Midterm 2 Review Questions CH.8-14

Suppose a bank has a​ "gap" of ​-$55 million dollars. If interest rates rise by 2​%, then the change in profits is Using duration​ analysis, if a​ bank's assets have an average duration of four years and the interest rate rises by 2​%, then the percentage change in the​ bank's assets is estimated to be

$-1 million -8%

For every ​$1500 in​ deposits, the amount that banks lost in forgone interest​ (opportunity cost) because of reserve requirements if banks charged 12​% on loans and the require reserve ratio was 20​% is If the required reserve ratio​ decreases, then the foregone interest due to reserve requirements

$36.00 declines

Suppose ​$10,000 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. What are the​ bank's total​ loans?

$8,000

Increasing the independence of a central bank would​ probably:

All of the above are correct

Why is the​ originate-to-distribute business model subject to the​ principal-agent problem?

All of the above are correct

The Board of Governors of the Federal Reserve​ System:

All of the above are correct.

Why is the New York Federal Reserve always a voting member on the​ FOMC?

All of the above are correct.

Suppose that you are the manager of a bank whose​ $100 billion of assets have an average duration of four years and whose​ $90 billion of liabilities have an average duration of six years. Conduct a duration analysis for the​ bank, and show what will happen to the net worth of the bank if interest rates rise by 2 percentage points.

Assets fall in value by ​$8 billion. Liabilities fall in value by ​$10.80 billion. ​ Net worth increases by ​$2.8 billion.

If a bank experiences a deposit outflow of​ $50 million with a required reserve ratio on deposits of​ 10%, which balance sheet would the bank rather have​ initially: Balance Sheet A or Balance Sheet B​? ​Why?

Balance Sheet B because the excess reserves are adequate to cover the deposit outflow without the bank needing to alter its balance sheet

Why is there a higher percentage of banks with less than​ $25 million of assets among commercial banks than among savings and loans and mutual savings​ banks?

Because restrictions on branching are stricter for commercial banks than for savings and​ loans, small commercial banks have greater protection from competition and are more likely to survive than small savings and loans.

Assume that the required reserve ratio on checkable deposits is​ 10%, banks do not hold any excess​ reserves, and the​ public's holdings of currency do not change. If the Fed reduces reserves by selling​ $5 million worth of bonds to the​ banks, what will the​ T-account of the banking system look like when the banking system is in​ equilibrium? What will have happened to the level of checkable​ deposits?

Checkable deposits fall by​ $50 million and the​ T-account is: RESERVES: -5 MILLION SECURITIES: +5 MILLION LOANS: -50 MILLION CHECKABLE DEPOSITS: -50 MILLION

A bank almost always insists that the firms it lends to keep compensating balances at the bank.​ Why?

Compensating balances help establish​ long-term customer​ relationships, which make it easier for the bank to collect information about prospective​ borrowers, thus reducing the adverse selection problem Compensating balances help the bank monitor the activities of a borrowing​ firm, which reduces the moral hazard problem Compensating balances can act as collateral

Which of the following is not an incentive created by regulatory agencies to encourage international​ banking?

Direct federal subsidies.

When depositors withdraw funds from commercial banks to seek other more attractive​ assets, deposit losses in the banking system may restrict the amount of funds that banks can lend. Which of the following identifies this​ process?

Disintermediation

If the Fed lends five banks an additional total of​ $100 million but depositors withdraw​ $50 million and hold it as​ currency, what happens to reserves and the monetary​ base? Use​ T-accounts to explain your answer.

FIVE BANKS: reserves: +50 million discount loans: +100 million deposits: -50 million FEDERAL RESERVE SYSTEM: discount loans: +100 million reserves: +50 million currency: +50 million reserves INCREASE BY 50 MILLION, and the monetary base INCREASES BY 100 MILLION

Why does the United States operate under a dual banking system​?

Federally chartered banks help to stabilize the banking system and are less prone to failure. There is skepticism of centralized power in the U.S. banking system.

How did competitive forces lead to the repeal of the​ Glass-Steagall Act's separation of the banking and securities​ industries?

Financial innovation motivated banks and other financial institutions to bypass the intent of the​ Glass-Steagall Act. The Fed allowed bank holding companies to enter the underwriting business. The​ Act's restrictions put American banks at a competitive disadvantage relative to foreign banks.

What effect might a financial panic have on the money multiplier and the money​ supply? Why?

In a financial​ panic, you would expect the money multiplier to decrease and the money supply to decrease ​, which would cause the excess reserves ratio to increase . Thus depositors are likely to increase their holdings of currency.

Which of the following factors does not explain the rapid growth in international​ banking?

Increased regulation of the U.S. banking industry.

What role does weak financial regulation and supervision play in causing financial​ crises?

It allows financial institutions a better opportunity to engage in excessive​ risk-taking behavior.

Do you think that eliminating or limiting the amount of deposit insurance would be a good​ idea? Explain your answer.

It is not a good idea. Eliminating or limiting the amount of deposit insurance would help reduce the moral hazard of excessive risk taking on the part of banks. It​ would, however, make bank failures and panics more likely.

How does the process of financial innovation impact the effectiveness of macroprudential​ regulation?

It may be difficult for regulators to understand how new financial innovations will impact the overall financial​ system, as these innovations may often be mismanaged or misunderstood.

The collapse of the Bank of Credit and Commerce​ International, BCCI, showed the difficulty of international banking regulation. BCCI operated in more than 70 countries and was supervised by the small country​ of:

Luxembourg

Deposit insurance prevents financial crises. Is this statement always​ true? Which of the following statements support your​ answer?

NO Deposit insurance is unable to prevent the effects of an asset price decline or the spread of a financial crisis to international financial markets. Deposit insurance creates moral hazard incentives encouraging risk taking on the part of banks

Do the​ fourteen-year nonrenewable terms for governors effectively insulate the Board of Governors from political​ pressure?

No. In order to gain additional power to regulate the financial​ system, the governors need the support of Congress and the president to pass favorable legislation.

Why do equity holders care more about ROE than about​ ROA?

ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run

If a bank depositor withdraws​ $1,000 of currency from an​ account, what happens to​ reserves, checkable​ deposits, and the monetary​ base? Assume that the required reserve ratio on checkable deposits is​ 10% and banks do not hold any excess reserves.

Reserves fall by​ $1,000, checkable deposits fall by​ $10,000, and the monetary base remains unchanged.

Why has the trend in bank supervision moved away from a focus on capital requirements to a focus on risk​ management?

Since capital requirements do not effectively indicate whether banks are taking on too much​ risk, risk management allows supervisors to focus more on​ risk-taking procedures and thus may prevent insolvency in the future.

The Fed promotes secrecy by not releasing the minutes of the FOMC meetings to Congress or the public immediately. Discuss the arguments for and against this policy.

The argument for not releasing the FOMC directives immediately is that it keeps Congress off the​ Fed's back, thus enabling the Fed to pursue an independent monetary policy that is less subject to inflation and political business cycles. The argument for releasing the directive immediately is that it would make the Fed more accountable for its actions.

Which of the following is a main provision of the Financial Institutions​ Reform, Recovery, and Enforcement Act of​ 1989?

The establishment of the Resolution Trust Corporation to manage and resolve insolvent thrifts.

Some countries do not advertise that a system of deposit insurance like the FDIC​ (The Federal Deposit Insurance​ Corporation) in the United States exists in their banking system. Which of the following explain why some countries do not advertise that a system of deposit insurance exists in their banking​ system?​

The information about the presence of a system of deposit insurance makes depositors and bank clients less likely to monitor a​ bank's activities. Not advertising deposit insurance may reduce the problem of moral​ hazard, which is created by a system of deposit insurance.

Which of the following is not part of the checks and balances of the Federal Reserve System?

The requirement that all depository institutions keep deposits at the Fed.

What special problem do​ off-balance-sheet activities present to bank​ regulators? What have bank regulators done about this​ problem, if​ anything?

These activities do not appear on bank balance sheets and thus cannot be handled with bank capital requirements. Bank regulators have imposed an additional​ risk-based bank capital requirement.

Which of the following is a correct statement about the​ Dodd-Frank Act of​ 2010?

The​ Dodd-Frank Act created a new independent agency—the Consumer Financial Protection Bureau—that is funded and housed within the Federal Reserve.

The Fed is the most independent of all US government agencies. What is the main difference between it and other government agencies that explains the​ Fed's greater​ independence?

The​ Fed's source of revenue is free from the appropriations process

​"If inflation had not risen in the 1960s and​ 1970s, the banking industry might be healthier​ today." Is this statement​ true, false, or​ uncertain? Explain your answer.

True. Higher inflation helped raise interest​ rates, which caused the disintermediation process to occur and helped create money market mutual funds.

For each of the following​ countries, identify the single most important​ (largest) and least important​ (smallest) source of external funding.

US: nonbank loans/stocks Germany: bank loans/bonds Japan: bank loans/stocks Canada: bank loans/stocks

​"The invention of the computer is the major factor behind the decline of the banking​ industry." Is this statement​ true, false, or​ uncertain? Explain your answer.

Uncertain. The invention of the computer did help lower transaction costs and the costs of collecting​ information, both of which have made other financial institutions more competitive with banks and have allowed corporations to bypass banks and borrow directly from securities markets.​ Therefore, computers were an important factor in the decline of the banking system.​ However, another source of the decline in the banking industry was the loss of cost advantages for the banks in acquiring​ funds, and this loss was due to factors unrelated to the invention of the​ computer, such as the rise in inflation and its interaction with regulations that produced disintermediation.

Why did the Bank of England up until 1997 have a low degree of​ independence?

Until​ 1997, the power to set interest rates was determined exclusively by Her​ Majesty's Treasury.

Regulation of the financial​ system:

adds to the stability of the financial system.

is an asymmetric information problem that occurs before the transaction.

adverse selection

is a special subsidiary of U.S. banks engaged primarily in international banking. are financial institutions within the United States that can accept time deposits from foreigners but are not subject to either reserve requirements or restrictions on interest payments.

an edge act corporation international banking facilities

An open market purchase of $100 of government security from the nonbank public results to _____________________ in checkable deposits in the Nonbank​ Public's T-account An open market sale of government securities to the nonbank public _______________ the monetary base.

an increase lowers

When the nonbank public decides to hold less currency, then we expect The money supply is expected to rise when a decrease in ____________ is observed.

an increase in the money supply excess reserves

The structure of financial markets is the result​ of:

attempting to reduce transaction costs

Which of the following is not an​ income-producing asset on a​ bank's balance​ sheet?

bank reserves

Why are financial intermediaries willing to engage in information collection activities when investors in financial instruments may be unwilling to do​ so?

banks make private loans; their conclusions on who is creditworthy are not made public

The government agency that oversees the banking system and is responsible for the supply of money and credit in the economy is the the __________established in​ 1791, is the first central bank in the United States. The current central bank of the United States is ______________

central bank bank of the united states; the federal reserve

The Federal Reserve System is the​ ___________ for the United​ States, which is defined as the government agency responsible for​ __________.

central​ bank; the conduct of monetary policy

Assets of value promised to the lender as compensation if the borrower defaults are​ called:

collateral

_______________ is property that is pledged to a lender to guarantee payment in the event that the borrower is unable to make debt payments.

collateral

Equity contracts account for a small fraction of external funds raised by American businesses​ because:

costly state verification makes the equity contract less desirable

When you deposit your ​$5000 paycheck in your​ bank, which was written on an account at a different​ bank, the immediate impact on your​ bank's balance sheet is that your​ bank's cash items in the process of collection rise by $5000 and your​ bank's The process of asset transformation is frequently described by saying that banks are in the business of

deposits rise by $5000 borrowing short and lending long

A government can take several steps to reduce asymmetric information problems. Which of the following is least likely to be observed in a nation like the United​ States?

development financial institutions that lend at artificially low rates

The government can solve the​ free-rider problem through the following except

discouraging information collection of private individuals or groups

Which of the following is a benefit to an individual purchasing a mutual​ fund?

diversification

The interest rate on overnight loans from one bank to another is the are the most important policy tool the Fed has for controlling the money supply.

federal funds rate open market operations

Currency in circulation that cannot be redeemed for gold is​ called:

fiat money

The​ ________ problem helps to explain why the private production and sale of information cannot eliminate asymmetric information.

free rider

Which of the following is a feature of the​ Dodd-Frank Act? The​ Dodd-Frank Act created a Financial Stability Oversight Council that designates which financial firms are systematically important and so received the official designation of

giving the federal government the ability to dissolve bank holding companies in an orderly fashion SIFI's

In recent​ years, the tendency for central banks has been​ to:

increase independence

The theory of bureaucratic behaviour when applied to the Fed helps to explain why the​ Fed:

is so secretive about the conduct of future monetary policy

The theory of bureaucratic behavior may help explain why the Fed The​ principal-agent problem

is sometimes slow to increase interest rates. is greater for politicians than for an independent central bank.

The Federal Reserve is remarkably free from political pressure because While the Fed enjoys a relativity high degree of independence for a government​ agency, it feels political pressure from the president and Congress because

it has an independent source of revenue. congress could limit Fed power through legislation

Each of the Federal Reserve banks is considered a​ quasi-public institution because The Board of Governors appoints _________ directors of each district bank.

it is owned by the private commercial banks in its district that are members of the federal reserve system three

Savings and loans grew rapidly in the latter half of the twentieth century because of the following except A significant part of the cost of the savings and loan bailout was ultimately passed onto the

large investment subsidies provided by the federal government to new savings and loans associations. taxpayers

The control exhibited by the Fed over the monetary base is best described as In addition to the currency ratio​ (c) and the excess reserve ratio​ (e), the third determinant of the money multiplier is the The negative effect of the dramatic increase in the excess reserve ratio​ (e) on the money multiplier during the 2007−2009 period could have been mitigated by the Fed by _____________ the required reserve ratio

less than complete since it​ influences, but does not completely​ determine, banks' borrowings from the Fed. required reserve ration (rr) decreasing

Government regulation ______________ the adverse selection problem.

lessens

Debt contracts are

long legal documents with substantial provisions

As a result of strict banking​ regulations, the United States​ has:

many more smaller banks when compared to other industrialised countries

In order to reduce the​ ________ problem in loan​ markets, banks often insist on collateral from potential borrowers.

moral hazard

Your parents loan you money to pay your​ tuition, and you use the money to play online poker instead. This is an example of

moral hazard

The​ principal-agent problem causes The​ principal-agent problem arises because of many reasons except the statement that indicates that

moral hazard agents incentives are always compatible with those of the principals

The monetary policy player that determines the currency holdings is the The monetary policy player that determines the nonborrowed monetary base is the The monetary policy player that determines the borrowed reserves is the

nonbank public federal reserve system banking system

The amount of lending in the economy is _____________________ controlled by the Fed. The monetary base less borrowed reserves is called

not completely the nonborrowed monetary base.

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

previous restrictions on branch banking

What might lead to poor management when control and ownership are​ separate, like in many American​ corporations? what is the reason for this problem?

principal-agent problem a manager does not have sufficient incentive to maximize the company's profits

You go into an electronics store to buy a​ big-screen television. A salesperson rudely tells you that​ he's too busy to help you now. He says​ you'll just have to wait. Then you watch him get a cup of coffee and take his break.​ You've just seen a demonstration of Which of the following reduces both adverse selection and moral hazard in a loan​ arrangement?

principal-agent problem requiring that the borrower have high net worth

If a bank becomes insolvent and the FDIC reorganizes the bank by finding a willing merger​ partner, the FDIC resolved this insolvency problem through the It is ______________for the taxpayer if the FDIC resolves an insolvent institution by the ​"payoff method​".

purchase and assumption method usually cheaper

The sum of a​ bank's vault cash plus its deposits at the Fed is the​ bank's Required reserves are a fixed percentage of a​ bank's If a bank has ​$1000 in deposits and the required reserve ratio is 10​%, then the amount required as the​ bank's reserves is

reserves checkable deposits $100

Asymmetric information can lead to a bank panic​ when:

rumors of impending bank failure lead to mass withdrawals of customer deposits.

Examples of off-balance-sheet activities ​include:

selling loan portfolios

When a bank suffers deposit outflows and has no excess​ reserves, the bank will generally first try to raise the funds by Suppose that a bank has ​$120 in checkable​ deposits, reserves of ​$15​, and a reserve requirement of​ 10%. Also assume that the the bank suffers a ​$10 deposit outflow. If the bank chooses to borrow from the Fed to meet its reserve​ requirement, then the bank would need to borrow

selling some of its securities $6.00

An increase in adverse selection and moral hazard in credit markets _____________ bank lending Financial crises

tends to decrease occur when information flows in financial markets experience a particularly large disruption.

A bank finds that its ROE is too low because it has too much bank capital. Which of the following will not raise its​ ROE?

the bank can sell part of its holdings of securities and hold more excess reserves

With lack of solid information about financial​ conditions, the failure of one bank can lead to runs on other banks. This is known​ as:

the contagion effect

The principal-agent problem that exists for bank trading activities can be reduced​ by:

the physical separation of trading activities from bookkeeping activities

How can the existence of asymmetric information provide a rationale for government regulation of financial​ markets?

the production of information to combat these asymmetries is subject to the free-rider problem

Which of the following is a cost for a bank when it decides to increase the amount of its bank​ capital?

the return on equity decreases

Identify the differences between the United​ States' experiences during the Great Depression and the financial crisis of​ 2007-2009.

the source of asset-price increases was different for both episodes no bank panic occurred in 2007-2009 as opposed to the great depression

When the charter of the Second Bank of the United States expired in​ 1836:

there was no lender of last resort to provide reserves to the banking system.

A deterioration in balance sheets of financial institutions reduces capital and causes a decline in economic activity.

true

The currency that is physically held by banks is known as The fraction of deposits required as reserves is known as the

vault cash required reserve ratio

Which of the following repealed the prohibition on interstate​ banking?

​Riegle-Neal Act.

Loans that the Fed makes to banks appear on the balance sheet as part of its​ __________, and deposits made by banks appear on the​ Fed's balance sheet as part of its​ ____________.

​assets; liabilities

Uncertainty about future​ interest-rate volatility and returns is known​ as:

​interest-rate risk