Chapter 16 Bank Mgt.

A security's bid price will be greater than its ask price.

False

If interest rates fall, a callable bond at par has the potential for large increases in price.

False

In general, banks are less willing to sell securities when the market value is greater than the book value.

False

Under a passive investment strategy, secondary reserves are invested in short-term securities.

False

Which of the following is not true regarding collateralized mortgage obligations (CMOs)? Interest earned on CMOs is exempt from state income taxes. CMO yields are generally higher than comparable Treasury yields. CMOs exhibit little default risk. All of the above are true. Only a. and c. are true.

Interest earned on CMOs is exempt from state income taxes.

Which of the following is not an objective of a bank's investment portfolio? Meeting capital requirements Maintaining liquidity Diversifying credit risk Managing interest rate exposure Preserving capital

Meeting capital requirements

A bank owns a zero coupon bond with 5 years to maturity and a face value of $10,000. If interest rates increase from 6% to 7%, what is the approximate change in price, using Macaulay's duration? $343 $352 -$343 -$352 not enough information is given to answer the question.

Price of Bond: FV = 10,000 N = 5 I = 6 PV = ? = $7,472.58 ΔPrice ≈ - Duration * [Δi/(1+i)] * P ΔPrice ≈ -5 * [.01/1.06] * $7,742.58 = -$352.48

A bank owns a zero coupon bond with 5 years to maturity and a face value of $10,000. If interest rates increase from 6% to 7%, what is the approximate change in price, using Macaulay's duration? In the above question, what is the approximate pricing error when using Macaulay's duration? $8 $10 $12 $14 $16

Price of Bond: FV = 10,000 N = 5 I = 7 PV = ? = $7,129.86 $7,129.86 - $7,472.58 = -$342.72 $352.48 - $342.72 = $9.76 ≈ $10.00

Which of the following U.S. government agencies can borrow directly from the U.S. Treasury? Government National Mortgage Association (Ginnie Mae) Student Loan Marketing Association (Sallie Mae) Small Business Administration (SBA) all of the above a. and c. only

Student Loan Marketing Association (Sallie Mae)

For which of the following classes of securities are unrealized gains and losses included as income? Held-to-maturity Available-for-sale Trading all of the above b. and c. only

Trading

All of the following are money market instruments except: Treasury bills. Eurodollar deposits. commercial paper. Treasury bonds. bankers acceptances.

Treasury bonds.

Fixed-rate mortgages and adjustable-rate mortgages prepay at different rates.

True

The security activities of large banks and small banks are fundamentally different.

True

The yield curve is generally inverted at the top of the business cycle.

True

When loan demand is weak, banks should keep investments short-term.

True

A bank purchases a new 52-week $1,000,000 face value Treasury bill for $950,000. What is the discount rate on this T-bill (Hint: A 52-week T-bill has an original maturity of 364 days) 4.95% 5.00% 5.06% 5.19% 5.26%

a dr = [(FV - P)/FV]*(360/n) = [($1,000,000 - $950,000)/$1,000,000]*(360/364) = .0495

A short-term interest-bearing time draft created by a high-quality bank is called: commercial paper. a bankers acceptance. a Eurodollar deposit. a reverse repurchase agreement. a negotiable CD.

a bankers acceptance.

Which passive investment strategy differentiates between bonds that have been purchased for liquidity versus income purposes? a. Barbell maturity strategy b. Riding the yield curve c. Laddered maturity strategy d. Timing maturity strategy e. Cycle maturity strategy

a. Barbell maturity strategy

Eurodollar: deposits are dollar-denominated deposits issued outside the United States. markets are less regulated than U.S. security markets. rates generally are lower than comparable U.S. CD rates. all of the above a. and b. only

a. and b. only

In general, commercial paper: is rated by the various rating agencies. has a maturity of 270 days or less. sells at a premium to face value. all of the above a. and b. only

a. and b. only

The underlying mortgages in Ginnie Mae mortgage pools include: Federal Housing Association (FHA) mortgages. Veterans Administration (VA) mortgages. privately issued mortgages. all of the above a. and b. only

a. and b. only

Which of the following is/are true? For rate increases, the estimated price based on duration will be below the actual price. For rate increases, the estimated price based on duration will be above the actual price. For rate decreases, the estimated price based on duration will be below the actual price. a. and c. b. and c.

a. and c.

Which of the following U.S. government agency securities are backed by the full faith and credit of the U.S. Government? Government National Mortgage Association (Ginnie Mae) Student Loan Marketing Association (Sallie Mae) Small Business Administration (SBA) all of the above a. and c. only

a. and c. only

Which of the following is true of Treasury bills? Interest on Treasury bills is exempt from state income taxes. Interest on Treasury bills is exempt from federal income taxes. Treasury bills pay a lower pretax yield than comparable corporate securities. All of the above are true. a. and c. only

a. and c. only

Long-term interest rates tend to be higher than short-term interest rates: a. at the bottom of the business cycle. b. at the end of an expansionary period. c. at the beginning of a contractionary period. d. at the peak of the business cycle. e. during periods of rapid deflation.

a. at the bottom of the business cycle.

Securities with embedded options: a. often have higher yields than comparable Treasury securities. b. generally have no prepayment risk. c. are always free of default risk. d. all of the above. e. a. and b. only

a. often have higher yields than comparable Treasury securities.

As market rates rise, prepayment speed _______, while modified duration _________. a. slows, lengthens b. slows, shortens c. accelerates, lengthens d. accelerates, shortens e. accelerates, is unaffected

a. slows, lengthens

Which of the following classes of securities are carried at market value on the balance sheet? Held-to-maturity Available-for-sale Trading all of the above b. and c. only

b. and c. only

Riding the yield curve: a. is risk-free. b. generally involves buying securities with a longer maturity than the intended holding period. c. can only be accomplished with stripped Treasury securities. d. all of the above e. a. and c. only

b. generally involves buying securities with a longer maturity than the intended holding period.

All of the following are capital market instruments except: Treasury bonds. Government National Mortgage Association (Ginnie Mae) bonds. mortgage backed securities. Treasury notes. bankers acceptances.

bankers acceptances.

An investor can invest in either a tax-exempt security that pays 5% or a taxable corporate security of comparable risk and maturity that pays 8%. At what marginal tax rate will the investor be indifferent between these two securities? a. 25.0% b. 32.5% c. 37.5% d. 57.5% e. 62.5%

c 1 - (5%/8%) = .375

A bank has a planned 2-year investment horizon. It is considering investing in a 2-year bond that pays 6% annually versus investing in a 4-year bond that pays 6.5% annually and then selling it after two years. The annual coupon payments can be reinvested at 4%. What will be the realized compound yield if the bank invests in the 2-year security and holds it until maturity? a. 4.00% b. 5.48% c. 5.94% d. 6.01% e. 6.85%

c i = [(Price Received + Coupon Interest + Reinvestment Income)/Price Paid]1/n - 1 i = [($1,000 + (2 * $60) + ($60 * 4%))/$1,000]1/2 - 1 = .05943

Interest on bonds issued by the ____________ are not exempt from state and local taxes. a. Farm Credit System b. Federal Home Loan Banks c. Government National Mortgage Association (Ginnie Mae) d. United States Postal Service e. Student Loan Marketing Association (Sallie Mae)

c. Government National Mortgage Association (Ginnie Mae)

A portfolio is equally invested in securities with 1-, 2-, and 3-years to maturity. Each year as the 1-year securities mature, the funds are reinvested in 3-year securities. This is an example of which investment strategy? a. Barbell maturity strategy b. Riding the yield curve c. Laddered maturity strategy d. Timing maturity strategy e. Cycle maturity strategy

c. Laddered maturity strategy

Which of the following is not true regarding prepayments? a. The greater the prepayments, the shorter the security's duration. b. Prepayments are relatively low during the first two years of a mortgage. c. Mortgages to older people tend to have more prepayments than mortgages to younger people. d. Prepayments increase as interest rates fall. e. all of the above are true

c. Mortgages to older people tend to have more prepayments than mortgages to younger people.

Municipal bonds whose primary source of repayment are the revenues from the underlying financed project are known as: a. general obligation bonds. b. credit free bonds. c. revenue bonds. d. exempt bonds. e. liquidity bonds.

c. revenue bonds.

Regulators generally prohibit banks from purchasing ____________ for income purposes. Treasury bills commercial paper common stock repurchase agreements bankers' acceptances

common stock

Dollar-denominated deposits issued by branches of foreign banks in the United States are known as: a. Asian bonds. b. Eurodollar bonds. c. Foreign bonds. d. Yankee bonds. e. Domestic bonds.

d. Yankee bonds.

The yield curve tends to be inverted: a. at the trough of the business cycle. b. during periods of rapid inflation. c. at the end of a contractionary period. d. at the peak of the business cycle. e. at the beginning of an expansionary period.

d. at the peak of the business cycle.

Banks can effectively improve their portfolios by: a. shortening maturities when yields are expected to fall. b. obtaining less call protection when rates are expected to fall. c. reducing diversification when the economy is slowing down. d. increasing bond quality when quality yield spreads are low. e. all of the above

d. increasing bond quality when quality yield spreads are low.

A security might exhibit negative convexity because: a. its duration is greater than its maturity. b. it has a fixed interest rate below current market rates. c. a bank has a negative GAP. d. it has embedded options. e. markets are not efficient.

d. it has embedded options.

A bank has a planned 2-year investment horizon. It is considering investing in a 2-year bond that pays 6% annually versus investing in a 4-year bond that pays 6.5% annually and then selling it after two years. The annual coupon payments can be reinvested at 4%. What will be the realized compound yield if the bank invests in the 4-year security and sells it at the end of two years, assuming interest rates remain unchanged? a. 4.00% b. 5.48% c. 5.94% d. 6.01% e. 6.85%

e Price Received after selling the 4-year security in 2 years: FV = 1,000 PMT = $65 I = 6 N = 2 PV = ? = $1,009.17 i = [(Price Received + Coupon Interest + Reinvestment Income)/Price Paid]1/n - 1 i = [($1,009.17 + (2 * $65) + ($65 * .04))/$1,000]1/2 - 1 = .06854

Which of the following would not be considered a bank qualified municipal security? a. A Hays County general obligation bond to modernize the county fire department. b. A Lubbock County general obligation bond to build a new sewer plant. c. A City of San Marcos general obligation bond to pay for street repairs. d. A City of El Paso general obligation bond to pay for a new city jail. e. A State of Texas bond to finance road repairs.

e. A State of Texas bond to finance road repairs.

The static spread is: a. the difference between the yield on a zero coupon bond and the yield on a coupon bond. b. the difference between a fixed-rate yield and a floating-rate yield. c. the difference between the yield on new Treasury bills versus new Treasury bonds. d. the difference between expected inflation and the current Treasury bill rate. e. the difference between the yield on a security with options and the yield on a maturity-matched zero coupon Treasury security.

e. the difference between the yield on a security with options and the yield on a maturity-matched zero coupon Treasury security.

If the economy is entering into a recessionary period, you would expect the yield curve to be: upward sloping. flat. inverted. humped. none of the above

inverted

Mortgage prepayment risk: is greatest for stripped securities. increases as interest rates increase. is eliminated in Z-tranche CMOs. is eliminated by buying stripped mortgage backed securities that mature when the bank needs the funds. is larger on high-rate mortgages.

is larger on high-rate mortgages.

A bond that has positive convexity: is more price sensitive when rates fall then when rates rise. is more price sensitive when rates rise then when rates fall. has a negative duration. has a duration greater than maturity. a. and d.

is more price sensitive when rates fall then when rates rise.

If the Federal reserve is easing monetary policy at the end of a recession, you would expect the yield curve to be: upward sloping. flat. inverted. humped. none of the above

upward sloping.

For which of the following classes of securities are unrealized gains and losses included as a component of capital? Held-to-maturity Available-for-sale Trading all of the above a. and c. only

Available-for-sale

On an unadjusted basis, yields on municipal securities are greater than the yields on corporate securities, everything else the same.

False

Most repurchase agreements are secured by: municipal securities. commercial paper. Treasury securities. discount window loans. cash.

Treasury securities.

Most long-term municipal bonds are serial bonds.

True

Which of the following is considered an active investment strategy? a. Barbell maturity strategy b. Riding the yield curve c. Laddered maturity strategy d. Interest maturity strategy e. Risk maturity strategy

b. Riding the yield curve

Which of the following classes of securities are recorded at amortized cost on the balance sheet? a. Held-to-maturity b. Available-for-sale c. Trading d. all of the above e. a. and b. only

A

All of the following are basic functions of a bank's trading activities except: offering investment advice to customers. maintaining an inventory of securities for possible sale to investors. speculating on short-term interest rate movements. All of the above are basic functions of a bank's trading activities. None of the above are basic functions of a bank's trading activities.

All of the above are basic functions of a bank's trading activities.