Money and Banking Chapter 12

A $5 million deposit outflow from a bank has the immediate effect of ________. A) reducing deposits and reserves by $5 million B) reducing deposits and loans by $5 million C) reducing deposits and securities by $5 million D) reducing deposits and capital by $5 million

Answer: A

A T-account represents ________. A) a simplified balance sheet B) asset transformation C) T-bills D) term deposits

Answer: A

A bank failure occurs whenever ________. A) a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements B) a bank suffers a large deposit outflow C) a bank has to call in a large volume of loans D) a bank is not allowed to borrow from the Bank of Canada

Answer: A

A bank is insolvent when ________. A) its liabilities exceed its assets B) its assets exceed its liabilities C) its capital exceeds its liabilities D) its assets increase in value

Answer: 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

Answer: A

Bank capital is equal to ________ minus ________. A) total assets; total liabilities B) total liabilities; total assets C) total assets; total reserves D) total liabilities; total borrowings

Answer: A

Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans. A) adverse selection B) moral hazard C) moral suasion D) intentional fraud

Answer: A

Conditions that likely contributed to a credit crunch in 2008 include ________. A) capital shortfalls caused in part by falling real estate prices B) regulated hikes in bank capital requirements C) falling interest rates that raised interest rate risk, causing banks to choose to hold more capital D) increases in reserve requirements

Answer: A

Holding all else constant, when a bank receives the funds for a deposited cheque, ________. A) cash items in the process of collection fall by the amount of the cheque B) bank assets increase by the amount of the cheque C) bank liabilities decrease by the amount of the cheque D) bank reserves increase by the amount of desired reserves

Answer: A

If a bank has $10 million of demand deposits, a desired reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of ________. A) $1.2 million B) $1.1 million C) $1 million D) $900,000

Answer: A

If a bank has $200,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds $80000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is ________. A) $50000 B) $40000 C) $30000 D) $25000

Answer: A

If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in ________. A) deposits and reserves B) deposits and loans C) capital and reserves D) capital and loans

Answer: A

If a bank's liabilities are more sensitive to interest rate movements than are its assets, then ________. A) an increase in interest rates will reduce bank profits B) a decrease in interest rates will reduce bank profits C) interest rates changes will not impact bank profits D) an increase in interest rates will increase bank profits

Answer: A

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. A) specialization in lending; diversifying B) specialization in lending; rationing C) credit rationing; diversifying D) screening; rationing

Answer: A

Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks. A) reduce; screen B) increase; screen C) reduce; increase D) increase; increase

Answer: A

Modern liability management has resulted in ________. A) increased sales of certificates of deposits to raise funds B) increase importance of deposits as a source of funds C) reduced borrowing by banks in the overnight loan market D) failure by banks to coordinate management of assets and liabilities

Answer: A

Net profit after taxes per dollar of assets is a basic measure of bank profitability called ________. A) return on assets B) return on capital C) return on equity D) return on investment

Answer: A

Property promised to the lender as compensation if the borrower defaults is called ________. A) collateral B) deductibles C) restrictive covenants D) contingencies

Answer: A

Secondary reserves are so called because ________. A) they can be converted into cash with low transactions costs B) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms C) 50 percent of these assets count toward meeting desired reserves D) they rank second to bank vault cash in importance of bank holdings

Answer: A

To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also ________. A) monitor and enforce them B) be willing to rewrite the contract if the borrower cannot comply with the restrictions C) trust the borrower to do the right thing D) be prepared to extend the deadline when the borrower needs more time to comply

Answer: A

When $1 million is deposited at a bank, the desired reserve ratio is 20 percent, and the bank chooses not to make any loans but 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

Answer: A

When a $10 cheque written on the First National Bank is deposited in an account at CIBC, then ________. A) the reserves of the First National Bank decrease by $10 B) the reserves of the First National Bank increase by $10 C) the reserves of CIBC decrease by $10 D) the assets of CIBC decrease by $10

Answer: A

When a new depositor opens a chequing account at the First National Bank, the bank's assets ________ and its liabilities ________. A) increase; increase B) increase; decrease C) decrease; increase D) decrease; decrease

Answer: A

Which of the following are bank assets? A) The building owned by the bank B) A discount loan C) A negotiable CD D) A customer's chequing account

Answer: A

Which of the following are primary concerns of the bank manager? A) Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows B) Extending loans to borrowers who will pay low interest rates, but who are poor credit risks C) Acquiring funds at a relatively high cost, so that profitable lending opportunities can be realized D) Maintaining high levels of capital and thus maximizing the returns to the owners

Answer: A

Which of the following are reported as liabilities on a bank's balance sheet? A) Advances B) Reserves C) Securities D) Loans

Answer: A

Which of the following has not resulted from more active liability management on the part of banks? A) Increased bank holdings of cash items B) Aggressive targeting of goals for asset growth by banks C) Increased use of negotiable CDs to raise funds D) An increased proportion of bank assets held in loans

Answer: A

Which of the following statements is true? A) Chequable deposits are payable on demand. B) Chequable deposits do not include notice deposits. C) Chequable deposits are the primary source of bank funds. D) Chequable deposits are chequable deposits that pay interest.

Answer: A

Which of the following statements most accurately describes the task of bank asset management? A) Banks seek the highest returns possible subject to minimizing risk and making adequate provisions for liquidity. B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return on their operations. C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity needs supersede the desire for profits. D) Banks seek to acquire funds in the least costly way.

Answer: A

With a 10 percent reserve requirement ratio, a $100 deposit into New Bank means that the maximum amount New Bank could lend is ________. A) $90 B) $100 C) $10 D) $110

Answer: A

A bank will want to hold more excess reserves (everything else equal) when ________. A) it expects to have deposit inflows in the near future B) brokerage commissions on selling bonds increase C) the cost of selling loans falls D) the discount rate decreases

Answer: B

A bank with insufficient reserves can increase its reserves by ________. A) lending overnight funds B) calling in loans C) buying short-term securities D) buying provincial bonds

Answer: B

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. A) an increase; increase B) an increase; reduce C) a decline; reduce D) a decline; not affect

Answer: B

Asset transformation can be described as ________. A) borrowing long and lending short B) borrowing short and lending long C) borrowing and lending only for the short term D) borrowing and lending for the long term

Answer: B

Bank capital is listed on the ________ side of the bank's balance sheet because it represents a ________ of funds. A) liability; use B) liability; source C) asset; use D) asset; source

Answer: B

Bank loans from the Bank of Canada are called ________ and represent a ________ of funds. A) advances; use B) advances; source C) overnight funds; use D) overnight funds; source

Answer: B

Bankers' concerns regarding the optimal mix of excess reserves, secondary reserves, borrowings from the Bank of Canada, and borrowings from other banks to deal with deposit outflows is an example of ________. A) liability management B) liquidity management C) managing interest rate risk D) managing credit risk

Answer: B

Banks hold excess and secondary reserves to ________. A) reduce the interest-rate risk problem B) provide for deposit outflows C) satisfy margin requirements D) achieve higher earnings than they can with loans

Answer: B

Credit risk management tools include ________. A) deductibles B) collateral C) interest rate swaps D) duration analysis

Answer: B

Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________. A) securities portfolio; non-deposit liabilities B) assets; liabilities C) loan portfolio; deposit liabilities D) assets; deposit liabilities

Answer: 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

Answer: B

If a bank has $100,000 of demand deposits, a desired reserve ratio of 20 percent, and it holds $40000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is ________. A) $30000 B) $25000 C) $20000 D) $10000

Answer: B

If a bank has ________ rate-sensitive assets than liabilities, a ________ in interest rates will reduce bank profits, while a ________ in interest rates will raise bank profits. A) more; rise; decline B) more; decline; rise C) fewer; decline; decline D) fewer; rise; rise

Answer: B

If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits. A) more; a decline B) more; an increase C) fewer; an increase D) fewer; a surge

Answer: B

If borrowers with the most risky investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, banks are said to face the problem of ________. A) adverse credit risk B) adverse selection C) moral hazard D) lemon lenders

Answer: 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

Answer: B

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. A) moral hazard B) adverse selection C) moral suasion D) adverse lending

Answer: B

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals times the change in the interest rate is called ________. A) basic gap analysis B) the maturity bucket approach to gap analysis C) the segmented maturity approach to gap analysis D) the segmented maturity approach to interest-exposure analysis

Answer: B

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called ________. A) basic duration analysis B) basic gap analysis C) interest-exposure analysis D) gap-exposure analysis

Answer: B

Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called ________. A) proscription bonds B) restrictive covenants C) due-on-sale clauses D) liens

Answer: B

Risk that is related to the uncertainty about interest rate movements is called ________. A) default risk B) interest-rate risk C) the problem of moral hazard D) security risk

Answer: B

The fraction of chequable deposits that banks choose to hold are ________. A) excess reserves B) desired reserves C) vault cash D) total reserves

Answer: B

Through correspondent banking, large banks provide services to small banks, including ________. A) loan guarantees B) foreign exchange transactions C) issuing stock D) debt reduction

Answer: B

Unanticipated moral hazard contingencies can be reduced by ________. A) screening B) long-term customer relationships C) specialization in lending D) credit rationing

Answer: B

When $1 million is deposited at a bank, the desired 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, ________. A) the assets at the bank increase by $800,000 B) the liabilities of the bank increase by $1,000,000 C) the liabilities of the bank increase by $800,000 D) reserves increase by $160,000

Answer: B

When you deposit a $50 bill in the New National Bank, ________. A) its liabilities decrease by $50 B) its assets increase by $50 C) its reserves decrease by $50 D) its cash items in the process of collection increase by $50

Answer: B

Which of the following are reported as assets on a bank's balance sheet? A) Borrowings B) Reserves C) Notice deposits D) Bank capital

Answer: B

Which of the following are reported as liabilities on a bank's balance sheet? A) Reserves B) Demand and notice deposits C) Loans D) Deposits with other banks

Answer: B

Which of the following bank assets is the most liquid? A) Consumer loans B) Reserves C) Cash items in process of collection D) Government securities

Answer: B

Which of the following statements is false? A) Chequable deposits are usually the lowest cost source of bank funds. B) Demand deposits are the primary source of bank funds. C) Chequable deposits are payable on demand. D) Chequable deposits include notice deposits.

Answer: B

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 ________. A) an adjustable gap loan B) an adjustable portfolio loan C) loan commitment D) pre-credit loan line

Answer: C

As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________. A) decrease; increase B) increase; decrease C) increase; increase D) decrease; not be affected

Answer: C

Bank reserves include ________. A) deposits at the Bank of Canada and short-term securities B) vault cash and short-term securities C) vault cash and deposits at the Bank of Canada D) deposits at other banks and deposits at the Bank of Canada

Answer: C

Bank's make their profits primarily by issuing ________. A) equity B) negotiable CDs C) loans D) notice deposits

Answer: C

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. A) loans; deposits B) securities; deposits C) liabilities; assets D) assets; liabilities

Answer: C

Banks that suffered significant losses in the 1980s made the mistake of ________. A) holding too many liquid assets B) minimizing default risk C) failing to diversify their loan portfolio D) holding only safe securities

Answer: C

Because of their ________ liquidity, ________ government securities are called secondary reserves. A) low; short-term B) low; long-term C) high; short-term D) high; long-term

Answer: 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

Answer: C

If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to ________. A) buy back bank stock B) pay higher dividends C) sell bank stock D) sell securities the bank owns and put the funds into the reserve account

Answer: C

If, after a deposit outflow, a bank needs an additional $3 million to meet its desired reserves, the bank can ________. A) reduce deposits by $3 million B) increase loans by $3 million C) sell $3 million of securities D) repay its advances from the Bank of Canada

Answer: C

In general, banks would prefer to acquire funds quickly by ________ rather than ________. A) reducing loans; selling securities B) reducing loans; borrowing from the Bank of Canada C) borrowing from the Bank of Canada; reducing loans D) "calling in" loans; selling securities

Answer: C

In the absence of regulation, banks would probably hold ________. A) too much capital, reducing the efficiency of the payments system B) too much capital, reducing the profitability of banks C) too little capital D) too much capital, making it more difficult to obtain loans

Answer: C

Large-denomination CDs are ________, so that like a bond they can be resold in a ________ market before they mature. A) nonnegotiable; secondary B) nonnegotiable; primary C) negotiable; secondary D) negotiable; primary

Answer: C

Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called ________. A) return on assets B) return on capital C) return on equity D) return on investment

Answer: C

The amount of assets per dollar of equity capital is called the ________. A) asset ratio B) equity ratio C) equity multiplier D) asset multiplier

Answer: C

The most important category of assets on a bank's balance sheet is ________. A) advances B) securities C) loans D) cash items in the process of collection

Answer: C

The share of chequable deposits in total bank liabilities has ________. A) expanded moderately over time B) expanded dramatically over time C) shrunk over time D) remained virtually unchanged since 1960

Answer: C

When a $10 cheque written on the First National Bank is deposited in an account at CIBC, then ________. A) the liabilities of the First National Bank increase by $10 B) the reserves of the First National Bank increase by $ 10 C) the liabilities of CIBC increase by $10 D) the assets of CIBC fall by $10

Answer: C

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 ________. A) coercive bargaining B) strategic holding out C) credit rationing D) collusive behavior

Answer: 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

Answer: C

When you deposit $50 in your account at First National Bank and a $100 cheque you have written on this account is cashed at Chemical Bank, then ________. A) the assets of First National rise by $50 B) the assets of Chemical Bank rise by $50 C) the reserves at First National fall by $50 D) the liabilities at Chemical Bank rise by $50

Answer: C

Which of the following is not a source of borrowings for a bank? A) Overnight funds B) Eurodollars C) Time deposits D) Advances

Answer: C

Which of the following statements are true? A) A bank's assets are its sources of funds. B) A bank's liabilities are its uses of funds. C) A bank's balance sheet shows that total assets equal total liabilities plus capital. D) A bank's balance sheet indicates whether or not the bank is profitable.

Answer: C

________ may antagonize customers and thus can be a very costly way of acquiring funds to meet an unexpected deposit outflow. A) Selling securities B) Selling loans C) Calling in loans D) Selling negotiable CDs

Answer: C

Because ________ are less liquid for the depositor than ________, they earn higher interest rates. A) savings account; time deposits B) money market deposit accounts; time deposits C) money market deposit accounts; savings account D) time deposits; savings account

Answer: D

Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the ________. A) adverse selection problem B) lemon problem C) adverse credit risk problem D) moral hazard problem

Answer: D

From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem. A) moral hazard; diversification B) diversification; moral hazard C) adverse selection; diversification D) diversification; adverse selection

Answer: D

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 ________. A) increase by $15 million B) increase by $1.5 million C) decline by $15 million D) decline by $1.5 million

Answer: D

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

Answer: D

The difference of rate-sensitive liabilities and rate-sensitive assets is known as the ________. A) duration B) interest-sensitivity index C) rate-risk index D) gap

Answer: D

The goals of bank asset management include ________. A) maximizing risk B) minimizing liquidity C) lending at high interest rates regardless of risk D) purchasing securities with high returns and low risk

Answer: D

When Jane Brown writes a $100 cheque to her nephew (who lives in another province), Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100. A) gains; gains B) gains; loses C) loses; gains D) loses; loses

Answer: D

When banks offer borrowers smaller loans than they have requested, banks are said to ________. A) shave credit B) rediscount the loan C) raze credit D) ration credit

Answer: D

Which of the following are not reported as assets on a bank's balance sheet? A) Cash items in the process of collection B) Loans C) Securities D) Demand deposits

Answer: D

Which of the following statements is false? A) A bank's assets are its uses of funds. B) A bank issues liabilities to acquire funds. C) The bank's assets provide the bank with income. D) Bank capital is recorded as an asset on the bank balance sheet.

Answer: D

Which of the following would a bank not hold as insurance against the highest cost of deposit outflow-bank failure? A) Excess reserves B) Secondary reserves C) Bank capital D) Mortgages

Answer: D

Which of the following would not be a way to increase the return on equity? A) Buy back bank stock B) Pay higher dividends C) Acquire new funds by selling negotiable CDs and increase assets with them D) Sell more bank stock

Answer: D

Explain the relationship between return on assets and return on equity. What incentives does this relationship give a bank manager? Is this the desired outcome preferred by regulators? Discuss.

Answer: For a given return on assets, the greater the amount of capital, the lower is the return on equity. Bank managers who seek to increase the return on equity must increase the asset base, purchase riskier assets, or reduce the amount of capital by paying dividends or buying back stock. Regulators (and depositors) prefer higher capital for bank safety. Managers typically prefer lower equity than regulators, resulting in regulatory bank capital requirements.

How can specializing in lending help to reduce the adverse selection problem in lending?

Answer: Reducing the adverse selection problem requires the banks to acquire information to screen bad credit risks from good credit risks. It is easier for banks to obtain information about local businesses. Also if the bank lends to firms in a few specific industries they will become more knowledgeable about those industries and a better judge of creditworthiness in those industries.

What are the main items in a bank's asset side of the balance sheet? Discuss them briefly.

Answer: The students must answer that the main items in a bank's asset side of the balance sheet are: - Cash reserves: vault cash, settlement balances - Deposits at other banks: interbank deposits - Cash items in process of collection: items in transit or bank float - Securities: government of Canada, provincial and municipal, and other securities - Loans: commercial, industrial, real estate - Fixed and other assets: physical capital, etc.