Exam 2

With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is

$90

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.

5; 15

Which of the following statements most accurately describes the task of bank asset management?

Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity

Of the following, which would be the last choice for a bank facing a reserve deficiency?

Call in loans

Taxpayers were served poorly by thrift regulators in the 1980s. This poor performance cannot be explained by

Congress's dogged determination to protect taxpayers from the unsound banking practices of managers at many of the nation's savings and loans

To prevent bank runs and the consequent bank failures, the United States established the _______ in 1934 to provide deposit insurance

FDIC

The legislation that separated investment banking from commercial banking until its repeal in 1999 is known as the

Glass-Steagall Act

Holding large amounts of bank capital helps prevent bank failures because

It can be used to absorb the losses resulting from bad loans

To eliminate the abuses of the state-chartered banks, the ______ created a new banking system of federally chartered banks, supervised by the _______

National Bank Act of 1863; Office of the Comptroller of the Currency

Which of the following statements concerning external sources of financing for businesses (other than financial businesses) in the United States are TRUE?

Stocks and bonds, combined, supply less than one-half of the external funds.

The _____ that required separation of commercial and investment banking was repealed in 1999.

The Glass-Steagall Act

Banks face the problem of ______ in loan markets because bad credit risks are the ones most likely to seek bank loans

adverse selection

In order to reduce the _____ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones.

adverse selection

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 default

adverse selection; moral hazard

Prior to 1863, the US commercial banking system was characterized by

all of the above

The government safety net creates _____ problem because risk-loving managers might find banking an attractive industry

an adverse selection

If a bank has $20 million in rate sensitive assets and $50 million in rate sensitive liabilities then

an increase in interest rates will reduce bank profits

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

an increase; reduce

The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance

are likely to take on greater risks than they otherwise would.

A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called

asymmetric information

Currency circulated by banks that could be redeemed for gold was called

banknotes

If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could

borrow from another bank in the federal funds market

Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that

borrowers may find loopholes that make the covenants ineffective.

Because of an expected rise in interest rates in the future, a banker will likely

buy short-term rather than long term bonds

A US bank that has committed to making a payment of 1 million Swiss francs in 3 months at a fixed rate today can hedge the risk of this commitment by

buying a forward contract on Swiss francs for delivery in 3 months

A US bank that has committed to making a payment of 1 million Swiss francs in 3 months at a fixed rate today can hedge the risk of this commitment by

buying a three-month call option on Swiss francs

The leverage ratio is the ratio of a bank's

capital divided by its total assets

Conditions that likely contributed to a credit crunch during the 2008 financial crisis include

capital shortfalls caused in part by falling real estate prices

Which of the following are reported as liabilities on a bank's balance sheet

checkable deposits

Although the National Bank Act of 1863 was designed to eliminate the problems of the state-chartered banking system, the new federally-chartered system was plagued by

chronic shortages of reserves leading to frequent market-wide drops in securities prices

Assets promised to the lender as compensation if the borrower defaults is called

collateral

In developing countries, it can be expensive and time-consuming for the poor to legalize their property ownership. Without legal title, the property cannot be used as ______ to borrow funds

collateral

Net worth can perform a similar role to

collateral

Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the

contagion effect

If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to

decline by 1.5 million

Which of the following are reported as liabilities on a bank's balance sheet?

discount loans

Bank loans from the Federal Reserve are called ______ and represent a ________ of funds

discount loans; source

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

disintermediation

The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks from

engaging in underwriting and dealing of corporate securities

Banks that suffered significant losses in the 1980s made the mistake of

failing to diversify their loan portfolio

The difference of rate-sensitive liabilities and rate-sensitive assets is known as the

gap

Money market mutual funds were originally established to

get around the Regulation Q interest rate ceiling that bank deposits were subject to

When a new depositor opens a checking account at the First National Bank with a cash deposit, First National Bank's assets ______ and its liabilities ______

increase; increase

Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in

increased risk taking by banks

Modern liability management has resulted in

increased sales of negotiable CDs to raise funds

In the early stages of the 1980s banking crisis, financial institutions were especially harmed by

increasing interest rates from late 1979 until 1981

Under the Gramm-Leach-Bliley Act states retain regulatory authority over

insurance activities

A bank can reduce its interest rate risk by entering an interest rate swap in which

its interest rate payments are fixed but interest rate receipts are indexed to the Fed Funds rate

A bank is insolvent when

its liabilities exceed its assets

Banks engage in regulatory arbitrage by

keeping high-risk assets on their books while removing low-risk assets with the same capital requirement

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

liability; asset

Regulators attempt to reduce the riskiness of banks' asset portfolios by

limiting the amount of loans in particular categories or to individual borrowers.

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

liquidity management

Bank's make their profits primarily by issuing

loans

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

loses; loses

To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also

monitor and enforce them.

When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of

moral hazard

Because borrowers, once they have a loan, are more likely to invest in a high-risk investment projects, banks face the

moral hazard problem

A well-capitalized financial institution has _______ to lose if it fails and thus is _______ likely to pursue risky activities

more; less

Interest income minus interest expenses divided by assets is a measure of bank performance known as the

net interest margin

The principal-agent problem would not occur if ______ of a firm had complete information about the actions of the _______

owners; managers

Traders working for banks are subject to the

principal-agent problem

The presence of so many commercial banks in the United States is most likely the result of

prior regulations that restricted the ability of these financial institutions to open branches

Moral hazard is an important concern of insurance arrangements because the existence of insurance

provides increased incentives for risk taking

If the FDIC decides that a bank is too big to fail, it will use the ______ method, effectively ensuring that _______ depositors will suffer losses.

purchase and assumption; no

Adjustable rate mortgages

reduce the interest-rate risk for financial institutions

Long-term customer relationships _____ the cost of information collection and make it easier to ______ credit risks

reduce; screen

Bank capital has both benefits and costs for the bank owners. Higher bank capital ______ the likelihood of bankruptcy, but higher bank capital _____ the return on equity for a given return on assets.

reduces; reduces

One of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the

requirement that firms place on their board of directors an officer from the bank

During times of financial crisis, mark-to-market accounting

requires that a financial firms' assets be marked down in value which can worsen the lending crisis.

Provisions in loan contracts the prohibit borrowers from engaging in specified risky activities are called

restrictive covenants

Based on the Net Interest Margin the poor bank performance in the late 1970s

resulted from a narrowing of the gap between interest earned on assets and inters paid on liabilities

The Basel Accord, an international agreement, requires banks to hold capital based on

risk-weighted assets

The process of transforming otherwise illiquid loans into marketable collateralized debt obligations is known as

securitization

If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can

sell $3 million of securities

One way for banks to reduce the principal-agent problems associated with trading activities is to

set limits on the total amount of a traders' transactions

In general, banks make profits by selling _______ liabilities and buying _______ assets.

short-term; longer term

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to

shrink the size of the bank

In one sense _____ appears surprising since it means that the bank is not _______ its portfolio of loans and thus is exposing itself to more risk.

specialization in lending; diversifying

Banks responded to disintermediation by

supporting the elimination of interest rate regulations, enabling them to better compete for funds.

Although the FDIC was created to prevent bank failures, its existence encourages banks to

take too much risk

State banking authorities have sole jurisdiction over state banks

that are without FDIC insurance

The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is

that the FDIC guarantees all deposits when it uses the "purchase and assumption" method.

The legislation overturning the Glass-Steagall Act is

the Gramm-Leach-Bliley Act

Under the Gramm-Leach-Bliley Act the oversight of the securities activities of bank holding companies belongs to

the SEC

Government regulations require publicly traded firms to provide information, reducing

the adverse selection problem

Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been

the creation of the FDIC and deposit insurance

The most significant change in the economic environment that changed the demand for financial products in recent years has been

the dramatic increase in the volatility of interest rates

For a given return on assets, the lower is bank capital

the higher is the return for the owners of the bank

One reason financial systems in developing and transition countries are underdeveloped is

the legal system may be poor making it difficult to enforce restrictive covenants

Adverse selection is a problem associated with equity and debt contracts arising from

the lender's relative lack of information about the borrower's potential returns and risks of his investment activities

When $1 million is deposited by a customer at a bank, the required reserved 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

the liabilities of the bank increase by $1 million

In the absence of regulation, banks would probably hold

too little capital

Bank capital is equal to _______ minus ______

total assets; total liabilities

By bundling share purchases of many investors together, mutual funds can take advantage of economies of scale and thereby lower

transaction costs

The too-big-to-fail policy

treats large depositors of small banks inequitably when compared to depositors of large banks

Bank reserves include

vault cash and deposits at the Fed

A major controversy involving the banking industry in its early years was

whether the federal government or the states should charter banks

The problem of adverse selection helps to explain

why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets

The principal-agent problem

would not arise if the owners of the firm has complete information about the activities of the managers