Exam 2
With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is
$90
In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent, in the 1980s it fluctuated between ______ percent and ______ percent.
5; 15
Which of the following statements most accurately describes the task of bank asset management?
Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity
Of the following, which would be the last choice for a bank facing a reserve deficiency?
Call in loans
Taxpayers were served poorly by thrift regulators in the 1980s. This poor performance cannot be explained by
Congress's dogged determination to protect taxpayers from the unsound banking practices of managers at many of the nation's savings and loans
To prevent bank runs and the consequent bank failures, the United States established the _______ in 1934 to provide deposit insurance
FDIC
The legislation that separated investment banking from commercial banking until its repeal in 1999 is known as the
Glass-Steagall Act
Holding large amounts of bank capital helps prevent bank failures because
It can be used to absorb the losses resulting from bad loans
To eliminate the abuses of the state-chartered banks, the ______ created a new banking system of federally chartered banks, supervised by the _______
National Bank Act of 1863; Office of the Comptroller of the Currency
Which of the following statements concerning external sources of financing for businesses (other than financial businesses) in the United States are TRUE?
Stocks and bonds, combined, supply less than one-half of the external funds.
The _____ that required separation of commercial and investment banking was repealed in 1999.
The Glass-Steagall Act
Banks face the problem of ______ in loan markets because bad credit risks are the ones most likely to seek bank loans
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
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 default
adverse selection; moral hazard
Prior to 1863, the US commercial banking system was characterized by
all of the above
The government safety net creates _____ problem because risk-loving managers might find banking an attractive industry
an adverse selection
If a bank has $20 million in rate sensitive assets and $50 million in rate sensitive liabilities 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.
A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called
asymmetric information
Currency circulated by banks that could be redeemed for gold was called
banknotes
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
Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that
borrowers may find loopholes that make the covenants ineffective.
Because of an expected rise in interest rates in the future, a banker will likely
buy short-term rather than long term bonds
A US bank that has committed to making a payment of 1 million Swiss francs in 3 months at a fixed rate today can hedge the risk of this commitment by
buying a forward contract on Swiss francs for delivery in 3 months
A US bank that has committed to making a payment of 1 million Swiss francs in 3 months at a fixed rate today can hedge the risk of this commitment by
buying a three-month call option on Swiss francs
The leverage ratio is the ratio of a bank's
capital divided by its total assets
Conditions that likely contributed to a credit crunch during the 2008 financial crisis include
capital shortfalls caused in part by falling real estate prices
Which of the following are reported as liabilities on a bank's balance sheet
checkable deposits
Although the National Bank Act of 1863 was designed to eliminate the problems of the state-chartered banking system, the new federally-chartered system was plagued by
chronic shortages of reserves leading to frequent market-wide drops in securities prices
Assets promised to the lender as compensation if the borrower defaults is called
collateral
In developing countries, it can be expensive and time-consuming for the poor to legalize their property ownership. Without legal title, the property cannot be used as ______ to borrow funds
collateral
Net worth can perform a similar role to
collateral
Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the
contagion effect
If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to
decline by 1.5 million
Which of the following are reported as liabilities on a bank's balance sheet?
discount loans
Bank loans from the Federal Reserve are called ______ and represent a ________ of funds
discount loans; source
The process in which people seeking higher yielding securities take their funds out of the banking system thus restricting the amount of funds banks can lend is called
disintermediation
The Glass-Steagall Act, before its repeal in 1999, prohibited commercial banks from
engaging in underwriting and dealing of corporate securities
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
Money market mutual funds were originally established to
get around the Regulation Q interest rate ceiling that bank deposits were subject to
When a new depositor opens a checking account at the First National Bank with a cash deposit, First National Bank's assets ______ and its liabilities ______
increase; increase
Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in
increased risk taking by banks
Modern liability management has resulted in
increased sales of negotiable CDs to raise funds
In the early stages of the 1980s banking crisis, financial institutions were especially harmed by
increasing interest rates from late 1979 until 1981
Under the Gramm-Leach-Bliley Act states retain regulatory authority over
insurance activities
A bank can reduce its interest rate risk by entering an interest rate swap in which
its interest rate payments are fixed but interest rate receipts are indexed to the Fed Funds rate
A bank is insolvent when
its liabilities exceed its assets
Banks engage in regulatory arbitrage by
keeping high-risk assets on their books while removing low-risk assets with the same capital requirement
Banks may borrow from or lend to another bank in the Federal Funds market. A loan of excess reserves from one bank to another bank is recorded as a(n) _______ for the borrowing bank and a(n) ________ for the lending bank
liability; asset
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
Bank's make their profits primarily by issuing
loans
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
To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also
monitor and enforce them.
When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of
moral hazard
Because borrowers, once they have a loan, are more likely to invest in a high-risk investment projects, banks face the
moral hazard problem
A well-capitalized financial institution has _______ to lose if it fails and thus is _______ likely to pursue risky activities
more; less
Interest income minus interest expenses divided by assets is a measure of bank performance known as the
net interest margin
The principal-agent problem would not occur if ______ of a firm had complete information about the actions of the _______
owners; managers
Traders working for banks are subject to the
principal-agent problem
The presence of so many commercial banks in the United States is most likely the result of
prior regulations that restricted the ability of these financial institutions to open branches
Moral hazard is an important concern of insurance arrangements because the existence of insurance
provides increased incentives for risk taking
If the FDIC decides that a bank is too big to fail, it will use the ______ method, effectively ensuring that _______ depositors will suffer losses.
purchase and assumption; no
Adjustable rate mortgages
reduce the interest-rate risk for financial institutions
Long-term customer relationships _____ the cost of information collection and make it easier to ______ credit risks
reduce; screen
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.
reduces; reduces
One of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the
requirement that firms place on their board of directors an officer from the bank
During times of financial crisis, mark-to-market accounting
requires that a financial firms' assets be marked down in value which can worsen the lending crisis.
Provisions in loan contracts the prohibit borrowers from engaging in specified risky activities are called
restrictive covenants
Based on the Net Interest Margin the poor bank performance in the late 1970s
resulted from a narrowing of the gap between interest earned on assets and inters paid on liabilities
The Basel Accord, an international agreement, requires banks to hold capital based on
risk-weighted assets
The process of transforming otherwise illiquid loans into marketable collateralized debt obligations is known as
securitization
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
One way for banks to reduce the principal-agent problems associated with trading activities is to
set limits on the total amount of a traders' transactions
In general, banks make profits by selling _______ liabilities and buying _______ assets.
short-term; longer term
If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to
shrink the size of the bank
In one sense _____ appears surprising since it means that the bank is not _______ its portfolio of loans and thus is exposing itself to more risk.
specialization in lending; diversifying
Banks responded to disintermediation by
supporting the elimination of interest rate regulations, enabling them to better compete for funds.
Although the FDIC was created to prevent bank failures, its existence encourages banks to
take too much risk
State banking authorities have sole jurisdiction over state banks
that are without FDIC insurance
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.
The legislation overturning the Glass-Steagall Act is
the Gramm-Leach-Bliley Act
Under the Gramm-Leach-Bliley Act the oversight of the securities activities of bank holding companies belongs to
the SEC
Government regulations require publicly traded firms to provide information, reducing
the adverse selection problem
Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been
the creation of the FDIC and deposit insurance
The most significant change in the economic environment that changed the demand for financial products in recent years has been
the dramatic increase in the volatility of interest rates
For a given return on assets, the lower is bank capital
the higher is the return for the owners of the bank
One reason financial systems in developing and transition countries are underdeveloped is
the legal system may be poor making it difficult to enforce restrictive covenants
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
When $1 million is deposited by a customer at a bank, the required reserved 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 million
In the absence of regulation, banks would probably hold
too little capital
Bank capital is equal to _______ minus ______
total assets; total liabilities
By bundling share purchases of many investors together, mutual funds can take advantage of economies of scale and thereby lower
transaction costs
The too-big-to-fail policy
treats large depositors of small banks inequitably when compared to depositors of large banks
Bank reserves include
vault cash and deposits at the Fed
A major controversy involving the banking industry in its early years was
whether the federal government or the states should charter banks
The problem of adverse selection helps to explain
why firms are more likely to obtain funds from banks and other financial intermediaries, rather than from securities markets
The principal-agent problem
would not arise if the owners of the firm has complete information about the activities of the managers