Money and Banking Test 2

are not

Bonds (are/are not) equities because they represent debt for a firm

increase, increase

If a​ firm's profits are expected to increase there will be (an increase/a decrease) in demand for that​ firm's stock and therefore (an increase/ a decrease) in its price.

rises above

A bubble is a situation in which the price of an asset (falls below/rises above) its fundamental value

A. Noise trading

All of the following are concepts from behavioral economics that help us understand how people make choices in financial​ markets, except: A. noise trading. B. overconfidence. C. loss aversion. D. hindsight bias.

Yes, employees no longer have a guaranteed benefit system.

Are there any reasons why​ 401(k) plans might be less desirable to employees?

1) the value of a​ firm's assets minus the value of its liabilities 2) a​ firm's profits 3) a​ firm's equity

Buying stock in a company gives an investor a legal claim on​ _____.

Rather than let banks​ fail, the FDIC steps in to minimize the amount of money it will have to pay out.

From this​ perspective, why might there be too few bank failures as the result of deposit​ insurance?

FDIC protects every dollar a customer has in a bank.

Despite these potential​ drawbacks, economists and members of Congress overwhelmingly support deposit insurance for all of the following​ reasons, except:

ROE is equal to ROA multiplied by the ratio of bank assets to bank capital.

How are ROA and ROE​ related?

1) Finance companies have a small advantage over commercial banks in monitoring the value of​ collateral, which gives them an advantage in consumer​ durables, inventories, and business equipment. 2) A lower degree of regulation allows finance companies to provide loans tailored to match the needs of borrowers more closely than do the standard loans that commercial banks provide.

How are finance companies able to compete against commercial​ banks?

1) Banks can manage credit risk by performing credit risk​ analysis, requiring borrowers to put up​ collateral, and using credit rationing. 2) Banks can manage credit risk by diversifying their assets. 3) Banks can manage risk by creating​ long-term business relationships by which the bank could acquire information about the creditor.

How do banks manage credit​ risk?

1) Banks manage this risk by keeping some funds very​ liquid, such as a reverse repurchase agreement. 2) Banks manage this risk by keeping some funds very​ liquid, such as in the federal funds market. 3) Banks can increase their borrowings to cover liquidity risk.

How do banks manage liquidity​ risk? ​(Check all that apply.​)

1) Banks can reduce​ interest-rate risk by making more floating rate​ loans, or ARMs. 2) ​Interest-rate swaps can reduce​ interest-rate risk exposure.

How do banks manage​ interest-rate risk? ​(Check all that apply.​)

1) By selling stocks when they are above their fundamental values. 2) By buying stocks when they are below their fundamental values.

How might an investor use excess volatility to earn​ above-average returns?

1) By selling stocks whose returns have recently been high. 2) By buying stocks whose returns have recently been low.

How might an investor use mean reversion to earn​ above-average returns?

​Yes, they​ can, but doing so will severely impact the financial system because the funds make up a large fraction of the market for commercial paper and because many firms have become heavily dependent on sales of commercial paper to finance their operations.

If money market mutual funds have​ problems, can't savers just deposit their money in​ banks?

​Yes, investors would have already decreased their demand for this stock causing its price to drop before the announcement was made.

If the decrease in​ Burberry's profits had not been a​ surprise, would the effect of the announcement on its stock price have been​ different?

Underwriting is financial intermediation because the bank brings together savers and the issuers of securities.

In what sense is an investment bank that engages in underwriting acting as a financial​ intermediary?

FDIC insurance is backed by the full faith and credit of the United States government.

In what sense might deposit insurance be considered a federal subsidy for​ banks?

Capital gains are taxed at a lower rate than salary and wage income.

In what way are capital gains taxed differently than salary and wage​ income?

They both borrow short and lend long.

In what ways are contractual savings institutions similar to commercial​ banks?

Investment institutions are different from commercial banks because they do not engage in traditional commercial banking​ activities, such as taking deposits and making loans.

In what ways are investment banks and commercial banks different?

They both borrow short and lend long.

In what ways are investment institutions similar to commercial​ banks?

Contractual savings institutions do not accept deposits like traditional commercial banks do.

In what ways contractual savings institutions and commercial banks different?

1) The shadow banking system invests in more risky assets and tends to be highly leveraged than commercial banks. 2) The commercial banking​ system, unlike the shadow banking​ system, is heavily regulated by the government. 3) The shadow banking​ system, unlike the commercial banking​ system, does not offer traditional banking services such as taking in deposits.

In what ways does the shadow banking system differ from the commercial banking​ system?

1) An investment bank that buys securities with its own capital is not acting as a financial intermediary. 2) By buying securities with its own capital the bank expects to get profit from the yield or the changes in price.

Is an investment bank that buys securities with its own capital acting as a financial​ intermediary?

increase, more

Leverage increases the risk of an investment because although borrowing may (increase, decrease) the potential return of an​ investment, in a market downturn a company may owe (more/less) than the value of the underlying asset.

a​ bank's consent to provide a borrower with a stated amount of funds during some specified time.

Loan commitment is

a financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to a third party.

Loan sales is

nominal, without an adjustment

One economic argument for taxing capital gains differently than other income is that investors have to pay taxes on their (nominal/real) gain (with/without) an adjustment for inflation.

a promise by a bank to lend​ funds, if​ necessary, to the seller of commercial paper at the time that the commercial paper matures.

Standby letters of credit are

1) ownership of a​ firm's stock represents partial ownership of the firm. 2) ownership of a​ firm's stock represents a legal claim on the​ firm's profits.

Stocks are called equities because (2 reasons):

Should

Suppose that the price of Goldman Sachs stock is currently ​$142 per share. You expect that the firm will pay a dividend of ​$1.82 per share at the end of the​ year, at which time you expect that the stock will be selling for ​$164 per share. If you require a return of 15​% to invest in this​ stock, you (should/should not) buy the stock.

the Federal Deposit Insurance Corporation.

The FDIC stands for

investment banks, sophisticated, could

The financial crisis might have been difficult to​ foresee, even by people working in​ high-level positions in the financial​ system, because policy makers assumed that (investment banks/retail banks) were dealing with (sophisticated/novice) investors who (could/couldn't) look after their own interests.

Assets​ = Liabilities​ + Shareholders' Equity.

The key accounting equation on which balance sheets are based is given by

bank deposits

The kind of funding that is obtained from open double quote "various investors who might want their money back within a short period" includes all of the​ following, except:

Real estate loans and U.S.​ government/agency securities.

The most important bank assets are:

​Small-denomination time deposits and Checkable deposits.

The most important bank liabilities are

sell, decreased, not understanding

This type of funding caused investors to (buy/sell) their investments as the underlying value of the investments (increased/decreased). ​Primarily, this was due to investors (understanding/not understanding)open double quote"what was going onclose double quote" during that period.

activities that include trading in the​ futures, options, or swaps market.

Trading activities are

retail, wholesale

Using deposits to finance investments is called _________ funding. Another source of funds is​ short-term borrowing primarily from other financial firms. This type of financing is called ________ funding.

Invest in index funds.

What alternative strategy might be better for an investor to follow instead of actively buying and selling securities​ regularly?

DJIA, S&P 500, NASDAQ Composite

What are the three most important stock market​ indexes?

Traditional plans are​ "defined benefit​ plans" whereas​ 401(k) plans are​ "defined contribution​ plans."

What are​ "traditional pension​ plans," and how do they differ from​ 401(k) plans?

A basket of​ "covered" services,​ i.e., specific practices and procedures as outlined by the insurance policy.

What basket of services does a medical insurance policy​ guarantee?

These indexes are averages of stock prices and indicate the overall performance of the stock market.

What do the stock market indexes do?

markets not subject to the same regulations as commercial banks

What does Bernanke mean by the​ short-term funding​ market?

Breaking the buck occurs when a money market mutual​ fund's share price falls below​ $1.00.

What does​ "breaking the​ buck" mean?

A profit from the sale of an investment.

What is a capital​ gain?

A high net worth or high income individual.

What is an accredited​ investor?

A​ "run" is a rush to withdraw money before everyone else does.

What is a​ "run"?

A stock exchange is a physical location where trading occurs​ face-to-face, while​ over-the-counter markets are virtual markets where dealers are linked by computers to buy and sell stocks.

What is the difference between a stock exchange and an​ over-the-counter market?

Adaptive expectations assume that​ investors' expectations are based on past values of a​ variable, whereas rational expectations assume that investors make forecasts of future values using all available information.

What is the difference between adaptive expectations and rational​ expectations?

A​ bank's return on assets​ (ROA) is the ratio of a​ bank's after-tax profit to the value of its assets. Return on equity​ (ROE) is the ratio of the value of a​ bank's after-tax profit to the value of its capital.

What is the difference between a​ bank's return on assets​ (ROA) and its return on equity​ (ROE)?

A collection of nonbank financial institutions that channel money from savers to borrowers.

What is the shadow banking​ system?

1) Lehman Brothers debt. 2) Lehman Brothers commercial paper.

What is​ "Lehman paper"?

The financing of investments by borrowing rather than using capital.

What is​ leverage?

Underwriting is an activity in which an investment bank guarantees to the issuing corporation the price of a new security and then resells the security for a profit.

What is​ underwriting?

1) The required rate of return is greater than the dividend growth rate of the stock. 2) Investors receive their first dividend immediately rather than at the end of the year. 3) The growth rate of dividends is constant.

What key assumptions does the Gordon growth model​ make?

The potential freezing of​ $1 trillion of positions due to the​ fund's high leverage posed a systemic risk to the system.

What risks did high leverage pose to the financial​ system?

Leverage is a​ double-edged sword: it can increase​ profits, but it can also magnify losses.

What risks does high leverage pose to the​ firm?

2008

When was TARP​ created?

1) Trading activities. 2) Loan sales 3) Loan commitment. 4) Standby letters of credit.

Which from the following are​ off-balance-sheet activities? ​(Check all that​ apply.)

1) Employees have the opportunity to be their own pension managers 2) The employee owns the value of the funds in the plan 3) Employees can make tax deductible contributions to their plan.

Which of the following are reasons why​ 401(k) plans might be more desirable to employees than traditional pension plans

The money market mutual fund industry is important because many firms rely on the access to commercial paper to meet payroll and other operating​ costs, and the elimination of this market would hurt access to this source of funding and have severe adverse consequences for the real economy.

Why is the money market mutual fund industry so​ important?

1) Investors may not exhibit rational behavior when purchasing an overvalued stock. 2) For every overvalued​ asset, there is always an investor willing to buy the asset at an even higher price. 3) Poor investor​ psychology, such as herd​ behavior, may not allow investors to see an asset as overvalued.

Why might bubbles be difficult to​ identify?

1) Policies must be kept affordable while meeting consumer expectations of the highest standard of care. 2) Cost uncertainties make difficult the determination of appropriate policy premiums.

Why might the fact that medical services are always improving and getting more expensive create difficulties for companies offering medical insurance​ policies?

1) The FDIC was established in 1934 after a series of bank failures. 2) The FDIC was established to ameliorate bank runs.

Why the FDIC​ established?

TARP was created to restore the market for​ mortgage-backed securities and other toxic assets in order to provide relief to financial firms that had trillions of dollars worth of these assets on their balance sheets.

Why was it​ created?

Lehman brothers went bankrupt which substantially reduced the value of its commercial paper.

Why was the Lehman paper in the​ fund's portfolio​ worthless?

Depositors at commercial banks were covered by deposit insurance.

Why was there a panic in the​ short-term funding market but not a panic among depositors at commercial​ banks?

It signals that the​ firm's assets are less secure than anticipated.

Why would one money market fund having broken the buck cause a run on other money market​ funds?

Pt = Dt x (1+g)/(re-g)

Write the equation for the Gordon growth model.

investment, commercial

_________ banks rely on wholesale funding of their investments as opposed to the retail funding that __________ banks rely on.

Bank capital appears on the right side of the balance​ sheet, because it is the difference between assets and liabilities.

b. Does a​ bank's capital appear on the left side of the​ bank's balance​ sheet?

​No, a loan from the treasury would not be counted as bank capital.

a. Would a loan from the Treasury be counted as part of a​ bank's capital?

Agree. A fall in interest rates with a positive duration gap will increase a​ bank's capital.

​"A bank that expects interest rates to fall will want the duration of its assets to be greater than the duration of its liabilities​ - a positive duration​ gap." Do you agree with this​ statement?

Disagree. Higher duration of its liabilities will reduce the value of the​ bank's capital.

​"If a bank manager expects interest rates to fall in the​ future, he should increase the duration of his​ bank's liabilities." Do you agree with this​ statement?

activities that do not affect a​ bank's balance sheet because they do not change either the​ bank's assets or its liabilities.

​Off-balance-sheet activities are