Econ 330 Exam 2

Federal deposit insurance covers deposits up to​ $250,000, but as part of a doctrine called ​"too−big−to−​fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does​ this, it uses the

"purchase and​ assumption" method.

A bank almost always insists that the firms it lends to keep compensating balances at the bank.​ Why?

1) 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 2) Compensating balances can act as collateral 3) Compensating balances help the bank monitor the activities of a borrowing​ firm, which reduces the moral hazard problem

Rank the following bank assets from most liquid to least liquid​ . ​(Enter a numerical value between 1 and​ 4.)

1) Reserves 2)Securities 3)Commercial loans 4)Physical capital

In recent years the interest paid on checkable and nontransaction deposits has accounted for around​ ________ of total bank operating​ expenses, while the costs involved in servicing accounts have been approximately​ ________ of operating expenses.

25​ percent; 50 percent

Which of the following is likely a result of increased​ interest-rate volatility?

An increase in demand for financial services and products

Which of the following statements are​ true?

A​ bank's balance sheet shows that total assets equal total liabilities plus equity capital.

At the height of the global financial crisis in October​ 2008, the U.S. Treasury forced nine of the largest U.S. banks to accept capital​ injections, in exchange for nonvoting ownership​ stock, even though some of the banks did not need the capital and did not want to participate. What could be the rationale for doing​ this?

By forcing all banks to accept capital​ injections, it would help prevent bank runs on the weakest banks.

________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow.

Calling in loans

Which of the following are reported as liabilities on a​ bank's balance​ sheet?

Checkable deposits

Which of the following are transaction​ deposits?

Checkable deposits

Which of the following is not an asset on a​ bank's balance​ sheet?

Checkable deposits

Which of the following statements are​ true?

Checkable deposits are payable on demand.

Why were consumer protection provisions included in the​ Dodd-Frank bill, a bill designed to strengthen the financial​ system?

Consumer protection will avert future financial problems in the housing market.

What are the five areas included in the​ Dodd-Frank Act of​ 2010?

Consumer​ protection, resolution​ authority, systemic risk​ regulation, Volcker​ rule, and derivatives.

If casualty insurance companies provided fire insurance without any​ restrictions, what kind of moral hazard problem might​ result?

Customers would take less preventive care in avoiding fire risk with this type of insurance

"Because diversification is a desirable strategy for avoiding​ risk, it never makes sense for a bank to specialize in making specific types of​ loans." Is this statement true or​ false? Explain your answer.

False. A bank may have developed expertise in screening and monitoring a particular type of​ loan, thus improving its ability to handle problems of adverse selection and moral hazard.

​________ is the process of researching and developing new instruments to address the needs of investors and institutions in a rapidly changing financial climate.

Financial engineering

If a bank doubles the amount of its capital and ROA stays​ constant, what will happen to​ ROE?

Given the​ ROA, if bank capital​ doubles, then ROE will fall by half.

Which of the following has not resulted from more active liability management on the part of​ banks?

Increased bank holdings of cash items

Which agency has regulatory responsibility when a bank operates in many different​ countries?

It is not always clear.

Which of the following is a main responsibility of the bank​ manager?

Maintaining reserves at a level to minimize the cost to the bank of deposit outflows.

Which of the following are primary concerns of the bank​ manager?

Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows

Which of the following may not be used as a backup line of​ credit?

Mortgages

If the bank you own has no excess reserves and a sound customer comes in asking for a​ loan, should you automatically turn the customer​ down, explaining that you​ don't have any excess reserves to lend​ out? Why or why​ not? What options are available for you to provide the funds your customer​ needs?

No. There are several ways that reserves can be acquired. For​ example, the bank can borrow at the discount window or in the federal funds​ market, or it can acquire funds by issuing negotiable CDs.

How can the​ S&L crisis be blamed on the principal-agent problem? As a​ result, politicians and regulators​ __________________________, thereby increasing the cost of the​ S&L bailout.

Politicians and​ regulators, who are known as the agents​, have not had the same incentives to minimize costs of deposit insurance as do the​ taxpayers, who are known as the principals relaxed capital​ standards, removed restrictions on holdings of risky​ assets, and engaged in regulatory forbearance

Which of the following are reported as assets on a​ bank's balance​ sheet?

Reserves

Which of the following bank assets is the most​ liquid?

Reserves

Why is it important for the U.S. government to have resolution​ authority?

Resolution authority allows the government to quickly takeover a failing firm.

How could higher deposit insurance premiums for banks with riskier assets benefit the​ economy?

Risk-based premiums would help mitigate the moral hazard​ problem; however, it is difficult to monitor the degree of risk in bank assets because often only the bank making the loans knows how risky they are

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.

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

If you are a banker and expect interest rates to rise in the​ future, would you want to make​ short-term or​ long-term loans?

You would want to make​ short-term loans so you can reinvest the funds at higher interest rates after their maturity.

A bank failure is less likely to occur when

a bank has more bank capital.

A reason why rogue traders have bankrupt their banks is due to

a failure to maintain proper internal controls

Banks face the problem of​ ________ in loan markets because bad credit risks are the ones most likely to seek bank loans.

adverse selection

If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment​ projects, banks are said to face the problem​ of:

adverse selection

In order to reduce the​ ________ problem in loan​ markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones.

adverse selection

When bad drivers line up to purchase collision​ insurance, automobile insurers are subject to the

adverse selection problem.

Collateral requirements lessen the consequences of​ ________ because the collateral reduces the​ lender's losses in the case of a loan default and it reduces​ ________ because the borrower has more to lose from a default.

adverse​ selection; moral hazard

The chartering process is especially designed to deal with the​ ________ problem, and regular bank examinations help to reduce the​ ________ problem.

adverse​ selection; moral hazard

If a​ bank's liabilities are more sensitive to interest rate movements than are its​ assets, then

an increase in interest rates will reduce bank profits.

All else the​ same, if a​ bank's liabilities are more sensitive to interest rate fluctuations than are its​ assets, then​ ________ in interest rates will​ ________ bank profits.

an​ increase; reduce

The existence of deposit insurance can increase the likelihood that depositors will need deposit​ protection, as banks with deposit insurance

are likely to take on greater risks than they otherwise would.

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called

basic gap analysis.

If a bank needs to acquire funds quickly to meet an unexpected deposit​ outflow, the bank could

borrow from another bank in the federal funds market.

Regulations that reduced competition between banks included

branching restrictions.

Because of an expected rise in interest rates in the​ future, a banker will likely

buy short−term rather than long−term bonds.

Banks earn profits from off−balance sheet loan sales

by selling existing loans for more than the original loan amount.

The leverage ratio is the ratio of a​ bank's

capital divided by its total assets.

Holding all else​ constant, when a bank receives the funds for a deposited​ check,

cash items in the process of collection fall by the amount of the check.

Suppose ​$200,000 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​ reserves?

chapter 9-10 problem # 3; Total reserves are ​$40,000

During the boom years of the​ 1920s, bank failures were quite

common, averaging about 600 per year.

The principal−agent problem that exists for bank trading activities can be reduced through

creation of internal controls that separate trading activities from bookkeeping.

When a lender refuses to make a​ loan, although borrowers are willing to pay the stated interest rate or even a higher​ rate, the bank is said to engage in

credit rationing.

If a bank has excess reserves greater than the amount of a deposit​ outflow, the outflow will result in equal reductions in

deposits and reserves.

A main provision of the Competitive Equality in Banking Act​ (CEBA) of 1987​ included:

directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance.

Regulations designed to provide information to the marketplace so that investors can make informed decisions are called

disclosure requirements.

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

discount​ loans; source

From the standpoint of​ ________, specialization in lending is surprising but makes perfect sense when one considers the​ ________ problem

diversification; adverse selection

The amount of assets per dollar of equity capital is called the

equity multiplier.

Banks that suffered significant losses in the 1980s made the mistake of

failing to diversify their loan portfolio.

The difference of rate−sensitive liabilities and rate−sensitive assets is known as the

gap.

Firms that are designated as systemically important financial institutions​ (SIFIs) are subject to all of the following additional Federal Reserve regulations except

interest rate ceilings on time deposits.

Risk that is related to the uncertainty about interest rate movements is called

interest−rate risk.

A bank is insolvent when

its liabilities exceed its assets.

The Depository Institutions Deregulation and Monetary Control Act of​ 1980:

led to the creation of NOW accounts nationwide.

Regulators attempt to reduce the riskiness of​ banks' asset portfolios by

limiting the amount of loans in particular categories or to individual borrowers.

Bankers' concerns regarding the optimal mix of excess​ reserves, secondary​ reserves, borrowings from the​ Fed, and borrowings from other banks to deal with deposit outflows is an example of

liquidity management.

A​ bank's commitment to provide a firm with loans up to pre−specified limit at an interest rate that is tied to a market interest rate is called

loan commitment.

When Jane Brown writes a​ $100 check to her​ nephew, and he cashes the​ check, Ms.​ Brown's bank​ ________ assets of​ $100 and​ ________ liabilities of​ $100

loses; loses

With​ ________, firms value assets on their balance sheet at what they would sell for in the market.

mark−to−market accounting

In order to reduce the​ ________ problem in loan​ markets, banks often insist on collateral from potential borrowers.

moral hazard

Which of the following is not an example of a backup line of​ credit?

mortgages

The practice of keeping high−risk assets on a​ bank's books while removing low−risk assets with the same capital requirement is know as

regulatory arbitrage.

Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called

restrictive covenants.

Net profit after taxes per dollar of assets is a basic measure of bank profitability called

return on assets.

The Basel​ Accord, an international​ agreement, requires banks to hold capital based on

risk−weighted assets.

Banks acquire the funds that they use to purchase income−earning assets from such sources as

savings accounts.

Because​ ________ are less liquid for the depositor than​ ________, they earn higher interest rates.

savings​ accounts; checkable deposits

Examples of off-balance-sheet activities include:

selling loan portfolios

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

sell​ $3 million of securities.

Bruce the Bank Manager can reduce interest rate risk by​ ________ the duration of the​ bank's assets to increase their rate sensitivity​ or, alternatively,​ ________ the duration of the​ bank's liabilities.

shortening; lengthening

Secondary reserves include

short−term U.S. government securities.

The share of checkable deposits in total bank liabilities has

shrunk over time.

The primary difference between the​ "payoff" and the​ "purchase and​ assumption" methods of handling failed banks is

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

Agreements such as​ ________ are attempts to standardize international banking regulations.

the Basel Accord

The new Consumer Financial Protection Bureau is an independent agency but is funded and housed within

the Federal Reserve.

When​ $1 million 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, then, in the​ bank's final balance​ sheet,

the liabilities of the bank increase by​ $1,000,000.

In the absence of​ regulation, banks would probably hold

too little capital.

Examples of off−balance−sheet activities include

trading activities.

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

trading risks.

The largest percentage of​ banks' holdings of securities consist of

treasury and government agency securities.

In order to ensure that borrowers have an ability to repay residential​ mortgages, the new consumer protection legislation requires lenders to do all of the following except

verify that the borrower can read and understand a loan contract.

In May​ 1991, the FDIC announced that it would sell the​ government's final​ 26% stake in Continental​ Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the​ bank, rather than liquidate​ it, because it believed that Continental Illinois

was too big to fail.

As the costs associated with deposit outflows​ ________, the banks willingness to hold excess reserves will​ ________.

​increase; increase

When a new depositor opens a checking account at the First National​ Bank, the​ bank's assets​ ________ and its liabilities​ ________.

​increase; increase

Risk that is related to the uncertainty about future​ interest-rate movements is​ called:

​interest-rate risk

Banks earn profits by selling​ ________ with attractive combinations of​ liquidity, risk, and​ return, and using the proceeds to buy​ ________ with a different set of characteristics.

​liabilities; assets

Banks generate profits by earning higher returns on their​ ____________ than they pay in interest on​ _____________.

​loans; deposits

Large-denomination CDs are​ ________, so that like a​ bond, they have a​ ________degree of liquidity and can be sold in secondary markets.

​negotiable; greater