2035 ch.10
Why do households hold less in checking accounts than they once did?
As wealth has increased, households have been better able to hold other assets, such as CDs, where their money is tied up for a while but on which they earn higher interest. Also, the increased availability of money market mutual funds have attracted funds from households, since they still allow limited checkwriting and pay higher interest.
What is an important difference between certificates of deposits (CDs) worth less than $100,000 compared to those worth $100,000 or more?
CDs of $100,000 or more are negotiable in that they can be traded in secondary markets prior to maturity.
Which of the following statements about checkable deposits is correct?
Checkable deposits are a smaller fraction of banks' funds today than in 1973.
What are the advantages of bank deposits compared to other types of assets?
Compared to cash, bank deposits offer safety against theft and may also pay interest. Compared with financial assets such as Treasury bills, bank deposits are more liquid. Deposits against which checks can be written offer a convenient way to make payments.
Which of the following statements about a checking deposit is TRUE?
It is an asset for households but a liability for a bank.
Suppose a bank has assets of $500 million and capital of $100 million. Its return on assets is -3%. What is its leverage ratio? What is its return on equity?
Its leverage ratio is bank capital / bank assets or $100 million / $500 million = 0.20. Its return on equity is its return on assets × bank assets / bank capital = -3% × (1 / 0.2) = -15%.
Suppose a bank has $10 million in capital, $100 million in assets, and after-tax profit of $2 million. what is its return on assets? What is its return on equity?
Its return on assets is after-tax profit / bank assets or $2 million / $100 million = 2%. Its return on equity is after-tax profits / bank capital or $2 million / $10 million = 20%.
Compare the characteristics of loans and marketable securities in terms of liquidity, risk, and information costs.
Loans are less liquid than marketable securities, have a higher default risk, and higher information costs.
If the value of bank's loans declines, what is the corresponding reduction in a liability entry that the bank makes?
Net worth is reduced by the amount of the decline in the value of the loan.
Suppose First National Bank has $200 million of assets and $20 million of equity capital. If First National has a 2% return on assets (ROA), what is its return on equity (ROE)? Suppose First National's equity capital declines to $10 million, while its assets and ROA are unchanged. What is First National's ROE now?
ROE = ROA × (Bank assets / Bank equity capital); ROE = 2% × (200 / 20) = 20%. ROE = 2% × (200 / 10) = 40%.
Banks use repurchase agreements to
borrow funds from business firms or other banks.
Credit risk is the risk that
borrowers might default on their loans.
Bank capital is
capital contributed by the bank's shareholders plus accumulated retained profits.
Limits on the value of the assets that commercial banks can acquire relative to their capital is known as
capital requirements.
Which of the following is a bank asset?
cash items in the process of collection
All of the following are examples of borrowings by a bank EXCEPT
commercial loans.
In which of the following assets are commercial banks in the United States NOT allowed to invest checkable deposits?
corporate bonds
Researchers at the Federal Reserve discovered that
couples who have similar credit scores at the beginning of their relationship are more likely to stay together than are couples with very different scores.
A checkable deposit that pays no interest is known as a
demand deposit.
The difference between a demand deposit and a NOW account is that
demand deposits pay no interest.
Banks use "credit-risk analysis" to
determine the appropriate interest rate to charge borrowers.
Loans by the Federal Reserve to banks are known as
discount loans.
Which of the following is the source of funds for bank loans?
excess reserves
Any reserves beyond what is required are called
excess reserves.
The interest rate on interbank loans is called the
federal funds rate.
The interest rate on unsecured loans between banks is called the
federal funds rate.
Short-term loans between banks are called
federal funds.
Bank capital can best be described as
funds contributed by shareholder purchasers of a bank's stock plus the accumulated retained earnings.
Moral hazard can contribute to high bank leverage in all of the following ways EXCEPT
having high capital requirements.
Banks experience interest rate risk
if changes in interest rates cause bank profits to fluctuate.
In order to reduce the likelihood of excessive leverage in the banking system, governments have traditionally
imposed capital requirements on commercial banks.
On a bank's balance sheet, total assets are equal to
total liabilities plus bank capital.
Excess reserves equal
total reserves less required reserves.
The most important factor in determining your FICO score is
your history of making payments.
Which of the following is a hybrid of a checking and savings account?
money market deposit account
Which of the following is NOT covered by federal deposit insurance?
money market mutual fund
What is the current limit on balances that are covered by federal deposit insurance?
$250,000
If you deposit a $50 check in the bank, the immediate impact on your bank's balance sheet will be a
$50 increase in reserves and a $50 increase in checkable deposits.
If a bank's ratio of assets to capital is 25 and it's return on assets is -5%, what is its return on equity?
-125%
About what percentage of bank assets was made up of cash items in 2016?
11%
In 2016, net worth was about what percentage of total funds raised by banks?
14%
If a bank has a leverage ratio of 0.1 and a return on assets of 2%, what is its return on equity?
20%
What percentage of bank assets were in security holdings in 2016?
22%
FICO scores range from
300 to 850.
As of 2016, mortgage-backed securities made up what portion of securities held by a bank?
57%
About what percentage of bank assets were loans in 2016?
59%
If a bank's total assets = $3,500 billion, its total liabilities = $3,200 billion, and its bank capital = $300 billion, its bank capital as a percentage of assets is approximately
8.6%.
Why are U.S. government securities referred to as a bank's secondary reserves?
They are very liquid.
What is a repurchase agreement?
Banks sell securities, such as Treasury bills, and agree to repurchase them, typically the next day.
What are the different forms of bank borrowings?
Borrowings include short-term loans in the federal funds market; loans from a bank's foreign branches, subsidiaries or affiliates; repurchase agreements; and discount loans from the Fed.
Which of the following helps explain why depositors sometimes put their funds in demand deposits rather than NOW accounts?
Businesses may not hold NOW accounts.
FICO scores are based on information gathered from the three major credit reporting agencies. Which of the following is NOT one of those agencies?
FDIC
How does moral hazard contribute to high bank leverage?
First, bank managers are typically compensated at least partly on the basis of their ability to provide shareholders with a high ROE. Second, federal deposit insurance has increased moral hazard by reducing the incentive depositors have to monitor the behavior of bank managers.
A person takes out a car loan at a bank, but actually uses the money to play the lottery. This situation is an example of which problem banks face in lending?
moral hazard
Which of the following is NOT considered a cash item by banks?
U.S. Treasury bills
Which asset is sometimes referred to as a bank's secondary reserves?
U.S. government securities
In what ways does a certificate of deposit (CD) differ from a savings deposit?
Unlike savings deposits, CDs have specified maturities. Banks penalize savers who withdraw funds prior to maturity. CDs are less liquid than savings deposits but pay a higher rate of interest.
Which of the following is NOT a nontransaction deposit?
a NOW account
Which of the following is a checkable deposit?
a NOW account
A cash item in the process of collection is
a check drawn against another bank, from whom the funds have not yet been collected.
When a bank issues a checkable deposit and loans the funds out to a business, it has transformed
a financial asset for a saver into a liability for a borrower.
On a bank's balance sheet, bank capital is considered
a liability.
When bank loan officers screen loan applicants to eliminate potentially bad risks, they are attempting to mitigate the problem of
adverse selection.
If you have a checking account at First National Bank, the account is
an asset to you and a liability to First National.
If you deposit $300 in your bank and the required reserve ratio is 10%, your bank will have
an increase in required reserves of $30 and an increase in excess reserves of $270.
Collateral is
assets pledged to the bank in the event the borrower defaults.
In banking, the spread refers to the difference between the
average interest rate earned on assets and the average interest rate paid on liabilities.
A bank's remaining value after it has met all its liabilities is known as
bank capital.
A bank's revenue comes from all of the following EXCEPT
interest earned on vault cash.
The prime interest rate is the
interest rate that banks charge high-quality borrowers.
Banks are exposed to interest rate risk primarily because
interest rates are very difficult to forecast.
A balance sheet
is a statement showing an individual's or a firm's financial position at a particular point in time.
A key difference between small-denomination and large-denomination time deposits is that
large-denomination time deposits may be bought and sold on secondary markets.
The ratio of bank capital to bank assets is known as the bank's
leverage ratio.
What is the largest category of bank assets?
loans
Which of the following things do banks do with the funds they acquire from savers?
make loans to individuals
Banks make use of the federal funds market in part to
manage liquidity risk.
The very low interest rates following the financial crisis of 2007-2009 resulted in
many people moving their funds from CDs and money market accounts to checking accounts in order to have more liquidity without sacrificing much interest.
Which of the following is NOT a bank liability?
mortgage loans
The difference between the interest a bank earns on loans and securities and the interest paid on deposits and debt divided by the total value of its assets is called
net interest margin.
On a bank's balance sheet, "borrowings" are
nondeposit liabilities.
Which of the following is a bank liability?
nontransaction deposits
Which of the following represented the largest liability on the balance sheet of U.S. commercial banks in 2016?
nontransaction deposits
Banks use credit rationing rather than simply raising the interest rate charged to borrowers with higher default risks because
of fear of adverse selection problems.
Customers who have long-term relationships with banks
often obtain credit at a lower rate or with fewer restrictions.
The difference between a savings deposit and a time deposit is
time deposits have specified maturities.
A loan officer uses a credit scoring system to
predict statistically whether an individual is likely to default on a loan.
Businesses hold substantial balances in demand deposits for all of the following reasons EXCEPT
relatively high interest rates.
Which of the following involves banks borrowing funds from firms or other banks using the value of underlying securities as collateral?
repurchase agreement
Securities that banks sell and agree to repurchase are known as
repurchase agreements.
For a bank, the ratio of after-tax profit to assets is its
return on assets.
The ratio of a bank's after-tax profit to bank capital is known as
return on equity.
As a result of the financial crisis, checkable deposits
roughly doubled in terms of the percent of liabilities.
Federal funds are
short-term loans between banks.
Bank capital is equal to
the difference between the value of the bank's assets and the value of its liabilities.
A bank's costs include all of the following EXCEPT
the fees paid to maintain its reserves at the Federal Reserve.
In managing its liabilities to deal with liquidity problems, banks trade off
the need for available funds to meet deposit outflows against the desire for greater profit.
Required reserves are
the portion of demand deposits and NOW accounts banks must hold.
On a bank's balance sheet, liabilities are
the sources of acquired funds.
On a bank's balance sheet, assets are
the uses of acquired funds.
