Econ 3229 Midterm 2 Lab Questions

If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is

$25,000

If a bank has a capital to asset ratio of 0.1 and a return on assets of 2%, what is its return on equity?

20%

Main reason Credit Default Swaps (CDS) are different from ordinary insurance because A) It insures different classes of assets B) CDS are traded over-the-counter C) Seller of CDS is required to set aside reserves to cover potential losses D) There are numerous regulations that apply to trading CDS

CDs are traded over-the-counter

A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It requires a 50% stake in the company.

It places people on the board of directors to better monitor the borrowing firm's activities

A ________ is a provision that restricts or specifies certain activities that a borrower can engage in.

Restrictive Covenant

Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE? A) Issuing marketable securities is the primary way that they finance their activities. B) Bonds are the least important source of external funds to finance their activities. C) Stocks are a relatively unimportant source of finance for their activities. D) Selling bonds directly to the American household is a major source of funding for American

Stocks are a relatively unimportant source of finance for their activities

A serious consequence of a financial crisis is

a contraction in economic activity

If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of

adverse selection

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

agents; principals

Debt deflation occurs when A) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness. B) rising interest rates worsen adverse selection and moral hazard problems. C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral. D) corporations pay back their loans before the scheduled maturity date.

an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness.

When asset prices rise above their fundamental economic values, a(n) ________ occurs.

asset-price bubble

If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n)

banking panic

The assumption of asymmetric information means that

borrowers know more than lenders

Of the following, which would be the last choice for a bank facing a reserve deficiency? A) Call in loans. B) Borrow from the Fed. C) Sell securities. D) Borrow from other banks.

call in loans

Which of the following are reported as liabilities on a bank's balance sheet? A) reserves B) checkable deposits C) consumer loans D) deposits with other banks

checkable deposits

Which of the following are transaction deposits? A) savings accounts B) small-denomination time deposits C) checkable deposits D) certificates of deposit

checkable deposits

When financial institutions go on a lending spree and expand their lending at a rapid pace they are participating in a

credit boom

When the value of loans begins to drop, the net worth of financial institutions falls causing them to cut back on lending causing

credit crunch

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

discount loans; source

The reduction in transactions costs per dollar of investment as the size of transactions increases is

economies of scale

On of the purposes of Glass Steagall Act of 1933 was to

establish a separation of investment and commercial banking

A major disruption in financial markets characterized by sharp declines in asset prices and firm failures is called a

financial crisis

CDS create severe moral hazard problems because A) Seller of CDS has no incentives to check the quality of the asset it insures B) Seller of CDS may not act in the best interest of the holder of CDS C) Owner of the asset that CDS insures has no incentives to check the quality of the asset D) Holder of CDS and owner of the asset CDS insures may not be the same entity

holder of CDs and owner of the asset Cds insures may not be the same entity

Agency problems in the subprime mortgage market included all of the following EXCEPT A) homeowners could refinance their houses with larger loans when their homes appreciated in value. B) mortgage originators had little incentives to make sure that the mortgagee is a good credit risk. C) underwriters of mortgage-backed securities had weak incentives to make sure that the holders of the securities would be paid back. D) the evaluators of securities, the credit rating agencies, were subject to conflicts of interest.

homeowners could refinance their houses with larger loans when their homes appreciated in value.

Holding large amounts of bank capital helps prevent bank failures because

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

When you deposit $50 in currency at Old National Bank

its liabilities increase by $50.

Because of the adverse selection problem

lenders are reluctant to make loans that are not secured by collateral

Although debt contracts require less monitoring than equity contracts, debt contracts are still subject to ________ since borrowers have an incentive to take on more risk than the lender would like.

moral hazard

Which of the following best explains "death spiral?" A) insurance companies requiring high deductibles from customers with terminal diseases. B) not enough healthy customers purchasing insurance so that cost of covering sick customers becomes prohibitively expensive. C) typically customers with perfect health records are offered the best policies. D) typically customers with bad health records are denied.

not enough healthy customers purchasing insurance so that cost of covering sick customers becomes prohibitively expensive

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

owners; managers

The free-rider problem occurs because

people who do not pay for information use it

If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses. A) payoff; large B) payoff; no C) purchase and assumption; large D) purchase and assumption; no

purchase and assumption; no

Bank capital has both benefits and costs for the bank owners. Higher bank capital ________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given return on assets. A) reduces; reduces B) increases; increases C) reduces; increases D) increases; reduces

reduces; reduces

Which of the following bank assets is the most liquid? A) consumer loans B) reserves C) state and local government securities D) U.S. government securities

reserves

Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are

restrictive covenants

Collateralized debt is also known as

secured debt

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

sell $3 million in securities

All of the following are examples of off-balance sheet activities that generate fee income for banks EXCEPT A) foreign exchange trades. B) guaranteeing debt securities. C) lines of credit. D) selling negotiable CDs.

selling negotiable CDs

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

short-term; longer-term

Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) stocks. C) bonds and commercial paper. D) loans from other financial intermediaries.

stocks

Because of securitization, a new class of residential mortgages offered to borrowers with less- than-stellar credit records developed. These mortgages are known as

subprime mortgages

The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is A) that the FDIC guarantees all deposits when it uses the "payoff" method. B) that the FDIC guarantees all deposits when it uses the "purchase and assumption" method. C) that the FDIC is more likely to use the "payoff" method when the bank is large and it fears that depositor losses may spur business bankruptcies and other bank failures. D) that the FDIC is more likely to use the purchase and assumption method for small institutions because it will be easier to find a purchaser for them compared to large institutions.

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

Government regulations require publicly traded firms to provide information, reducing

the adverse selection problem

When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to make any loans but decides to hold excess reserves instead, then, in the bank's final balance sheet

the assets at the bank increase by $1 million

As a result of the global financial crisis several of the large, free-standing investment banking firms chose to become bank holding companies. This means that they will now be regulated by

the federal reserve

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

the higher is the return for the owners of the bank

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

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

In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation know as "breaking the buck." This means that A) they could no longer afford to redeem shares at the par value of $1. B) they required shareholders to contribute a dollar more in fees each month. C) shareholders were able to redeem shares for more than a $1. D) shares earned more than a dollar in interest.

they could no longer afford to redeem shares at the par value of $1

The Volcker Rule addresses the off-balance-sheet problem involving

trading risks