C) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 25 percent by 2014. 4. D) has expanded dramatically, from around 15 percent of total credit advanced in the late 1970s to above 30 percent by 2014.

B 74

Since 1980 1. A) banks have decreased risk taking to offset the decline in profits. 2. B) banks have offset the decline in profits from traditional activities with increased income from off-balance-sheet activities. 3. C) banks have offset the decline in profits from off-balance-sheet activities with increased income from traditional activities. 4. D) bank profits have grown rapidly due to deregulation.

B 75

Financial innovation has caused 1. A) banks to suffer declines in their cost advantages in acquiring funds, although it has not caused a decline in income advantages. 2. B) banks to suffer a simultaneous decline of cost and income advantages. 3. C) banks to suffer declines in their income advantages in acquiring funds, although it has not caused a decline in cost advantages. 4. D) banks to achieve competitive advantages in both costs and income.

B 76

Which of the following is an entity of the Federal Reserve System? 1. A) the U.S. Treasury Secretary 2. B) the FOMC 3. C) the Comptroller of the Currency 4. D) the FDIC

B 8

The most important developments that reduced banks cost advantages include 1. A) the growth of the junk bond market. 2. B) the competition from money market mutual funds. 3. C) the growth of securitization. 4. D) the growth in the commercial paper market.

B 81

The Federal Home Loan Bank Board and the FSLIC, both of which failed in their regulatory tasks, were abolished by the 1. A) Competitive Equality Banking Act of 1987. 2. B) Financial Institutions Reform, Recovery and Enforcement Act of 1989. 3. C) Office of Thrift Supervision. 4. D) Office of the Comptroller of the Currency.

B 82

The most important developments that reduced banks' income advantages include 1. A) the increase in off-balance sheet activities. 2. B) the growth of securitization. 3. C) the elimination of Regulation Q ceilings. 4. D) the competition from money market mutual funds.

B 82

Banks have attempted to maintain adequate profit levels by 1. A) making fewer riskier loans, such as commercial real estate loans. 2. B) pursuing new off-balance-sheet activities. 3. C) increasing reserve deposits at the Fed. 4. D) decreasing capital accounts.

B 83

The decline in traditional banking internationally can be attributed to 1. A) increased regulation. 2. B) improved information technology. 3. C) increasing monopoly power of banks over depositors. 4. D) increased protection from competition.

B 84

The large number of banks in the United States is an indication of 1. A) vigorous competition within the banking industry. 2. B) lack of competition within the banking industry. 3. C) only efficient banks operating within the United States. 4. D) consumer preference for local banks.

B 89

The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is 1. A) that the FDIC guarantees all deposits when it uses the "payoff" method. 2. B) that the FDIC guarantees all deposits when it uses the "purchase and assumption" method. 3. C) that the FDIC is more likely to use the "payoff" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures. 4. D) that the FDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions.

B 9

Which of the following is a TRUE statement concerning bank holding companies? 1. A) Bank holding companies own few large banks. 2. B) Bank holding companies have experienced dramatic growth in the past three decades. 3. C) The McFadden Act has prevented bank holding companies from establishing branch banks. 4. D) Bank holding companies can own only banks.

B 91

Allowing bank branching across state lines gives banks greater ability to coordinate bank operations. This makes it easier for them to receive the benefits of 1. A) the dual banking system. 2. B) economies of scale. 3. C) disintermediation. 4. D) interest-rate irregularities.

B 98

Why did the interest rate volatility of the 1970s spur financial innovation?

Banks were very vulnerable to interest-rate risk in the mortgage loans. To protect themselves, banks began to issue adjustable-rate mortgages whose interest rate will increase along with market interest rates. Additionally financial derivatives were developed to help hedge against interest-rate risk. 85

Of all commercial banks, about ________ belong to the Federal Reserve System. 1. A) 10% 2. B) one half 3. C) one third 4. D) 90%

C

Before 1863 1. A) federally-chartered banks had regulatory advantages not granted to state-chartered banks. 2. B) the number of federally-chartered banks grew at a much faster rate than at any other time since the end of the Civil War. 3. C) banks acquired funds by issuing banknotes. 4. D) banks were required to maintain 100% of their deposits as reserves.

C 10

A bank's 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 1. A) an adjustable gap loan. 2. B) an adjustable portfolio loan. 3. C) loan commitment. 4. D) pre-credit loan line.

C 100

A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be reduced, will require borrowers to 1. A) place a bank officer on their board of directors. 2. B) place a corporate officer on the bank's board of directors. 3. C) keep compensating balances in a checking account at the bank. 4. D) purchase the bank's CDs.

C 103

Experts predict that the future structure of the U.S. banking industry will have 1. A) an increased number of banks. 2. B) as few as ten banks. 3. C) several thousand banks. 4. D) a few hundred banks.

C 103

Bank consolidation will likely result in 1. A) less competition. 2. B) the elimination of community banks. 3. C) increased competition. 4. D) a shift in assets from larger banks to smaller banks.

C 104

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 1. A) coercive bargaining. 2. B) strategic holding out. 3. C) credit rationing. 4. D) collusive behavior.

C 105

Nationwide banking might reduce bank failures due to 1. A) reduced competition. 2. B) reduced lending to small businesses. 3. C) diversification of loan portfolios across state lines. 4. D) elimination of community banks.

C 107

Under the Gramm-Leach-Bliley Act states retain regulatory authority over 1. A) bank holding companies. 2. B) securities activities. 3. C) insurance activities. 4. D) bank subsidiaries engaged in securities underwriting.

C 110

Although the National Bank Act of 1863 was designed to eliminate state-chartered banks by imposing a prohibitive tax on banknotes, state banks were able to stay in business by 1. A) issuing credit cards. 2. B) ignoring the regulations. 3. C) acquiring funds through deposits. 4. D) branching into other states.

C 12

Mutual savings banks are owned by 1. A) shareholders. 2. B) partners. 3. C) depositors. 4. D) foreign investors.

C 120

What country is given credit for the birth of the Eurodollar market? 1. A) the United States 2. B) England 3. C) the Soviet Union 4. D) Japan

C 125

Banks earn profits from off-balance sheet loan sales 1. A) by foreclosing on delinquent accounts. 2. B) by selling the loans at discounted prices. 3. C) by selling existing loans for more than the original loan amount. 4. D) by calling-in loans before the maturity date.

C 129

Member commercial banks have purchased stock in their district Fed banks; the dividend paid by that stock is limited by law to ________ percent annually. 1. A) four 2. B) five 3. C) six 4. D) eight

C 13

Off-balance sheet activities involving guarantees of securities and back-up credit lines 1. A) have no impact on the risk a bank faces. 2. B) greatly reduce the risk a bank faces. 3. C) increase the risk a bank faces. 4. D) slightly reduce the risk a bank faces.

C 132

When banks involved in trading activities attempt to outguess markets, they are 1. A) forecasting. 2. B) diversifying. 3. C) speculating. 4. D) engaging in riskless arbitrage.

C 133

Which regulatory body charters national banks? 1. A) the Federal Reserve 2. B) the FDIC 3. C) the Comptroller of the Currency 4. D) the U.S. Treasury

C 14

Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of liabilities with a duration of 1.05. The duration gap for this bank is 1. A) 0.5 year. 2. B) 1 year. 3. C) 1.5 years. 4. D) 2 years.

C 141

For banks 1. A) return on assets exceeds return on equity. 2. B) return on assets equals return on equity. 3. C) return on equity exceeds return on assets. 4. D) return on equity is another name for net interest margin.

C 147

Today the United States has a dual banking system in which banks supervised by the ________ and by the ________ operate side by side. 1. A) federal government; municipalities 2. B) state governments; municipalities 3. C) federal government; states 4. D) municipalities; states

C 16

The U.S. banking system is considered to be a dual system because 1. A) banks offer both checking and savings accounts. 2. B) it actually includes both banks and thrift institutions. 3. C) it is regulated by both state and federal governments. 4. D) it was established before the Civil War, requiring separate regulatory bodies for the North and South.

C 17

Which of the following functions is NOT performed by any of the twelve regional Federal Reserve Banks? 1. A) check clearing 2. B) conducting economic research 3. C) setting interest rates payable on time deposits 4. D) issuing new currency

C 17

The Federal Reserve Act of 1913 required that 1. A) state banks be subject to the same regulations as national banks. 2. B) national banks establish branches in the cities containing Federal Reserve banks. 3. C) national banks join the Federal Reserve System. 4. D) state banks could not join the Federal Reserve System.

C 18

The Federal Reserve Act of 1913 required all ________ banks to become members of the Federal Reserve System, while ________ banks could choose to become members of the system. 1. A) state; national 2. B) state; municipal 3. C) national; state 4. D) national; municipal

C 19

In May 1991, the FDIC announced that it would sell the government's final 26% stake in Continental Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois 1. A) was a good investment opportunity for the government. 2. B) could be the Chicago branch of a new governmentally-owned interstate banking system. 3. C) was too big to fail. 4. D) would become the center of the new midwest region central bank system.

C 21

With the creation of the Federal Deposit Insurance Corporation, member banks of the Federal Reserve System ________ to purchase FDIC insurance for their depositors, while non-member commercial banks ________ to buy deposit insurance. 1. A) could choose; were required 2. B) could choose; were given the option 3. C) were required, could choose 4. D) were required; were required

C 21

The legislation that separated investment banking from commercial banking until its repeal in 1999 is known as the 1. A) National Bank Act of 1863. 2. B) Federal Reserve Act of 1913. 3. C) Glass-Steagall Act. 4. D) McFadden Act.

C 24

Members of the Board of Governors are 1. A) chosen by the Federal Reserve Bank presidents. 2. B) appointed by the newly elected president of the United States, as are cabinet positions. 3. C) appointed by the president of the United States and confirmed by the Senate. 4. D) never allowed to serve more than 7-year terms.

C 25

The too-big-to-fail policy 1. A) reduces moral hazard problems. 2. B) puts large banks at a competitive disadvantage in attracting large deposits. 3. C) treats large depositors of small banks inequitably when compared to depositors of large banks. 4. D) allows small banks to take on more risk than large banks.

C 26

The Chairman of the Board of Governors is chosen from among the seven governors and serves a ________, renewable term. 1. A) one-year 2. B) two-year 3. C) four-year 4. D) eight-year

C 27

As "haircuts" increased during 2007-2009, financial institutions found that to borrow the same loan amount now required ________ collateral. 1. A) less 2. B) no 3. C) more 4. D) default-free

C 28

The fact that banks operate on a "sequential service constraint" means that 1. A) all depositors share equally in the bank's funds during a crisis. 2. B) depositors arriving last are just as likely to receive their funds as those arriving first. 3. C) depositors arriving first have the best chance of withdrawing their funds. 4. D) banks randomly select the depositors who will receive all of their funds.

C 3

The Federal Open Market Committee usually meets ________ times a year. 1. A) four 2. B) six 3. C) eight 4. D) twelve

C 31

The global financial crisis of 2007-2009 not only led to a worldwide recession, but also a ________ in the European nations that use the euro currency. 1. A) currency devaluation 2. B) budget surplus 3. C) sovereign debt crisis 4. D) tax cut

C 31

The leverage ratio is the ratio of a bank's 1. A) assets divided by its liabilities. 2. B) income divided by its assets. 3. C) capital divided by its total assets. 4. D) capital divided by its total liabilities.

C 31

The Federal Reserve entity that makes decisions regarding the conduct of open market operations is the 1. A) Board of Governors. 2. B) chairman of the Board of Governors. 3. C) Federal Open Market Committee. 4. D) Open Market Advisory Council

C 32

To be considered well capitalized, a bank's leverage ratio must exceed 1. A) 10%. 2. B) 8%. 3. C) 5%. 4. D) 3%.

C 32

The FDIC must take steps to close down banks whose equity capital is less than ________ of assets. 1. A) 4% 2. B) 3% 3. C) 2% 4. D) 1%

C 33

The Federal Open Market Committee consists of the 1. A) five senior members of the seven-member Board of Governors. 2. B) seven members of the Board of Governors and seven presidents of the regional Fed banks. 3. C) seven members of the Board of Governors and five presidents of the regional Fed banks. 4. D) twelve regional Fed bank presidents and the chairman of the Board of Governors.

C 33

Uncertainty about interest-rate movements and returns is called 1. A) market potential. 2. B) interest-rate irregularities. 3. C) interest-rate risk. 4. D) financial creativity.

C 33

Off-balance-sheet activities 1. A) generate fee income with no increase in risk. 2. B) increase bank risk but do not increase income. 3. C) generate fee income but increase a bank's risk. 4. D) generate fee income and reduce risk.

C 34

Adjustable rate mortgages 1. A) protect households against higher mortgage payments when interest rates rise. 2. B) keep financial institutions' earnings high even when interest rates are falling. 3. C) benefit homeowners when interest rates are falling. 4. D) generally have higher initial interest rates than on conventional fixed-rate mortgages.

C 35

Although reserve requirements and the discount rate are not actually set by the ________, decisions concerning these policy tools are effectively made there. 1. A) Federal Reserve Bank of New York 2. B) Board of Governors 3. C) Federal Open Market Committee 4. D) Federal Reserve Banks

C 36

The agreement to provide a standardized commodity to a buyer on a specific date at a specific future price is 1. A) a put option. 2. B) a call option. 3. C) a futures contract. 4. D) a mortgage-backed security.

C 37

An instrument developed to help investors and institutions hedge interest-rate risk is 1. A) a debit card. 2. B) a credit card. 3. C) a financial derivative. 4. D) a junk bond.

C 38

The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is known as 1. A) competition in laxity. 2. B) depositor supervision. 3. C) regulatory arbitrage. 4. D) a dual banking system.

C 38

The Federal Open Market Committee's "balance of risks" is an assessment of whether, in the future, its primary concern will be 1. A) higher exchange rates or higher unemployment. 2. B) higher inflation or a stronger economy. 3. C) higher inflation or a weaker economy. 4. D) lower inflation or a stronger economy.

C 39

The Dodd-Frank bill created an agency to monitor markets for asset price bubbles and the buildup of systemic risk. This agency is called the 1. A) Resolution Trust Authority. 2. B) Board of Governors. 3. C) Financial Stability Oversight Council. 4. D) Macroprudential Supervisory Agency.

C 41

The most important source of the changes in supply conditions that stimulate financial innovation has been the 1. A) deregulation of financial institutions. 2. B) dramatic increase in the volatility of interest rates. 3. C) improvement in information technology. 4. D) dramatic increase in competition from foreign banks.

C 41

New computer technology has 1. A) increased the cost of financial innovation. 2. B) increased the demand for financial innovation. 3. C) reduced the cost of financial innovation. 4. D) reduced the demand for financial innovation.

C 42

One suggested method of reducing excessive risk-taking by SIFIs is to require them to hold ________ capital when credit is expanding rapidly and ________ capital when credit is contracting. 1. A) less; more 2. B) more; no 3. C) more; less 4. D) less; no

C 43

A debit card differs from a credit card in that 1. A) a debit card is a loan while for a credit card purchase, payment is made immediately. 2. B) a debit card is a long-term loan while a credit card is a short-term loan. 3. C) a credit card is a loan while for a debit card purchase, payment is made immediately. 4. D) a credit card is a long-term loan while a debit card is a short-term loan.

C 46

Automated teller machines 1. A) are more costly to use than human tellers, so banks discourage their use by charging more for use of ATMs. 2. B) cost about the same to use as human tellers in banks, so banks discourage their use by charging more for use of ATMs. 3. C) cost less than human tellers, so banks may encourage their use by charging less for using ATMs. 4. D) cost nothing to use, so banks provide their services free of charge.

C 47

Members of Congress are able to influence monetary policy, albeit indirectly, through their ability to 1. A) withhold appropriations from the Board of Governors. 2. B) withhold appropriations from the Federal Open Market Committee. 3. C) propose legislation that would force the Fed to submit budget requests to Congress, as must other government agencies. 4. D) instruct the General Accounting Office to audit the foreign exchange market functions of the Federal Reserve.

C 47

The declining cost of computer technology has made ________ a reality. 1. A) brick and mortar banking 2. B) commercial banking 3. C) virtual banking 4. D) investment banking

C 48

The case for Federal Reserve independence does NOT include the idea that 1. A) political pressure would impart an inflationary bias to monetary policy. 2. B) a politically insulated Fed would be more concerned with long-run objectives and thus be a defender of a sound dollar and a stable price level. 3. C) policy is always performed better by an elite group such as the Fed. 4. D) a Federal Reserve under the control of Congress or the president might make the so-called political business cycle more pronounced.

C 49

The current supervisory practice toward risk management 1. A) focuses on the quality of a bank's balance sheet. 2. B) determines whether capital requirements have been met. 3. C) evaluates the soundness of a bank's risk-management process. 4. D) focuses on eliminating all risk.

C 49

Because of the abuses by state banks and the clear need for a central bank to help the federal government raise funds during the War of 1812, Congress created the 1. A) Bank of United States in 1812. 2. B) Bank of North America in 1814. 3. C) Second Bank of the United States in 1816. 4. D) Second Bank of North America in 1815.

C 5

________ are asymmetric information problems that act as a barrier to efficient allocation of capital. 1. A) Asset prices 2. B) Credit imbalances 3. C) Financial frictions 4. D) Financial derivatives

C 5

The driving force behind the securitization of mortgages and automobile loans has been 1. A) the rising regulatory constraints on substitute financial instruments. 2. B) the desire of mortgage and auto lenders to exit this field of lending. 3. C) the improvement in information technology. 4. D) the relaxation of regulatory restrictions on credit card operations.

C 58

Financial crises in advanced economies might start from a 1. A) debt deflation. 2. B) currency crisis. 3. C) mismanagement of financial innovations. 4. D) currency mismatch.

C 6

Under the European System of Central Banks, the National Central Banks have the same role as the ________ of the Federal Reserve System. 1. A) Board of Governors 2. B) Federal Open Market Committee 3. C) Federal Reserve Banks 4. D) Federal Advisory Council

C 60

According to Edward Kane, because the banking industry is one of the most ________ industries in America, it is an industry in which ________ is especially likely to occur. 1. A) competitive; loophole mining 2. B) competitive; innovation 3. C) regulated; loophole mining 4. D) regulated; innovation

C 62

Loophole mining refers to financial innovation designed to 1. A) hide transactions from the IRS. 2. B) conceal transactions from the SEC. 3. C) get around regulations. 4. D) conceal transactions from the Treasury Department.

C 63

In the Governing Council, the decision of what policy to implement is made by 1. A) majority vote of the Executive Board members. 2. B) majority vote of the heads of the National Banks. 3. C) consensus. 4. D) majority vote of all members of the Governing Council.

C 64

The central bank which is generally regarded as the most independent in the world because its charter cannot be changed by legislation is the 1. A) Bank of England. 2. B) Bank of Canada. 3. C) European Central Bank. 4. D) Bank of Japan.

C 65

The process in which people seeking higher yielding securities take their funds out of the banking system thus restricting the amount of funds banks can lend is called 1. A) capital mobility. 2. B) loophole mining. 3. C) disintermediation. 4. D) deposit jumping.

C 67

During the boom years of the 1920s, bank failures were quite 1. A) uncommon, averaging less than 30 per year. 2. B) uncommon, averaging less than 100 per year. 3. C) common, averaging about 600 per year. 4. D) common, averaging about 1000 per year.

C 7

The major provisions of the Competitive Equality Banking Act of 1987 include 1. A) expanding the responsibilities of the FDIC, which is now the sole administrator of the federal deposit insurance system. 2. B) the establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts placed in conservatorship or receivership. 3. C) directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance. 4. D) prompt corrective action when a bank gets in trouble.

C 75

"Bureaucratic gambling" refers to 1. A) the strategy of thrift managers that they would not be audited by thrift regulators in the 1980s due to the relatively weak bureaucratic power of thrift regulators. 2. B) the risk that thrift regulators took in publicizing the plight of the S&L industry in the early 1980s. 3. C) the strategy adopted by thrift regulators of lowering capital requirements and pursuing regulatory forbearance in the 1980s in the hope that conditions in the S&L industry would improve. 4. D) the risk that regulators took in going to Congress to ask for additional funds.

C 77

An analysis of the political economy of the savings and loan crisis helps one to understand 1. A) why politicians aided the efforts of thrift regulators, raising regulatory appropriations and encouraging closing of insolvent thrifts. 2. B) why thrift regulators were so quick to inform Congress of the problems that existed in the thrift industry. 3. C) why thrift regulators willingly acceded to pressures placed upon them by members of Congress. 4. D) why politicians listened so closely to the taxpayers they represented.

C 80

Taxpayers were served poorly by thrift regulators in the 1980s. This poor performance cannot be explained by 1. A) regulators' desire to escape blame for poor performance, leading to a perverse strategy of "bureaucratic gambling." 2. B) regulators' incentives to accede to pressures imposed by politicians, who sought to keep regulators from imposing tough regulations on institutions that were major campaign contributors. 3. C) Congress's dogged determination to protect taxpayers from the unsound banking practices of managers at many of the nation's savings and loans. 4. D) politicians strong incentives to act in their own interests rather than the interests of the taxpayers.

C 81

The presence of so many commercial banks in the United States is most likely the result of 1. A) consumers' strong desire for dealing with only local banks. 2. B) adverse selection and moral hazard problems that give local banks a competitive advantage over larger banks. 3. C) prior regulations that restricted the ability of these financial institutions to open branches. 4. D) consumers' preference for state banks.

C 86

The belief that bank failures were regularly caused by fraud or the lack of sufficient bank capital explains, in part, the passage of 1. A) the National Bank Charter Amendments of 1918. 2. B) the Garn-St. Germain Act of 1982. 3. C) the National Bank Act of 1863. 4. D) Federal Reserve Act of 1913.

C 9

The three largest Federal Reserve banks (New York, Chicago, and San Francisco) combined hold more than ________ percent of the assets of the Federal Reserve System. 1. A) 25 2. B) 33 3. C) 50 4. D) 67

C 9

Make the case for and against an independent Federal Reserve.

Case for: 1. An independent Federal Reserve can shield the economy from the political business cycle, and it will be less likely to have an inflationary bias to monetary policy. 2. Control of the money supply is too important to leave to inexperienced politicians. Case against: 1. It is undemocratic to have monetary policy be controlled by a small number of individuals that are not accountable. 2. In the past, an independent Fed has not used its freedom wisely. 3. Its independence may encourage it to pursue its own self-interest rather than the public's interest. 54 The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize 1. A) the public's welfare. 2. B) profits. 3. C) its own welfare. 4. D) conflict with the executive and legislative branches of government. Answer: C 55

The Governing Council usually meets ________ times a year. 1. A) four 2. B) six 3. C) eight 4. D) twelve

D 63

The business term for economies of scope is 1. A) economies of scale. 2. B) diversification. 3. C) cooperation. 4. D) synergies.

D 100

The legislation that overturned the prohibition on interstate banking is 1. A) the McFadden Act. 2. B) the Gramm-Leach-Bliley Act. 3. C) the Glass-Steagall Act. 4. D) the Riegle-Neal Act.

D 101

Although it has a population about half that of the United States, Japan has 1. A) many more banks. 2. B) about 25 percent of the number of banks. 3. C) more than 5000 commercial banks. 4. D) fewer than 100 commercial banks.

D 102

When banks offer borrowers smaller loans than they have requested, banks are said to 1. A) shave credit. 2. B) rediscount the loan. 3. C) raze credit. 4. D) ration credit.

D 106

As the banking system in the United States evolves, it is expected that 1. A) the number and importance of small banks will increase. 2. B) the number and importance of large banks will decrease. 3. C) small banks will grow at the expense of large banks. 4. D) the number and importance of large banks will increase.

D 108

Each Federal Reserve bank has nine directors. Of these ________ are appointed by the member banks and ________ are appointed by the Board of Governors. 1. A) three; six 2. B) four; five 3. C) five; four 4. D) six; three

D 11

The difference of rate-sensitive liabilities and rate-sensitive assets is known as the 1. A) duration. 2. B) interest-sensitivity index. 3. C) rate-risk index. 4. D) gap.

D 115

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 1. A) increase by $15 million. 2. B) increase by $1.5 million. 3. C) decline by $15 million. 4. D) decline by $1.5 million.

D 116

Thrift institutions include 1. A) commercial banks. 2. B) brokerage firms 3. C) insurance companies. 4. D) mutual savings banks.

D 118

The nine directors of the Federal Reserve Banks are split into three categories: ________ are professional bankers, ________ are leaders from industry, and ________ are to represent the public interest and are not allowed to be officers, employees, or stockholders of banks. 1. A) 5; 2; 2 2. B) 2; 5; 2 3. C) 4; 2; 3 4. D) 3; 3; 3

D 12

An essential characteristic of credit unions is that 1. A) they are typically large. 2. B) branching across state lines is prohibited. 3. C) their lending is primarily for mortgage loans. 4. D) they are organized for individuals with a common bond.

D 122

________ are the only depository institutions that are tax-exempt. 1. A) Commercial banks 2. B) Savings and loans 3. C) Mutual savings banks 4. D) Credit unions

D 123

If a banker expects interest rates to fall in the future, her best strategy for the present is 1. A) to increase the duration of the bank's liabilities. 2. B) to buy short-term bonds. 3. C) to sell long-term certificates of deposit. 4. D) to increase the duration of the bank's assets.

D 125

In a bank panic, the source of contagion is the 1. A) free-rider problem. 2. B) too-big-to-fail problem. 3. C) transactions cost problem. 4. D) asymmetric information problem.

D 13

All of the following are examples of off-balance sheet activities that generate fee income for banks EXCEPT 1. A) foreign exchange trades. 2. B) guaranteeing debt securities. 3. C) back-up lines of credit. 4. D) selling negotiable CDs.

D 130

Which of the following is NOT an example of a backup line of credit? 1. A) loan commitments 2. B) overdraft privileges 3. C) standby letters of credit 4. D) mortgages

D 131

A reason why rogue traders have bankrupt their banks is due to 1. A) the separation of trading activities from the bookkeepers. 2. B) stringent supervision of trading activities by bank management. 3. C) accounting errors. 4. D) a failure to maintain proper internal controls.

D 135

Foreign banks may engage in banking activities in the United States by opening all of the following EXCEPT 1. A) an agency office of the foreign bank. 2. B) a subsidiary U.S. bank. 3. C) a branch of the foreign bank. 4. D) a McFadden Corporation.

D 136

Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of liabilities with a duration of 1.05. If interest rates increase from 5 percent to 6 percent, the net worth of the bank falls by 1. A) $1 million. 2. B) $2.4 million. 3. C) $3.6 million. 4. D) $4.8 million.

D 140

If interest rates increase from 9 percent to 10 percent, a bank with a duration gap of 2 years would experience a decrease in its net worth of 1. A) 0.9 percent of its assets. 2. B) 0.9 percent of its liabilities. 3. C) 1.8 percent of its liabilities. 4. D) 1.8 percent of its assets.

D 142

The president from which Federal Reserve Bank always has a vote in the Federal Open Market Committee? 1. A) Philadelphia 2. B) Boston 3. C) San Francisco 4. D) New York

D 15

The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as a 1. A) bilateral regulatory system. 2. B) tiered regulatory system. 3. C) two-tiered regulatory system. 4. D) dual banking system.

D 15

Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ________ problem that banks may take on too ________ risk. 1. A) adverse selection; little 2. B) adverse selection; much 3. C) moral hazard; little 4. D) moral hazard; much

D 18

Banks subject to reserve requirements set by the Federal Reserve System include 1. A) only nationally chartered banks. 2. B) only banks with assets less than $100 million. 3. C) only banks with assets less than $500 million. 4. D) all banks whether or not they are members of the Federal Reserve System.

D 22

If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses. 1. A) payoff; large 2. B) payoff; no 3. C) purchase and assumption; large 4. D) purchase and assumption; no

D 22

The Depository Institutions Deregulation and Monetary Control Act of 1980 1. A) established higher reserve requirements for nonmember than for member banks. 2. B) established higher reserve requirements for member than for nonmember banks. 3. C) abolished reserve requirements. 4. D) established uniform reserve requirements for all banks.

D 23

The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely. 1. A) small; fewer 2. B) small; greater 3. C) big; fewer 4. D) big; greater

D 24

Which bank regulatory agency has the sole regulatory authority over bank holding companies? 1. A) the FDIC 2. B) the Comptroller of the Currency 3. C) the FHLBS 4. D) the Federal Reserve System

D 26

While the discount rate is "established" by the regional Federal Reserve Banks, in truth, the rate is determined by 1. A) Congress. 2. B) the president of the United States. 3. C) the Senate. 4. D) the Board of Governors.

D 28

A bank failure is less likely to occur when 1. A) a bank holds less U.S. government securities. 2. B) a bank suffers large deposit outflows. 3. C) a bank holds fewer excess reserves. 4. D) a bank has more bank capital.

D 30

The government passed the Economic Recovery Act in October 2008 to prevent the financial crisis from continuing to worsen. A controversial component of this act was the 1. A) temporary decrease in the federal deposit insurance limit. 2. B) sale of new subprime mortgage assets. 3. C) borrowing of $150 million from AIG. 4. D) Troubled Asset Relief Program (TARP).

D 32

Microprudential supervision does all of the following EXCEPT 1. A) checking capital ratios of a bank. 2. B) checking a bank's compliance with disclosure requirements. 3. C) assessing the riskiness of an individual bank's activities. 4. D) focusing on financial system liquidity.

D 34

The majority of members of the Federal Open Market Committee are 1. A) Federal Reserve Bank presidents. 2. B) members of the Federal Advisory Council. 3. C) presidents of member banks. 4. D) the seven members of the Board of Governors.

D 34

Each Fed bank president attends FOMC meetings; although only ________ Fed bank presidents vote on policy, all ________ provide input. 1. A) three; ten 2. B) five; ten 3. C) three; twelve 4. D) five; twelve

D 35

In order to ensure that borrowers have an ability to repay residential mortgages, the new consumer protection legislation requires lenders to do all of the following EXCEPT 1. A) verify the income of the borrower. 2. B) verify the borrower's job status. 3. C) check the credit history of the borrower. 4. D) verify that the borrower can read and understand a loan contract.

D 36

Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________. 1. A) 2; adverse selection 2. B) 2; credit risk 3. C) 4; adverse selection 4. D) 4; credit risk

D 37

The Dodd-Frank legislation of 2010 permanently increased the federal deposit insurance to 1. A) $40,000. 2. B) $100,000. 3. C) $200,000. 4. D) $250,000.

D 38

The teal book is the Fed research document containing 1. A) the forecast of national economic variables for the next three years. 2. B) forecasts of the money aggregates conditional on different monetary policy stances. 3. C) information on the state of the economy in each Federal Reserve district. 4. D) both A and B. 5. E) A, B and C.

D 38

Firms that are designated as systemically important financial institutions (SIFIs) are subject to all of the following additional Federal Reserve regulations EXCEPT 1. A) higher capital standards. 2. B) stricter liquidity requirements. 3. C) providing a plan for orderly liquidation if necessary. 4. D) interest rate ceilings on time deposits.

D 39

Subject to the approval of the Board of Governors, the decision of choosing the president of a district Federal Reserve Bank is made by 1. A) all nine district bank directors. 2. B) the six district bank directors elected by the member banks. 3. C) three district bank directors who are professional bankers. 4. D) district bank directors who are not professional bankers. 5. E) class A and class B directors.

D 40

Instrument independence is the ability of ________ to set monetary policy ________. 1. A) the central bank; goals 2. B) Congress; goals 3. C) Congress; instruments 4. D) the central bank; instruments

D 43

The ability of a central bank to set monetary policy instruments is 1. A) political independence. 2. B) goal independence. 3. C) policy independence. 4. D) instrument independence.

D 44

Bank customers perceive Internet-only banks as being 1. A) more secure than physical bank branches. 2. B) a better method for the purchase of long-term savings products. 3. C) better at keeping customer information private. 4. D) prone to many more technical problems.

D 49

Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the 1. A) too-big-to-fail effect. 2. B) moral hazard problem. 3. C) adverse selection problem. 4. D) contagion effect.

D 5

The financial panic of 1907 resulted in such widespread bank failures and substantial losses to depositors that the American public finally became convinced that 1. A) the First Bank of the United States had failed to serve as a lender of last resort. 2. B) the Second Bank of the United States had failed to serve as a lender of last resort. 3. C) the Federal Reserve System had failed to serve as a lender of last resort. 4. D) a central bank was needed to prevent future panics.

D 5

A disadvantage of virtual banks (clicks) is that 1. A) their hours are more limited than physical banks. 2. B) they are less convenient than physical banks. 3. C) they are more costly to operate than physical banks. 4. D) customers worry about the security of on-line transactions.

D 50

Newly-issued high-yield bonds rated below investment grade by the bond-rating agencies are frequently referred to as 1. A) municipal bonds. 2. B) Yankee bonds. 3. C) "fallen angels." 4. D) junk bonds.

D 52

________ is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans. 1. A) Diversification 2. B) Arbitrage 3. C) Computerization 4. D) Securitization

D 57

Which of the following is NOT a reason financial regulation and supervision is difficult in real life? 1. A) Financial institutions have strong incentives to avoid existing regulations. 2. B) Unintended consequences may happen if details in the regulations are not precise. 3. C) Regulated firms lobby politicians to lean on regulators to ease the rules. 4. D) Financial institutions are not required to follow the rules.

D 58

Securitization is a process of asset transformation that involves a number of different financial institutions working together. These financial institutions are known collectively as the 1. A) transformers. 2. B) amalgamation. 3. C) movers and shakers. 4. D) shadow banking system.

D 59

The contagion effect refers to the fact that 1. A) deposit insurance has eliminated the problem of bank failures. 2. B) bank runs involve only sound banks. 3. C) bank runs involve only insolvent banks. 4. D) the failure of one bank can hasten the failure of other banks.

D 6

In the ten year period 1981-1990, 1202 commercial banks were closed, with a peak of 206 failures in 1989. This rate of failures was approximately ________ times greater than that in the period from 1934 to 1980. 1. A) two 2. B) three 3. C) five 4. D) ten

D 63

Prior to 2008, the bank's cost of holding reserves equaled 1. A) the interest paid on deposits times the amount of reserves. 2. B) the interest paid on deposits times the amount of deposits. 3. C) the interest earned on loans times the amount of loans. 4. D) the interest earned on loans times the amount on reserves.

D 65

The Depository Institutions Deregulation and Monetary Control Act of 1980 1. A) separated investment banks and commercial banks. 2. B) restricted the use of ATS accounts. 3. C) imposed restrictive usury ceilings on large agricultural loans. 4. D) increased deposit insurance from $40,000 to $100,000.

D 66

Reasons regulators chose to follow regulatory forbearance rather than to close the insolvent S&Ls include all of the following EXCEPT 1. A) they had insufficient funds to close all of the insolvent S&Ls. 2. B) they were friends with the S&L owners. 3. C) they hoped the problem would go away. 4. D) they did not have the authority to close the insolvent S&Ls.

D 72

The experience of disintermediation in the banking industry illustrates that 1. A) more regulation of financial markets may avoid such problems in the future. 2. B) banks are unable to remain competitive with other financial intermediaries. 3. C) consumers no longer desire the services that banks provide. 4. D) markets invent alternatives to costly regulations.

D 78

Lack of competition in the United States banking industry can be attributed to 1. A) the fact that competition does not benefit consumers. 2. B) the fact that branching has eliminated competition. 3. C) recent legislation restricting competition. 4. D) nineteenth-century populist sentiment.

D 90

The evidence from banking crises in other countries indicates that 1. A) deposit insurance is to blame in each country. 2. B) a government safety net for depositors need not increase moral hazard. 3. C) regulatory forbearance never leads to problems. 4. D) deregulation combined with poor regulatory supervision raises moral hazard incentives.

D 90

All of the following are common to banking crises in different countries EXCEPT 1. A) financial liberalization or innovation. 2. B) weak bank regulatory systems. 3. C) a government safety net. 4. D) a dual banking system.

D 91

A financial innovation that developed as a result of banks avoidance of bank branching restrictions was 1. A) money market mutual funds. 2. B) commercial paper. 3. C) junk bonds. 4. D) bank holding companies.

D 92

The primary reason for the recent reduction in the number of banks is 1. A) bank failures. 2. B) re-regulation of banking. 3. C) restrictions on interstate branching. 4. D) bank consolidation.

D 96

A situation in which a substantial decline in the price level sets in, leading to a further deterioration in firms' net worth because of the increased burden of indebtedness.

Debt Deflation Ch. 13

Explain two concepts of central bank independence. Is the Fed politically independent? Why do economists think central bank independence is important?

Instrument independence is the ability of the central bank to set its instruments, and goal independence is the ability of a central bank to set its goals. The Fed enjoys both types of independence. The Fed is largely independent of political pressure due to its earnings and the conditions of appointment of the Board of Governors and its chairman. However, some political pressure can be applied through the threat or enactment of legislation affecting the Fed. Independence is important because there is some evidence that independent central banks pursue lower rates of inflation without harming overall economic performance. 48

How can specializing in lending help to reduce the adverse selection problem in lending?

Reducing the adverse selection problem requires the banks to acquire information to screen bad credit risks from good credit risks. It is easier for banks to obtain information about local businesses. Also if the bank lends to firms in a few specific industries they will become more knowledgeable about those industries and a better judge of creditworthiness in those industries. 108 Risk that is related to the uncertainty about interest rate movements is called 1. A) default risk. 2. B) interest-rate risk. 3. C) the problem of moral hazard. 4. D) security risk. Answer: B 109

Typically, the economy recovers fairly quickly from a recession. Why did this NOT happen in the United States during the Great Depression?

The 25% decline in the price level from 1930-1933 triggered a debt deflation. The loss of net worth increased adverse selection and moral hazard problems in the credit markets and increased and prolonged the economic contraction. 19

Who are the voting members of the Federal Open Market Committee and why is this committee important? Where does the power lie within this committee?

The FOMC determines the monetary policy of the United States through its decisions about open market operations. It also effectively determines the discount rate and reserve requirements. The seven members of the Board of Governors, the president of the New York Fed, and four of the other eleven regional bank presidents are voting members on a rotating basis. Within the FOMC, the chairman of the Board of Governors wields the power. 42

Why does the Federal Reserve Bank of New York play a special role within the Federal Reserve System?

The New York district contains the largest banks in the country. The New York Fed supervises and examines these banks to insure their soundness and the safety of the nation's financial system. The New York Fed conducts open market operations and foreign exchange transactions for the Fed and Treasury. The New York Fed belongs to the Bank for International Settlements, so its president and the chairman of the Board of Governors represent the U.S. at the monthly meetings of the world's central banks. The New York Fed president is the only president of a regional Fed who is a permanent voting member of the FOMC. 41

What financial innovations helped banks to get around the bank branching restrictions of the McFadden Act?

The introduction of the automated teller machine allowed a bank's customers to have access to funds from various locations not just the bank building and was not subject to the branching restrictions. Bank holding companies could own controlling interest in several banks and other companies related to banking. 95

Explain the similarities and differences between the European System of Central Banks and the Federal Reserve System.

The similarities between the two are in their structure. The National Central Banks of the member countries of the Eurosystem have the same role as the Federal Reserve Banks in the Federal Reserve System. The Executive Board and the Governing Council of the Eurosystem resemble the Board of Governors and the Federal Open Market Committee of the Federal Reserve System, respectively. There are three major differences between the two. The first difference is concerning the control of the budgets. In the Fed, the Board of Governors controls the budgets of the Reserve Banks while in the Eurosystem, the National Banks control the budget of the European Central Bank. The second difference is the monetary operations of the Eurosystem are conducted by the National Banks, so they are not as centralized as the monetary operations in the Federal Reserve System. Finally, the European Central Bank is not involved in the supervision and regulation of the financial institutions in the euro zone while the Federal Reserve is involved with the regulation and supervision of the financial institutions in the United States. 66

What is the theory of bureaucratic behavior and how can it be used to explain the behavior of the Federal Reserve?

The theory of bureaucratic behavior concludes that the main objective of any bureaucracy is to maximize its own welfare, which is related to power and prestige. This can explain why the Federal Reserve has defended its autonomy, avoids conflict with Congress and the president, and its push to gain more control over banks. 57 Under the European System of Central Banks, the Executive Board is similar in structure to the ________ of the Federal Reserve System. 1. A) Board of Governors 2. B) Federal Open Market Committee 3. C) Federal Reserve Banks 4. D) Federal Advisory Council Answer: A 58

Discuss three ways in which U.S. banks can become involved in international banking.

United States banks could open a foreign branch of their bank. A U.S. bank holding company could purchase controlling interest in a foreign bank in a foreign country. A U.S. bank could open a Edge Act Corporation. A U.S. bank could open an International Banking Facility in the U.S. which accepts time deposits from foreigners and makes loans to foreigners in the U.S. Ch. 12

Bank capital is equal to ________ minus ________. 1. A) total assets; total liabilities 2. B) total liabilities; total assets 3. C) total assets; total reserves 4. D) total liabilities; total borrowings

A 19

The largest percentage of banks' holdings of securities consist of 1. A) Treasury and government agency securities. 2. B) tax-exempt municipal securities. 3. C) state and local government securities. 4. D) corporate securities.

A 26

Secondary reserves are so called because 1. A) they can be converted into cash with low transactions costs. 2. B) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms. 3. C) 50% of these assets count toward meeting required reserves. 4. D) they rank second to bank vault cash in importance of bank holdings.

A 30

Banks' asset portfolios include state and local government securities because 1. A) they help to attract business from these government entities. 2. B) banks consider them helpful in attracting accounts of Federal employees. 3. C) the Federal Reserve requires member banks to buy securities from state and local governments located within their respective Federal Reserve districts. 4. D) there is no default-risk with state and local government securities.

A 31

Which of the following are bank assets? 1. A) the building owned by the bank 2. B) a discount loan 3. C) a negotiable CD 4. D) a customer's checking account

A 34

When a new depositor opens a checking account at the First National Bank, the bank's assets ________ and its liabilities ________. 1. A) increase; increase 2. B) increase; decrease 3. C) decrease; increase 4. D) decrease; decrease

A 39

Holding all else constant, when a bank receives the funds for a deposited check 1. A) cash items in the process of collection fall by the amount of the check. 2. B) bank assets increase by the amount of the check. 3. C) bank liabilities decrease by the amount of the check. 4. D) bank reserves increase by the amount of required reserves.

A 43

When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then 1. A) the liabilities of the First National Bank decrease by $10. 2. B) the reserves of the First National Bank increase by $10. 3. C) the liabilities of Citibank decrease by $10. 4. D) the assets of Citibank decrease by $10.

A 45

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 bank's final balance sheet 1. A) the assets at the bank increase by $1 million. 2. B) the liabilities of the bank decrease by $1 million. 3. C) reserves increase by $200,000. 4. D) liabilities increase by $200,000.

A 48

With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is 1. A) $90. 2. B) $100. 3. C) $10. 4. D) $110.

A 49

Which of the following are reported as liabilities on a bank's balance sheet? 1. A) discount loans 2. B) reserves 3. C) U.S. Treasury securities 4. D) real estate loans

A 5

A $100 deposit into my checking account at My Bank increases my checkable deposits by $100, and the bank's ________ by $100. 1. A) reserves 2. B) loans 3. C) capital 4. D) securities

A 51

Which of the following are primary concerns of the bank manager? 1. A) maintaining sufficient reserves to minimize the cost to the bank of deposit outflows 2. B) extending loans to borrowers who will pay low interest rates, but who are poor credit risks 3. C) acquiring funds at a relatively high cost, so that profitable lending opportunities can be realized 4. D) maintaining high levels of capital and thus maximizing the returns to the owners

A 53

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 1. A) $50,000. 2. B) $40,000. 3. C) $30,000. 4. D) $25,000.

A 55

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 1. A) $1.2 million. 2. B) $1.1 million. 3. C) $1 million. 4. D) $900,000.

A 56

If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in 1. A) deposits and reserves. 2. B) deposits and loans. 3. C) capital and reserves. 4. D) capital and loans.

A 57

A $5 million deposit outflow from a bank has the immediate effect of 1. A) reducing deposits and reserves by $5 million. 2. B) reducing deposits and loans by $5 million. 3. C) reducing deposits and securities by $5 million. 4. D) reducing deposits and capital by $5 million.

A 58

Of the following, which would be the last choice for a bank facing a reserve deficiency? 1. A) Call in loans. 2. B) Borrow from the Fed. 3. C) Sell securities. 4. D) Borrow from other banks.

A 62

If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could 1. A) borrow from another bank in the federal funds market. 2. B) buy U.S. Treasury bills. 3. C) increase loans. 4. D) buy corporate bonds.

A 66

Which of the following statements most accurately describes the task of bank asset management? 1. A) Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity. 2. B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return on their operations. 3. C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity needs supersede the desire for profits. 4. D) Banks seek to acquire funds in the least costly way.

A 67

Which of the following has NOT resulted from more active liability management on the part of banks? 1. A) increased bank holdings of cash items 2. B) aggressive targeting of goals for asset growth by banks 3. C) increased use of negotiable CDs to raise funds 4. D) an increased proportion of bank assets held in loans

A 73

Modern liability management has resulted in 1. A) increased sales of negotiable CDs to raise funds. 2. B) increase importance of deposits as a source of funds. 3. C) reduced borrowing by banks in the overnight loan market. 4. D) failure by banks to coordinate management of assets and liabilities.

A 75

A bank failure occurs whenever 1. A) a bank cannot satisfy its obligations to pay its depositors and other creditors. 2. B) a bank suffers a large deposit outflow. 3. C) a bank has to call in a large volume of loans. 4. D) a bank refuses to make new loans.

A 76

A bank is insolvent when 1. A) its liabilities exceed its assets. 2. B) its assets exceed its liabilities. 3. C) its capital exceeds its liabilities. 4. D) its assets increase in value.

A 77

Net profit after taxes per dollar of assets is a basic measure of bank profitability called 1. A) return on assets. 2. B) return on capital. 3. C) return on equity. 4. D) return on investment.

A 79

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. 1. A) reduces; reduces 2. B) increases; increases 3. C) reduces; increases 4. D) increases; reduces

A 83

Banks hold capital because 1. A) they are required to by regulatory authorities. 2. B) higher capital increases the returns to the owners. 3. C) it increases the likelihood of bankruptcy. 4. D) higher capital increases the return on equity.

A 85

Conditions that likely contributed to a credit crunch during the global financial crisis include 1. A) capital shortfalls caused in part by falling real estate prices. 2. B) regulated hikes in bank capital requirements. 3. C) falling interest rates that raised interest rate risk, causing banks to choose to hold more capital. 4. D) increases in reserve requirements.

A 86

Which of the following statements are TRUE? 1. A) Checkable deposits are payable on demand. 2. B) Checkable deposits do not include NOW accounts. 3. C) Checkable deposits are the primary source of bank funds. 4. D) Checkable deposits are assets for the bank.

A 9

Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans. 1. A) adverse selection 2. B) moral hazard 3. C) moral suasion 4. D) intentional fraud

A 90

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. 1. A) specialization in lending; diversifying 2. B) specialization in lending; rationing 3. C) credit rationing; diversifying 4. D) screening; rationing

A 94

To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also 1. A) monitor and enforce them. 2. B) be willing to rewrite the contract if the borrower cannot comply with the restrictions. 3. C) trust the borrower to do the right thing. 4. D) be prepared to extend the deadline when the borrower needs more time to comply.

A 97

Your bank has the following balance sheet: Assets Liabilities Reserves $ 50 million Checkable deposits $200 million Securities 50 million Loans 150 million Bank capital 50 million If the required reserve ratio is 10%, what actions should the bank manager take if there is an unexpected deposit outflow of $50 million?

After the deposit outflow, the bank will have a reserve shortfall of $15 million. The bank manager could try to borrow in the Federal Funds market, take out a discount loan from the Federal Reserve, sell $15 million of the securities the bank owns, sell off $15 million of the loans the bank owns, or lastly call-in $15 million of loans. All of the actions will be costly to the bank. The bank manager should try to acquire the funds with the least costly method. 89

Banks acquire the funds that they use to purchase income-earning assets from such sources as 1. A) cash items in the process of collection. 2. B) savings accounts. 3. C) reserves. 4. D) deposits at other banks.

B 16

Bank loans from the Federal Reserve are called ________ and represent a ________ of funds. 1. A) discount loans; use 2. B) discount loans; source 3. C) fed funds; use 4. D) fed funds; source

B 17

Bank ________ is/are listed on the liability side of the bank's balance sheet. 1. A) reserves 2. B) capital 3. C) securities 4. D) cash items

B 20

The amount of checkable deposits that banks are required by regulation to hold are the 1. A) excess reserves. 2. B) required reserves. 3. C) vault cash. 4. D) total reserves.

B 22

Which of the following are reported as assets on a bank's balance sheet? 1. A) borrowings 2. B) reserves 3. C) savings deposits 4. D) bank capital

B 23

Through correspondent banking, large banks provide services to small banks, including 1. A) loan guarantees. 2. B) foreign exchange transactions. 3. C) issuing stock. 4. D) debt reduction.

B 25

Which of the following bank assets is the most liquid? 1. A) consumer loans 2. B) reserves 3. C) state and local government securities 4. D) U.S. government securities

B 27

In general, banks make profits by selling ________ liabilities and buying ________ assets. 1. A) long-term; shorter-term 2. B) short-term; longer-term 3. C) illiquid; liquid 4. D) risky; risk-free

B 37

Asset transformation can be described as 1. A) borrowing long and lending short. 2. B) borrowing short and lending long. 3. C) borrowing and lending only for the short term. 4. D) borrowing and lending for the long term.

B 38

Which of the following are reported as liabilities on a bank's balance sheet? 1. A) reserves 2. B) checkable deposits 3. C) consumer loans 4. D) deposits with other banks

B 4

When you deposit a $50 bill in the Security Pacific National Bank 1. A) its liabilities decrease by $50. 2. B) its assets increase by $50. 3. C) its reserves decrease by $50. 4. D) its cash items in the process of collection increase by $50.

B 41

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 bank's final balance sheet 1. A) the assets at the bank increase by $800,000. 2. B) the liabilities of the bank increase by $1,000,000. 3. C) the liabilities of the bank increase by $800,000. 4. D) reserves increase by $160,000.

B 47

A deposit outflow results in equal reductions in 1. A) loans and reserves. 2. B) assets and liabilities. 3. C) reserves and capital. 4. D) assets and capital.

B 50

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 1. A) $30,000. 2. B) $25,000. 3. C) $20,000. 4. D) $10,000.

B 54

Bankers' 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 1. A) liability management. 2. B) liquidity management. 3. C) managing interest rate risk. 4. D) managing credit risk.

B 59

A bank with insufficient reserves can increase its reserves by 1. A) lending federal funds. 2. B) calling in loans. 3. C) buying short-term Treasury securities. 4. D) buying municipal bonds.

B 61

Banks hold excess and secondary reserves to 1. A) reduce the interest-rate risk problem. 2. B) provide for unexpected deposit outflows. 3. C) satisfy margin requirements. 4. D) achieve higher earnings than they can with loans.

B 65

Which of the following statements is FALSE? 1. A) Checkable deposits are usually the lowest cost source of bank funds. 2. B) Checkable deposits are the primary source of bank funds. 3. C) Checkable deposits are payable on demand. 4. D) Checkable deposits include NOW accounts.

B 7

A bank will want to hold more excess reserves (everything else equal) when 1. A) it expects to have deposit inflows in the near future. 2. B) brokerage commissions on selling bonds increase. 3. C) the cost of selling loans falls. 4. D) the discount rate decreases.

B 70

Banks that actively manage liabilities will most likely meet a reserve shortfall by 1. A) calling in loans. 2. B) borrowing federal funds. 3. C) selling municipal bonds. 4. D) seeking new deposits.

B 74

For a given return on assets, the lower is bank capital 1. A) the lower is the return for the owners of the bank. 2. B) the higher is the return for the owners of the bank. 3. C) the lower is the credit risk for the owners of the bank. 4. D) the lower the possibility of bank failure.

B 82

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 1. A) adverse credit risk. 2. B) adverse selection. 3. C) moral hazard. 4. D) lemon lenders.

B 91

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. 1. A) moral hazard 2. B) adverse selection 3. C) moral suasion 4. D) adverse lending

B 93

Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called 1. A) proscription bonds. 2. B) restrictive covenants. 3. C) due-on-sale clauses. 4. D) liens.

B 96

Which of the following are transaction deposits? 1. A) savings accounts 2. B) small-denomination time deposits 3. C) checkable deposits 4. D) certificates of deposit

C 11

All of the following are nontransaction deposits EXCEPT 1. A) savings accounts. 2. B) small-denomination time deposits. 3. C) checkable deposits. 4. D) certificates of deposit.

C 12

Large-denomination CDs are ________, so that like a bond they can be resold in a ________ market before they mature. 1. A) nonnegotiable; secondary 2. B) nonnegotiable; primary 3. C) negotiable; secondary 4. D) negotiable; primary

C 13

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. 1. A) money market deposit accounts; time deposits 2. B) checkable deposits; savings accounts 3. C) savings accounts; checkable deposits 4. D) savings accounts; time deposits

C 14

Which of the following is NOT a source of borrowings for a bank? 1. A) federal funds 2. B) Eurodollars 3. C) transaction deposits 4. D) discount loans

C 18

Which of the following statements are TRUE? 1. A) A bank's assets are its sources of funds. 2. B) A bank's liabilities are its uses of funds. 3. C) A bank's balance sheet shows that total assets equal total liabilities plus equity capital. 4. D) A bank's balance sheet indicates whether or not the bank is profitable.

C 2

Bank reserves include 1. A) deposits at the Fed and short-term treasury securities. 2. B) vault cash and short-term Treasury securities. 3. C) vault cash and deposits at the Fed. 4. D) deposits at other banks and deposits at the Fed.

C 21

Secondary reserves include 1. A) deposits at Federal Reserve Banks. 2. B) deposits at other large banks. 3. C) short-term U.S. government securities. 4. D) state and local government securities.

C 28

Because of their ________ liquidity, ________ U.S. government securities are called secondary reserves. 1. A) low; short-term 2. B) low; long-term 3. C) high; short-term 4. D) high; long-term

C 29

Bank's make their profits primarily by issuing 1. A) equity. 2. B) negotiable CDs. 3. C) loans. 4. D) NOW accounts.

C 32

The most important category of assets on a bank's balance sheet is 1. A) other assets. 2. B) securities. 3. C) loans. 4. D) cash items in the process of collection.

C 33

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. 1. A) loans; deposits 2. B) securities; deposits 3. C) liabilities; assets 4. D) assets; liabilities

C 36

When you deposit $50 in currency at Old National Bank 1. A) its assets increase by less than $50 because of reserve requirements. 2. B) its reserves increase by less than $50 because of reserve requirements. 3. C) its liabilities increase by $50. 4. D) its liabilities decrease by $50.

C 42

When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then 1. A) the liabilities of the First National Bank increase by $10. 2. B) the reserves of the First National Bank increase by $ 10. 3. C) the liabilities of Citibank increase by $10. 4. D) the assets of Citibank fall by $10.

C 44

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 1. A) the assets of First National rise by $50. 2. B) the assets of Chemical Bank rise by $50. 3. C) the reserves at First National fall by $50. 4. D) the liabilities at Chemical Bank rise by $50.

C 46

The share of checkable deposits in total bank liabilities has 1. A) expanded moderately over time. 2. B) expanded dramatically over time. 3. C) shrunk over time. 4. D) remained virtually unchanged since 1960.

C 6

If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can 1. A) reduce deposits by $3 million. 2. B) increase loans by $3 million. 3. C) sell $3 million of securities. 4. D) repay its discount loans from the Fed.

C 60

In general, banks would prefer to acquire funds quickly by ________ rather than ________. 1. A) reducing loans; selling securities 2. B) reducing loans; borrowing from the Fed 3. C) borrowing from the Fed; reducing loans 4. D) "calling in" loans; selling securities

C 63

________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow. 1. A) Selling securities 2. B) Selling loans 3. C) Calling in loans 4. D) Selling negotiable CDs

C 64

Banks that suffered significant losses in the 1980s made the mistake of 1. A) holding too many liquid assets. 2. B) minimizing default risk. 3. C) failing to diversify their loan portfolio. 4. D) holding only safe securities.

C 69

As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________. 1. A) decrease; increase 2. B) increase; decrease 3. C) increase; increase 4. D) decrease; not be affected

C 71

Holding large amounts of bank capital helps prevent bank failures because 1. A) it means that the bank has a higher income. 2. B) it makes loans easier to sell. 3. C) it can be used to absorb the losses resulting from bad loans. 4. D) it makes it easier to call in loans.

C 78

In recent years the interest paid on checkable and nontransaction deposits has accounted for around ________ of total bank operating expenses, while the costs involved in servicing accounts have been approximately ________ of operating expenses. 1. A) 45 percent; 55 percent 2. B) 55 percent; 4 percent 3. C) 25 percent; 50 percent 4. D) 50 percent; 30 percent

C 8

Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called 1. A) return on assets. 2. B) return on capital. 3. C) return on equity. 4. D) return on investment.

C 80

The amount of assets per dollar of equity capital is called the 1. A) asset ratio. 2. B) equity ratio. 3. C) equity multiplier. 4. D) asset multiplier.

C 81

In the absence of regulation, banks would probably hold 1. A) too much capital, reducing the efficiency of the payments system. 2. B) too much capital, reducing the profitability of banks. 3. C) too little capital. 4. D) too much capital, making it more difficult to obtain loans.

C 84

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to 1. A) buy back bank stock. 2. B) pay higher dividends. 3. C) shrink the size of the bank. 4. D) sell securities the bank owns and put the funds into the reserve account.

C 88

Because checking accounts are ________ liquid for the depositor than savings accounts, they earn ________ interest rates. 1. A) less; higher 2. B) less; lower 3. C) more; higher 4. D) more; lower

D 10

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. 1. A) savings accounts; time deposits 2. B) money market deposit accounts; time deposits 3. C) money market deposit accounts; savings accounts 4. D) time deposits; savings accounts

D 15

Which of the following are NOT reported as assets on a bank's balance sheet? 1. A) cash items in the process of collection 2. B) deposits with other banks 3. C) U.S. Treasury securities 4. D) checkable deposits

D 24

Which of the following statements is FALSE? 1. A) A bank's assets are its uses of funds. 2. B) A bank issues liabilities to acquire funds. 3. C) The bank's assets provide the bank with income. 4. D) Bank capital is recorded as an asset on the bank balance sheet.

D 3

Banks may borrow from or lend to another bank in the Federal Funds market. A loan of excess reserves from one bank to another bank is recorded as a(n) ________ for the borrowing bank and a(n) ________ for the lending bank. 1. A) asset; asset 2. B) asset; liability 3. C) liability; liability 4. D) liability; asset

D 35

When Jane Brown writes a $100 check to her nephew and he cashes the check, Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100. 1. A) gains; gains 2. B) gains; loses 3. C) loses; gains 4. D) loses; loses

D 40

The goals of bank asset management include 1. A) maximizing risk. 2. B) minimizing liquidity. 3. C) lending at high interest rates regardless of risk. 4. D) purchasing securities with high returns and low risk.

D 68

Which of the following would a bank NOT hold as insurance against the highest cost of deposit outflow-bank failure? 1. A) excess reserves 2. B) secondary reserves 3. C) bank capital 4. D) mortgages

D 72

Which of the following would NOT be a way to increase the return on equity? 1. A) Buy back bank stock. 2. B) Pay higher dividends. 3. C) Acquire new funds by selling negotiable CDs and increase assets with them. 4. D) Sell more bank stock.

D 87

Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the 1. A) adverse selection problem. 2. B) lemon problem. 3. C) adverse credit risk problem. 4. D) moral hazard problem.

D 92

From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem. 1. A) moral hazard; diversification 2. B) diversification; moral hazard 3. C) adverse selection; diversification 4. D) diversification; adverse selection

D 95

Banking crises have occurred throughout the world. What similarities do we find when we look at the different countries?

Financial deregulation with inadequate supervision can lead to increased moral hazard as banks take on more risk. Although deposit insurance was not necessarily a major factor in every country's bank crisis, there was always some kind of government safety net. The presence of the government safety net also leads to increased risk-taking from the banks. Ch. 11 1

Using T-accounts show what happens to reserves at Security National Bank if one individual deposits $1000 in cash into her checking account and another individual withdraws $750 in cash from her checking account.

Security National Bank Assets Liabilities Reserves +$250 Checkable deposits +$250 52

How did the increase in the interest rates in the early 80s contribute to the S&L crisis?

The S&Ls suffered from an interest-rate risk problem. They had many fixed-rate mortgages with low interest rates. As interest rates in the economy began to climb, S&Ls began to lose profitability. Because of deregulation and financial innovation, it became possible for the S&Ls to undertake more risky ventures to try to regain their profitability. Many of them lacked expertise in judging credit risk in the new loan areas resulting in large losses. 89

The government safety net creates both an adverse selection problem and a moral hazard problem. Explain.

The adverse selection problem occurs because risk-loving individuals might view the banking system as a wonderful opportunity to use other peoples' funds knowing that those funds are protected. The moral hazard problem comes about because depositors will not impose discipline on the banks since their funds are protected and the banks knowing this will be tempted to take on more risk than they would otherwise. 27

Your bank has the following balance sheet Assets Liabilities Rate-sensitive $100 million Rate-sensitive $75 million Fixed-rate 100 million Fixed-rate 125 million What would happen to bank profits if the interest rates in the economy go down? Is there anything that you could do to keep your bank from being so vulnerable to interest rate movements?

The bank's profits would go down because it has more interest-rate sensitive assets than liabilities. In order to reduce interest-rate sensitivity, the bank manager could use financial derivatives such as interest-rate swaps, options, or futures. The bank manager could also try to adjust the balance sheet so that the bank's profits are not vulnerable to the movement of the interest rate. 127