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