Econ Ch 9

US government and agency; state and local, and other securities

3 categories of securities held by banks:

D

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) back-up lines of credit. D) selling negotiable CDs.

A

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

B

Bank loans from the Federal Reserve are called ________ and represent a ________ of funds. A) discount loans; use B) discount loans; source C) fed funds; use D) fed funds; source

B

For a given return on assets, the lower is bank capital A) the lower is the return for the owners of the bank. B) the higher is the return for the owners of the bank. C) the lower is the credit risk for the owners of the bank. D) the lower the possibility of bank failure.

C

Holding large amounts of bank capital helps prevent bank failures because A) it means that the bank has a higher income. B) it makes loans easier to sell. C) it can be used to absorb the losses resulting from bad loans. D) it makes it easier to call in loans.

B

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 A) $30,000. B) $25,000. C) $20,000. D) $10,000.

D

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 (ROE)? A) 0.2% B) 2.1% C) 5% D) 20%

C

If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A) reduce deposits by $3 million. B) increase loans by $3 million. C) sell $3 million of securities. D) repay its discount loans from the Fed.

B

In general, banks make profits by selling ________ liabilities and buying ________ assets. A) long-term; shorter-term B) short-term; longer-term C) illiquid; liquid D) risky; risk-free

A

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.

A

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 A) the assets at the bank increase by $1 million. B) the liabilities of the bank decrease by $1 million. C) reserves increase by $200,000. D) liabilities increase by $200,000.

C

When you deposit $50 in currency at Old National Bank A) its assets increase by less than $50 because of reserve requirements. B) its reserves increase by less than $50 because of reserve requirements. C) its liabilities increase by $50. D) its liabilities decrease by $50.

B

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

C

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

B

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

loan commitment

a bank's commitment (for a specified future period of time) to provide a firm with loans up to a given amount at an interest rate that is tied to some market interest rate; issued to create long-term relationships and gather info

return on equity (ROE)

a basic measure of bank profitability that indicates how much the bank is earning on their equity investment; the net profit after taxes per dollar of equity (bank) capital

return on assets (ROA)

a basic measure of bank profitability; the net profit after taxes per dollar of assets; provides info on how efficiently a bank is being run because it indicates how much is being generated, on average, by each dollar of assets

compensating balances

a firm receiving a loan must keep a required minimum amount of funds in a checking account at the bank

balance sheet

a list of a bank's assets and liabilities; also a list of its sources of bank funds (liabilities and capital) and uses to which the funds are put (assets)

duration analysis

a method for measuring interest-rate risk that examines the sensitivity of the market value of the bank's total assets and liabilities to changes in interest rates; based on the average lifetime of a security's stream of payments

bank failure

a situation in which the bank cannot satisfy its obligations to pay its depositors and other creditors, and so goes out of business

off-balance-sheet activities

activities that involve trading financial instruments and generating income from fees and loan sales, activities that affect bank profits but do not appear on bank balance sheets.

excess reserves

additional amount of reserves minus the required amount, held by the bank because they are the most liquid bank asset and can be used to meet the banks obligations when funds are withdrawn, either directly by a depositor or indirectly when a check is written on an account

checkable deposits

bank accounts that allow the owner of the account to write checks to third parties; include all the accounts on which checks can be drawn; "payable on demand"; liability for bank, asset for depositor

securities

bank asset made up entirely of debt instruments (because banks aren't allowed to hold stock) that provide commercial banks with about 10% of their revenue

reserves

bank asset that consists of funds held by banks acquired as deposits in an account at the Fed plus currency that is physically held by banks (vault currency) that earn a low interest rate

other assets

bank assets that include the physical capital (bank buildings, computers, and other equipment) owned by banks

federal funds

bank borrowings from other banks; unsecured "overnight loans"

discount loans (advances)

bank borrowings from the Fed

bank capital (net worth)

bank liability that equals the difference between total assets and liabilities; raised by selling new equity (stock) or from retained earnings; bank's protection from a drop in the value of its assets which could force bank into insolvency (excess of more liabilities than assets) meaning it could be forced into liquidation

EM=assets/equity capital (ROE= ROA x EM)

equity multiplier (EM) =

savings

funds can be added to or withdrawn from these accounts at any time; transactions and interest payments are recorded in a monthly statement or on a passbook held by the owner of the account

borrowings

funds obtained by banks from borrowing from the Federal Reserve System, the Federal Home Loan banks, other banks, and corporations (repos/repo agreement - secured)

the higher the return for the bank owners

given the ROA, the lower the bank capital

time deposits

have a fixed maturity length (ranging from several months to over 5 years) and assess substantial penalties (the forfeiture of several months' interest) for early withdrawal of funds; can be small or large

liabilities

issued (sold) by banks to acquire funds which are used to purchase income-earning assets; sources of funds (everything bank owes)

money center banks

large banks in the 1960s in key financial centers that began to explore ways in which the liabilities on their balance sheets could provide them with reserves and liquidity, leading to an expansion of overnight loan markets and the development of new financial instruments which enabled them to acquire funds quickly

large-denomination time deposits (negotiable CDs)

negotiable time deposits typically bought by corporations, MMMFs, and other financial institutions as alt. assets to T-bills and other short-term bonds; available in denominations of $100,000 or more and can be resold in secondary markets before they mature

asset transformation

process by which banks make profits by selling liabilities with one set of characteristics (specific combo of liquidity, risk, size, and return) and using the proceeds to buy assets with a different set of characteristics

assets

purchased by banks with funds acquired by issuing liabilities; includes Reserves, cash items in process of collection, deposits at other banks, securities, loans, and other assets

credit rationing

refusing to make loans even though borrowers are willing to pay the stated interest rate, or even a higher rate

ROA=(net profit after taxes)/assets

return on assets =

ROE=(net profit after taxes)/equity capital

return on equity =

secondary securities

short-term US gov and agency securities; the most liquid type of securities because they can be easily traded and converted into cash with low transaction costs

T-account

simplified balance sheet that lists only the changes that occur in balance sheet items starting from some initial balance sheet position

liquidity management

the acquisition of assets that are liquid enough to meet the bank's obligations to depositors in order (to keep enough cash on hand for payments to depositors)

asset management

the acquisition of assets that have a low rate of default and diversifying asset holdings in order to obtain an acceptably low level of risk

liability management

the concern of the bank manager to acquire funds at low cost

capital adequacy management

the concern of the bank manager to decide the amount of capital the bank should maintain and then acquire needed capital

discount rate

the cost associated with discount loans is the interest rate that must be paid to Fed

equity multiplier (EM)

the direct relationship between the ROA and ROE; the amount of assets per dollar of equity capital

required reserve

the first reason banks hold reserves held because of reserve requirements

required reserve ratio

the fraction, or percent, determined by the reserve requirements that must be kept by the bank as reserves

non transaction deposits

the primary source of bank funds that include savings and time deposits(CDs)

reserve requirements

the regulation that for every dollar of checkable deposits at the bank, a certain fraction must be kept as reserves

credit risk

the risk arising because borrowers may default

interest-rate risk

the riskiness of earnings and returns on bank assets caused by interest-rate changes

small-denomination time deposits

time deposits of less than $100,000 that are less liquid for the depositor than passbook savings, earn higher interest rates, and a more costly source of funds for the banks

basic operation of a bank

to transform deposits (short-term liabilities) into different assets (mostly long-term)

loan sales

type of off-balance-sheet activity that involves a contract that sells all or part of the cash stream from a specific loan and thereby removes the loan so that it is no longer an asset on the bank's balance sheet; also called secondary loan participation

gap analysis

used to measure the sensitivity of bank profits to changes in interest rates more directly by subtracting the amount of rate-sensitive liabilities from the amount of rate-sensitive assets

deposit outflows

when deposits are lost because depositors make withdrawals and demand payment