Money and Banking Test #2

Government deficits can complicate monetary policy because government borrowing can lead to

"crowding out," which leads to higher interest rates.

CH 14 The FDIC currently insures deposits up to what amount?

$250,000

If the required reserve ratio is 3%, an initial demand deposit made in a bank of $100,000 can result in an expansion in the money supply of

$3,333,000.

Midtown Bank has net income of $50 million, total assets of $1 billion, and equity capital of $500 million. Midtown's ROA is

%5.0 ROA (return on assets) = Net income/Total assets = $50 million/$1 billion = 5.0%.

Midtown Bank has net income of $50 million, total assets of $1 billion, and equity capital of $500 million. Midtown's ROE is

10.0%

For much of U.S. history, banks have been limited in how much they could pay in interest on deposits, but the interest rate ceiling was done away with by the passage of the Depository Institutions Deregulation and Monetary Control Act, which was implemented in what decade?

1980s

CH 14 For much of U.S. history, banks have been limited in how much they could pay in interest on deposits, but the interest rate ceiling was done away with by the passage of the Depository Institutions Deregulation and Monetary Control Act, which was implemented in what decade?

1980s The Depository Institutions Deregulation and Monetary Control Act of 1980 was implemented in that upcoming decade, leaving only the part of Regulation Q that prohibited paying interest on demand deposits.

Ivy has a debt-to-income ratio of 5%; her only debt is her student loan. She would like to take on a car payment. This will be a good idea as long as the new debt does not push her debt-to-income ratio up past what percentage?

20%

Three rounds of extraordinary expansionary monetary policy (QE1, QE2, and QE3) were undertaken by the Fed beginning in November 2008 and ending when?

2014

Adele is looking to get a bank loan for some new appliances. Her net monthly income is $2,000, and she has the following monthly expenses: $500 rent, $100 car payment, $100 student loan payment, $50 car insurance payment, $100 credit card payment, $400 food, $50 gasoline, $100 phone service, $100 Internet service, and $500 retirement fund contribution. Adele's fixed payments as a percentage of her net monthly income are

42.5%

Consider the following data about the economy: currency outstanding (C) = $1 trillion, total deposits (D) = $750 billion, total reserves (R) = $76 billion, and the required reserve ratio (RR ratio) = 10%. What is the level of required reserves for this economy?

75 billion

A bank charter may be issued by which of these agencies

A branch of the US Treasury Department

CH 14 A bank charter may be issued by which of these agencies? The Federal Reserve A branch of the US Treasury Department In large cities, the relevant municipal agency Only by state governments

A branch of the US Treasury Department

Which of the following would be considered an asset on a bank's balance sheet?

A consumer loan

The increasing average debt burden of American households beginning in the mid-1990s coincided with which of these other facts?

A decrease in real wage growth, combined with the elimination of many financial market regulations

If bankers have reason to feel optimistic about the future, they may become very eager to loan money. If insufficient regulations are in place, this could most likely cause what?

A higher percentage of loans in default, as riskier borrowers are attracted to easy loans

Liquidity is the term that has which of these meanings?

A measure of the ease with which one asset can be converted into another asset, usually money

Which of these statements best describes why the required reserve ratio is no longer relevant in most cases today?

About 70% of banks already have reserves that exceed their level of required reserves.

Duration analysis is sometimes done to understand the sensitivity of a bank's position to changes in risk. This is most often done by calculating the duration gap, which is

Asset duration − Liability duration (Liability/Asset)

What do economists mean when they say that banks perform the function of asset transformation?

Asset transformation is the process by which a financial institution creates a new asset out of existing liabilities with different characteristics. Commercial banks take their liabilities (e.g., bank deposits), which are short term and generally small in size, and transform them into large, long-term assets (e.g., bank loans).

Explain the dilemma that bank managers face in trying to balance risk and return.

Bank managers must pay interest to attract deposits, which means that in order to remain solvent and, in fact, be profitable, they must be able to use those funds in a way that generates revenue in excess of the cost of the deposits. However, the assets that offer greater returns, loans, also have a greater risk of default. Bankers must walk a fine line between high-return, high-risk assets and lower-return, more-secure assets.

In 1994, Congress passed a banking act that allowed banks to do what?

Banks could merge across state lines to have branches in multiple states.

Which of these statements best describes the function of banks as part of the aggregate economy?

Banks create or reduce the amount of money available in the economy.

Market risk was a major problem during the financial crisis that began in 2008. As a result, Congress passed the Wall Street Reform and Consumer Protection Act in 2010. Which of the following is specified by the Volcker Rule, which is included in that act?

Banks may not hold assets for speculation to increase their profitability.

Which of these statements is most true of the function of banks?

Banks play a key role in creating money, and they help with the problem of adverse selection.

Which of these statements is most true of the function of banks? Banks are a safe way to save, and savers earn high interest. Banks lend money and help with the problem of symmetric information. Banks play a key role in creating money, and they help with the problem of adverse selection. Banks lend money and help with the problem of free-riders.

Banks play a key role in creating money, and they help with the problem of adverse selection.

Why is it easier for the Fed to manage the level of bank reserves using the term auction facility (TAF) as opposed to using discount window lending?

Banks receive TAF proceeds on a 3-day delay, rather than on the day they are requested.

Which two of these activities define the essence of how a bank functions?

Banks take deposits and make loans.

Which of these describes an example of asymmetric information in the bond market?

Bond issuers have better insight about their future profitability than bond buyers.

Which of these describes an example of asymmetric information in the bond market? Bond issuers have longer-term goals than bond buyers. Bond issuers have better insight about their future profitability than bond buyers. Bond issuers and bond buyers have different experiences in the bond market. Bond issuers are more conservative about the future than bond buyers.

Bond issuers have better insight about their future profitability than bond buyers. Bond issuers have more information than bond buyers do because they have better information about their future profitability than bond buyers.

Which of these statements is the most accurate description of a liquidity trap?

Borrowers are unwilling to borrow, and lenders are unwilling to lend due to pessimism about the future. A liquidity trap arises when borrowers are unwilling to borrow and lenders are unwilling to lend because of pessimism about the future. Expansionary monetary policy, by Keynesian definition, is unlikely to solve the problem, as lack of money is not the issue.

Which of these is an example of asymmetric information in banking? Borrowers and lenders have different expectations about financial markets. Lenders know more about the capacity of borrowers to repay loans than borrowers. Borrowers' goals are short-term while lenders' goals are long-term. Borrowers know more about their capacity to repay loans than lenders.

Borrowers know more about their capacity to repay loans than lenders do, meaning that there is asymmetric information in this relationship.

What is the difference between adverse selection and moral hazard?

Both adverse selection and moral hazard arise out of the existence of asymmetric information in transactions between two or more entities. Asymmetric information is a situation where one party to a transaction has more information relevant to the transaction than the other party. An example of adverse selection would be a person with a life-threatening condition seeking to acquire life insurance. Adverse selection is a problem prior to a transaction. Moral hazard becomes a problem after a transaction is completed. Consider again the life insurance example. Suppose that after a person takes out a $1,000,000 life insurance policy, he begins to participate in extreme sports. This would be an example of moral hazard.

Bank regulators use the CAMELS system to provide a standardized assessment of a bank, where CAMELS stands for

Capital, Assets, Management, Earnings, Liquidity, and Sensitivity

In 1997, the Federal Reserve eased banking regulations so that commercial banks could do what?

Commercial banks could directly take over existing investment banks.

What are two common names for smaller banks? Community or retail banks State or community banks Mini or retail banks Local or state banks

Community or retail banks

Which of these is the best way to get an idea of how a bank is performing?

Compare the different components of a bank's income statement to those of similar banks.

Which of these are among the primary responsibilities of the Federal Reserve?

Conducting monetary policy and acting as the fiscal agent of the US Treasury In addition to conducting monetary policy, the primary responsibilities of the Fed are to provide financial market oversight, act as the fiscal agent of the US Treasury, protect consumers by enforcing financial market regulations, and disseminate economic information.

Which of these are among the assets on a bank's balance sheet? Cash and savings accounts Consumer loans and demand deposits Consumer loans and cash Demand deposits and savings accounts

Consumer loans and cash

The business of banking can best be described in which of these ways? Converting short-term liabilities into short-term assets Converting long-term liabilities into long-term assets Converting monetary deposits into loans Creating new liabilities

Converting monetary deposits into loans

ABC Bank's biggest customers do a lot of business in Country X. This exposes ABC Bank to a high level of risk of what type?

Country risk ABC Bank will have a high degree of country risk as it is so heavily involved in another country. If there is significant governmental failure in this country, ABC Bank is greatly at risk.

Which of these categories describes the largest group of liabilities for banks—by far? Borrowing Demand and long-term deposits Trading Loans from other banks

Demand and long-term deposits

Which of these are among the liabilities on a bank's balance sheet?

Demand deposits and savings accounts

Which of these is not a likely result if banks hold onto excess reserves?

Demand for loans will increase, and business activity will increase.

CH 14 When the FDIC decides to deal with a failed bank using the pay off and liquidate policy, what is being paid off?

Deposit balances to the bank's depositors only

The risk of bank losses due to the impact of a natural disaster is known as a country risk.

False

When interest rates on loans and mortgages are low, the huge rush of easy borrowing is sometimes referred to as a credit crunch.

False

When the US Treasury decides to reduce the value of the US dollar relative to the British pound, there will be a decline in the monetary base in the United States. (T/F)

False

When the US Treasury decides to reduce the value of the US dollar relative to the British pound, there will be a decline in the monetary base in the United States. (T/F)

False When the US Treasury wants the US dollar to fall in value relative to the British pound, it will order the Federal Reserve to buy pounds on the open market. When the Federal Reserve executes this order, it will buy pounds from commercial banks, thus increasing bank reserves and, in the process, increasing the monetary base.

Following the Great Depression, the power of the Fed shifted to the

Federal Open Market Committee. The Banking Act of 1935 brought major changes to the Federal Reserve, one of which was the creation of the Federal Open Market Committee, which became the most powerful committee of the Fed.

Which of these are two approaches a bank can use to evaluate a customer's current capacity to handle more debt?

Fixed payments; debt-to-income ratio

The formula for a bank's interest rate spread is

IRspread = IRloans − IRdeposits.

Since 1933, the FDIC has offered deposit insurance to banks to protect depositors from losses if the bank should fail. When was this amount increased?

In 2008, after the global financial crisis

CH 14 Since 1933, the FDIC has offered deposit insurance to banks to protect depositors from losses if the bank should fail. When was this amount increased?

In 2008, after the global financial crisis FDIC deposit insurance was increased temporarily from $100,000 to $250,000 in 2008. This change was made permanent under the Financial Reform Act of 2010.

One thing a bank can do if it faces a liquidity crisis is to borrow funds from a bank with excess liquidity. (T/F)

In a liquidity crisis, one option is to go to the federal funds market and borrow funds from a bank with more liquidity.

What is the significance of the Glass-Steagall Act?

In the 1930s, it was believed that commercial bank involvement in the underwriting of stocks and bonds contributed to the wave of bank failures. In response to these fears, Congress passed the Glass-Steagall Act in 1933; among other things, this act separated commercial banking, investment banking, and the insurance industry. Under the Glass-Steagall Act, banks were forbidden from underwriting almost all stocks and bonds and were banned from selling insurance. Over time, financial institutions found ways to circumvent the intent of the Glass-Steagall Act until finally in 1999, with the passage of the Financial Services Modernization Act, the separation between commercial banking and investment banking was completely gone.

Explain what is meant by interest rate risk.

In the world of commercial banking, interest rate risk is the risk that changes in interest rates will negatively affect the standing of a bank. When interest rates change, bank assets such as consumer loans and business loans are affected. Similarly, changes in interest rates affect bank liabilities, such as the interest the bank must pay on deposits. Bank deposits tend to be short term, whereas loans tend to be long term. If long-term loans were issued when interest rates were low, but the interest rates the bank must pay on deposits has now increased, it reduces the interest rate spread and the bank's profitability.

What is the biggest gross interest expense for banks?

Interest paid on deposits

Which of the following is true of the European Banking Authority (EBA)?

It was created in 2011 to provide some banking regulations across the European Union and to ensure similar regulations across nations.

CH 14 Which of the following is true of the European Banking Authority (EBA)? It was created in 1995 to provide some banking regulations across the European Union and to ensure similar regulations across nations. It was created in 2011 to provide consistent banking regulations across the European Union and to eliminate national-level regulations. It was created in 2011 to provide some banking regulations across the European Union and to ensure similar regulations across nations. It was created in 1995 to provide consistent banking regulations across the European Union and to eliminate national-level regulations.

It was created in 2011 to provide some banking regulations across the European Union and to ensure similar regulations across nations. The European Banking Authority (EBA) was created in 2011 in response to the global financial crisis that began in 2007-2008. The main goal is to provide European Union-wide regulation and to ensure that national regulations are similar across the various EU member states.

When the Federal Reserve makes a loan at the discount window to a bank, which of the following will happen?

It will increase bank reserves and increase the monetary base.

Tristate Bank has just had a visit from the bank examiner and received a rating of 5 in the CAMELS categories of management and earnings; in each of the other categories, the rating was a 4. If you were an investor in this bank, how would you most likely react to this news?

Liquidate my investment as soon as possible because with these ratings, this bank might be in significant trouble

The net stable funding ratio requires banks to do what?

Maintain stable funding over the next twelve months

Which of these is the most often used and the most flexible monetary tool used by the Federal Reserve?

Open market operations

Eight times a year, the Bank of Canada announces the key policy rates for the nation. These key rates refer to what?

Overnight interest rate

Consider the figure below. The initial equilibrium in the loanable funds market in Etopia is at A. If the banks in Etopia begin to see an upsurge in deposits, this will result in a new equilibrium at what point?

Point D with a decrease in the interest rate

Name the 5 Cs of credit risk, and explain what they are used for. Explain when the debt-to-income ratio would be used.

The 5 Cs of credit risk are character, capacity, capital, collateral, and conditions. These are useful in determining the creditworthiness of a potential borrower. The debt-to-income ratio is useful in deciding if a current borrower can safely take on additional debt.

Critics argue that the Bank of Japan was somewhat timid in its reaction to the global financial crisis that initiated in the United States in 2007. What is the Bank of Japan's response to that criticism?

The Bank of Japan states that it was in no position to be aggressive in its response to the global financial crisis because its balance sheet was already significantly extended in response to its own financial crisis in the late 1990s.

Which of these entities and/or groups can directly affect the monetary base?

The Federal Reserve, commercial banks, and the cash-holding public

Until the implementation of the Financial Services Act of 2012, the United Kingdom had a three-part framework for regulation of its financial system, consisting of the Bank of England, the Treasury Department, and which other entity?

The Financial Services Authority (FSA)

Explain how the Treasury affects the monetary base.

The Treasury can impact the monetary base in two ways. The first is through the conduct of foreign exchange intervention. If the Federal Reserve wants the US dollar to depreciate relative to a foreign currency, it will instruct the Fed to buy the foreign currency on the open market. When the Fed executes that order, it will buy the currency from commercial banks, increasing their reserves of US dollars and expanding the monetary base. The second is through its daily business of the Treasury, collecting tax revenue and making expenditures. When the Treasury makes expenditures, funds are withdrawn from the Treasury's accounts at commercial banks and deposited into its account at the Federal Reserve, temporarily reducing commercial bank reserves.

When there is a high degree of trust in a country's banking system, the amount of cash held out of banks relative to deposits in banks would tend to be what?

The amount of cash held out of banks would be relatively low.

CH 14 What are the arguments for and against allowing banks to hold equities as part of their assets?

The argument against banks holding equities is that shares of stock are risky. If a bank is allowed to hold substantial amounts of equities, and the stock market falls dramatically—as it has a number of times in the past—then the bank's total assets would be affected and would be less valuable overall. The bank might even become insolvent. The argument for holding equities is that even though they are a riskier asset, equities do generally outperform bonds—and other, safer, assets—in the long run. If European banks were to hold equities, then European banks would become more attractive than US banks, as they would have higher returns, albeit with somewhat greater risk. This could cause investors to shift to European bank stocks and away from holding shares in US banks. Thus, the now-less-competitive US banks might have financial difficulty—or even become insolvent.

What are the arguments for and against allowing banks to hold equities as part of their assets?

The argument against banks holding equities is that shares of stock are risky. If a bank is allowed to hold substantial amounts of equities, and the stock market falls dramatically—as it has a number of times in the past—then the bank's total assets would be affected and would be less valuable overall. The bank might even become insolvent. The argument for holding equities is that even though they are a riskier asset, equities do generally outperform bonds—and other, safer, assets—in the long run. If European banks were to hold equities, then European banks would become more attractive than US banks, as they would have higher returns, albeit with somewhat greater risk. This could cause investors to shift to European bank stocks and away from holding shares in US banks. Thus, the now-less-competitive US banks might have financial difficulty—or even become insolvent.

What would be expected in a market for used cars, assuming asymmetric information and buyers who have little way to determine good used cars from poor used cars?

The average price for used cars would go down and drive the better used cars out of the market.

Which of these statements is true of the board of governors of the Fed?

The board of governors consists of six members plus the chair; the term length for members is fourteen years.

The position of chair of the Federal Reserve is filled in what way?

The chair of the Fed is appointed by the president of the United States and confirmed by the US Senate.

Systemic risk is a factor in the current banking system. What does this mean?

The collapse of a single megabank could result in the collapse of the entire financial system

Systemic risk is a factor in the current banking system. What does this mean? The collapse of the largest ten banks worldwide could result in the collapse of the entire financial system. The collapse of a single megabank could result in the collapse of the entire financial system. The collapse of the entire community banking system could result in the collapse of the megabanks. The collapse of the larger megabanks could result in the collapse of the community banks.

The collapse of a single megabank could result in the collapse of the entire financial system.

What problem may occur if an economy has too few banks or none at all?

The economy will be underdeveloped, with a possible increase in unemployment and business failures.

Rachel goes for a job interview and knows a lot about the job she is applying for. The woman who interviews her is filling in for another employee and knows very little about Rachel. We might say the woman conducting the interview is likely to have what kind of situation?

The interviewer has asymmetric information as she knows less about Rachel than Rachel knows of herself.

Christopher buys a US Treasury security from the Federal Reserve in the secondary market. He pays cash. What is the result of this transaction?

The monetary base will decrease, and bank reserves will stay the same.

Claire sells a US Treasury security to the Federal Reserve on the secondary market. She receives a check as payment and then cashes the check at her bank, keeping the cash. Which of the following best describes the result?

The monetary base will increase but bank reserves will stay the same

Claire sells a US Treasury security to the Federal Reserve on the secondary market. She receives a check as payment and then cashes the check at her bank, keeping the cash. Which of the following best describes the result?

The monetary base will increase but bank reserves will stay the same. When the Federal Reserve purchases US Treasury securities from the nonbank public and citizens exchange the checks for cash, bank reserves remain unchanged but currency in circulation grows, increasing the monetary base.

Trevor goes to the ATM machine and withdraws $500 in cash. How will this affect the monetary base?

The monetary base will remain unchanged with the increase in the currency in circulation being exactly offset by a decrease in bank reserves.

Explain the logic of the inverse relationship between the currency ratio and the money supply multiplier.

The money supply multiplier is equal to (1 + k)/(k + re + rr), where k is the currency ratio, re is the excess reserve ratio, and rr is the required reserve ratio. A higher k means the public is holding more cash, so banks have less cash or fewer deposits. Banks need those deposits in order to make loans. With the volume of loans reduced, the money supply will not grow as much. So, when k increases, the money supply multiplier decreases.

The economy is experiencing a decrease in excess reserves relative to the level of bank deposits. What effect will this have on the money supply multiplier?

The money supply multiplier will increase; it will be strengthened.

What is the term for the most liquid assets that a bank holds?

The most liquid assets that a bank has are collectively known as the primary reserves.

During the Great Recession and immediate post-recession years between 2008 and 2014, what happened to the price level in the United States?

The price level fell sharply but then rebounded somewhat

During the Great Recession and immediate post-recession years between 2008 and 2014, what happened to the price level in the United States?

The price level fell sharply but then rebounded somewhat. Between 2008 and 2014, the price level fell sharply at first, but then rebounded somewhat, roughly between 2011 and 2014. Meanwhile, in terms of real GDP growth, the economy did not significantly rebound either.

When the Federal Reserve was created in response to the Panic of 1907, it operated under a doctrine meant to correct the previous problems that led to the panic. Which of these statements best names and describes that doctrine?

The real bills doctrine meant that central banks should lend money to commercial banks with collateral only if those banks, in turn, would support "real" but not speculative economic activity.

What is the meaning of credit risk from the point of view of the bank?

The risk that a borrower will not repay as promised

Explain the simple deposit multiplier process.

The simple deposit multiplier process begins with a bank deposit that creates excess reserves. For example, consider a cash deposit of $10,000 made in Bank A. The deposit creates both an asset and a liability for the bank—the $10,000 deposit is a liability to the bank, but the $10,000 cash is added to the bank's stock of reserves. The required reserve ratio, let's say 10%, tells the bank the portion of its deposits that it must hold as reserves and the portion that it can lend out. In this case, the $10,000 deposit means reserves must increase by $1,000; however, the bank's reserves have increased by $10,000, meaning that $9,000 can be loaned out. When a $9,000 loan is made, the money supply expands by $9,000. The person receiving the loan will deposit it in his or her bank, creating more excess reserves that get loaned out, and the process goes on and on.

What is the purpose of the term auction facility (TAF)?

The term auction facility (TAF), created in December 2007, is a combination of open market operations and discount window lending that allows the Federal Reserve to inject liquidity into financial markets without the stigma associated with banks borrowing from the Fed.

If the US Treasury engages in a foreign exchange intervention to increase the value of the dollar relative to the yuan renminbi by having the Federal Reserve buy dollars and sell yuan renminbi in the foreign market, how will this affect the monetary base?

There will be no impact on the monetary base.

Why are US Treasury securities an attractive asset for banks? They are backed by the global banking system. They have a short term to maturity. They offer a high rate of return. They have a low default risk.

They have a low default risk. US Treasury securities have a low default risk, which makes them attractive to banks.

Banks will most often use financial derivatives, known as derivative contracts, for which of these purposes?

To hedge exchange rate or interest rate risk

Banks will sometimes use derivative contracts for which of these purposes?

To speculate on interest rate movements

What are transaction accounts? Give examples.

Transaction accounts are accounts from which an accountholder can make immediate transactions. There are several types of transaction accounts, including demand deposit accounts, interest-bearing checking accounts, negotiable order of withdrawal (NOW) accounts, and money market deposit accounts (MMDAs).

John Maynard Keynes argued that people demand money for three reasons. What are these three reasons?

Transactions motive, precautionary motive, and speculative motive

Bank certificates of deposit, commonly known as CDs, are a nice, virtually risk-free way to build savings. (T/F)

True

Banks that are too big to fail are prime candidates for bailouts when they experience solvency issues. (T/F)

True

One of the Federal Reserve's most used tools of monetary policy is the buying and selling of US government securities in the secondary market. (T/F)

True

The Financial Services Act of 2012 made it clear that the Bank of England is now the main regulator of British financial markets. (T/F)

True

The complex web of regulators in the US financial industry has contributed to the less than stellar performance of the financial system. (T/F)

True

The money supply multiplier is equal to (1 + k)/(k + rr + re). (T/F)

True

A FICO credit score of higher than 700 is considered good. (T/F)

True The FICO score can range from a low of 300 to a high of 850. A score of higher than 700 is rated as "good."

In 1968, Congress passed a key piece of legislation to protect consumers called the __________ Act.

Truth in Lending

Irving Fisher's equation of exchange is expressed as

V = (PL × T)/MS.

The Bank of Japan's ability to respond to the global financial crisis that began in 2007 was limited by

a bloated balance sheet, which was a result of its response to a financial crisis in Japan in the late 1990s.

In Vance's homeowner's insurance policy, it states that he is required to pay out-of-pocket the first $5,000 for any homeowner's insurance claim that he submits before the insurance company will reimburse for any loss. This is an example of using

a deductible to try to mitigate the problem of moral hazard. Insurance companies will typically use deductibles as part of their insurance policies in order to mitigate the problem of moral hazard.

The business of banking solves the problem of

a liquidity mismatch with savers desiring liquidity and borrowers desiring illiquid loans.

The business of banking solves the problem of moral hazard. liquidity mismatch with savers desiring illiquidity and borrowers desiring liquid loans. liquidity mismatch with savers desiring liquidity and borrowers desiring illiquid loans. adverse selection.

a liquidity mismatch with savers desiring liquidity and borrowers desiring illiquid loans.

If the public's confidence in the banking system is shaken, it may cause

a run on banks

The result of asymmetric information in a market is __________ selection.

adverse

The bond rating system, in which companies like Moody's and Standard & Poor's provide ratings for a company's default risk, is one way to deal with

adverse selection

The loan application process that banks require potential borrowers to go through is an attempt to deal with

adverse selection

Liquidity is important to banks because it allows them to earn a high rate of return. allows them to meet the cash needs of their depositors. lowers their cost of doing business. increases their profits.

allows them to meet the cash needs of their depositors. Banks must maintain a level of liquidity that allows them to meet the cash needs of their depositors.

A one-time deposit in a bank will result in

an expansion in the money supply that is larger than the size of the one-time deposit. A one-time deposit in a bank will result in that bank lending out a majority of the deposit, thus creating new money. This new money will then be deposited in another bank, and the process repeats. Thus, the one-time deposit results in an expansion of the money supply that is larger than the size of the one-time deposit.

When the parties to a transaction have different levels of knowledge about each other and/or the nature and implications of the transaction, it is said that there exists __________ information.

asymmetric

Initially, quantitative easing was not much help in creating economic growth because

banks did not lend out the excess reserves that were created by quantitative easing.

Which of the following is the most liquid of a bank's assets?

cash

Tevye owns a shoe store in the United States and wants to buy some shoes from Aldo, an Italian shoe manufacturer. Aldo is unsure of Tevye's ability to make payment and so is leery of selling the shoes to him. In order to make this transaction, Tevye might go to his bank to get a(n) __________ letter of credit.

commercial

Holly goes to her bank to take out a loan, and the bank agrees to the loan on the condition that Holly maintain a balance of $1,000 in her savings account with the bank. This is an example of a bank using a

compensating balance as a way to mitigate the problem of moral hazard. Banks will sometimes require a borrower to maintain a minimal balance in an account with the bank, known as a compensating balance, as a way to mitigate the problem of moral hazard.

ABC Bank has made several big loans to a mining equipment manufacturer that sells its equipment to the copper mining industry in Chile. Political unrest in Chile is a source of what kind of risk for ABC Bank?

country risk A bank can face risk if one of its customers does business with a company in a politically unstable country. This is referred to as country risk.

If a bank has a positive interest rate gap and interest rates decline, then the bank will experience a(n)

decline in revenue

If a bank has a positive interest rate gap and interest rates decline, then the bank will experience a(n) increase in revenue. decline in revenue. increase in deposits. decrease in deposits.

decline in revenue. If the bank has a positive interest rate gap (amount of interest rate-sensitive assets, IRSA, exceeds the amount of interest rate-sensitive liabilities, IRSL) and interest rates fall, it will experience a greater fall in the income generated by its IRSAs than savings on its IRSLs, thus suffering a decline in revenue.

When the Federal Reserve increases the required reserve ratio, the impact will be to

decrease the size of the money multiplier.

A bank's pretax net income = Net interest income + Noninterest income.

false

Public mistrust of banks was a factor in limiting the effectiveness of the quantitative easing policies that began in 2008.

false

Open market operations in which the European Central Bank specifies an interest rate at which it will lend and then participating banks submit bids on the amount of money they wish to borrow at that rate are known as __________ tenders.

fixed-rate standard

The two major goals of Canadian monetary policy are __________ and __________.

flexible exchange rates; inflation control

The entity responsible for making the monetary policy decisions in the European Central Bank is the

governing council

A measure that can be used to determine whether banks have sufficient liquidity is the liquidity coverage ratio. A bank is considered to have sufficient liquidity when this ratio is

greater than 1

An example of asymmetric information in financial markets is that, in equity markets, directors __________ than shareholders.

have a better sense of future profitability

If the goal of monetary policy is to keep interest rates stable, the Federal Reserve's response to increases in the demand for money will be to

increase the supply of money

Periodic physical examinations of banks by bank regulators typically include

inspection of the quality of a bank's management, assets, lending policies, and compliance with banking regulations.

Regulation Q, part of the Banking Act of 1933, prohibited banks from paying interest on checking accounts. interest on savings accounts. higher interest on checking accounts than they did on savings accounts. higher interest on savings accounts than they did on checking accounts.

interest on checking accounts.

A bank has a customer who deposits $10,000 into a 12-month CD that pays 2.5% interest, and at the end of the 12 months, the customer rolls the funds over into another 12-month CD. This continues for five or six years. Next, suppose the bank uses these funds to grant a five-year auto loan on which the bank charges 4% interest. After a couple of years, the interest rate the bank must pay on CDs rises to 3%. This is an example of what phenomenon?

interest rate risk

For bank executives, the level of bank capital and the level of executive compensation are

inversely related

CH 14 The FDIC prefers to use the purchase and assume strategy to deal with a failed bank rather than the pay off and liquidate approach because it is typically

less expensive.

Federal Reserve notes are considered to be

liabilities of the Federal Reserve. Federal Reserve notes are the Fed's IOUs, or promises to repay, and are therefore liabilities of the Fed.

The goal of Regulation Q was to

limit competition between banks.

A leveraged buyout is an example of a __________ loan.

long-term business

When the Federal Reserve buys US Treasury securities on the open market, it is attempting to

lower interest rates

A potentially important difference between NOW accounts and demand deposits is that NOW accounts

may reserve the right to require seven days' notice prior to making a withdrawal

The Bank of England has two primary responsibilities, which are __________ and __________.

monetary stability; financial stability The two primary responsibilities of the Bank of England are monetary stability and financial stability.

Petra has an automobile accident and finds that as a result her auto insurance premium will increase by 25%. This is an example of an adjustable premium that insurance companies often use as a mechanism to combat

moral hazard.

As a country's financial markets become more highly developed, we can expect monetary policy to be

more effective

As a country's financial markets become more highly developed, we can expect monetary policy to be

more effective. As a country's financial markets become more developed, there is a decrease in the need to hold cash, so the currency rate (k) will fall. A fall in the currency rate increases the money supply multiplier, making monetary policy more effective.

What is the term for mortgages that are pooled together and then sold to investors?

mortgage-backed securities

Savings accounts and certificates of deposit are commonly referred to as __________ accounts.

nontransaction

Banks want to hold as little cash as possible because holding cash

offers a minimal rate of return

The risk that a bank faces from the possibility of a foreign terrorist hacking into its computer network is known as __________ risk.

operational

ABC Bank acquires XYZ Bank through a merger but subsequently fails due to some unforeseen incompatibilities resulting from their widely different cultures. This is an example of __________ risk.

operational Losses from failed strategic moves, like mergers or acquisitions, are typically considered to be a type of operational risk.

The Dodd-Frank Act allowed banks, for the first time, to

pay interest on demand deposits

One advantage that nontransaction accounts have over transaction accounts is that they

pay more interest

Alistair tells a friend that he likes to deposit his entire paycheck into his checking account just in case prices fall. This is an example of the __________ demand for money.

precautionary

A financially healthy bank borrowing overnight from the Federal Reserve is known as

primary credit.

The purchase of direct debt and mortgage-backed securities by the Federal Reserve in November 2008 is referred to as

quantitative easing. In order to inject liquidity into financial markets, the Federal Reserve engaged in the purchase of direct debt and mortgage-backed securities in a policy called quantitative easing.

f the European Central Bank is pursuing a contractionary monetary policy, it will

raise the minimum reserve requirement.

If the European Central Bank is pursuing a contractionary monetary policy, it will

raise the minimum reserve requirement. If the European Central Bank wishes to pursue a contractionary monetary policy, it might increase the minimum reserve requirement, thus reducing the growth rate of the money supply.

In the early days of the Fed, the discount rate, the rate at which the regional Federal Reserve banks would lend to commercial banks, was determined by the

regional Federal Reserve banks

Imagine that Roland goes to his bank and deposits $10,000 in cash into his savings account. The bank, wanting to use those funds to generate revenue for itself, will look to make a loan with this cash. An important determinant of how much of that $10,000 the bank can lend is the

required reserve ratio The required reserve ratio determines the portion of a bank's deposits that must be maintained at the bank in the form of cash or reserves. If that ratio is 10%, then the bank must keep 10%, or $1,000, of Roland's deposit as reserves, while $9,000 can be used to make loans.

Actual bank reserves are equal to

required reserves + excess reserves

Actual bank reserves are equal to

required reserves + excess reserves.

If a bank made a self-liquidating inventory loan, it would be making a __________ loan.

short term business

If a bank made a self-liquidating inventory loan, it would be making a __________ loan

short-term business

An unsecured personal loan is an example of a __________ loan.

short-term consumer

Currently, the power of the Federal Reserve rests with

the chair of the Federal Reserve and a board of six governors.

The Federal Reserve district banks are primarily responsible for

the check-clearing system, supervising and examining banks in their districts, and keeping track of the economy in their districts.

The sum of Federal Reserve notes in circulation, plus US coins, plus bank reserves is collectively referred to by which of these designations?

the monetary base

Cleo is hired as the CEO of Wolfstarter Company, a publicly owned corporation. After she is hired, she authorizes the purchase of a company limousine to chauffeur her around town, purchases a skybox at the stadium of the local NFL team, and provides herself with a company-paid membership at the local country club. This behavior could be an example of

the principal-agent problem.

The Fair Credit Reporting Act of 1970 was passed with the goal to ensure which of the following?

the regulation of consumer credit information

In the figure below, the loanable funds market is in equilibrium at C with the interest rate IR1. In conducting monetary policy, the Federal Reserve engages in the selling of US Treasury securities on the open market, which causes

the supply of loanable funds to decrease to S, causing the equilibrium interest rate to increase to IR2.

In the early stages of the 2007 financial crisis, the Fed introduced term auction lending

to increase the amount of liquidity in the financial system.

When not responding to global financial meltdowns, the main goal of the monetary policy of the Bank of Japan is

to pursue price stability

The liquid bank accounts most often used by accountholders to transfer funds to other parties are known as

transaction deposit accounts

The liquid bank accounts most often used by accountholders to transfer funds to other parties are known as transaction deposit accounts. passbook accounts. certificates of deposit. savings accounts.

transaction deposit accounts. Transaction deposit accounts are accounts that depositors typically use to transfer funds to other parties.

A dual banking system is one in which charters can be granted by national or state/provincial authorities.

true

A significant fault of the bond rating system is the free-rider problem.

true

Bank certificates of deposit, commonly known as CDs, are a nice, virtually risk-free way to build savings.

true

Deductibles are one way insurance companies protect themselves from careless drivers.

true

In the conduct of monetary policy, the Federal Reserve has greater control over open market operations than it does over the results of quantitative easing.

true

One very important function that banks perform in a society is matching savers with borrowers.

true

Times of financial uncertainty tend to cause an increase in the overall demand for money.

true

Deductibles are one way insurance companies protect themselves from careless drivers. (T/F)

true Careless drivers are a risk to insurance companies and sometimes a greater risk to the insurance company than they are to themselves. To overcome this moral hazard to some degree, car insurance typically carries a deductible for damages to the car.

A significant fault of the bond rating system is the free-rider problem. (T/F)

true Bond ratings are relatively easy to find and understand. This creates the free-rider problem, where some members of society benefit from the consumption of a good or service without paying for the good or service.

Banks must weigh the risk versus the return in deciding

what to hold in their portfolio of assets

Banks must weigh the risk versus the return in deciding what to hold in their portfolio of assets. what interest rate to pay on deposit accounts. whether to become a Federal Reserve bank. what portion of their deposits to hold in the form of reserves.

what to hold in their portfolio of assets.

At its inception and during its early days, the power of the Federal Reserve bank lay mostly

with the 12 independent regional Federal Reserve banks