Bank Management and Financial Services by Rose & hudgins

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Chapter 1

An Overview of the Changing Financial-Services Sector

Fill in the Blank Questions

1. _______________________ is a traditional service provided by banks in which the banks store the valuables of their customers and certify their true value.

________________________________________

2. The fact that financial institutions monitor the financial condition of their borrowers by serving only as an agent on behalf of depositors is the _______________________ theory of banking.

________________________________________

3. _______________________ refers to when a financial institution trades one form of currency for another. An example of this would be when the bank trades dollars for yen.

________________________________________

4. A(n) _______________________ is a traditional service which permits a depositor to write a draft in payment for goods and services.

________________________________________

5. _______________________ is a service provided by banks where the bank lends money to individuals for the purchase of durable and other goods.

________________________________________

6. The _______________________ of a bank is a traditional service where the bank manages the financial affairs and property of individuals (and in some cases businesses).

________________________________________

7. Companies such as Merrill Lynch and Sears which offered some but not all banking services in the 1980s were called ______________________.

________________________________________

8. The loosening of government regulation and control of financial institutions is called ______________________.

________________________________________

9. ___________________________ is an alternative to lending in which the financial institution purchases the equipment and rents it to its customers.

________________________________________

10. The ___________________________ is a landmark act which allows financial service providers to offer an expanded menu of financial services for the customer. This law allows banks to truly become conglomerate financial service providers.

________________________________________

11. The country with the most banks is ______________________.

________________________________________

12. According to Congress, a ____________ is defined as any institution that can qualify for deposit insurance administered by the FDIC.

________________________________________

13. A bank which spans regions, nations, and continents, offering the widest menu of financial services is known as a _________ bank.

________________________________________

14. _____________ refers to the movement of businesses across industry lines in order to broaden its base.

________________________________________

15. Banks which serve primarily households and small firms are known as ____________ banks.

________________________________________

16. Banks that sell deposits and make loans to businesses, individuals, and institutions are known as _____________ banks.

________________________________________

17. Banks which underwrite issues of new securities on behalf their corporate customers are known as ________ banks.

________________________________________

18. Banks which function under a federal charter through the Comptroller of the Currency in the United States are known as ____________ banks.

________________________________________

19. Banks which supply both debt and equity capital to businesses are known as _________ banks.

________________________________________

20. A bank that offers its services only over the Internet is known as a(n) _______.

________________________________________

21. When a local merchant sells the accounts receivables they hold against their customer to a bank this generally known as _______.

________________________________________

22. A(n) ________ offers loans to commercial enterprises (such as appliance dealers) and to individuals and families using funds borrowed in the open market or from other financial institutions.

________________________________________

23. A(n) ________ buys and sells securities on behalf of their customers and for their own accounts. Examples of this type of financial service provider include Merrill Lynch and Charles Schwab.

________________________________________

24. A(n) ________ sells shares mainly to upscale investors in a broad group of different kinds of assets including nontraditional investments in commodities, real estate, loans to new and ailing companies, and other risky assets.

________________________________________

25. When a bank agrees to handle the cash collections and disbursements for a company and invest any temporary cash surpluses in interest bearing assets, they are providing ________ services to their customers.

________________________________________

True / False Questions

26. Under U.S. federal law, an institution making only loans to households and offering uninsured checkable deposits and savings deposits qualifies as a commercial bank.

True False

27. Nonbank financial-service institutions can offer deposits to the public, but these deposits are not eligible for insurance coverage by the FDIC.

True False

28. The etymological roots of the word “bank” trace this word back to an Italian term referring to a “money-changer’s table”.

True False

29. According to the textbook, the largest banks tend to offer the widest range of services of any financial-service firm today.

True False

30. According to the delegated monitoring theory, the bank serves as an agent on behalf of its depositors, monitoring the financial condition of those customers who receive loans from them.

True False

31. Managing the financial affairs and property of individuals and business firms falls under the type of banking service line known as cash management services.

True False

32. The role performed by banks in the economy in which they transform savings into credit is known as the intermediation role.

True False

33. The role performed by banks in which they guarantee to make payments on behalf of their customers when those customers are unable to pay a debt obligation is known as the guarantor role.

True False

34. When banks serve as conduits for government policy this is referred to as their agency role.

True False

35. According to the textbook, high-volume transactions are required to make efficient use of automation and other technological innovations.

True False

36. The number of independently owned banks has risen in the United States over the last decade.

True False

37. Money-center banks usually service local communities, towns, and cities, offering a narrow menu of services to the public.

True False

38. A greater proportion of major corporations have deserted the banking system in recent years to raise borrowed funds directly from the open market.

True False

39. The recent erosion of the banking market share relative to other financial institutions means that banking is a dying industry.

True False

40. Lending institutions act as delegated monitors and can diversify and reduce their risk exposure, resulting in increased safety for savers’ funds.

True False

41. Current theory suggests that banks exist because of imperfections in our financial system.

True False

42. According to the textbook, traditional banking may be on the decline.

True False

43. Convergence refers to the fact that the number of bank mergers has increased in recent years.

True False

44. Banks which offer virtually all financial services are known as universal banks.

True False

45. Banks have now expanded their service offerings into providing investment banking, insurance protection, financial planning, and other services rather than restricting themselves to traditional financial services.

True False

Multiple Choice Questions

46. In the United States, a commercial bank qualifies as a “bank” under federal law if it offers:

A. consumer installment loans, CDs.

B. trust services, commercial loans.

C. checking accounts, commercial loans.

D. security investments, inventory loans to business customers.

E. commercial deposit accounts, consumer savings plans.

47. J.C. Penney, and Sears provided are among leading firms that in the 1980s organized competitors with banks that are known as:

A. nonbank financial-service institutions.

B. discount security companies.

C. savings institutions.

D. credit unions.

E. commercial banks.

48. A study of history shows that one of the first services offered by banks was:

A. equipment leasing.

B. currency exchange.

C. security brokerage and underwriting.

D. sale of real estate.

E. None of the options are correct

49. Banks perform the indispensable task of:

A. creating money without making loans.

B. absorbing the excess liquidity created by other financial institutions.

C. intermediating between surplus-spending parties and deficit-spending parties.

D. issuing risky deposits.

E. None of the options are correct

50. The view that depositors hire banks to analyze the financial condition of prospective borrowers and continually evaluate the condition of outstanding loans is referred to as:

A. delegated monitoring.

B. the concept of financial intermediation.

C. the liquidity function in banking.

D. market imperfection theory.

E. the efficiency contribution of banking.

51. Which of the following has been an important trend regarding consolidation and geographic expansion in banks?

A. Increased bank branching activity

B. The formation of more holding companies to purchase smaller banks

C. Mergers among some of the largest banks in the industry

D. Significant rise in the average size of individual banks

E. All of the options are correct

52. Included among leading structural trends in the U.S. banking industry in recent years are:

A. the number of independently owned banks has declined.

B. the average size of individual banking firms has increased.

C. entry across state lines from neighboring states has increased.

D. the mergers among some of the largest banks in the industry.

E. All of the options are correct.

53. Smaller, locally focused commercial and savings banks that offer narrower but more personalized menu of financial services are known as:

A. money-center banks.

B. community banks.

C. mutual funds.

D. state banks.

E. fringe banks.

54. The banking services that include marketing new securities to raise funds for corporations and other institutions is referred to:

A. comprehensive packaging.

B. wrap-around accounts.

C. investment banking.

D. professional banking.

E. None of the options are correct.

55. A bank that wires funds for the purchase of a beach house in South Carolina for a customer in Oklahoma is carrying out the __________ of banks.

A. intermediation role

B. payment role

C. guarantor role

D. agency role

E. policy role

56. Examples of imperfections in the financial system which allow banks to exist include which of the following?

A. Informational asymmetry

B. Efficiency of markets

C. Divisibility of assets

D. Adequate liquidity

E. All of the examples are of the imperfections that exist.

57. A bank which manages the investment portfolio and pays the bills of an elderly customer who is unable to do it for him or herself is carrying out the __________ of banks.

A. intermediation role

B. payment role

C. guarantor role

D. agency role

E. policy role

58. Which of the following is not a current trend in the banking industry?

A. The number of banks is declining

B. The number of bank branches is declining

C. The number of bank services is increasing

D. The number of bank competitors is increasing

E. Bank industry convergence

59. Which of the following types of banks would most likely offer the largest number of financial services virtually?

A. A retail bank

B. A community bank

C. A commercial bank

D. A universal bank

E. An international bank

60. The phenomenon of convergence refers to:

A. financial service firms expanding into other product lines.

B. firms reducing their product lines.

C. bank merger activity.

D. globalization in banking.

E. technological innovation in banking.

61. Bank equipment leasing activity involves:

A. a bank leasing its office facilities instead of buying.

B. a bank buying equipment and then leasing the item to a customer.

C. a customer buying equipment and then leasing it to a bank.

D. a bank leasing computer equipment.

E. None of the options are correct.

62. Wholesale banks are those banks that:

A. sell at a discount relative to all commercial banks.

B. only make loans to the wholesale industry.

C. lend almost exclusively to farmers.

D. serve corporations and government.

E. have only retail customers.

63. Jonathan Robbins has an account in a bank that does not have a physical branch. Jonathan does all of his banking business over the Internet. What type of bank does Jonathan have his account at?

A. Virtual Bank

B. Mortgage Bank

C. Community Bank

D. Minority banks

E. None of the options are correct.

64. The Edmond National Bank serves only the City of Edmond, Oklahoma and concentrates on providing the best possible service to this city. What type of bank is this most likely to be?

A. Virtual Bank

B. Mortgage Bank

C. Community Bank

D. Bankers’ banks

E. None of the options are correct.

65. The Charleston Southern Bank makes loans for families to purchase new and existing homes but does not take deposits. What type of bank is this most likely to be?

A. Virtual Bank

B. Mortgage Bank

C. Community Bank

D. Merchant banks

E. None of the options are correct.

66. Which of the following is considered a fringe bank?

A. Community Bank

B. Wholesale Bank

C. Merchant Bank

D. Payday Lender

E. None of the options are correct.

67. During the middle ages, banks encountered religious opposition because:

A. loans to the poor often carried high interest rates.

B. loans and deposits were primarily for wealthy customers.

C. the Industrial Revolution demanded new methods of making payments and obtaining credit.

D. savings and wealth were lost due to war, theft, and expropriation by governments.

E. All of the options are correct.

68. Religious opposition decreased during the Renaissance because:

A. loans to the poor often carried high interest rates.

B. loans and deposits primarily consisted of wealthy customers.

C. the Industrial Revolution demanded new methods of making payments and obtaining credit.

D. savings and wealth were lost due to war, theft, and expropriation by governments.

E. All of the options are correct.

69. Banks like the Medici Bank in Italy and the Hochstetter Bank in Germany were successful because __________ and they responded well to these new needs.

A. the poor needed loans at high interest rates

B. primarily wealthy customers needed loans and deposits

C. the Industrial Revolution demanded new methods of making payments and obtaining credit

D. people needed to protect their savings and wealth from the government

E. All of the options are correct.

70. Early European banks were places for safekeeping of wealth because:

A. loans to the poor often carried high interest rates.

B. loans and deposits were primarily for wealthy customers.

C. the industrial revolution demanded new methods of making payments and obtaining credit.

D. savings and wealth were lost due to war, theft, and expropriation by governments.

E. All of the options are correct.

71. The U.S. government wants to prevent money laundering by drug cartels. To promote this goal, they have asked banks to report any cash deposits greater than $10,000 to the government. Which of the following roles is the bank performing?

A. The intermediation role

B. The payments role

C. The risk management role

D. The guarantor role

E. The policy role

72. The Edmond Wine and Cheese shop wants to buy 30 cases of French Champagne on credit. Bank of America writes a letter of credit stating that the Edmond Wine and Cheese shop is a good risk and that if they do not pay off the loan, Bank of America will. Which of the following roles is the bank performing?

A. The intermediation role

B. The payments role

C. The risk management role

D. The guarantor role

E. The policy role

73. Alexander Phua goes to his local bank and gets an insurance policy that protects him against loss in case he is in a car accident. Which of the following roles is the bank performing?

A. The intermediation role

B. The payments role

C. The risk management role

D. The guarantor role

E. The policy role

74. Chris Jones gets a cashier’s check from Wachovia Bank to make his down payment on a new home. Which of the following roles is the bank performing?

A. The intermediation role

B. The payments role

C. The risk management role

D. The guarantor role

E. The policy role

75. The Bank, N.A. accepts deposits from thousands of individuals and lends that money to (among others) the Stillwater Body Shop to expand their work bays. Which of the following roles is the bank performing?

A. The intermediation role

B. The payments role

C. The risk management role

D. The guarantor role

E. The policy role

76. Major trends affecting the performance of financial firms today include all of these except:

A. greater product-line diversification.

B. reduced branching.

C. geographic diversification.

D. convergence.

E. increasing automation.

77. The First National Bank of Lakeland makes risky loans to businesses to expand and grow their businesses while at the same time issuing low-risk securities to their depositors and other fund providers. Which of the following services is this bank offering to their customers?

A. Risky arbitrage services

B. Liquidity services

C. Delegated monitoring services

D. Divisibility of money services

E. Credit services

78. Jonathan Wynn knows that if he wanted to purchase a Treasury Bill, the minimum amount he would spend would be close to $10,000. He also knows that he could deposit $1,000 in a money market deposit account at a bank and earn about the same rate of interest. Jonathan does not have $10,000 to invest in a Treasury Bill. If Jonathan puts his money in the bank, which service that a bank can provide, is he taking advantage of?

A. Risky arbitrage services

B. Liquidity services

C. Delegated monitoring services

D. Divisibility of money services

E. Credit services

79. Nick Rodr gets a loan from the First State Bank of Guthrie to purchase a new refrigerator for his condo. What service that a bank provides is he taking advantage of?

A. Risky arbitrage services

B. Liquidity services

C. Delegated monitoring services

D. Divisibility of money services

E. Credit services

80. Drew Davis goes to his local bank to get help developing a financial plan and making investment decisions. Which of the more recent services banks offer is Drew taking advantage of?

A. Getting a consumer loan

B. Getting financial advice

C. Managing cash

D. Getting venture capital services

E. Buying a retirement plan

81. The Bartholemew Bakery receives a lot of payments in cash. They deposit it in their local bank who invests the money in an interest bearing account until it is needed to pay bills. Which of the financial services banks offer, is the Bartholemew bakery taking advantage of?

A. Getting a consumer loan

B. Getting financial advice

C. Managing cash

D. Getting venture capital services

E. Buying a retirement plan

82. MyWebCast is a new company that makes it easy for individuals to create streaming videos on the Internet to share with friends and family for a small fee. MyWebCast wants to expand their offerings of video streaming services but needs cash to be able to do this. The Second National Bank of Oklahoma City, through a subsidiary, gives them the cash they need for an ownership share in the company. Which of the more recent services that banks offer is MyWebCast taking advantage of?

A. Getting a consumer loan

B. Getting financial advice

C. Managing cash

D. Getting venture capital services

E. Buying a retirement plan

83. Chandriga Suppiah has opened a Roth IRA with North Carolina State Bank and plans on making regular contributions to this account until she retires. Which of the financial services is Chandriga taking advantage of?

A. Getting a consumer loan

B. Getting financial advice

C. Managing cash

D. Getting venture capital services

E. Buying a retirement plan

84. The principal functions and services offered by many financial-service firms today include:

A. lending and investing money.

B. making payments on behalf of customers to facilitate their purchases of goods and services.

C. managing and protecting customers’ cash and other property.

D. assisting customers in raising and investing funds profitably.

E. All of the above.

85. Which of the following is considered a depository financial institution?

A. Mortgage company

B. Private pension funds

C. Savings and Loan associations

D. Money market funds

E. Insurance company

86. Which of the following is not a purpose of bank regulation?

A. Guarantee minimal profitability of the banking system

B. Provide monetary stability

C. Ensure safety and soundness of banks

D. Provide competitive financial system

E. Protect consumers from abuses of banks

87. During the financial crisis of 2007-2009, the collapse of Lehman Brothers and the bailout of Bear Stearns reaffirmed the importance of the fundamental principle of:

A. superior management.

B. globalization.

C. government bailout.

D. regulatory arbitrage.

E. public trust and confidence in the system.

88. Which of the following is an example of a commercial bank?

A. State and local government retirement funds

B. Foreign banking offices in the United States

C. Finance and mortgage companies

D. Property/casualty and other insurers

E. Mutual funds

89. Which of the following reasons leads to an implication that traditional banking is dying?

A. Decrease in number of branches

B. Increased restructuring of loans

C. Degradation of market share

D. Reduction of public trust and confidence in the system.

E. Increase in risky arbitrage services

90. Which one of the following nonbank financial-service institutions sell shares to the public representing an interest in a professionally managed pool of stocks, bonds, and other securities?

A. Security brokers and dealers

B. Investment banks

C. Finance companies

D. Mutual funds

E. Hedge funds

91. Which of the following activities do the banks perform as dealers in arranging for risk protection for customers from third parties?

A. Hedging services

B. Merchant banking services

C. Investment banking services

D. Mutual funds services

E. Security underwriting services

92. Which of the following are the implied motivators of reforms that have taken place in the banking sector since the credit crisis of 2007-2009?

A. Increased liquidity

B. Increased dominance of the largest financial firms

C. Increased disclosure of credit charges and other consumer expenses

D. Increased number of bank branches

E. Increased speed of innovation and invention

Chapter 2

The Impact of Government Policy and Regulation on the Financial
Services Industry

Fill in the Blank Questions

1. The _____________________ was created as part of the Glass-Steagall Act. In the beginning it insured deposits up to $2,500.

________________________________________

2. The ________________________ is the law that states that a bank must get federal approval in order to combine with another bank.

________________________________________

3. One tool that the Federal Reserve uses to control the money supply is ________________. The Federal Reserve will buy and sell T-bills, bonds, notes, and selected federal agency securities when they are using this tool of monetary policy.

________________________________________

4. The __________________________ was created in 1913 in response to a series of economic depressions and failures. Its principal role is to serve as the lender of last resort and to stabilize the financial markets.

________________________________________

5. The McFadden Act and the Douglas amendment which prevented banks from crossing state lines were later repealed by the _______________________________.

________________________________________

6. The policy of FDIC to levy fixed insurance premiums regardless of the risk involved, led to a/an _____________ problem among banks. The fixed premiums encouraged banks to accept greater risk.

________________________________________

7. In 1980, the __________________________ was passed, which lifted U.S government ceilings on deposit interest rates in favor of free-market interest rates.

________________________________________

8. One tool that the Federal Reserve uses to control the money supply is ________________. The Federal Reserve will change the interest rate they charge for short-term loans when they are using this tool of monetary policy.

________________________________________

9. The first major federal banking law in the U.S. was the _________________________. This law was passed during the Civil War and set up a system for chartering new national banks through the OCC.

________________________________________

10. The _________________________ was passed during the Great Depression. It separated investment and commercial banks and created the FDIC.

________________________________________

11. The __________________________ brought bank holding companies under the jurisdiction of the Federal Reserve.

________________________________________

12. The __________________________ allows adequately capitalized and managed bank holding companies to acquire banks anywhere in the United States. However, no one bank can control more than 30 percent of the deposits in any one state (unless the state waives this restriction) or more than 10 percent of the deposits across the country.

________________________________________

13. The ___________________________ allows well-managed and well-capitalized banking companies with satisfactory CRA ratings to affiliate with insurance companies and securities firms either through a financial holding company or through a subsidiary firm owned by a bank.

________________________________________

14. Customers of financial-service companies may _____________________ of having their private information shared with a third party, such as a telemarketer. However, in order to do this, they must tell the financial-services company in writing that they do not want their personal information shared with outside parties.

________________________________________

15. The federal bank regulatory agency which examines the most banks is the _____________.

________________________________________

16. The _________________ requires selected financial institutions to report suspicious activity in customer accounts to the Treasury Department.

________________________________________

17. The central bank of the new European Union is known as the ______________________.

________________________________________

18. The _____________________ Act prohibits banks and publicly owned firms from publishing false or misleading financial performance information.

________________________________________

19. One of the main roles of the Federal Reserve today is ________________. They have three tools that they use today to carry out this role: open market operations, the discount rate, and legal reserve requirements.

________________________________________

20. The _____________________________ is the center of authority and decision making within the Federal Reserve. It consists of seven members appointed by the president for terms not exceeding 14 years.

________________________________________

21. The main regulators of insurance companies are ____________________________.

________________________________________

22. Federal Credit Unions are regulated and examined by _________________________________.

________________________________________

23. The ___________________________________ makes it easier for victims of identity theft to file a theft report with the Federal Trade Commission and allows the public to apply for a free credit report once a year from the national credit bureaus.

________________________________________

24. The _____________________ makes it faster and less costly for banks to clear checks. It allows for banks to electronically send check images instead of shipping paper checks across the country.

________________________________________

25. The _____________________________________ was created by the National Bank Act and is part of the Treasury Department. It is the primary regulator of national banks.

________________________________________

26. The _________________________ proposes various regulations applying to the financial markets to combat the recent credit crisis. This “bail-out” bill granted the US Treasury the means to purchase troubled loans, allowed the FDIC to temporarily increase deposit insurance, and permitted the government to inject additional capital into the banking system.

________________________________________

True / False Questions

27. Federal Reserve Act authorized the creation of the Federal Deposit Insurance Corporation.

True False

28. In the United States, fixed fees charged for deposit insurance, regardless of how risky a bank is, led to a problem known as moral hazard.

True False

29. Government-sponsored deposit insurance typically encourages individual depositors to monitor their banks’ behavior in accepting risk.

True False

30. The Federal Reserve changes reserve requirements frequently because the effect of these changes is small.

True False

31. The Bank Merger Act and its amendments require that Bank Holding Companies be under the jurisdiction of the Federal Reserve.

True False

32. National banks cannot merge without the prior approval of the Comptroller of the Currency.

True False

33. The Truth in Lending (or Consumer Credit Protection) Act was passed by the U.S. Congress to outlaw discrimination in providing bank services to the public.

True False

34. The federal law that states individuals and families cannot be denied a loan merely because of their age, sex, race, national origin, or religious affiliation is known as the Competitive Equality in Banking Act.

True False

35. Under the terms of the 1994 Riegle-Neal Interstate Banking and Branching Efficiency Act, adequately capitalized and managed bank holding companies can acquire a bank anywhere inside the United States.

True False

36. The 1994 Federal Interstate Banking bill does not limit the percentage of statewide or nationwide deposits that an interstate banking firm is allowed to control.

True False

37. The term “regulatory dialectic” refers to the dual system of banking regulation in the United States and selected other countries where both the federal or central government and local governments regulate banks.

True False

38. The moral hazard problem of banks is caused by the fixed insurance premiums paid by banks which make them accept greater risk.

True False

39. When the Federal Reserve buys T-bills through its open market operations, it causes the growth of bank deposits and loans to decrease.

True False

40. When the Federal Reserve increases the discount rate, it generally causes other interest rates to decrease.

True False

41. The National Bank Act (1863-64) created the Federal Reserve which acts as the lender of last resort.

True False

42. The Financial Institutions Reform, Recovery, and Enforcement Act (1989) allowed bank holding companies to acquire nonbank depository institutions and, if desired, convert them into branch offices.

True False

43. The Sarbanes-Oxley Act allows banks, insurance companies, and securities firms to form Financial Holding Companies (FHCs).

True False

44. The Gramm-Leach-Bliley Act of 1999 essentially repeals the Glass-Steagall Act passed in the 1930s.

True False

45. Passed in 1977, the Equal Credit Opportunity Act prohibits banks from discriminating against customers merely on the basis of the neighborhood in which they live.

True False

46. The tool used by the Federal Reserve System to influence the economy and behavior of banks is known as moral hazard.

True False

47. One of the principal reasons for government regulation of financial firms is to protect the safety and soundness of the financial system.

True False

Multiple Choice Questions

48. Banks are regulated for which of the reasons listed below?

A. Banks are leading repositories of the public’s savings.

B. Banks have the power to create money.

C. Banks provide businesses and individuals with loans that support consumption and investment spending.

D. Banks assist governments in conducting economic policy, collecting taxes, and dispensing government payments.

E. All of the options are correct.

49. An institutional arrangement in which federal and state authorities both have significant bank regulatory powers is referred to as:

A. balance of power.

B. federalism.

C. dual banking system.

D. cooperative regulation.

E. coordinated control.

50. The law that set up the federal banking system and provided for the chartering of national banks was the:

A. National Bank Act.

B. McFadden Act.

C. Glass-Steagall Act.

D. Bank Merger Act.

E. Federal Reserve Act.

51. The federal law that prohibited federally supervised commercial banks from offering investment banking services on privately issued securities is known as:

A. the Glass-Steagall Act.

B. the Bank Merger Act.

C. the Depository Institutions Deregulation and Monetary Control Act.

D. the Federal Reserve Act.

E. None of the options are correct.

52. The Gramm-Leach-Bliley Act (Financial Services Modernization Act) calls for linking the government supervision of the financial-services firm to the types of activities that the firm undertakes. For example, the insurance portion of the firm would be regulated by state insurance commissions and the banking portion of the firm would be regulated by banking regulators. This approach to government supervision of financial services is known as:

A. consolidated regulation and supervision.

B. functional regulation.

C. government reregulation.

D. umbrella supervision and regulation.

E. None of the options are correct.

53. The Federal Reserve policy tool under which the Fed attempts to bring psychological pressure to bear on individuals and institutions to conform to the Fed’s policies using letters, phone calls, and speeches is known as:

A. margin requirement.

B. moral suasion.

C. discount window supervision.

D. conference and compromise.

E. None of the options are correct.

54. The 1994 law that allowed bank holding companies to acquire banks anywhere in the U.S. is:

A. the Glass-Steagall Act.

B. the Federal Deposit Insurance Corporation Improvement Act.

C. the National Bank Act.

D. the Riegle-Neal Interstate Banking and Branching Efficiency Act.

E. None of the options are correct.

55. Of the principal reasons for regulating banks, what was the primary purpose of the National Banking Act (1863)?

A. Separation of commercial and investment banking

B. Separation of commercial banking and insurance activities

C. Chartering new banks and examining existing ones

D. Establishment of a network to clear and collect checks

E. Preventing banks from realizing monopoly powers

56. Of the principal reasons for regulating banks, what was the primary purpose of the Federal Reserve Act of 1913?

A. Establishment of a network to clear and collect checks

B. Control of the money supply

C. Preventing banks from realizing monopoly powers

D. Ensuring an adequate and fair supply of loans

E. None of the options are correct.

57. The law which lifted government deposit interest ceilings in favor of competitive interest rates is:

A. the National Bank Act.

B. the Glass-Steagall Act.

C. the Bank Merger Act.

D. the Depository Institutions Deregulation and Monetary Control Act.

E. None of the options are correct.

58. The law that allows banks to affiliate with insurance companies and securities firms to form financial services conglomerates is:

A. the National Bank Act.

B. the Glass-Steagall Act.

C. the Garn-St Germain Depository Institutions Act.

D. the Riegle-Neal Interstate Banking Act.

E. the Gramm-Leach-Bliley Act (Financial Services Modernization Act).

59. Of the principal reasons for regulating banks, what was the primary purpose of the Consumer Credit Protection Act?

A. Establish a network to clear and collect checks

B. Control of the money supply

C. Prevent banks from realizing monopoly powers

D. Ensure that customers are aware of their rights and responsibilities under a loan agreement

E. None of the options are correct.

60. Which of the following is an unresolved issue in the new century?

A. What should be done about the regulatory safety net set up to protect small depositors?

B. If financial institutions are allowed to take on more risk, how can taxpayers be protected from paying the bill when more institutions fail?

C. Does functional regulation actually work?

D. Should regulators allow the mixing of banking and commerce?

E. All of these are unresolved issues

61. The law that made bank and nonbank depository institutions more alike in the services they could offer and allowed banks and thrifts to more fully compete with other financial institutions is:

A. the National Banking Act.

B. the Federal Reserve Act.

C. the Garn-St Germain Depository Institutions Act.

D. the Riegle-Neal Interstate Banking and Branching Efficiency Act.

E. the Gramm-Leach-Bliley Act (Financial Services Modernization Act).

62. The act that allowed bank holding companies to acquire nonbank depository institutions and convert them to branches is:

A. the National Banking Act.

B. the Garn-St Germain Act.

C. the Financial Institutions Reform, Recovery and Enforcement Act.

D. the Riegle-Neal Interstate Banking and Branching Efficiency Act.

E. None of the options are correct.

63. The equivalent of the Federal Reserve System in Europe is known as the:

A. European Union.

B. Bank of London.

C. European Council.

D. European Central Bank.

E. Swiss Bank Corporation.

64. As per the Gramm-Leach-Bliley Act, one of the ways through which a banking-insurance-securities affiliation can take place is through:

A. a financial holding company.

B. the state insurance commissions.

C. the European Central Bank.

D. a financial service corporation.

E. a financial modernization organization.

65. The act which requires financial institutions to share information about customer identities with government agencies is:

A. the Sarbanes-Oxley Act.

B. the National Banking Act.

C. the Garn-St Germain Depository Institutions Act.

D. the USA Patriot Act.

E. the Gramm-Leach-Bliley Act.

66. The 1977 act that prevents banks from “redlining” certain neighborhoods, refusing to serve those areas is:

A. the National Banking Act.

B. the Garn-St. Germain Act.

C. the Financial Institutions Reform, Recovery and Enforcement Act.

D. the Riegle-Neal Interstate Banking and Branching Efficiency Act.

E. the Community Reinvestment Act.

67. Common minimum capital requirements on banks in leading industrialized nations that are based on the riskiness of their assets is imposed by:

A. the National Banking Act.

B. the Financial Institutions Reform, Recovery and Enforcement Act.

C. the International Banking Act.

D. the Basel Agreement.

E. None of the options are correct.

68. The fastest growing financial crime in the U.S. is:

A. financial statement misrepresentation.

B. bank robberies.

C. individual privacy violations.

D. credit card fraud.

E. identity theft.

69. The oldest federal bank agency is the:

A. Office of the Comptroller of the Currency.

B. Federal Deposit Insurance Corporation.

C. Federal Reserve System.

D. state banking commission.

E. state insurance commission.

70. The federal agency that regulates the most banks is the:

A. Office of the Comptroller of the Currency.

B. Federal Deposit Insurance Corporation.

C. Federal Reserve System.

D. state banking commission.

E. state insurance commission.

71. Which federal banking act requires that financial service providers establish the identity of customers opening new accounts?

A. the Sarbanes-Oxley Act

B. the USA Patriot Act

C. the Check 21 Act

D. the Fair and Accurate Credit Transactions Act

E. the Bankruptcy Abuse Prevention and Consumer Protection Act

72. Which federal banking act prohibits publishing false or misleading information about the financial performance of a public company and requires top corporate officers to vouch for the accuracy of their company’s financial statements?

A. The Sarbanes-Oxley Act

B. The USA Patriot Act

C. The Check 21 Act

D. The Fair and Accurate Credit Transactions Act

E. The Bankruptcy Abuse Prevention and Consumer Protection Act

73. Which federal banking act reduces the need for banks to transport paper checks across the country?

A. The Sarbanes-Oxley Act

B. The USA Patriot Act

C. The Check 21 Act

D. The Fair and Accurate Credit Transactions Act

E. The Bankruptcy Abuse Prevention and Consumer Protection Act

74. Which federal banking act forces more individuals to repay at least part of what they owe and will push higher-income borrowers into more costly forms of bankruptcy?

A. The Sarbanes-Oxley Act

B. The USA Patriot Act

C. The Check 21 Act

D. The Fair and Accurate Credit Transactions Act

E. The Bankruptcy Abuse Prevention and Consumer Protection Act

75. Which federal banking act requires the Federal Trade Commission to make it easier for victims of identity theft to file theft reports and requires credit bureaus to help victims resolve the problem?

A. The Sarbanes-Oxley Act

B. The USA Patriot Act

C. The Check 21 Act

D. The Fair and Accurate Credit Transactions Act

E. The Bankruptcy Abuse Prevention and Consumer Protection Act

76. The _________ allows adequately capitalized bank holding companies to acquire banks in any state.

A. Riegle-Neal Interstate Banking and Branching Efficiency Act

B. Competitive Equality Banking Act

C. Financial Institutions Reform, Recovery and Enforcement Act

D. Federal Deposit Insurance Corporation Improvement Act

E. Depository Institutions Deregulation and Monetary Control Act

77. One of the earliest theories regarding the impact of regulation on banks was developed by George Stigler. He contends that:

A. firms in regulated industries actually seek out regulations because they bring monopolistic rents.

B. regulations shelter firms from changes in demand and cost, lowering its risk.

C. regulations can increase consumer confidence which increases customer loyalty to regulated firms.

D. depository institutions should be regulated no differently than any other corporation with no subsidies or special privileges.

E. None of the options are correct.

78. Samuel Peltzman had a different view to George Stigler on the impact of regulation on banks. He contends that:

A. firms in regulated industries actually seek out regulations because they bring monopolistic rents.

B. regulations shelter firms from changes in demand and cost, lowering its risk.

C. regulations can increase consumer confidence which increases customer loyalty to regulated firms.

D. depository institutions should be regulated no differently than any other corporation with no subsidies or special privileges.

E. None of the options are correct.

79. There is an important debate raging today regarding whether banks should be regulated at all. George Benston contends that:

A. firms in regulated industries actually seek out regulations because they bring monopolistic rents.

B. regulations shelter firms from changes in demand and cost, lowering its risk.

C. regulations can increase consumer confidence which increases customer loyalty to regulated firms.

D. depository institutions should be regulated no differently than any other corporation with no subsidies or special privileges.

E. None of the above options are correct.

80. The European Central Bank has the main goal of:

A. ensuring that commercial and investment banks are separated.

B. keeping unemployment low.

C. ensuring price stability.

D. ensuring an adequate and fair supply of loans.

E. All of the above options are correct.

81. Which of the following has become the principal tool of central bank monetary policy today?

A. Open market operations

B. Functional regulation

C. Umbrella supervision and regulation

D. Margin requirement

E. None of the options are correct.

82. The Federal Reserve buys Treasury Bills in the open market. This will tend to:

A. decrease the price of treasury bills.

B. increase the available for use funds with banks and dealers involved in the transaction.

C. cause reserves held at the Federal Reserve to decrease.

D. cause a decrease in the growth of deposits and loans.

E. All of the options are correct.

83. Which federal banking act extends deposit insurance coverage on qualified retirement accounts from $100,000 to $250,000 and authorizes the FDIC to periodically increase deposit insurance coverage to keep up with inflation?

A. The Sarbanes-Oxley Act

B. The Gramm-Leach-Bliley Act

C. The Check 21 Act

D. The Fair and Accurate Credit Transactions Act

E. The Federal Deposit Insurance Reform Act

84. The Financial Services Regulatory Relief Act of 2006:

A. adds selected new service powers to depository institutions.

B. loosens regulations on depository institutions.

C. grants the Federal Reserve authority to pay interest on depository institutions’ legal reserves.

D. All of the options are correct.

E. None of the options are correct.

85. The Emergency Economic Stabilization Act passed in 2008 during the global credit crisis, allowed for:

A. an emergency sale of “bad assets.”

B. a temporary increase of FDIC deposit insurance to $250,000 for all deposits.

C. injections of capital by the government into banks and other qualified lenders.

D. a closer surveillance of the mortgage market participants, such as brokers and lenders.

E. All of the options are correct.

86. As per the National Currency and Bank Acts, the comptroller of currency ensures that every national bank is examined by a team of federal examiners at least:

A. twice in a year.

B. once in 3 months.

C. once every 12 to 18 months.

D. once every 9 to 12 months.

E. once in a month.

87. _____ requires corporations controlling two or more banks to register with the Federal Reserve Board and seek approval for any new business acquisitions.

A. The Glass-Steagall Act

B. The Federal Deposit Insurance Corporation Improvement Act

C. The National Bank Act

D. The Riegle-Neal Interstate Banking and Branching Efficiency Act

E. The Bank Holding Company Act

88. _____ allows European and foreign banks greater freedom to cross national borders.

A. The European Monetary Union

B. The European Council

C. The Sarbanes-Oxley Act

D. The Garn-St Germain Depository Institutions Act

E. The Gramm-Leach-Bliley Act

89. Which of the following acts created a Financial Stability Oversight Council to dampen systemic risk?

A. The Dodd-Frank Regulatory Reform Act

B. The Sarbanes-Oxley Act

C. The Garn-St Germain Depository Institutions Act

D. The Gramm-Leach-Bliley Act

E. The Financial Institutions Reform, Recovery and Enforcement Act

90. Which of the following created the Truth in Savings Act?

A. The FDIC Improvement Act

B. The International Banking Act

C. The Sarbanes-Oxley Act

D. The Gramm-Leach-Bliley Act

E. The Financial Institutions Reform, Recovery and Enforcement Act

Chapter 3

The Organization and Structure of Banking and the Financial Services Industry

Fill in the Blank Questions

1. A(n) ___________________ is a machine located at the merchant’s place of business which allows depositors to use their debit card to pay for purchases directly.

________________________________________

2. A(n) _____________________ is one which offers its full range of banking services from several locations.

________________________________________

3. A(n) _____________________ is one which offers its full range of banking services from only one location.

________________________________________

4. A(n) ________________________ is a corporation chartered for the specific purpose of holding the stock of one or more banks, often along with other businesses.

________________________________________

5. Managers who value fringe benefits, plush offices, and ample travel budgets over the pursuit of maximum returns for stockholders are exhibiting signs of _________________________.

________________________________________

6. A(n) __________________________ can invest in corporate stock as well as loan money to help finance the start of new ventures or support the expansion of existing businesses.

________________________________________

7. A bank which operates exclusively over the internet is known as a ___________ bank.

________________________________________

8. A(n) _____________________ is a special type of holding company that may offer the broadest range of financial services, including dealing in and underwriting securities, and selling and underwriting insurance.

________________________________________

9. The key problem in a large money center bank is ________________. Managers may be knowledgeable about banking practices but may be less informed about products and services of subsidiary companies.

________________________________________

10. The Gramm-Leach-Bliley Act moved the U.S. banking industry closer to the concept of ___________ banking in which banks merge with security and insurance firms and various other financial products.

________________________________________

11. A bank that is not owned by a holding company is called a(n) ______________ bank.

________________________________________

12. ___________________ is a larger view of how modern corporations operate, and analyzes the relationship between a firm’s owners and its managers.

________________________________________

13. Many experts believe that lower agency costs and better company performance depend upon the effectiveness of ____________ the relationship that exists among managers, the board of directors, stockholders, and other stakeholders.

________________________________________

14. ___________________________ is the idea that as the output grows, cost of production per unit of goods and services will grow at a lower rate.

________________________________________

15. ______________________ is the idea that cost of producing multiple services, using the same organization and resources, will grow at a lower rate as the product mix expands.

________________________________________

16. ___________________ is the committee selected by stockholders to set policies and monitor the performance of a bank.

________________________________________

True / False Questions

17. Bank size is not considered a significant factor in determining how banks are organized.

True False

18. Nearly three quarters of all U.S. banks exceed $100 million in asset size apiece.

True False

19. Nearly all U.S. banks with federal or state charters have their deposits insured by the Federal Deposit Insurance Corporation.

True False

20. State-chartered banks in the United States represent about a quarter of all U.S.-chartered banks, while national banks account for approximately three quarters of all U.S. chartered banks.

True False

21. The majority of all U.S. banks are members of the Federal Reserve System.

True False

22. A banking corporation, chartered by either federal or state governments, that operates only one full-service office is called a unit bank.

True False

23. Over half of all U.S. states today limit branching activity.

True False

24. An average U.S. bank is larger in size (in terms of number of branch offices) than an average Canadian bank.

True False

25. Despite the rapid growth of automation in U.S. banking, there are more full-service branch banking offices than automated teller machines across the whole U.S.

True False

26. In the United States there are more one-bank holding companies than multi-bank holding companies.

True False

27. Financial holding companies hold more than 90 percent of the industry’s assets in the United States.

True False

28. Research evidence suggests that banks taken over by interstate banking organizations have generally increased their market share over their competitors within the same state and are generally more profitable than their competitors.

True False

29. The concentration of bank deposits at the local level (that is in urban communities and rural counties) has displayed only moderate changes in recent years.

True False

30. There is evidence that branch banks charge higher service fees for some banking services than unit banks, which reflects greater knowledge on the part of larger banks concerning true cost of service.

True False

31. A unit branch faces the risk of variability in earnings if the surrounding economy weakens and people and businesses move away to other market areas.

True False

32. Recent research suggests that branch banks tend to be more profitable than either unit or holding company banks, while interstate banks tend to be the most profitable of all.

True False

33. Less than 10 percent of the largest banks in the U.S. control almost 90 percent of the industry assets.

True False

34. Agency theory suggests that bank management will always pursue the goal of maximizing returns of the bank’s shareholders.

True False

35. Recent research suggests that the relationship between bank size and the cost of production per unit of output is roughly U shaped.

True False

36. Bank holding companies that want to achieve some reduction in earnings risk through interstate banking, can achieve the same level of risk reduction by entering any of the fifty states.

True False

37. Bank holding companies are allowed to own nonbank businesses as long as those businesses offer services closely related to banking.

True False

38. Banks tend to have a higher proportion of outside directors than a typical manufacturing firm.

True False

39. Banks which operate entirely on the web are known as invisible banks.

True False

40. Banks acquired by holding companies are referred to as affiliated banks.

True False

41. Bank organizational structure has become more complex in recent years.

True False

42. There are only a very small number of unit banks in the U.S. today.

True False

43. Traditional brick-and-mortar bank branch offices are on the decline in the U.S. today.

True False

44. Community banks are usually smaller banks that are devoted principally to the markets for smaller, local deposits and loans.

True False

45. X-efficiency is a concept which measures the divergence between the actual operating costs and the lowest possible operating costs of a financial services firm if it is operating under maximum efficiency.

True False

Multiple Choice Questions

46. In banking, organizational form follows _________, because banks usually are organized in such a way as to carry out the tasks and supply the services demanded of them.

A. bank size

B. management’s decision

C. function

D. regulation

E. location

47. Which of the following is charged with setting policies and overseeing the performance of a bank?

A. Stockholders

B. Board of directors

C. Regulators

D. Depositors

E. None of the options are correct

48. According to the textbook, large banks possess some potential advantages over small and medium-size banks. Which of the following is not such an advantage?

A. Greater diversification, geographically and by product line

B. Availability of financial capital at lower cost

C. Greater professional expertise to allocate capital to the most promising products and services

D. Better positioned to take advantage of the opportunities afforded by interstate banking

E. All the options are advantages typically possessed by large banks

49. Before offering any financial service to the public, a bank in the United States must have a:

A. certificate of deposit insurance.

B. charter of incorporation.

C. list of established customers.

D. new building constructed to be the bank’s permanent home.

E. None of the options are correct.

50. A typical branch banking organization:

A. has complete centralization of authority.

B. has complete decentralization of authority.

C. has partial decentralization of authority.

D. is completely operated by regulators.

E. is completely operated by shareholders.

51. Which of the following is one of the few states that has opted out of interstate banking?

A. New York

B. Ohio

C. Texas

D. Montana

E. None of the options are correct

52. The concentration of U.S. bank deposits in the hands of the largest banks has _________ recently.

A. declined

B. increased

C. remained essentially unchanged

D. exhibited large fluctuations in both directions

E. None of the options are correct

53. Which of the following is one of the several advantages that bank holding company organizations have over other types of banking organizations?

A. Greater access to capital markets

B. Tax advantage

C. Product-line diversification

D. Ability to use higher leverage

E. All the options are correct

54. A company which owns stocks of three different banks is categorized as a(n):

A. unit bank.

B. interstate bank.

C. investment bank.

D. multi-bank holding company.

E. None of the options are correct.

55. Which of the following is considered to be an advantage of branch banking?

A. Increased availability and convenience of services

B. Decreased chance of failure

C. Reduced transaction costs

D. Decreased chance of failure and reduced transaction costs

E. All the options are correct

56. Which of the following is a type of nonbank businesses a bank holding company can own?

A. Retail Computer Store

B. Security Brokerage Firm

C. Retail Grocery Store

D. Wholesale Electronic Distribution Company

E. All the options are correct

57. A bank which offers its full range of services from only one office is known as a:

A. unit bank.

B. branch bank.

C. correspondent bank.

D. bank holding company.

E. None of the options are correct.

58. Which of the following is a reason that many states and the federal government finally enact interstate banking laws?

A. The need for new capital in order to revive struggling local economies

B. The expansion of service offerings by nonbank financial institutions

C. The belief among regulators that larger firms may be more efficient and stable

D. Advances in technology which allowed banks to service customers in broader geographic areas

E. All the options are reasons for the passage of interstate banking laws

59. What is a bank holding company?

A. It is a bank that offers all of its services out of one office

B. It is a bank that offers all of its services out of several offices

C. It is a corporation formed to hold the stock of one or more banks

D. It is a merchant bank

E. None of the options are correct

60. Which of the following is a type of service that a bank holding company is not allowed to own?

A. Merchant banking company

B. Savings and loan association

C. Retail electronics equipment sales company

D. Security brokerage firm

E. Insurance agency

61. Over the last half-a-decade, the number of banks in the U.S. has __________ and the number of branches has ________.

A. declined; increased

B. grown; increased

C. grown; decreased

D. declined; decreased

E. stabilized; stabilized

62. Websites known as electronic branches offer all of the following except:

A. Internet banking services.

B. ATMs.

C. point of sale terminals.

D. computer and phone services connecting customers.

E. traveler’s checks.

63. Relative to manufacturing firms, banks tend to have ___________ number of board members.

A. same

B. larger

C. smaller

D. insignificant

E. None of the options are correct

64. About a quarter of all commercial banks in the U.S. are:

A. investment banks

B. branch banks

C. unit banks

D. virtual banks

E. bank holding companies

65. A ‘typical’ community bank is committed to:

A. attracting deposits from large companies.

B. attracting deposits from high net-worth individuals.

C. making loans to large corporates.

D. making loans to small households.

E. None of the options are correct.

66. A “typical” money center bank:

A. has a complex organizational chart.

B. is often plagued by span of control.

C. is owned by a bank holding company.

D. is well diversified—both geographically and by product line.

E. All the options are correct.

67. Majority of banks today are:

A. federally chartered.

B. uninsured.

C. state chartered.

D. national banks.

E. All the options are correct.

68. Member banks are:

A. members of the FDIC.

B. national banks.

C. unit banks.

D. members of the Federal Reserve System in the U.S.

E. All the options are correct.

69. ____________ and ___________ banks tend to be larger and hold more of the public’s deposits in the United States.

A. National, member

B. State, nonmember

C. National, uninsured

D. State, insured

E. None of the options are correct

70. Which of the following is a reason for the rapid growth in branch banks?

A. Exodus of population from cities to suburban areas

B. Bank convergence

C. Business failures

D. Decreased costs of brick-and-mortar

E. All the options are correct

71. Under the Bank Holding Company Act, control of a bank is assumed to exist only if:

A. The bank holding company acquires 100% of at least one bank’s outstanding stock

B. The bank holding company acquires 50% or more of at least one bank’s outstanding stock

C. The bank holding company acquires 25% or more of at least one bank’s outstanding stock

D. The bank holding company acquires at least three banks

E. None of the options are correct

72. When a bank holding company acquires a nonbank business it must be approved by the:

A. FDIC.

B. Comptroller of the Currency.

C. Federal Reserve.

D. SEC.

E. All the options are correct

73. Many financial experts believe that the customers most likely to be damaged by decreased competition include:

A. large corporations in large cities.

B. households and business in smaller cities and towns.

C. households that earn more than a million dollars a year.

D. students away at college.

E. None of the options are correct.

74. According to Levonian and Rose, in order to achieve some reduction in earnings risk, interstate banks must:

A. expand into different product lines.

B. expand into a number of different regions.

C. increase the number of people in the management.

D. increase the number of employees.

E. buy smaller banks.

75. Consolidation, particularly among saving associations, finance companies, credit unions, security firms, and insurance companies, is:

A. occurring at a rapid pace.

B. non-existent.

C. occurring at a slow pace.

D. disapproved of by the regulators.

E. None of the options are correct.

76. Of the following countries in Europe, which one has the largest number of banks?

A. Belgium

B. France

C. Germany

D. Great Britain

E. None of the options are correct

77. Which of the following country’s banks were owned by the state until the 1990’s?

A. Belgium

B. France

C. Germany

D. Italy

E. None of the options are correct

78. When different financial service providers offer a similar range of services including banking, insurance and securities services, it is known as:

A. consolidation.

B. convergence.

C. economies of scale.

D. e-efficiencies.

E. None of the options are correct.

79. Gradual evolution of markets and institutions such that geographic boundaries do not restrict financial transactions is known as:

A. deregulation.

B. integration.

C. re-regulation.

D. globalization.

E. moral suasion.

80. Banks with _______ in assets are generally called community banks.

A. more than $1 billion

B. less than $1 billion

C. more than $5 million

D. less than $1 trillion

E. more than $1 trillion

81. Nonbank financial firms that supply insurance coverage to customers borrowing money to guarantee repayment of a loan are referred to as:

A. merchant bankers.

B. factoring companies.

C. savings associations.

D. investment bankers.

E. credit insurance underwriters.

82. A financial holding company (FHC), defined as a special type of holding company that may offer the broadest range of financial services such as securities and insurance activities, was allowed under which act?

A. Riegle-Neal Interstate Banking and Branching Efficiency Act

B. The Competitive Equality in Banking Act

C. The Basel Agreement

D. The FDIC Improvement Act

E. The Gramm-Leach-Bliley (Financial Services Modernization) Act

83. A bank devoted principally to the markets for smaller, locally based deposits and loans is often referred to as a(n):

A. wholesale bank.

B. retail bank.

C. commercial bank.

D. investment bank.

E. social bank.

84. Senior management of a community bank reports periodically to the:

A. management.

B. managing director.

C. CEO.

D. board of directors.

E. stockholders.

85. A money center bank is typically owned by:

A. private equity companies.

B. bank holding companies.

C. foreign banks.

D. hedge funds.

E. mutual funds.

86. In recent years, organizational hierarchy in banks is increasingly becoming more:

A. simpler.

B. complex.

C. vertical.

D. horizontal.

E. flat.

87. One reason for the fairly large number of unit banks in the United States is:

A. de-merger of branch banks.

B. low profitability in larger banks.

C. continuous formation of new banks.

D. regulations prohibiting formation of branch banks.

E. All the options are correct.

88. Outside the United States, the holding company form:

A. is usually legal and very popular.

B. is usually legal but not often used.

C. is not legal.

D. is not legal yet popular.

E. is legal but never used.

89. A bank holding company that wishes to acquire _________ or more of equity shares of an additional bank must seek approval from the Federal Reserve Board.

A. 5 percent

B. 10 percent

C. 15 percent

D. 25 percent

E. 51 percent

90. ________________ manage and care for the property of businesses, individuals, and non-profit organizations.

A. Insurance companies

B. Holding companies

C. Real estate companies

D. Trust companies

E. Factoring companies

91. ____________ offer savings deposit plans and housing related credit, predominantly to individuals and families.

A. Insurance companies

B. Real estate companies

C. Trust companies

D. Factoring companies

E. Savings associations

92. In theory, if an interstate organization can acquire banks in states where bank earnings have a ______________ with bank earnings in those states where the interstate company is already represented, a “portfolio effect” may occur.

A. perfectly positive correlation

B. negative correlation

C. zero correlation

D. zero covariance

E. positive covariance

Chapter 4

Establishing New Banks, Branches, ATMs, Telephone Services, and Websites

Fill in the Blank Questions

1. The state banking commissions (at the state level) and the Office of the Comptroller of the Currency (at the federal level) are the only ones able to issue a(n) ______________________ for a new U.S. bank.

________________________________________

2. The ______________________ issues charters for new national banks.

________________________________________

3. The ____________________ issues charters for new state banks.

________________________________________

4. ______________________ is demonstrated by organizers of new banks by showing that local banks are not conveniently located or fail to offer some key services.

________________________________________

5. Banks which offer services with in the grocery stores and other retail outlets are offering services from a(n) ______________________ branch.

________________________________________

6. A(n) ______________________ terminal in a retail store allows a customer to pay for goods and services by instantly debiting his or her checking account.

________________________________________

7. A(n) ______________________ combines a computer terminal, record keeping system, and vault cash in one unit allowing customers to withdraw money, check deposit balances, and other limited services 24 hours a day.

________________________________________

8. “Virtual” banks are found on the ____________________, and more and more banks are using this medium to deliver selected services.

________________________________________

9. A(n) ______________________ is a full service facility which offers many of the same services as the home or main office of a bank.

________________________________________

10. The ______________________ can be calculated when the present value of the future net cash flows are set equal to the initial cash outflow. It is the interest rate that is actually earned on a new project.

________________________________________

11. ____________________ reduces a bank’s overall risk exposure by establishing service facilities in different market areas.

________________________________________

12. A(n) ______________________ bank is one that offers its services only through the Internet. It does not have any brick-and-mortar offices.

________________________________________

13. ____________________________________________ allows customers to carry pocket-sized terminals with them and pay for goods and services and transfer funds as needed. These are already popular in Europe.

________________________________________

14. The acronym ACH stands for _____________.

________________________________________

15. For most of the history of financial service providers, ‘convenience’ has meant ____________.

________________________________________

16. Depository institutions are required to get their deposits insured from the ____________.

________________________________________

17. The most effective delivery channel of financial services appears to be ____________. It combines full-service branches and electronic limited service facilities within the same firm.

________________________________________

18. The _____________ of setting up a new ATM is the present value of the future stream of cash savings discounted at the firm’s required rate of return less the total cash outlay for the ATM.

________________________________________

19. Fees for ATMs are larger and more common if a customer uses another financial institution’s ATM because most institutions charge each other _____________ fees.

________________________________________

True / False Questions

20. The FDIC Improvement Act requires that all depository institutions must have FDIC insurance.

True False

21. One argument frequently presented for regulation and control over bank chartering activity is that banks can create money and chartering too many might result in excessive money creation and inflation in the economy.

True False

22. State banking commissions, on average, impose tougher standards for chartering new banks than the federal chartering agency, the Comptroller of the Currency.

True False

23. One of the benefits of applying for a federal banking charter is that banks need not join the Federal Reserve System.

True False

24. Applying for a bank charter from the Comptroller of the Currency is simultaneously followed by an application for FDIC insurance, to expedite the formation process and save duplication of efforts.

True False

25. Most new banks are situated along major routes of travel for commuters going to work, shopping areas, and schools.

True False

26. “Public need” is usually established with federal or state chartering authorities by showing that existing banks in the area are adequately profitable and have satisfactory amounts of capital.

True False

27. Society pays a price if it restricts the number of bank charters below the number that the private sector normally would generate due to lessened competition.

True False

28. Most U.S. banks are chartered in urban areas.

True False

29. The total number of full-service branch offices has declined in the United States in recent years.

True False

30. Newly designed bank branch offices in recent years have emphasized more heavily on effective communication of service options to the customers in an effort to promote service sales.

True False

31. More desirable office sites for new bank branches normally have residents who are above-average in age.

True False

32. Higher levels of savings deposits are usually found in those bank branch office locations where there is a higher proportion of residents with above-average age and residents who own their own homes.

True False

33. The optimal choice for a new branch site must be one that offers the bank the highest expected rate of return on the capital invested in the project.

True False

34. To close a bank branch office in the United States, a bank must give its customers 30 days advance notice.

True False

35. Bank branch offices are often specially configured today to maximize sales opportunities.

True False

36. One of the keys to branch office profitability is to apply the latest information technology and thereby lower personnel costs.

True False

37. A customer can use a POS terminal at a store to pay for his purchases through a debit or a credit card.

True False

38. Half of all transactions made through an ATM machine are deposits.

True False

39. The first ATM machine could only handle cash withdrawals.

True False

40. ATMs are profitable for all banks since they can eliminate tellers at branches that have ATMs.

True False

41. Research indicates that states with more liberal chartering standards experience a higher rate of bank failures.

True False

42. Recently, the issue of public need has become an increasingly important factor in the granting of bank charters.

True False

43. Research suggests that in the short-term, newly chartered banks fail at a higher rate than established banks.

True False

44. A majority of new banks do not become profitable for at least a decade.

True False

45. The Office of the Comptroller of the Currency does not charter internet-only banks.

True False

46. Payments made by electronic direct deposit now comprise over 50 percent of all transactions in the U.S.

True False

47. When considering possible location for new branches, expected rate of return is the only criteria that a management should consider.

True False

48. Negative correlation of returns of a proposed new branch with returns of the existing branch offices and other assets can serve to lower the overall bank’s riskiness and is an important justification for branch establishment. This is referred to as geographic diversification effect.

True False

Multiple Choice Questions

49. U.S. banking laws require the organizers of a proposed new bank to demonstrate:

A. adequate future earnings prospects.

B. adequate owners’ capital availability.

C. evidence of a public need for a new bank.

D. existing banks will not be endangered.

E. All of the options are correct.

50. One of the benefits of securing a state charter instead of a federal charter for a bank is that:

A. it brings added prestige.

B. it results in the automatic receipt of federal deposit insurance.

C. it is often able to lend a higher percentage of its capital to a single borrower.

D. state laws can pre-empt federal laws.

E. None of the options are correct.

51. One of the benefits for a bank securing a federal (national) charter instead of a state charter is that:

A. federal rules can pre-empt state laws.

B. a federal charter is generally easier and less costly to secure.

C. a federal charter often allows to lend a higher percentage of capital to a single borrower.

D. a federal charter usually entails lower supervisory fees.

E. None of the options are correct.

52. The number of bank charters issued annually in the United States averages about:

A. 1,000

B. 2,000

C. 10

D. 100

E. None of the options are correct

53. The existence of branch banking in a given state:

A. encourages new banks to be chartered.

B. discourages new banks from being chartered.

C. results in more bank failures than normal.

D. results in lower operating cost per unit of service.

E. None of the options are correct

54. Most new banks:

A. become profitable in the first 3 years of their operation.

B. have pro-competitive effects on the markets they enter.

C. are more closely supervised by regulators than established institutions.

D. All of the options are correct

E. None of the options are correct.

55. Most new U.S. banks are chartered in:

A. small communities where there is very little existing competition.

B. relatively large urban areas where organizers can earn higher expected rates of return on their investment.

C. rural areas where they will be more convenient for customers.

D. All of the options are correct

E. small communities where there is very little existing competition and provides more convenience for the customers.

56. A charter of incorporation to start a new U.S. bank can be issued by:

A. the Office of the Comptroller of the Currency.

B. the state banking commissions of each state.

C. the Federal Deposit Insurance Corporation (FDIC).

D. All of the options are correct

E. both the Office of the Comptroller of the Currency and the state banking commissions.

57. Which of the following factor(s) does OCC assess during the application process for a national bank charter?

A. Market demand

B. Probable customer base

C. Competition and economic conditions

D. Inherent risks in the services to be offered to the public

E. All of the options are correct

58. One of the benefits of applying for a federal (national) bank charter over a state charter is that:

A. it brings added prestige.

B. it results in the automatic receipt of federal deposit insurance.

C. there is better technical support in times of trouble.

D. it brings added prestige and better technical support in times of trouble.

E. All of the options are correct

59. According to the textbook, the disadvantages of a federal charter include:

A. closer supervision of banking activities.

B. stricter standards for capital.

C. more stringent limits on the offering of new services.

D. All of the options are correct

E. stricter capital standards and more stringent limit on new offerings.

60. Which of the following is a key factor that organizers of a proposed new bank use in evaluating their investment opportunity?

A. The level and growth of economic activity

B. The need for a new financial firm

C. Management quality

D. Pledging of capital required to cover all costs of getting started

E. All of the options are correct.

61. The FDIC Improvement Act of 1991 requires a bank closing one of its branches to give its customers a minimum notice of:

A. 90 days.

B. 60 days.

C. 30 days.

D. 10 days.

E. None of the options are correct.

62. The most desirable sites for full-service branch bank offices usually have which of the following characteristics?

A. Heavy traffic volume

B. Large numbers of retail shops and stores

C. Above-average age populations

D. All of the options are correct

E. None of the options are correct

63. ____________ are much less costly to build and maintain, typically costing as little as one-fourth the expense incurred in constructing and operating a stand-alone bank branch, and experiencing more traffic flow than conventional branches.

A. ATMs

B. POS terminals

C. ACHs

D. In-store branches

E. ALMs

64. Computer facilities in retail shops and stores that permit a customer to instantly pay for goods and services electronically by deducting the cost of each purchase directly from his or her deposit account are known as:

A. ATMs.

B. POS terminals.

C. ACHs.

D. In-store branches.

E. ALMs.

65. A personal identification number (PIN) gives a bank customer access to his or her account through a(n):

A. ACH.

B. bank-by-mail service.

C. ATM.

D. electronic calculator.

E. None of the options are correct.

66. Computer terminals which allow customers to make cash withdrawals, check deposit balances, and make deposits without dealing with a teller are known as:

A. ATMs.

B. POS terminals.

C. ACHs.

D. in-store branches.

E. ALMs.

67. Which of the following is one of the common services provided by banks on the internet today?

A. Applying for a loan

B. Applying for a new savings account

C. Making payments (especially recurring utility bills)

D. All the options are correct

E. None of the options are correct

68. A bank is planning to set up a new branch. It expects the new branch to generate 20 percent of the total business of the bank after it is opened. The bank expects the returns on this branch to be 15 percent with a standard deviation of 5 percent. Currently the bank has a 12 percent rate of return with a standard deviation of 4 percent. The correlation between the bank’s current returns and the returns on the new branch is expected to be 0.25. What is the bank’s total expected return after adding this branch?

A. 15 percent

B. 12.6 percent

C. 12 percent

D. 14.4 percent

E. 15.5 percent

69. A bank is planning to set up a new branch. It expects the new branch to generate 20 percent of the total business of the bank after it is opened. The bank expects the returns on this branch to be 15 percent with a standard deviation of 5 percent. Currently the bank has a 12 percent rate of return with a standard deviation of 4 percent. The correlation between the returns on the new branch and the bank’s current returns is expected to be 0.25. What is the bank’s expected standard deviation after adding this branch?

A. 12.84 percent

B. 3.35 percent

C. 4.36 percent

D. 3.58 percent

E. 6.8 percent

70. The Clearwater National Bank is planning to set up a new branch. This new branch is anticipated to generate 5 percent of the total business of the bank after it is opened. The bank also expects the returns on this branch to be 15 percent with a standard deviation of 5 percent. Currently the bank has a 10 percent rate of return with a standard deviation of 5 percent. The correlation between the bank’s current return and returns on the new branch is expected to be -0.3. What is the bank’s total expected return after adding this branch?

A. 15 percent

B. 10 percent

C. 15.25 percent

D. 10.25 percent

E. 11.5 percent

71. The Clearwater National Bank is planning to set up a new branch. This new branch is anticipated to generate 5 percent of the total business of the bank after it is opened. The bank also expects the return for this branch to be 15 percent with a standard deviation of 5 percent. Currently the bank has a 10 percent rate of return with a standard deviation of 5 percent. The correlation between the bank’s current return and returns on the new branch is expected to be -0.3. What is this bank’s expected risk (measured by the standard deviation) after adding this branch?

A. 21.91 percent

B. 12.84 percent

C. 4.68 percent

D. 3.02 percent

E. 8.2 percent

72. The Clearwater National Bank is planning to set up a new branch. This new branch is anticipated to generate 5 percent of the total business of the bank after it is opened. The bank also expects the return for this branch to be 15 percent with a standard deviation of 5 percent. Currently the bank has a 10 percent rate of return with a standard deviation of 5 percent. The correlation between the bank’s current return and returns on the new branch is expected to be -0.3. In this problem, the proposed new branch _______ overall risk exposure due to ______ effect.

A. increases; economies of scale

B. increases; economies of scope

C. reduces; convergence

D. reduces; geographical diversification

E. none of the options are correct

73. Ratio of population per branch is calculated as:

A. total population in the area to be served divided by number of branch offices present in the area.

B. total population in the state divided by number of branch offices present in the area.

C. total population in the state divided by number of branch expected to be opened in next one year.

D. total population in the area to be served divided by number of employees hired for the new branch office.

E. None of the options are correct

74. Second National Bank is considering adding 5 new ATM machines. Each machine costs $25,000 and installation costs are $15,000 per machine. Second National Bank expects the new machines to save $0.33 per transaction on 250,000 transactions per year on the new machines. It also expects the new machines to last for 15 years. If the bank needs to earn 14 percent return on this investment, what is the net present value of this investment?

A. $506,729

B. $306,729

C. $272,269

D. $381,729

E. $424,228

75. Third State Bank wants to add a new branch office. It has determined that the cost of construction of the new facility will be $1.5 million with another $500,000 in organizational costs. The bank has estimated that it will generate $319,522 per year in net revenues. If the new branch is expected to last 20 years, what is the expected rate or return on this investment?(Round to the nearest whole percent)

A. 6 percent

B. 21 percent

C. 15 percent

D. 32 percent

E. 25 percent

76. Third State Bank wants to add a new branch office. It has determined that the cost of construction of the new facility will be $1.5 million with another $500,000 in organizational costs. The bank has estimated that it will generate $319,522 per year in net revenues for 20 years. If Third State requires a 17% return on its money, what is this project’s net present value?

A. $201,805

B. -$201,805

C. $1,798,195

D. -$1,798,195

E. $298,195

77. Which of the following is true concerning branch offices?

A. The number of full-service branch offices in the U.S. has shrunk in recent years.

B. An ideal location for a new branch bank is one with below average population density.

C. Branch offices are generally cheaper to establish than chartering a whole new banking corporation.

D. The decision about whether to establish a new branch is the sole prerogative of the CFO.

E. All of the options are correct

78. Murphy National Bank is thinking about adding a new branch in a very different market area. It estimates that the new office will have an expected return of 16% with a standard deviation of 8%. Currently, it has an expected return of 12% with a standard deviation of 4%. The correlation between the returns on the new branch and the bank’s current returns is estimated to be 0.20. The bank estimates that the new branch will represent 15 percent of the revenues of the bank. What is the expected return of the bank with the new branch?

A. 12.6 percent

B. 15.4 percent

C. 4.6 percent

D. 7.4 percent

E. 8.2 percent

79. Murphy National Bank is thinking about adding a new branch in a very different market area. It estimates that the new office will have an expected return of 16% with a standard deviation of 8%. Currently, it has an expected return of 12% with a standard deviation of 4%. The correlation between the returns on the new branch and the bank’s current returns is estimated to be 0.20. The bank estimates that the new branch will represent 15 percent of the revenues of the bank. What is the bank’s expected risk (measured by the standard deviation) with the new branch? Round to the nearest 0.1 percent.

A. 14.6 percent

B. 3.8 percent

C. 4.6 percent

D. 7.4 percent

E. 5.8 percent

80. The FDIC requires the insured banks to maintain Tier 1 capital of at least __________ for at least the first three years of their operations.

A. 10 percent

B. 8 percent

C. $12 million

D. 15 percent

E. $10 million

81. In the short-term, newly-chartered banks fail at:

A. a lower rate than established banks.

B. the same rate as established banks.

C. a higher rate than established banks.

D. a higher rate than non-chartered banks.

E. a lower rate than non-chartered banks.

82. Chester National Bank is considering adding a new branch bank. It knows that it will cost $2.5 million to build the branch and it believes that it will generate $214,526 per year for the next 25 years. Chester National Bank requires a return of 10% on all new projects it undertakes. What is this project’s net present value?(Round to the nearest $100)

A. -$552,700

B. -$3,052,700

C. $1,947,300

D. $2,863,200

E. $5,363,200

83. Chester National Bank is considering adding a new branch bank. It knows that it will cost $2.5 million to build the branch and it believes that it will generate $214,526 per year for the next 25 years. Chester National Bank requires a return of 10% on all new projects it undertakes. What is this project’s expected rate of return or internal rate of return? (Round to the nearest whole percent)

A. 0%

B. 7%

C. 12%

D. 2%

E. 25%

84. The Chahad Bank wants to open a new branch in a distant city with very different economic conditions. Currently, the bank has an expected return of 15% with a standard deviation of 7%. The new branch is expected to have a return of 20% with a standard deviation of 10%. The correlation between the bank’s returns and the returns from the new branch is -0.3. The new branch is expected to contribute 10% of the bank’s revenues. What is the expected return for the bank if they add the new branch?

A. 35%

B. 19.5%

C. 17.5%

D. 15.5%

E. -15.9%

85. The Chahad Bank wants to open a new branch in a distant city with very different economic conditions. Currently, the bank has an expected return of 15% with a standard deviation of 7%. The new branch is expected to have a return of 20% with a standard deviation of 10%. The correlation between the bank’s returns and the returns from the new branch is -0.3. The new branch is expected to contribute 10% of the bank’s revenues. What is the standard deviation of returns for the bank if they add the new branch? (Round your answer to the nearest 0.1%)

A. 36.9%

B. 6.1%

C. 50.3%

D. 7.1%

E. 6.7%

86. The Boyer Bank wants to add a new ATM machine in a busy mall. It knows the new machine will cost $60,000 and another $30,000 is required to install it in the mall. It expects to save $0.27 per transaction and generate 100,000 transactions per year. Also, it expects the new machine to last 8 years. If it needs to earn a 12% return, what is the NPV of this project? (Round your answer to the nearest $1,000)

A. $126,000

B. $44,000

C. $134,000

D. $27,000

E. $117,000

87. The Boyer Bank wants to add a new ATM machine in a busy mall. It knows the new machine will cost $60,000 and another $30,000 is required to install it in the mall. It expects to save $0.27 per transaction and generate 100,000 transactions per year. Also, it expects the new machine to last 8 years. What is the expected rate of return or internal rate or return of this project?

A. 25%

B. 3.3%

C. 30%

D. 12%

E. 2.4%

88. A group of six investors wants to open a new bank. In their application to the Comptroller of the Currency, they discuss that the community they want to do business in has a median income of $55,000, that there are approximately 75,000 homes in the community, and that there is approximately $5.6 million in sales generated in the community on any given day. Which decision factor are the investors discussing for seeking a new charter?

A. The level of economic activity in the community

B. The growth of economic activity in the community

C. The need for a new financial firm

D. The strength and character of the local competition

E. None of the options are correct

89. A group of six investors wants to open a new bank. In their application to the Comptroller of the Currency, they discuss that new housing starts in the area are up 19% from a year ago with an additional 25 families moving into the community every month. School enrollment has also increased 14% from the previous year. Which decision factor are the investors discussing for seeking a new charter?

A. The level of economic activity in the community

B. The growth of economic activity in the community

C. The need for a new financial firm

D. The strength and character of the local competition

E. None of the options are correct

90. A group of six investors wants to open a new bank. In their application to the Comptroller of the Currency, they discuss that the population per banking office has risen to 6,000. In addition, growth in the community is to the west of town and there is only one bank serving that part of the community. Also, a new housing subdivision has just started in this part of town that should include 350 new homes. Which decision factor are the investors discussing for seeking a new charter?

A. The level of economic activity in the community

B. The growth of economic activity in the community

C. The need for a new financial firm

D. The growth in the local competition

E. None of the options are correct

91. A group of six investors wants to open a new bank. In their application to the Comptroller of the Currency, they discuss that there are six banks already existing in the community and that the largest of these has just acquired one of the smaller banks. These six banks do a moderate amount of advertising in the community. There is also one credit union that has one office and a savings bank that has two branches on the east side of town. Growth in the community is to the west. Which decision factor are the investors discussing for seeking a new charter?

A. The level of economic activity in the community

B. The growth of economic activity in the community

C. The need for additional advertising in the community

D. The strength and character of the local competition

E. None of the options are correct

92. A group of six investors wants to open a new bank in the community of Edmond, Oklahoma. It has submitted the application to the Comptroller of the Currency. Which of the following would best describe the nature of the bank?

A. A state, member bank

B. A state, insured bank

C. A national bank

D. A national bank without FDIC insurance

E. None of the options are correct

93. The Cassil National Bank charges its customers $0.50 per transaction for using the ATM machine, if their deposit balance is below $500. It charges $0.25 per transaction for using the ATM if their deposit balance is between $500 and $1,000. If its customers’ deposit balance is over $1,000, there is no charge for using the ATM machine. This is an example of:

A. an interchange fee.

B. an independent pricing schedule.

C. a conditional pricing schedule.

D. a surcharge fee.

E. None of the options are correct

94. Which of the following would not be a telephone service that customers can get from a bank call center?

A. The current balance in their account

B. A fax copy of a loan application to the bank

C. List of what transactions have passed through the account

D. Access to their safety deposit box

E. All the options are telephone services customers can get from a bank call center

95. Which of the following is a category of authentication factors used by federal banking agencies?

A. Something a customer knows

B. Something a customer has

C. Something a customer is

D. Something a customer knows, has, or is

E. None of the options are correct

96. The Jones State Bank is planning to add a branch office on the west side of Edmond, Oklahoma. Growth of new homes in the area has averaged 15% per year over the last five years and is expected to continue at that rate in the future. Which factor would this address when considering whether to add a new branch?

A. Traffic count

B. Number of retail shops

C. Average age of the local population

D. Population Density

E. Population Growth

97. The Jones State Bank is planning to add a branch office on the west side of Edmond, Oklahoma. The bank has done a study and found that the site where it wants to build the branch office sees 35,000 cars pass in an average day. Which factor would this address when considering whether to add a new branch?

A. Traffic count

B. Number of retail shops

C. Average age of the local population

D. Population Density

E. Population Growth

98. The Jones State Bank is planning to add a branch office on the west side of Edmond, Oklahoma. The bank has discovered that area surrounding the proposed site averages 4 houses per acre and has several subdivisions that each has 300 to 400 homes. Which factor would this address when considering whether to add a new branch?

A. Traffic count

B. Number of retail shops

C. Average age of the local population

D. Population Density

E. Population Growth

99. The Jones State Bank is planning to add a branch office on the west side of Edmond, Oklahoma. The bank has done a survey of local residents near the area where it wants to build the branch office and has discovered that most residents are in their 50’s and 60’s. Which factor would this address when considering whether to add a new branch?

A. Traffic count

B. Number of retail shops

C. Average age of the local population

D. Population Density

E. Population Growth

100. The Fred National Bank is planning to add a branch office on the west side of town. The bank has done a survey and has discovered that the mean household income in the area is $76,000 per year. Which factor would this address when considering whether to add a new branch?

A. Number of retail shops

B. Average income level of households

C. Ratio of population to branches

D. Number of service facilities operated by financial service competitors

E. Population density

101. Which of the following is not an advantage of ATMs?

A. Personalized service

B. Cost per transaction

C. Number of transactions processed

D. Staffing needs

E. Geographic accessibility

102. Under the feasibility standard adopted by the Comptroller of the Currency, applicants for a national bank charter are required to submit _____________, which contains a description of the proposed bank and its marketing, management, and financial plans.

A. memorandum of association

B. articles of association

C. a business plan

D. a merger plan

E. a contingency plan

103. A minimum of ___________ persons are required as organizers to apply for a federal bank charter.

A. two

B. three

C. five

D. seven

E. ten

104. Following charter approval, a bank’s stock can be legally offered to the public through a(n) ___________________ that describes the charter’s business plan and terms of sale.

A. offering memorandum

B. offering article

C. underwriter’s commitment report

D. merchant banker’s report

E. None of the options are correct

105. Increases in ______________ ratios tend to reduce new chartering activities in a particular region.

A. gross NPA

B. net NPA

C. liquidity

D. concentration

E. net interest margin

106. An average new bank branch today reaches the break-even point in:

A. 12 months.

B. 18 months.

C. 24 months.

D. 5 years.

E. 10 years.

107. A common approach adopted by banks to decide on whether or not to install a new ATM is to estimate _____________ that the new machine is expected to generate.

A. new savings account

B. cash savings

C. credit card sales

D. time deposits

E. commercial transaction accounts

108. Which of the following is a challenge faced by a virtual bank?

A. Ability to verify real time account balances

B. Ability to confirm that deposits of funds have been received

C. Ability to submit applications for loans and credit cards

D. Ability to move funds instantly from one account to another

E. Ability to prevent identity theft

109. In-store services usually require:

A. more capital than other banks.

B. more aggressive marketing plans than other banks.

C. more employees than other banks.

D. more advanced technology than other banks.

E. All the options are correct.

Chapter 5

The Financial Statements of Banks and Their Principal Competitors

Fill in the Blank Questions

1. Fed funds purchased is an example of _______________________ along with Eurodollar borrowings.

________________________________________

2. The short-term securities of the bank, including T-Bills and commercial paper, are often called __________________________ because they are the second line of defense to meet demands for cash.

________________________________________

3. __________________________ is a noncash expense on the bank’s income statement which allows the bank to account for future bad loans.

________________________________________

4. __________________________ is the difference between total interest income and total interest expenses for a financial institution.

________________________________________

5. __________________________ are the primary long-term liabilities of the bank.

________________________________________

6. A(n) __________________________ is where the financial institution agrees to guarantee repayment of a customer’s loan, which the customer has received from a third party.

________________________________________

7. A(n) __________________________ is a short term collateralized loan. The collateral that is used generally consists of T-Bills.

________________________________________

8. A(n) __________________________ is a deposit account which pays an interest rate competitive with money market mutual funds and which generally has limited check writing ability.

________________________________________

9. _____________________ is the sum of all outstanding IOUs owed to the bank in the form of consumer, real estate, commercial, and agriculture loans as well as other types of credit extensions.

________________________________________

10. A financial institution often records the value of its assets and liabilities at ____________ which is the historical cost of the asset.

________________________________________

11. The principal types of __________________________ include fee income, income from fiduciary activities, and service charges on deposits.

________________________________________

12. The __________________________ shows the amount of revenues received and expenses incurred over a specific time period.

________________________________________

13. The __________________________ lists the assets, liabilities and equity capital held by the bank on a given date.

________________________________________

14. ______________ is labeled “Accounting for Derivative Instruments and Hedging Activities.”

________________________________________

15. ________________ labeled “Accounting for Derivative Instruments and Hedging Activities” and its recent amendments, __________, are designed to make derivatives more publicly visible on corporate financial statements.

________________________________________

16. Temporarily buying and selling securities by a securities firm in a thinly traded market so as to influence the price is known as ________________.

________________________________________

17. The activity of manipulating the financial statements to artificially enhance the banks financial strength is known as __________________.

________________________________________

18. ________________ is an asset category which includes direct and indirect investment in real estate. These are properties obtained for compensations for nonperforming loans.

________________________________________

19. __________ consists of interest income received on loans from customers that has not yet been earned by the bank under accrual accounting methods.

________________________________________

20. __________ can be held by individuals and nonprofit institutions, bear interest and permit drafts to be written against the account to pay third parties.

________________________________________

21. In the worldwide banking system, __________ represent transferable time deposits in a variety of currencies and are often the principal source of short term borrowings by banks.

________________________________________

22. One part of __________ arises from fees charged for ATM and POS transactions.

________________________________________

23. Fees that arise from a financial firm’s trust activities, fees for managing a corporation’s interest and dividend payments, and fees for managing corporate or individual retirement plans are all included in the category of fees arising from __________.

________________________________________

24. Checking account maintenance fees and overdraft fees are included in the noninterest income account under _________.

________________________________________

True / False Questions

25. On a bank’s income statement (Report of Income) deposit costs are financial inputs.

True False

26. Loans and leases are financial outputs on a financial institution’s balance sheet or Report of Condition.

True False

27. Nondeposit borrowings are a financial input on a bank’s balance sheet or Report of Condition.

True False

28. The cost of nondeposit borrowings is a financial input on a bank’s income statement or Report of Income.

True False

29. Securities income is a financial output listed on a financial institution’s Report of Condition.

True False

30. Net loans on a bank’s balance sheet are derived by deducting the allowance for loan losses and unearned discounts from gross loans.

True False

31. When a loan is classified as nonperforming, any accrued interest recorded on the books, but not actually received, must be deducted from the bank’s loan revenues.

True False

32. In U.S. banking, securities gains are treated as an ordinary income.

True False

33. Most banks report securities gains as a component of their total noninterest income.

True False

34. A bank displaying trading-account securities on its balance sheet is serving as a security dealer and plans to sell those securities before they reach maturity.

True False

35. Bad loans normally do not affect a bank’s current income.

True False

36. The expensing of a worthless loan usually must occur in the year that troubled loans are judged to be worthless.

True False

37. Recoveries on loans previously charged off are added to the Provision for Loan Losses (PLL) account on a bank’s income statement.

True False

38. Loan-loss reserves set aside to cover a particular loan or loans expected to be a problem or loans that represent above-average risk are known as specific reserves.

True False

39. U.S. banks (especially those with $500 million or more in total assets) are required to file financial statements, audited by an independent public accountant, with their principal federal regulatory agency and with the FDIC.

True False

40. Off-balance-sheet items for a bank are fee generating transactions which are not recorded on their balance sheet.

True False

41. The experience method of accounting for future loan loss reserves allows a bank to deduct from their income statement up to 0.6 percent of their eligible loans.

True False

42. After the Tax Reform Act of 1986, large banks (>$500 million in assets) were required to use the reserve method of accounting for future loan loss reserves.

True False

43. The number one source of revenue for a bank based on dollar volume is loan income.

True False

44. In looking at comparative balance sheets, it can be seen that large banks rely more heavily on nondeposit borrowings while small banks rely more heavily on deposits.

True False

45. The Pension Fund industry is now larger than the Mutual Fund industry.

True False

46. Off-balance-sheet items for banks have declined in recent years.

True False

47. Except for commercial banks, savings & loans and savings banks hold the most deposits.

True False

48. “Painting the tape” refers to the practice whereby banks understate their nonperforming loans.

True False

49. Financial statements issued by banks and by nonbank financial-service firms look increasingly similar today.

True False

Multiple Choice Questions

50. Each of the following falls into the category of bank assets except:

A. loans.

B. investment securities.

C. demand deposits.

D. cash and due from banks.

E. other assets.

51. Banks generate their largest portion of income from:

A. loans.

B. short-term investments.

C. demand deposits.

D. trading account gains & fees.

E. certificates of deposits.

52. Each of the following typically falls into the category of loans except:

A. real estate.

B. consumer.

C. commercial and industrial (business).

D. agricultural.

E. municipal.

53. Which of the following adjustments are made to gross loans and leases to obtain net loans and leases?

A. Loan and lease loss allowance is added to gross loans.

B. Unearned income is subtracted from gross interest received.

C. Investment income is added to gross interest received.

D. Loan and lease loss allowance and unearned income is subtracted from gross loans.

E. Loan and lease loss allowance is subtracted from gross loans and investment income is added to gross interest received.

54. An example of a contra-asset account is:

A. loan and lease loss allowance.

B. trading account assets.

C. buildings and equipment.

D. revenue bonds.

E. provision for loan loss.

55. The noncash expense item on a bank’s Report of Income designed to shelter a bank’s current earnings from taxes and to help prepare for bad loans is called:

A. short-term debt interest.

B. noninterest expense.

C. provision for taxes.

D. provision for possible loan losses.

E. None of the options are correct.

56. A financial institution’s bad-debt reserve, as reported on its balance sheet, is called:

A. unearned income or discount.

B. allowance for possible loan losses.

C. intangible assets.

D. customer liability on acceptances.

E. None of the options are correct.

57. When a bank serves as a security dealer for certain kinds of securities (mainly federal, state, and local government obligations) the value of these securities is usually recorded in what account on a bank’s Report of Condition?

A. Investment securities

B. Taxable and tax-exempt assets

C. Trading account assets

D. Secondary reserves

E. None of the options are correct.

58. ___________ is calculated by deducting noninterest expense and provision for loan losses from noninterest income.

A. Net profit margin

B. Net interest income

C. Net income after provision for possible loan losses

D. Income or loss before income taxes

E. Net noninterest income

59. The account that is built up by annual noncash expense deductions and is subtracted from Gross Loans on the Report of Condition is:

A. unearned income.

B. nonperforming loans.

C. allocated loan risk deductions.

D. allowance for possible loan losses.

E. None of the options are correct.

60. Nonperforming loans are credits on which any scheduled loan repayments and interest payments are past due for more than:

A. 30 days.

B. 60 days.

C. 90 days.

D. 180 days.

E. None of the options are correct.

61. One-time-only transactions that often involve sale of financial assets or real property pledged as collateral behind a loan and upon which the bank has foreclosed, affect a bank’s account known as:

A. allowance for loan losses.

B. nonrecurring sales of assets.

C. asset gains or losses.

D. provision for loan and security losses.

E. None of the options are correct.

62. The use of fixed assets, rather than financial assets, in order to increase the operating earnings is known as:

A. plant and equipment investment.

B. financial leverage.

C. operating leverage.

D. nondeposit capital.

E. None of the options are correct.

63. Banks depend heavily upon borrowed funds supplied by customers with little owners’ capital invested. This means that banks make heavy use of:

A. financial leverage.

B. capital restructuring.

C. operating leverage.

D. margin borrowing.

E. None of the options are correct.

64. When a loan is considered uncollectible, the bank’s accounting department will write (charge) it off the books by reducing the ______ and the ______ accounts. Which choice below correctly fills in the blanks in the preceding sentence?

A. PLL, gross loans

B. ALL, net loans

C. ALL, gross loans

D. PLL, net loans

E. None of the options are correct.

65. The common banking practice of selling those investment securities that have appreciated in order to reap a capital gain and holding onto those securities whose prices have declined is known as:

A. gains trading.

B. performance banking.

C. loss control trading.

D. selective portfolio management.

E. None of the options are correct.

66. Noninterest revenue sources for a bank are called:

A. commitment fees on loans.

B. fee income.

C. supplemental income.

D. noninterest margin.

E. None of the options are correct.

67. Large U.S. banks must use which of the methods listed below to determine their provision for loan loss expense?

A. Experience method

B. Reserve method

C. Specific charge-off method

D. Historical cost method

E. None of the options are correct.

68. A bank’s temporary lending of excess reserves to other banks is labeled on the balance sheet as:

A. fed funds purchased.

B. fed funds sold.

C. money market deposits.

D. securities purchased for resale.

E. None of the options are correct.

69. A bank sells shares of its common stock with a par value of $100 for $200 in the market. Which two accounts on the bank’s balance sheet are going to be affected?

A. Retained earnings and surplus accounts

B. Subordinated notes and debentures and commons stock outstanding accounts

C. Retained earnings and common stock outstanding accounts

D. Common stock outstanding and surplus accounts

E. Only the common stock outstanding account

70. A bank which starts with ALL of $1.48 million at the beginning of the year, charges off worthless loans of $0.94 million during the year, recovers $0.12 million on loans previously charged off and charges current income for a $1.02 million provision for loan losses, will have an ALL at the end of the year of:

A. $0.66 million.

B. $3.32 million.

C. $1.68 million.

D. $1.28 million.

E. The same amount as at the beginning of the year.

71. A bank has total interest income of $67 million and total noninterest income of $14 million. This bank has total interest expenses of $35 million and total noninterest expenses (excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5. What is this bank’s net interest income?

A. $7

B. -$14

C. $18

D. $32

E. None of the options are correct.

72. A bank has total interest income of $67 million and total noninterest income of $14 million. This bank has total interest expenses of $35 million and total noninterest expenses (excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5. What is this bank’s net noninterest income?

A. $7

B. -$20

C. $18

D. $32

E. None of the options are correct.

73. A bank has total interest income of $67 million and total noninterest income of $14 million. This bank has total interest expenses of $35 million and total noninterest expenses (excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5. What is this bank’s net income?

A. $7

B. -$14

C. $18

D. $32

E. None of the options are correct.

74. Which of the following financial statements shows the revenues and expenses of a bank over a set period of time?

A. The Statement of Stockholders Equity

B. The Funds-Flow Statement

C. The Report of Financial Condition

D. The Report of Income

E. None of the options are correct.

75. Which of the following accounts is also called the bank’s primary reserves?

A. Cash and deposits due from banks

B. Investment securities

C. Trading account securities

D. Fed funds sold

E. None of the options are correct.

76. Which of the following assets is the largest asset item on the bank’s balance sheet?

A. Securities

B. Cash

C. Loans and leases

D. Bank premises

E. None of the options are correct.

77. What financial-service industry category is second to the banking industry in total financial assets held?

A. Mutual funds

B. Thrifts

C. Investment banks

D. Insurance companies

E. Pension funds

78. FASB Rule 115 focuses primarily on:

A. deposit sources.

B. investments in marketable securities.

C. derivatives trading.

D. loan-loss reserves.

E. hedging activities.

79. Which of the following most accurately describes the principal type(s) of bank noninterest income?

A. Fees from fiduciary transactions

B. Fees from deposit transactions

C. Fees from securities transactions

D. Fees from additional noninterest income

E. All of the options are correct.

80. Fee income arising from fiduciary transactions include all of the following except:

A. fees for checking account maintenance.

B. fees for managing and protecting a customer’s property.

C. fees for recordkeeping for corporate security.

D. fees for dispersing interest and dividend payments for a corporation.

E. fees for managing corporate and individual retirement plans.

81. You know the following information about the Miller State Bank:

Given this information, what is the value of this firm’s net loans?

A. $250

B. $350

C. $500

D. $50

E. $150

82. You know the following information about the Miller State Bank:

Given this information, what is the value of this firm’s depreciation?

A. $250

B. $30

C. $70

D. $40

E. $110

83. You know the following information about the Miller State Bank:

Given this information, what is the value of this firm’s total liabilities?

A. $390

B. $60

C. $450

D. $500

E. $50

84. You know the following information about the Miller State Bank:

Given this information, what the value of this firm’s undivided profits?

A. $50

B. $5

C. $10

D. $40

E. $450

85. You know the following information about the Miller State Bank:

Given this information, what is the value of this firm’s total liabilities plus equity?

A. $250

B. $450

C. $150

D. $50

E. $500

86. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s net interest income?

A. $300

B. $150

C. ($50)

D. $120

E. $80

87. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s net noninterest income?

A. $300

B. $150

C. ($150)

D. $120

E. $80

88. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s pretax net operating income (or net income before extraordinary items)?

A. $300

B. $150

C. ($50)

D. $120

E. $80

89. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s net income?

A. $300

B. $150

C. ($50)

D. $120

E. $80

90. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s increase in undivided profits?

A. $300

B. $150

C. ($50)

D. $120

E. $80

91. You know the following information about the Davis National Bank:

Given this information, what is the value of this firm’s total revenues?

A. $800

B. $850

C. $150

D. $950

E. $900

92. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s allowance for loan losses?

A. $1,300

B. $1,000

C. $50

D. $200

E. $100

93. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s net premises?

A. $130

B. $1,000

C. $50

D. $200

E. $100

94. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s total nondeposit borrowings?

A. $1,000

B. $300

C. $800

D. $200

E. $500

95. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s total liabilities?

A. $1,000

B. $300

C. $800

D. $200

E. $500

96. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s total equity?

A. $1,000

B. $300

C. $800

D. $200

E. $500

97. You know the following information about the Webb State Bank:

Given this information, what is the value of this firm’s total assets?

A. $1,000

B. $300

C. $800

D. $200

E. $500

98. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s net interest income?

A. $150

B. $210

C. $400

D. ($250)

E. $750

99. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s net noninterest income?

A. $150

B. $210

C. $400

D. ($350)

E. $750

100. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s net operating income or net income before extraordinary income?

A. $150

B. $210

C. $400

D. ($250)

E. $750

101. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s net income?

A. $150

B. $210

C. $400

D. ($250)

E. $750

102. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s increase in undivided profits?

A. $150

B. $210

C. $400

D. ($250)

E. $750

103. You know the following information about the Taylor National Bank:

Given this information, what is the value of this firm’s total revenues?

A. $1,500

B. $2,000

C. $2,050

D. $1,950

E. $1,450

104. The largest expense item often observed in the financial statement of the banks is:

A. personnel cost.

B. premises and equipment cost.

C. interest on borrowed funds.

D. provision for loan loss.

E. employee benefits.

105. The available-for-sale securities are shown on the:

A. Report of Condition at book value.

B. Report of Income at fair market value.

C. Report of Condition as a contra asset.

D. Report of Condition at fair market value.

E. Report of Income as an income.

106. The beginning balance in the allowance for loan loss account for Synopsis Bank is $500 million. The banking firm charges $2 million for provision for loan losses. Synopsis Bank will report:

A. $502 million as adjusted allowance for loan losses.

B. $498 million as noninterest expense.

C. $2 million as allowance for loan losses.

D. $502 million as provision for loan loss expense.

E. $2 million as adjusted allowance for loan losses.

107. A bank’s Report of Condition shows gross loans and leases or $1,500 million. The loan loss allowance for the year is accumulated to $50 million and the bank reports an unearned income amounting to $2 million. The net loans and leases accounted by the banks would be:

A. $1,550 million

B. $1,450 million

C. $1,448 million

D. $1,452 million

E. $1,548 million

108. Which of the following asset items may include deposits placed with correspondent deposits?

A. Savings deposit

B. Trading account assets

C. NOW accounts

D. Allowance for loan losses

E. Cash and due from depository institutions

109. If writing off a large loan reduces the balance in the allowance for loan losses account too much, the principal regulatory agency:

A. reduces the provision for loan loss expense.

B. transfers funds to the account from retained earnings.

C. reduces the number of loans being sanctioned.

D. increases the provision for loan loss deduction.

E. removes the reserve from the financial statement.

110. Securities purchased to provide short-term profits from short-term price movements are reported as:

A. investment securities.

B. trading account assets.

C. reverse repurchase agreements.

D. due from depository institutions.

E. federal funds.

Chapter 6
Measuring and Evaluating the Performance of Banks and Their Principal Competitors

Fill in the Blank Questions

1. The equity multiplier measures the amount of _____________________ for a bank and is one principal component of the bank’s ROE.

________________________________________

2. __________________________ risk is one that deals with the quality of the bank’s assets and, in particular, the bank’s loans.

________________________________________

3. A phenomenon wherein interest rates and security prices in the financial marketplace move against a troubled firm, forcing it to make crucial adjustments in policies and performance in order to calm investors’ worst fears is often referred to as __________________ by economists.

________________________________________

4. __________________________ assets of a financial institution are those that will mature or be repriced within a set period of time.

________________________________________

5. __________________________ is the risk that the value of the financial institution’s asset portfolio will decline due to falling market prices.

________________________________________

6. For a bank, sources of funds like Eurodollars, Fed funds, repurchase agreements, and large CDs are categorized as ____________________.

________________________________________

7. __________________________ is the risk that a financial institution may not be able to meet the needs for cash of its depositors.

________________________________________

8. __________________________ assets, including loans, are those which are past due by 90 days or more.

________________________________________

9. One of the principal components of evaluating ROE is _____________________ ratio, which reflects a bank’s portfolio management policies and the mix and yield on its assets.

________________________________________

10. __________________________ reflects the effectiveness of the expense management of a bank and is one of the principal components of evaluating ROE.

________________________________________

11. __________________________ measures the return to stockholders on their investment in a bank. It is the product of net profit margin, asset utilization, and the equity multiplier.

________________________________________

12. __________________________ measures the amount of debt or leverage a bank has and is one part of the evaluation of the bank’s ROE. It is generally a number larger than one.

________________________________________

13. The __________________________ is a standardized report provided by federal regulators which reports the balance sheet, income statement, and other data for all federally supervised banks. It also contains information on peer institutions.

________________________________________

14. The cumulative impact of all the risks (market risk, credit risk, operational risk, and legal and compliance risk) put together that can affect a financial firm’s long-run survival is often referred to as _________________________.

________________________________________

15. __________________________ is the risk that shifting interest rates in the market will adversely affect a financial institution’s net income or the value of its assets or equity.

________________________________________

16. The ____________________ Act restricts combined auditing and consulting relationships in order to promote auditor independence and objectivity.

________________________________________

17. ________________________ is one of the most widely respected private institutions that rates the credit quality of financial institutions.

________________________________________

18. ________________________ refers to the uncertainty regarding a financial firm’s earnings due to failures in computer systems, errors, misconduct by employees, lightning strikes, and similar events.

________________________________________

19. ________________________ refers to variability in earnings resulting from actions taken by the legal system including unenforceable contracts, lawsuits, and adverse judgements.

________________________________________

20. ________________________ includes violations of rules and regulations. It can include failure to hold adequate capital which can lead to costly corrective actions.

________________________________________

21. ________________________ is the uncertainty associated with public opinion. Negative publicity (whether true or not) can affect a financial firm’s earnings by dissuading customers from using the services of the institution.

________________________________________

22. As data processing of financial information becomes more important, managers of financial firms can realize cost savings from _______________________, transferring tasks from inside the firm to other firms specializing in information technology.

________________________________________

23. One of the traditional measures of earnings efficiency is ________________________ or total interest income over total earnings assets less total interest expenses over total interest bearing bank liabilities. It measures the effectiveness of a firm’s intermediation function in the borrowing and lending of money.

________________________________________

24. One part of ROE is ________________________ or net income divided by pre-tax net operating income, which measures a financial firm’s use of security gains and losses and other tax management tools to minimize tax exposure.

________________________________________

25. Net profit margin can be split into two parts, ________________________ and tax management efficiency. The first part is pre-tax net operating income over total operating revenue which looks at how many dollars of revenue survive after operating expenses are removed.

________________________________________

True / False Questions

26. Financial institutions that pursue the “quiet life” as a goal face less risk of losing earnings or market share.

True False

27. Basic principles of financial management suggest that attempting to maximize a bank’s stock value is the key objective for banks which should have priority over all other goals.

True False

28. If the expected stream of future dividends for a bank’s shareholder rises, the bank’s stock price should also rise, other factors held constant.

True False

29. If the discount factor associated with the value of a bank’s stock rises, the bank’s stock price should rise, other factors held constant.

True False

30. A bank’s ROA equals its ROE times the ratio of total assets divided by total equity capital.

True False

31. According to the textbook, a bank’s asset-utilization ratio reflects the mix and yield on a bank’s portfolio of assets.

True False

32. A bank’s profit margin or ratio of net after-tax income to total operating revenue is a measure of financial leverage for a bank.

True False

33. According to the text, the ratio of a bank’s net after-tax income to pre-tax net operating income is a measure of tax management efficiency.

True False

34. According to the textbook, the ratio of a bank’s pre-tax net operating income to total operating revenues is a measure of expense-control efficiency.

True False

35. The ratio of non-performing assets to total loans and leases is a measure of credit risk in banking industry.

True False

36. One of the measures of a bank’s efficiency and return is “earnings spread”. It is calculated by the ratio of total interest income to total liabilities as reduced by the ratio of total interest expenses to total assets.

True False

37. In recent years, the U.S. banking industry’s equity multiplier has generally risen in response to regulatory pressure to raise more capital.

True False

38. If a bank adds more full-time employees and posts the same net operating income, its employee productivity ratio, as defined in the text, must fall.

True False

39. According to the textbook, the most profitable U.S. banks in terms of both ROA and ROE are medium-size institutions in the asset size range of $100 million to $10 billion.

True False

40. ROA measures how capably the management of a financial institution has been converting the institution’s assets into net earnings.

True False

41. The noninterest margin is generally positive for most banks.

True False

42. The ratio of nonperforming assets to total loans and leases is considered to be a measure of a bank’s market risk.

True False

43. Charge-offs represent the securities a bank decides to sell because they have declined in value.

True False

44. Loans past due for 90 days or more are classified as nonperforming assets.

True False

45. The ratio of cash and government securities to total assets is considered to be a measure of liquidity risk in banking.

True False

46. The ratio of uninsured deposits to total deposits is considered to be a measure of credit risk in banking.

True False

47. The interest rate spread between market yields on bank debt issues (such as capital notes and CDs) and the market yields on government securities of the same maturity is considered to be a measure of market risk in banking.

True False

48. The ratio of a bank’s net operating income to the number of a bank’s full-time-equivalent employees is called the employee productivity ratio.

True False

49. Smaller banks usually have fewer liquid assets than larger banks.

True False

50. A bank’s asset utilization ratio reflects the effectiveness of the bank’s expense management.

True False

51. The FDIC is a private credit rating company which provides credit ratings on the short term and long term securities issued by banks.

True False

52. During the 1980s, the Comptroller of the Currency, the Federal Reserve and the FDIC created a new tool called the Uniform Bank Performance Report to help them analyze the financial condition of banks.

True False

53. Liquidity risk examines the quality of a bank’s assets and, in particular, the quality of the bank’s loans.

True False

54. A bank’s degree of asset utilization (AU) or the ratio of total operating revenues to total assets is a measure of asset management efficiency, especially in terms of the mix and yield on assets.

True False

55. The main reason behind the failure of Superior Bank of Chicago and eventual FDIC’s takeover of this institution in 2001 was attributed to misleading accounting practices of inflating asset values and revenues deflating liabilities and expenses.

True False

Multiple Choice Questions

56. The ratio of a bank’s interest income from its loans and security investments less interest expenses on debt issued, divided by total earning assets measures a bank’s:

A. net operating margin.

B. net return before special transactions.

C. net interest margin.

D. return on assets.

E. None of the options is correct

57. ROE for a bank is calculated by:

A. dividing net after-tax income by total equity capital.

B. dividing total operating revenue less operating expenses by total assets.

C. dividing net pre-tax income by total equity capital.

D. noninterest income less noninterest expenses divided by total earning assets.

E. None of the options is correct.

58. The difference between such sources of bank income as service charges on deposits and trust-service fees, and such sources of bank expenses as salaries and wages and overhead expenses divided by total assets or total earning assets is called the:

A. net profit margin.

B. net operating margin.

C. net noninterest margin.

D. net return on assets.

E. None of the options is correct.

59. A bank’s ROE equals its ROA times its:

A. net profit margin.

B. total assets divided by total equity capital.

C. total operating revenues divided by total assets.

D. ratio of net after-tax income to total operating revenues.

E. None of the options is correct.

60. The earnings spread for a bank is equal to:

A. total interest income divided by total earning assets less total interest expense divided by total interest-bearing bank liabilities.

B. total interest income less total interest expenses divided by earning assets.

C. total operating revenues less total operating expenses divided by total assets.

D. total cash and noncash expenses subtracted from interest and noninterest income divided by total assets.

E. None of the options is correct.

61. The employee productivity ratio for a bank is equal to:

A. net operating revenue less total interest expenses per employee.

B. total interest and noninterest expense per employee.

C. net operating income per full-time-equivalent employee.

D. total operating earnings less salaries and wages expense per employee.

E. None of the options is correct.

62. A larger proportion of small and medium-size bank’s loans tend to be:

A. lower-interest-business loans.

B. higher-interest business loans.

C. lower-interest consumer loans.

D. higher-interest consumer loans.

E. None of the options is correct.

63. A bank’s stock price will tend to rise if the:

A. value of the stream of future stockholder dividends is expected to increase.

B. banking organization’s perceived level of risk increases.

C. expected dividends decrease.

D. All of the options are correct.

E. None of the options is correct.

64. The ratio that equals total interest income divided by total earning assets less total interest expense divided by total interest-bearing liabilities is known as the:

A. earnings base.

B. earnings spread.

C. net income margin.

D. net return prior to special transactions.

E. None of the options is correct

65. What do loans and security investments represent for a bank?

A. Earning assets

B. Contra-assets

C. Discretionary accounts

D. Market-valued assets

E. None of the options is correct

66. The tax-management efficiency ratio consists of:

A. total tax liabilities over net income.

B. tax-exempt assets over taxable assets.

C. net income over pre-tax net operating income.

D. taxes owed over total liabilities of a bank.

E. None of the options is correct.

67. The risk that a financial institution may be forced to borrow emergency funds excessive cost to cover its immediate cash needs is known as:

A. credit risk

B. liquidity risk

C. market risk

D. interest-rate risk

E. None of the options is correct

68. ROE for a bank indicates:

A. how capable the management has been in converting assets into net earnings.

B. the growth of bank’s interest margin.

C. the growth of bank’s earnings spread.

D. the rate of return flowing to the shareholders of the bank.

E. All of the options are correct.

69. Which of the following ratios can be used to measure a bank’s credit risk?

A. Net loans’ duration/Total assets

B. Interest sensitive assets/Interest sensitive liabilities

C. Total assets/Number of full time employees

D. Nonperforming assets/Total loans and leases

E. Cash and equivalents/Total loans and leases

70. A bank that has a low profit margin most likely:

A. is doing a poor job of controlling expenses.

B. has a small amount of financial leverage.

C. has a small amount of liquidity risk.

D. has assets that are not very productive.

E. None of the options is correct.

71. A bank that has a high asset utilization (AU) ratio most likely:

A. is doing a poor job of controlling expenses.

B. has a small amount of financial leverage.

C. has a small amount of liquidity risk.

D. is allocating assets to the most productive investments.

E. None of the options is correct

72. Which of the following would be the best example of a ratio used to examine the cost of one of a bank’s liabilities?

A. Demand deposits/Total assets

B. Interest on time deposits/Total time deposits

C. Interest on real estate loans/Total real estate loans

D. Interest sensitive assets/Interest sensitive liabilities

E. Interest on business loans/Total business loans

73. Which of the following would be the best example of a ratio used to examine the return on one of a bank’s assets?

A. Demand deposits/Total assets

B. Interest on time deposits/Total time deposits

C. Interest on real estate loans/Total real estate loans

D. Interest sensitive assets/Interest sensitive liabilities

E. Interest on CDs/Total CDs issued

74. Which of the following would be the best example of a ratio used to examine a bank’s interest rate risk?

A. Demand deposits/Total assets

B. Interest on time deposits/Total time deposits

C. Interest on real estate loans/Total real estate loans

D. Interest sensitive assets/Interest sensitive liabilities

E. Nonperforming assets/Total capital

75. A bank expects to pay a dividend of $3.45 next year and growth rate on dividends to be 7%. If the appropriate discount rate is 15%, what should the bank’s stock price be in the market?

A. $23.00

B. $43.13

C. $46.14

D. $49.29

E. $24.61

76. Following is the information for Carter State Bank. What is the bank’s ROE?

A. 8.46 percent

B. 16.03 percent

C. 15.71 percent

D. 1.36 percent

E. None of the options is correct

77. Following is the information listed below for Carter State Bank. What is the bank’s ROA?

A. 8.46 percent

B. 16.03 percent

C. 15.71 percent

D. 1.36 percent

E. None of the options is correct

78. Following is the information listed below for Carter State Bank. What is the bank’s net profit margin?

A. 8.46 percent

B. 16.03 percent

C. 15.71 percent

D. 1.36 percent

E. None of the options is correct

79. Following is the information listed below for Carter State Bank. What is the bank’s asset utilization ratio?

A. 8.46 percent

B. 16.03 percent

C. 15.71 percent

D. 1.36 percent

E. None of the options is correct

80. The TRC Bank has a net profit margin of 7.5%, an asset utilization ratio of 18%, and an equity multiplier of 20. What is the bank’s ROA?

A. 27.00 percent

B. 1.35 percent

C. 7.50 percent

D. 1.50 percent

E. 3.6 percent

81. The TRC Bank has a net profit margin of 7.5%, an asset utilization ratio of 18%, and an equity multiplier of 20. What is the bank’s ROE?

A. 27.00 percent

B. 1.35 percent

C. 7.50 percent

D. 1.50 percent

E. 3.6 percent

82. The Smith-James Bank has an ROE of 17.5%, an asset utilization ratio of 13%, and a net profit margin of 9%. What is the bank’s ROA?

A. 14.96 percent

B. 1.58 percent

C. 1.17 percent

D. 134.62 percent

E. None of the options is correct

83. The Smith-James Bank has an ROE of 17.5%, an asset utilization ratio of 13%, and a net profit margin of 9%. What is the bank’s equity multiplier?

A. 14.96 times

B. 1.58 times

C. 1.17 times

D. 134.62 times

E. None of the options is correct

84. What is the equity multiplier for a bank whose equity is equal to 10 percent of total assets?

A. 90.0

B. 10.0

C. 1.1

D. 110.0

E. 1.0

85. Which of the following ratios would be a measure of credit risk?

A. Net charge-offs of loans/Total loans and leases

B. Interest on CDs/Total CDs issued

C. Interest Sensitive Assets/Interest Sensitive Liabilities

D. Equity Capital/Total Assets

E. None of the options is correct

86. Which of the following ratios would be a measure of market risk?

A. Nonperforming Loans/Net Loans

B. Net Loans/Total Assets

C. Cash and equivalents/Total assets

D. Equity Capital/Total Assets

E. None of the options is correct

87. In recent years, banks have been __________ profitable than (as) S&Ls and Savings Banks.

A. more

B. less

C. as

D. much more

E. much less

88. Operational risk includes which of the following?

A. Failure of bank’s computer system

B. Closure of a bank for three months due to flooding from a major hurricane

C. Embezzlement of funds of a bank by a teller of the bank

D. Closure of a bank for two weeks due to a fire from a lightning strike

E. All of the options are correct.

89. Brian Smith, the CEO of Carter National Bank, anticipates that interest rates may fall in the future and as a result buys $100 million in 30 year Treasury Bonds for the bank’s security portfolio. Instead, interest rates rise, causing the value of these bonds to fall. This would be an example of which of the following types of risk?

A. Operational risk

B. Legal risk

C. Compliance risk

D. Strategic risk

E. Reputation risk

90. Chaos State Bank has an old computer system which can go down for weeks at a time, leaving customers unable to access their accounts online. Many customers have left the bank for banks with more reliable computer systems. Which type of risk would this be an example of?

A. Operational risk

B. Legal risk

C. Compliance risk

D. Strategic risk

E. Reputation risk

91. Carson County State Bank has a ratio of equity capital to total assets of 2.5%. The regulators have asked all banks of similar size to maintain a capital adequacy ratio of 8%. They are making the bank issue new stock in the market. In addition, they are not allowing the bank to issue dividends to their current stockholders. Which type of risk would this be an example of?

A. Operational risk

B. Legal risk

C. Compliance risk

D. Strategic risk

E. Reputation risk

92. Everett Bank has just learned that there is a disgruntled former employee who has created a blog that is telling everyone that Everett Bank has halved their customer service representatives and therefore customers have great difficulty getting through to a relationship officer when there is a problem with their account. Everett is worried that it may lose customers as a result of such a write-up. Which type of risk would this be an example of?

A. Operational risk

B. Legal risk

C. Compliance risk

D. Strategic risk

E. Reputation risk

93. Norman Bank made a loan of $1,000,000 to Jarod LeFevre. Jarod has declared bankruptcy and Norman Bank has just learned that the judge in the case has ruled that Jarod does not have to pay any part of the loan back or forfeit any of his assets. Which type of risk would this be an example of?

A. Operational risk

B. Legal risk

C. Compliance risk

D. Strategic risk

E. Reputation risk

94. Forrest Fennell is planning to invest in Capital City Bank. He is examining the ratios of nonperforming loans to total loans and leases and the provision for loan losses to total loans and leases. What type of risk is Forrest attempting to measure with these ratios?

A. Credit risk

B. Liquidity risk

C. Market risk

D. Interest rate risk

E. Operational risk

95. Gerald Wilkens is planning to invest in the stock of Tallahassee State Bank. He is examining the ratios of cash assets and government securities to total assets and purchased funds to total assets. What type of risk is Gerald attempting to measure with these ratios?

A. Credit risk

B. Liquidity risk

C. Market risk

D. Interest rate risk

E. Operational risk

96. Amy Farmer is planning to invest in the stock of Guthrie National Bank. She is examining ratios of the book value of the assets to the market value of the assets and the market value of the bonds held by the bank to their recorded value. What type of risk is Amy attempting to measure with these ratios?

A. Credit risk

B. Liquidity risk

C. Market risk

D. Legal risk

E. Operational risk

97. Paul Smith is planning to invest in the stock of Capital City Bank. He is examining the ratios of interest sensitive assets to interest sensitive liabilities and uninsured deposits to total deposits. What type of risk is Paul attempting to measure with these ratios?

A. Credit risk

B. Liquidity risk

C. Legal risk

D. Interest rate risk

E. Operational risk

98. The Garic State Bank of New Orleans has been under water for three weeks since hurricane Katrina hit the state. The lobby is full of mud and other debris. Many of the valuables stored in the bank’s safety deposit boxes have been ruined. John Garic, the President and CEO of the bank, has been working night and day to reopen the bank. What type of risk has John been dealing with?

A. Credit risk

B. Liquidity risk

C. Market risk

D. Interest rate risk

E. Operational risk

Following data pertains to Castle State Bank.

99. What is Castle State Bank’s ROE?

A. 20.45%

B. 18.33%

C. 12.22%

D. 7.33%

E. 2.5%

100. What is the bank’s ROA?

A. 20.45%

B. 18.33%

C. 12.22%

D. 7.33%

E. 2.5%

101. What is the bank’s net profit margin?

A. 20.45%

B. 18.33%

C. 12.22%

D. 7.33%

E. 2.5%

102. What is the bank’s asset utilization ratio?

A. 20.45%

B. 18.33%

C. 12.22%

D. 7.33%

E. 2.5%

103. What is the bank’s equity multiplier?

A. 20.45 times

B. 18.33 times

C. 12.22 times

D. 7.33 times

E. 2.5 times

104. What is the bank’s earnings spread?

A. 37.5%

B. 22.22%

C. 14.33%

D. 7.89%

E. 2.5%

The following financial information pertains to Harrison Bank.

105. What is the bank’s ROA?

A. 1.6%

B. 10%

C. 12.8%

D. 16%

E. None of the options is correct

106. What is the bank’s ROE?

A. 1.6%

B. 10 %

C. 12.8%

D. 16%

E. None of the options is correct

107. What is the bank’s equity multiplier?

A. 1.6 times

B. 10 times

C. 12.8 times

D. 16 times

E. None of the options is correct

108. Harrison Bank has the following financial information:

What is the bank’s asset utilization ratio?

A. 1.6%

B. 10%

C. 12.8%

D. 16%

E. None of the options is correct

109. Harrison Bank has the following financial information.

What is the bank’s total operating revenue?

A. $125

B. $8,000

C. $488,281

D. $31,250,000

E. None of the options is correct

110. Which of the following assets are excluded from the category of risk assets?

A. Real Estate Loans

B. Commercial Paper

C. Plant and Equipment

D. Commercial and Industrial Loans

E. All of the options are correct

111. The value of a bank’s stock will tend to rise if the:

A. stream of future stockholder dividends is expected to increase.

B. financial organization’s perceived level of risk falls.

C. market interest rates decrease.

D. expected dividend increases are combined with declining risk, as perceived by investors.

E. All of the options are correct.

112. The Trust-worthy Bank had declared and paid a dividend of $2 last year. The dividend amount to shareholders is expected to grow at the rate of 10 percent while the minimum acceptable rate for the investors on the bank’s stock is 15 percent. What is the price at which the stock of Trust-worthy bank must be valued at in the market?

A. $40

B. $44

C. $38

D. $22

E. $88

113. A financial institution with a low ROA can achieve a relatively high ROE through:

A. high leverage.

B. low leverage.

C. high owner’s capital.

D. tax swap.

E. None of the options is correct.

114. Which of the following statements is true regarding Subchapter S firms?

A. These firms are liable to pay federal income taxes.

B. These firms cannot have more than 100 shareholders.

C. These firms need to pass-through at least half of their earnings to their shareholders.

D. Income from these firms is tax-exempt for its shareholders.

E. All of the options are true for Subchapter S firms.

115. Which of the following types of banks tend to enjoy the highest net-interest margins in the industry?

A. Small-sized banks

B. Virtual banks

C. Investment banks

D. Large commercial banks

E. Federally chartered banks

116. The risk of deterioration in the value of a financial firm’s assets as a result of fluctuating currency prices is known as:

A. basis risk.

B. country risk.

C. political risk.

D. foreign-exchange risk.

E. economic risk.

117. The risk of a government’s ability to repay its debt owed to international lending institutions is known as:

A. market risk.

B. credit risk.

C. operational risk.

D. sovereign risk.

E. legal risk.

118. Which of the following is an indicator of increasing capital risk in a bank?

A. Rise in the market yields on debt issued by a bank and market yields on government securities of similar maturities

B. Fall in the ratio of stock price per share to earnings per share

C. Decline in the ratio of equity capital to total assets

D. Increase in purchased funds as a percentage of total liabilities

E. All of the options are correct.

Chapter 7
Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques

Fill in the Blank Questions

1. The ___________________ view of assets and liabilities held that the amount and types of deposits was primarily determined by customers and hence the key decision a bank needed to make was with the assets.

________________________________________

2. Recent decades have ushered in dramatic changes in banking. The goal of __________________ was simply to gain control of the bank’s sources of funds.

________________________________________

3. The __________________________ is the interest rate that equalizes the current market price of a bond with the present value of the future cash flows.

________________________________________

4. The __________________ premium on a bond allows the investor to be compensated for their projected loss in purchasing power from the increase in the prices of goods and services in the future.

________________________________________

5. The __________________ shows the relationship between the time to maturity and the yield to maturity of bonds.

________________________________________

6. The __________________ premium on a bond reflects the differences in the ease and ability to sell the bond in the secondary market at a favorable price.

________________________________________

7. __________________________ are those assets which mature or must be repriced within the planning period.

________________________________________

8. __________________________ is the difference between interest-sensitive assets and interest-sensitive liabilities.

________________________________________

9. A(n) __________________________ means that the bank has more interest-sensitive liabilities than interest-sensitive assets.

________________________________________

10. The bank’s __________________________ takes into account the idea that the speed (sensitivity) of interest rate changes will differ for different types of assets and liabilities.

________________________________________

11. __________________________ is the coordinated management of both the bank’s assets and its liabilities.

________________________________________

12. __________________________ is the risk due to changes in market interest rates which can adversely affect the bank’s net interest margin, assets, liabilities, and equity.

________________________________________

13. The __________________________ is the rate of return on a financial instrument using a 360-day year relative to the instrument’s face value.

________________________________________

14. The __________________________ component of interest rates is the risk premium due to the probability that the borrower will miss some payments or will not repay the loan.

________________________________________

15. __________________ is the weighted average maturity for a stream of future cash flows.

________________________________________

16. __________________________ is the difference between the dollar-weighted duration of the asset portfolio and the dollar-weighted duration of the liability portfolio.

________________________________________

17. A(n) __________________________ gap means that for a parallel increase in all interest rates, the market value of net worth will tend to decline.

________________________________________

18. A(n) __________________________ gap means that for a parallel increase in all interest rates, the market value of net worth will tend to increase.

________________________________________

19. The __________________________ is equal to the duration of each individual type of asset weighted by the market value of each type of asset out of the total market value of all assets.

________________________________________

20. The __________________________ is equal to the duration of each individual type of liability in the portfolio weighted by the market value of each type of liability in the portfolio out of the total market value of all liabilities.

________________________________________

21. A bank is __________________ against changes in its net worth if its duration gap is equal to zero.

________________________________________

22. The relationship between a change in an asset’s price and an asset’s change in the yield or interest rate is captured by _________________________.

________________________________________

23. The change in a financial institution’s __________________ is equal to difference between the average duration of assets times the change in the interest rate divided by (1+ original discount rate) times the dollar amount of total assets and the average duration of liabilities times the change in the interest rate divided by 1+ original discount rate times the dollar amount of total liabilities.

________________________________________

24. When a bank has a positive duration gap a parallel increase in the interest rates on the assets and liabilities of the bank will lead to a(n) __________________ in the bank’s net worth.

________________________________________

25. When a bank has a negative duration gap, a parallel decrease in the interest rates on the assets and liabilities of the bank will lead to a(n) _________________________ in the bank’s net worth.

________________________________________

26. Most lending institutions tend to do better when the yield curve is upward-sloping because they tend to have ____________ maturity gap positions.

________________________________________

27. One of the government-created giant mortgage banking firm which has subsequently been privatized is the ____________________________________.

________________________________________

28. One part of interest-rate risk is _____________________. This part of interest-rate risk reflects that as interest rates rise, prices of securities tend to fall.

________________________________________

29. One part of interest-rate risk is ____________________. This part of interest-rate risk reflects that as interest rates fall, any cash flows that are received are invested at a lower interest rate.

________________________________________

30. The interest-rate risk which arises when a borrower has the right to pay off a loan early reducing the lender’s expected rate of return is called ______________.

________________________________________

31. In recent decades, banks have aggressively sought to insulate their assets and liability portfolios and profits from the ravages of changing interest rates. Many banks now conduct their asset-liability management strategy with the help of a(n) _____________________.

________________________________________

32. __________________________ is interest income from loans and investments less interest expenses on deposits and borrowed funds divided by total earning assets.

________________________________________

33. _____________________________ are those liabilities that mature or must be repriced within the planning period.

________________________________________

34. Variable rate loans and securities are included as part of _______________________ for banks.

________________________________________

35. Money market deposits are included as part of ______________________ for banks.

________________________________________

36. Interest sensitive assets less interest sensitive liabilities divided by total assets of the bank is known as _______________________.

________________________________________

37. Interest sensitive assets divided by interest sensitive liabilities is known as: ____________________________.

________________________________________

38. _______________________ is a measure of interest-rate risk exposure which is the total difference in dollars between those assets and liabilities that can be repriced over a designated time period.

________________________________________

39. ___________________________ is the phenomenon by which interest rates attached to various assets often change by different amounts and at different speeds than interest rates attached to various liabilities.

________________________________________

True / False Questions

40. One of the principal goals of asset-liability management is to maximize or at least stabilize a bank’s margin or spread.

True False

41. Asset management strategy in banking assumes that the amount and kinds of deposits and other borrowed funds a bank attracts are determined largely by its management.

True False

42. The ultimate goal of liability management is to gain control over a financial institution’s sources of funds.

True False

43. If interest rates fall when a bank is in an asset-sensitive position, its net interest margin will rise.

True False

44. A liability-sensitive bank will experience an increase in its net interest margin if interest rates rise.

True False

45. Under the so-called liability management view in banking, the key control lever banks possess over the volume and mix of their liabilities is price.

True False

46. Under the so-called funds management view, bank management’s control over assets must be coordinated with its control over liabilities, so that asset and liability management are internally consistent.

True False

47. Bankers cannot determine the level or trend of market interest rates; instead, they can only react to the level and trend of rates.

True False

48. Short-term interest rates tend to rise more slowly than long-term interest rates and to fall more slowly when the long-term interest rates in the market are headed down.

True False

49. A financial institution is liability sensitive, if its interest-sensitive liabilities are less than its interest-sensitive assets.

True False

50. If a bank’s interest-sensitive assets and liabilities are equal, then its interest revenues from assets and funding costs from liabilities will change in the same proportion relative to changes in market interest rates.

True False

51. Banks with a positive cumulative interest-sensitive gap will benefit if interest rates rise, but lose income if interest rates decline.

True False

52. Banks with a negative cumulative interest-sensitive gap will benefit if interest rates rise, but lose income if interest rates decline.

True False

53. Repriceable liabilities include long-term savings and retirement accounts.

True False

54. Interest-sensitive gap techniques do not consider the impact of changing interest rates on stockholders’ equity.

True False

55. Interest-sensitive gap, relative interest-sensitive gap, and the interest-sensitivity ratio will often reach different conclusions as to whether the bank is asset or liability sensitive.

True False

56. The yield curve is constructed using corporate bonds with different default risks, so that the bank can determine the risk/return tradeoff for default risk.

True False

57. Financial securities that are the same in all other ways may have differences in interest rates that reflect the differences in the ease of selling the security in the secondary market at a favorable price.

True False

58. Financial institutions face two major kinds of interest-rate risk. These risks include price risk and reinvestment risk.

True False

59. Interest-sensitive gap and weighted interest-sensitive gap will always reach the same conclusion as to whether a bank is asset sensitive or liability sensitive.

True False

60. Weighted interest-sensitive gap is less accurate than interest-sensitive gap in determining the effect of changes in interest rates on net interest margin.

True False

61. A bank with a positive duration gap experiencing a rise in interest rates will experience an increase in its net worth.

True False

62. A bank with a negative duration gap experiencing a rise in interest rates will experience an increase in its net worth.

True False

63. Duration is a direct measure of the price risk but not the reinvestment risk of a bond.

True False

64. A bank with a positive duration gap experiencing a decrease in interest rates will experience an increase in its net worth.

True False

65. A bank with a negative duration gap experiencing a decrease in interest rates will experience an increase in its net worth.

True False

66. Duration is the weighted average maturity of a promised stream of future cash flows.

True False

67. Convexity is a direct measure of the price risk of a bond.

True False

68. A bond with a greater duration will have a smaller price change in percentage terms when interest rates change.

True False

69. Long-term interest rates tend to change very little with the cycle of economic activity.

True False

70. A bank with a duration gap of zero is immunized against changes in the value of net worth due to changes in interest rates in the market.

True False

71. Convexity is the idea that the rate of change of an asset’s price varies with the change in interest rates depending on the prevailing interest rates.

True False

72. The change in the market price of an asset due to a change in market interest rates is roughly equal to the asset’s duration times the relative change in interest rates attached to that particular asset.

True False

73. U.S. banks having positive maturity gap positions tend to do better when the yield curve is upward-sloping.

True False

74. Net interest margin tends to rise for U.S. banks having positive maturity gap positions when the yield curve is upward-sloping.

True False

75. Financial institutions laden with home mortgages tend be immune to interest-rate risk.

True False

76. If a financial institution’s net interest margin is immune to interest-rate risk, then so is its net worth.

True False

Multiple Choice Questions

77. A bank’s IS GAP is defined as:

A. the dollar amount of interest-sensitive assets divided by the dollar amount of interest-sensitive liabilities.

B. the dollar amount of earning assets divided by the dollar amount of total liabilities.

C. the dollar amount of interest-sensitive assets minus the dollar amount of interest-sensitive liabilities.

D. the dollar amount of interest-sensitive liabilities minus the dollar amount of interest-sensitive assets.

E. the dollar amount of earning assets times the average liability interest rate.

78. The maturing of the liability management techniques, coupled with more volatile interest rates, gave birth to the __________________ approach, which dominates banking today.

A. liability management

B. asset management

C. risk management

D. funds management

E. None of the options is correct.

79. The principal goal of interest rate hedging strategy is to hold fixed a bank’s:

A. net interest margin.

B. net income before taxes.

C. value of loans and securities.

D. interest sensitive assets.

E. None of the options is correct.

80. A bank is asset-sensitive if its:

A. loans and securities are affected by changes in interest rates.

B. interest-sensitive assets exceed its interest-sensitive liabilities.

C. interest-sensitive liabilities exceed its interest-sensitive assets.

D. deposits and borrowings are affected by changes in interest rates.

E. None of the options is correct.

81. The change in a bank’s net income that occurs due to changes in interest rates equals the overall change in market interest rates (in percentage points) times ____________.

A. volume of interest-sensitive assets

B. price risk of the bank’s assets

C. price risk of the bank’s liabilities

D. size of the bank’s cumulative gap

E. None of the options is correct

82. A bank with a negative interest-sensitive GAP:

A. has a greater dollar volume of interest-sensitive liabilities than interest-sensitive assets.

B. will generate a higher interest margin if interest rates rise.

C. will generate a lower interest margin if interest rates fall.

D. has assets and liabilities with the same duration.

E. has liabilities with a greater duration than its assets.

83. The net interest margin of a bank is influenced by:

A. changes in the level of interest rates.

B. changes in the volume of interest-bearing assets and interest-bearing liabilities.

C. changes in interest income from loans and investments.

D. changes in interest expense on deposits and other borrowed funds.

E. All of the options are correct.

84. The discount rate that equalizes the current market value of a loan or security with the expected stream of future income payments from that loan or security is known as:

A. bank discount rate.

B. yield to maturity.

C. annual percentage rate.

D. net interest margin.

E. None of the options is correct.

85. The interest-rate measure often quoted on short-term loans and money market securities such as U.S. Treasury bills is the

A. bank discount rate.

B. yield to maturity.

C. annual percentage rate.

D. net interest margin.

E. None of the options is correct.

86. A bank whose interest-sensitive assets total $350 million and its interest-sensitive liabilities amount to $175 million has:

A. an asset-sensitive gap of $525 million.

B. a liability-sensitive gap of $175 million.

C. an asset-sensitive gap of $175 million.

D. a liability-sensitive gap of $350 million.

E. None of the options is correct.

87. A bank has a 1-year $1,000,000 loan outstanding, payable in four equal quarterly installments. What dollar amount of the loan would be considered rate sensitive in the 0-90 day bucket?

A. $0

B. $250,000

C. $500,000

D. $750,000

E. $1,000,000

88. A bank has Federal funds totaling $25 million with an interest-rate sensitivity weight of 1.0. This bank also has loans of $105 million and investments of $65 million with interest rate sensitivity weights of 1.40 and 1.15 respectively. It also has $135 million in interest-bearing deposits with an interest rate sensitivity weight of 0.90 and other money market borrowings of $75 million with an interest rate sensitivity weight of 1.0. What is the weighted interest-sensitive gap for this bank?

A. $50.25 million

B. -$15.00 million

C. -$50.25 million

D. $34.25 million

E. $196.5 million

89. A bond has a face value of $1,000 and five years to maturity. This bond has a coupon rate of 13 percent and is selling in the market today for $902. Coupon payments are made annually on this bond. What is the yield to maturity (YTM) for this bond?

A. 13 percent

B. 12.75 percent

C. 16 percent

D. 11.45 percent

E. 12 percent

90. A treasury bill currently sells for $9,845, has a face value of $10,000 and has 46 days to maturity. What is the bank discount rate on this security?

A. 12.49 percent

B. 12.13 percent

C. 12.30 percent

D. 2 percent

E. None of the options is correct.

91. The _______________ is determined by the demand and supply for loanable funds in the market.

A. coupon rate

B. reserve requirement

C. interest-sensitive gap

D. risk-free real rate of interest

E. duration gap

92. As per the __________________ strategy, financial-service managers set interest-sensitive gap as close to zero as possible to reduce the expected volatility of net interest income.

A. aggressive GAP management

B. defensive GAP management

C. cumulative GAP management

D. weighted GAP management

E. asset-sensitive GAP management

93. The fact that a consumer who purchases a particular basket of goods for $100 today has to pay $105 next year for the same basket of goods is an example of which of the following risks?

A. Inflation risk

B. Default risk

C. Liquidity risk

D. Price risk

E. Maturity risk

94. A bank has Federal Funds totaling $25 million with an interest-rate sensitivity weight of 1.0. This bank also has loans of $105 million and investments of $65 million with interest rate sensitivity weights of 1.40 and 1.15 respectively. It also has $135 million in interest-bearing deposits with an interest rate sensitivity weight of 0.90 and other money market borrowings of $75 million with an interest rate sensitivity weight of 1.0. What is the dollar interest-sensitive gap for this bank?

A. $50.25 million

B. -$15 million

C. -$50.25 million

D. $34.25 million

E. None of the options is correct.

95. If a bank has a positive interest-sensitive gap, one of the possible management responses would be to:

A. wait for the interest rates to rise or be stable.

B. shorten asset maturities.

C. decrease interest-sensitive liabilities.

D. increase interest-sensitive assets.

E. extend liability maturities.

96. If a bank has a negative interest-sensitive gap, one of the possible management responses would be to:

A. lengthen asset maturities.

B. shorten liability maturities.

C. increase interest-sensitive liabilities.

D. decrease interest-sensitive assets.

E. wait for the interest rates to fall or be stable.

97. A treasury bill currently selling for $9,845, has a face value of $10,000 and has 46 days to maturity. What is the yield to maturity equivalent on this security?

A. 12.49 percent

B. 12.13 percent

C. 12.30 percent

D. 2 percent

E. None of the options is correct.

98. The Third National Bank of Edmond reports a net interest margin of 5.83 percent. It has total interest revenues of $275 million and total interest expenses of $210 million. What will be the bank’s earning assets total?

A. $4,717 million

B. $3,602 million

C. $1,115 million

D. $3,790 million

E. None of the options is correct.

99. The Third National Bank of Edmond reports a net interest margin of 5.83 percent. It has total interest revenues of $275 million and total interest expenses of $210 million. This bank has earnings assets of $1,115. Suppose this bank’s interest revenues rise by 8 percent and its interest expenses and earnings assets rise by 10 percent next year, what is this bank’s new net interest margin?

A. 5.83 percent

B. 7.09 percent

C. 3.59 percent

D. 5.38 percent

E. 7.80 percent

100. Financial firms devote greater attention to opening up new sources of funding and monitoring the mix and cost of their deposit and non-deposit liabilities under the _______________________ strategy.

A. asset management

B. liabilities management

C. interest-sensitive gap management

D. weighted gap management

E. duration gap management

101. If Fifth National Bank’s asset duration exceeds its liability duration and if interest rates rise, the bank’s net worth will _________________.

A. decrease

B. increase

C. stabilize

D. be unaffected

E. None of the options is correct.

102. Main Street Bank has $100 million in commercial loans with an average duration of 0.40 years; $40 million in consumer loans with an average duration of 1.75 years; and $30 million in U.S. Treasury bonds with an average duration of 6 years. What will be the bank’s dollar-weighted asset portfolio duration?

A. 0.4 years

B. 1.7 years

C. 2.7 years

D. 4.1 years

E. None of the options is correct.

103. A an average asset duration of 4.7 years and an average liability duration of 3.3 years. This bank has $750 million in total assets and $500 million in total liabilities. This bank’s leverage-adjusted duration gap is a:

A. positive gap of 8.0 years.

B. negative gap of 2.5 years.

C. positive gap of 1.4 years.

D. positive gap of 2.5 years.

E. None of the options is correct.

104. A bank has an average asset duration of 1.15 years and an average liability duration of 2.70 years. This bank has $250 million in total assets and $225 million in total liabilities. This bank’s leverage-adjusted duration gap is a:

A. negative gap of 1.55 years.

B. positive gap of 1.28 years.

C. negative gap of 3.85 years.

D. negative gap of 1.28 years.

E. None of the options is correct.

105. The duration of a bond is the weighted average maturity of the future cash flows expected to be received on a bond. Which of the following statements concerning duration is true?

A. The longer the time to maturity, the greater the duration.

B. The higher the coupon rate, the lower the duration.

C. The shorter the duration, the greater the price volatility.

D. All of the options are true.

E. None of the options is true.

106. A bond has a duration of 7.5 years. Its current market price is $1,125. Interest rates in the market are 7 percent today. It has been forecasted that interest rates will rise to 9 percent over the next couple of weeks. How will the bond’s price change in percentage terms?

A. The bond’s price will rise by 2 percent.

B. The bond’s price will fall by 2 percent.

C. The bond’s price will fall by 14.02 percent.

D. The bond’s price will rise by 14.02 percent.

E. The bond’s price will not change.

107. A bank has an average asset duration of 5 years and an average liability duration of 3 years. This bank has total assets of $500 million and total liabilities of $250 million. Currently, market interest rates are 10 percent. If interest rates fall by 2 percent (to 8 percent), what is this bank’s change in net worth?

A. Net worth will decrease by $31.81 million.

B. Net worth will increase by $31.81 million.

C. Net worth will increase by $27.27 million.

D. Net worth will decrease by $27.27 million.

E. Net worth will not change at all.

108. A bank has an average asset duration of 5 years and an average liability duration of 3 years. This bank has total assets of $500 million and total liabilities of $250 million. Currently, market interest rates are 10 percent. What will be this bank’s leverage-adjusted duration gap?

A. 2 years

B. -2 years

C. 3.5 years

D. -3.5 years

E. None of the options is correct.

109. A bank has an average asset duration of 5 years and an average liability duration of 9 years. This bank has total assets of $1,000 million and total liabilities of $850 million. Currently, market interest rates are 5 percent. If interest rates rise by 2 percent (to 7 percent), what is this bank’s change in net worth?

A. Net worth will decrease by $50.47 million.

B. Net worth will increase by $50.47 million.

C. Net worth will decrease by $240.95 million.

D. Net worth will increase by $240.95 million.

E. Net worth will not change at all.

110. A bank has an average asset duration of 5 years and an average liability duration of 9 years. This bank has total assets of $1,000 million and total liabilities of $850 million. Currently, market interest rates are 5 percent. What will be this bank’s leverage-adjusted duration gap?

A. -4 years

B. 4 years

C. 2.65 years

D. -2.65 years

E. 3.65 years

111. A bank has $100 million of investment grade bonds with a duration of 9.0 years. This bank also has $500 million of commercial loans with a duration of 5.0 years. This bank has $300 million of consumer loans with a duration of 2.0 years. This bank has deposits of $600 million with a duration of 1.0 year and non-deposit borrowings of $100 million with an average duration of .25 years. What is this bank’s duration gap? These are all of the assets and liabilities this bank has.

A. This bank has a duration gap of 14.75 years.

B. This bank has a duration gap of 15.03 years.

C. This bank has a duration gap of 3.55 years.

D. This bank has a duration gap of 3.75 years.

E. This bank has a duration gap of 5.15 years.

112. Which of the following statements concerning a bank’s leverage-adjusted duration gap is true?

A. If it has a positive duration gap and interest rates rise, its net worth will decline.

B. If it has a positive duration gap and interest rates fall, its net worth will decline.

C. If it has a negative duration gap and interest rates rise, its net worth will decline.

D. If it has a negative duration gap and interest rates fall, its net worth will increase.

E. All of the options are correct.

113. A bank has an average duration for its asset portfolio of 5.5 years. The bank has total assets of $1,000 million and total liabilities of $750 million. If this bank’s leverage-adjusted duration gap is zero, what must be the duration of its liabilities portfolio?

A. 7.33 years

B. 4.125 years

C. 7.5 years

D. 5.5 years

E. None of the options is correct.

114. A bond has a face value of $1,000 and coupon payments of $80 annually. This bond matures in three years and is selling for $1,000 in the market. Market interest rate is 8 percent. What is this bond’s duration?

A. 3 years

B. 2.78 years

C. 1.95 years

D. 4.31 years

E. None of the options is correct.

115. A bond has a face value of $1,000 and coupon payments of $120 annually. This bond matures in three years and is selling in the market for $1,160. Market interest rate is 6 percent. What is this bond’s duration?

A. 3 years

B. 5.71 years

C. 1.96 years

D. 2.71 years

E. None of the options is correct.

116. A bond is selling in the market for $950 and has a duration of 6 years. Market interest rates are 9 percent and are expected to decrease to 7 percent in the near future. What will this bond’s price be after the change in market interest rates?

A. $969

B. $931

C. $1,055

D. $854

E. $950

117. A bond is selling in the market for $1,100 and has a duration of 4.5 years. Market interest rates are 5 percent and are expected to increase to 7 percent in the near future. What will this bond’s price be after the change in market interest rates?

A. $1,006

B. $1,194

C. $1,122

D. $1,078

E. $1,100

118. Which of the following is a true statement?

A. The longer the time to maturity of a security, the smaller will be the duration

B. The lower the coupon rate of a security, the higher the duration

C. For a given duration and change in interest rates, the change in the price of the security will be larger for a lower starting level of interest rates

D. The duration of a security remains constant no matter the level of market interest rates

E. All of the options are true statements.

119. The fact that the rate of change in an asset’s price varies with the level of interest rates is known as:

A. portfolio.

B. convexity.

C. maturity.

D. yield.

E. None of the options is correct.

120. U.S. banks tend to fare best when the yield curve is:

A. horizontal.

B. downward-sloping.

C. vertical.

D. upward-sloping.

E. None of the options is correct.

121. Carolina National Bank knows that the interest rate on its loans change faster and by a larger amount than the interest rate on its deposits. What type of risk is this an example of?

A. Default risk

B. Inflation risk

C. Liquidity risk

D. Call risk

E. Basis risk

122. Havoc State Bank has a loan that it fears will not be repaid because the company is going into bankruptcy. What type of risk would this be an example of?

A. Default risk

B. Inflation risk

C. Liquidity risk

D. Call risk

E. Basis risk

123. Carter National Bank is worried because it knows that the municipal bonds it has in its bond portfolio can be difficult to sell quickly. What type of risk would this be an example of?

A. Default risk

B. Inflation risk

C. Liquidity risk

D. Call risk

E. Basis risk

124. Jackson State Bank is worried because many of the loans it has made are home mortgages which can be paid off early by the homeowner. What type of risk would this be an example of?

A. Default risk

B. Inflation risk

C. Liquidity risk

D. Call risk

E. Basis risk

125. A bank is liability sensitive, if its:

A. deposits and non-deposit borrowings are not affected by changes in interest rates.

B. interest-sensitive assets exceed its interest-sensitive liabilities.

C. interest-sensitive liabilities exceed its interest-sensitive assets.

D. loans and securities are affected by changes in interest rates.

E. None of the options is correct.

126. Which of the following would be an example of a repriceable asset?

A. Money the bank has borrowed from the money market

B. Cash in the vault

C. Demand deposits that do not pay interest

D. Short-term securities issued by the government about to mature

E. All of the options are correct.

127. Which of the following would be an example of a repriceable liability?

A. Money the bank has borrowed from the money market

B. Cash in the vault

C. Demand deposits that do not pay an interest rate

D. Short term securities issued by the government about to mature

E. All of the options are correct.

128. Which of the following would be an example of a nonrepriceable asset?

A. Money the bank has borrowed from the money market

B. Cash in the vault

C. Demand deposits that do not pay an interest rate

D. Short term securities issued by the government about to mature

E. All of the options are correct.

129. Which of the following would be an example of a nonrepriceable liability?

A. Money the bank has borrowed from the money market

B. Cash in the vault

C. Demand deposits that do not pay an interest rate

D. Short term securities issued by the government about to mature

E. All of the options are correct.

The Tidewater State Bank has $1,000 in total assets (all of which are earning assets), $700 of which will be repriced within the next 90 days. This bank also has $800 in total liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is earning 8 percent on its assets and is paying 5 percent on its liabilities.

130. If interest rates do not change in the next 90 days, what is this bank’s net interest margin?

A. 8 percent

B. 5 percent

C. 4 percent

D. 1.4 percent

E. 3 percent

131. What is the dollar interest-sensitive gap of this bank?

A. -$200

B. -$100

C. $200

D. $300

E. $600

132. If interest rates on both assets and liabilities rise by 2 percent in the next 90 days, what would be the bank’s net interest margin?

A. 4 percent

B. 4.4 percent

C. 4.6 percent

D. 2.4 percent

E. 6 percent

133. If interest rates on both assets and liabilities rise by 2 percent in the next 90 days, what should happen to this bank’s net interest margin?

A. It should rise by 0.60 percent.

B. It should rise by 2 percent.

C. It should rise by 4 percent.

D. It should rise by 1 percent.

E. It should not show any rise.

134. If interest rates on both assets and liabilities decrease by 2 percent in the next 90 days, what would be this bank’s net interest margin?

A. 3.4 percent

B. 4 percent

C. 0.4 percent

D. 5.6 percent

E. 2 percent

135. If interest rates on both assets and liabilities decrease by 2 percent in the next 90 days, what should happen to this bank’s net interest margin?

A. It should fall by 2 percent.

B. It should fall by 0.6 percent.

C. It should fall by 4 percent.

D. It should fall by 1 percent.

E. It should not show any fall.

136. The Arnold National Bank has a bond portfolio that consists of bonds with 5 years to maturity and a 9 percent coupon rate having a face value of $1,000. These bonds are selling in the market for $1,126. Coupon payments are made annually on this bond.

What is the yield to maturity on these bonds?

A. 3 percent

B. 6 percent

C. 9 percent

D. 12 percent

E. None of the options is correct.

137. The Arnold National Bank has a bond portfolio that consists of bonds with 5 years to maturity and a 9 percent coupon rate having a face value of $1,000. These bonds are selling in the market for $1,126. Coupon payments are made annually on this bond.

What is duration of these bonds?

A. 3.77 years

B. 4.23 years

C. 5 years

D. 9 years

E. None of the options is correct.

The Harris State Bank has $2,000 in total assets (all of which are earning assets), $500 of which will be repriced in the next 90 days. This bank also has $1,600 in total liabilities, $1,000 of which will be repriced in 90 days. The bank currently earns 9 percent on its assets and pays 4 percent on its liabilities.

138. If interest rates do not change in the next 90 days, what is this bank’s net interest margin?

A. 0.5 percent

B. 0.8 percent

C. 1.8 percent

D. 5.8 percent

E. None of the options is correct.

139. What is the dollar interest-sensitive gap of this bank?

A. $400

B. -$1,100

C. -$500

D. $1,000

E. None of the options is correct.

140. If interest rates on both assets and liabilities rise by 2 percent in the next 90 days, what would be this bank’s net interest margin?

A. 4.2 percent

B. 5.3 percent

C. 5.8 percent

D. 6.2 percent

E. 7.8 percent

141. If interest rates on both assets and liabilities rise by 2 percent in the next 90 days, what should happen to this bank’s net interest margin?

A. It should fall by 2 percent.

B. It should fall by 0.5 percent.

C. It should fall by 4 percent.

D. It should fall by 1 percent.

E. It should not record any fall.

142. If interest rates on both assets and liabilities fall by 2 percent in the next 90 days, what would be this bank’s net interest margin?

A. 3.8 percent

B. 5.4 percent

C. 5.8 percent

D. 6.3 percent

E. 7.8 percent

143. If interest rates on both assets and liabilities fall by 2 percent in the next 90 days, what should happen to this bank’s net interest margin?

A. It should rise by 0.5 percent.

B. It should fall by 0.5 percent.

C. It should stay the same.

D. It should rise by 2 percent.

E. It should fall by 2 percent.

144. Maryellen Epplin notices that a particular T-Bill has a banker’s discount rate of 9 percent in the Wall Street Journal. She knows that this T-Bill has 20 days to maturity and has a face value of $10,000.

What price is this T-Bill selling for in the market?

A. $9,100

B. $10,000

C. $9,950

D. $1,900

E. None of the options is correct.

145. Maryellen Epplin notices that a particular T-Bill has a banker’s discount rate of 9 percent in the Wall Street Journal. She knows that this T-Bill has 20 days to maturity and has a face value of $10,000.

What is the yield to maturity on this T-Bill?

A. 9 percent

B. 0.5 percent

C. 4.5 percent

D. 9.17 percent

E. None of the options is correct.

146. The Raymond Burr National Bank has $1,000 in assets with an average duration of 5 years. This bank has $800 in liabilities with an average duration of 6.25 years. What is the duration gap of this bank?

A. -1.25 years

B. 0 years

C. 1.25 years

D. -2.25 years

E. None of the options is correct.

147. The Raymond Burr National Bank has $1,000 in assets with an average duration of 5 years. This bank has $800 in liabilities with an average duration of 6.25 years. Market interest rates start at 6 percent and fall by 1 percent. What is the change in net worth of this bank?

A. $11.29

B. -$11.29

C. $0

D. -$22.22

E. $22.22

148. The interest rate on one year Treasury Bonds is 5 percent. The interest rate on five year Treasury Bonds is 7.5 percent. The interest rate on ten year Treasury Bonds is 10 percent. What is true about the yield curve?

A. It is upward sloping.

B. It is downward sloping.

C. It is a horizontal curve.

D. It is a vertical curve.

E. It is parallel to the x-axis.

149. The assets and liabilities of Finacle Bank as on December 31, 2015, are as follows:

$20,000 of short-term securities issued by governments and private borrowers (about to mature), $12,000 of borrowings from the money market, $15,000 of short-term savings accounts, $12,000 of variable-rate loans and securities, $18,000 of long-term loans made at a fixed interest rate, $25,000 of long-term savings and retirement accounts, $22,000 of deposits in the Central Bank (held as legal reserves), $550,000 of equity capital provided by the bank’s owners, and $500,000 of building and equipment.

What is the total of repriceable assets held by the bank as on December 31, 2015?

A. $32,000

B. $50,000

C. $45,000

D. $55,000

E. $52,000

150. The assets and liabilities of Finacle Bank as on December 31, 2015, are as follows:

$20,000 of short-term securities issued by governments and private borrowers (about to mature), $12,000 of borrowings from the money market, $15,000 of short-term savings accounts, $12,000 of variable-rate loans and securities, $18,000 of long-term loans made at a fixed interest rate, $25,000 of long-term savings and retirement accounts, $22,000 of deposits in the Central Bank (held as legal reserves), $550,000 of equity capital provided by the bank’s owners, and $500,000 of building and equipment.

Which of the following is a repriceable liability for Finacle Bank?

A. Long-term savings and retirement accounts

B. Variable-rate loans and securities

C. Borrowings from the money market

D. Equity capital provided by the owners

E. Long-term loans made at a fixed interest rate

151. Brendon Brothers Bank reports interest-sensitive assets at $35 million, interest-sensitive liabilities at $60 million and total assets at $80 million. What is the relative IS GAP of the bank?

A. -0.29

B. 0.29

C. -0.31

D. 0.31

E. -0.33

152. Loyola Bank classifies its assets and liabilities and the period (maturity buckets) within which they are subject to repricing as on March 31, 2015 as follows:

What is the interest-sensitive gap of the bank as on March 31, 2015?

A. -$30 million

B. $40 million

C. -$45 million

D. $32 million

E. -$38 million

153. Loyola Bank classifies its assets and liabilities and the period (maturity buckets) within which they are subject to repricing as on March 31, 2015 as follows:

What is the cumulative gap of the bank for interest-sensitive assets and interest-sensitive liabilities of maturity buckets up to 180 days as on March 31, 2015?

A. -$65 million

B. -$60 million

C. $65 million

D. $60 million

E. $45 million

154. Loyola Bank classifies its assets and liabilities and the period (maturity buckets) within which they are subject to repricing as on March 31, 2015 as follows:

What is the interest-sensitivity ratio of the bank for the 90 to 180 days maturity bucket?

A. 0.82

B. 0.88

C. 0.91

D. 0.92

E. 0.85

155. Loyola Bank classifies its assets and liabilities and the period (maturity buckets) within which they are subject to repricing as on March 31, 2015 as follows:

Silvershine bank has $200 million in earning assets and $280 million in liabilities that are subject to an interest rate change each month over the next six months. If market interest rates suddenly rise by 2 full percentage points, what will be approximate change in the net interest income for the bank?

A. $8.2 million

B. -$8.5 million

C. $8.5 million

D. $9.6 million

E. -$9.6 million

Chapter 8
Risk Management: Financial Futures, Options, Swaps, and Other Hedging Tools

Fill in the Blank Questions

1. A(n) _________________________ is an agreement between a buyer and a seller today which calls for the delivery of a particular security in exchange for cash at some future date for a set price.

________________________________________

2. A financial institution goes _________________________ in the futures market by selling a futures contract.

________________________________________

3. A financial institution goes _________________________ in the futures market by buying a futures contract.

________________________________________

4. _________________________ is the difference in interest rates (or prices) between the cash market and the futures market on an underlying security.

________________________________________

5. A(n) _________________________ is the fee a buyer must pay to be able to put securities to, or to call securities away from the option writer.

________________________________________

6. A(n) _________________________ allows the holder the right to either sell securities to another investor (put) or buy securities from another investor (call) at a set price before the expiration date.

________________________________________

7. Futures contracts are _________________________ daily, which means that futures contracts are settled each day as their market value changes.

________________________________________

8. Most options today are traded on a(n) ________________________. These options are standardized to make offsetting an existing position easier.

________________________________________

9. The buyer of a(n) _________________________ option contract believes that the market price of the underlying security will decline in the future.

________________________________________

10. The buyer of a(n) _________________________ option contract believes that the market price of the underlying security will increase in the future.

________________________________________

11. A(n) _________________________ is a contract where a borrower with a lower credit rating enters into an agreement with a borrower with a higher credit rating to exchange interest payments.

________________________________________

12. In an interest rate swap, the ________________________ or principal amount is not exchanged.

________________________________________

13. A(n) _________________________ is a new swap agreement which offsets the original interest rate swap contract.

________________________________________

14. In an interest rate swap agreement, __________________ reduces the default risk. This is where the swap parties exchange only the net difference between the interest payments owed.

________________________________________

15. A(n) _________________________ is a contract where two parties exchange interest payments in order to save money and hedge against interest rate risks.

________________________________________

16. A(n) _________________________ is an agreement between two parties where they agree to exchange, based on a predetermined agreement, amounts in different currencies. It is designed to reduce exchange rate risks.

________________________________________

17. A(n) _________________________ protects the holder from rising market interest rates. It sets the maximum interest rate that a lender can charge on a floating-rate loan.

________________________________________

18. A(n) _________________________ protects the lender from falling interest rates. It is the minimum rate that the borrower must pay on a floating-rate loan.

________________________________________

19. A(n) _________________________ is where there is both a minimum and a maximum interest rate set on a loan.

________________________________________

20. In an interest-rate swap, the principal amount of the loan, usually called the ________________________, is not exchanged.

________________________________________

21. The category of derivative contracts with the largest use by banks is _________.

________________________________________

22. _______ is the spread between the cash price and futures price of an underlying asset.

________________________________________

23. An interest-rate ________ would protect the swap party receiving a floating-rate payment in a swap.

________________________________________

24. An interest-rate _______ would protect the swap party receiving a fixed-rate payment and making a floating-rate payment in a swap.

________________________________________

25. The combination of both a cap and floor is known as an interest-rate ________.

________________________________________

26. One reason that banks use derivatives is to generate ________, the money that does not come from interest earned on loans and securities.

________________________________________

27. _________ are financial instruments that derive their value from some underlying asset.

________________________________________

28. The _________ largest U.S. FDIC-insured banking companies account for more than 90 percent of bank derivatives activity in the U.S.

________________________________________

29. When investors buy or sell a futures contract, they must deposit a(n) _________ when they first enter into the contract.

________________________________________

30. On the exchange floor, _________ execute orders received from the public to buy and sell the futures contract at the best possible price.

________________________________________

31. The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-averse investors to ________.

________________________________________

32. Futures contracts can be traded ________, without the help of an organized exchange.

________________________________________

33. The _________ is determined by the clearing house and is used to calculate the mark-to-market amounts.

________________________________________

34. The most actively traded futures contract in the world is the ________. It is traded on exchanges in Chicago, London, Tokyo, Singapore and elsewhere and allows investors the opportunity to hedge against market interest rate changes.

________________________________________

35. The buyer of a call option has the right to buy from the writer of the option contract, securities at the ________.

________________________________________

True / False Questions

36. One of the most popular methods of neutralizing duration gap risks is to buy and sell financial futures contracts.

True False

37. The financial futures markets are designed to shift the risk of interest rate fluctuations from risk-averse investors to speculators who are willing to accept and possibly profit from such risks.

True False

38. When a financial institution offers to sell financial futures contract, it is agreeing to take delivery of certain kinds of securities on a stipulated date at a predetermined price.

True False

39. There are some significant limitations to financial futures as interest-rate hedging devices; among them is a special form of risk known as credit risk.

True False

40. An effective hedge is one where the positive or negative returns earned in the cash market are approximately offset by the profit or loss from futures trading.

True False

41. A hedging tool that provides “one-sided” insurance against interest rate risk is the interest rate option, which, like financial futures contracts, obligates the parties to the contract to either deliver or take delivery of securities.

True False

42. U.S. Treasury bond futures contracts call for the future delivery of U.S. T-bonds with minimum denominations of $100,000 and minimum maturities of 15 years.

True False

43. A futures hedge against interest-rate changes generally requires a bank to take an opposite position in the futures market from its current position in the cash market.

True False

44. The short hedge in financial futures contracts is most likely to be used in situations where a bank would suffer losses due to falling interest rates.

True False

45. The long hedge in financial futures contracts is most likely to be used in situations where a bank would suffer losses due to rising interest rates.

True False

46. The short hedge would usually be the correct choice if a bank is concerned about avoiding lower than expected yields from loans and security investments.

True False

47. A financial institution with a positive interest-sensitive gap and anticipating falling interest rates could protect against loss by covering the gap with a long hedge.

True False

48. A financial institution confronted with a negative interest-sensitive gap could avoid unacceptable losses from rising interest rates by covering the gap with a short hedge.

True False

49. The sensitivity of the market price of a financial futures contract depends partly upon the duration of the security to be delivered under the futures contract.

True False

50. Money center banks appear to use option contracts to protect the value of a bond portfolio or to hedge against interest-sensitive or duration gaps.

True False

51. Banks are generally writers (sellers) of put and call option contracts.

True False

52. The market value of a futures contract changes daily as the market price of the underlying security price changes.

True False

53. A futures contract is “marked-to-market” weekly to reflect the current market price of the contract. This means that one or the other party has to make a cash payment to the exchange at the end of each week.

True False

54. If a financial institution makes an offsetting sale and purchase of the same futures contract, it has no obligation either to deliver or take delivery of the contract.

True False

55. A bank will use a short hedge in the futures market to avoid higher borrowing costs or to protect against declining asset values.

True False

56. One of the significant disadvantages of using futures contracts to hedge against interest rate risk is the high commissions that must be paid to brokers.

True False

57. Basis risk is the difference in the interest rates (or prices) of the same security between the cash market and the futures market.

True False

58. In a typical quality swap, a borrower with a positive duration gap is more likely to pay all or part of the other swap party’s long-term interest rate.

True False

59. A currency swap is where two parties agree to exchange interest payments in order to hedge against interest rate risk.

True False

60. In most interest rate swaps, netting reduces the default risk because the parties actually exchange only the difference in the interest payments.

True False

61. One advantage of an interest rate swap agreement is that the brokerage fees are very low.

True False

62. Unlike futures contracts, interest rate swap agreements have no basis risk.

True False

63. Interest rate caps protect the lender from falling interest rates.

True False

64. Interest rate floors protect the lender from falling interest rates.

True False

65. An interest rate collar sets both, a minimum and a maximum interest rate on a variable rate loan agreement.

True False

66. Basis risk exists on interest rate swaps because the interest rate on the swap agreement may differ from the interest rate on assets and liabilities that the parties hold.

True False

67. A reverse swap is where the parties exchange the principal payments instead of the interest payments on loans.

True False

68. An interest-rate cap on a loan would protect the lender.

True False

69. Many banks are not only users of derivative products but also dealers.

True False

70. Most derivatives (measured by notional value) are traded on organized exchanges.

True False

71. An interest-rate cap will become more valuable as interest rates rise.

True False

72. Virtually all banks in the U.S. use derivative contracts to hedge their risks.

True False

73. The number of futures contracts needed to hedge a position increases as the bank’s duration gap increases.

True False

74. A financial institution with a negative gap would like to receive the floating rate in an interest-rate swap.

True False

Multiple Choice Questions

75. A financial institution with a negative gap can reduce the risk of loss due to changing interest rates by:

A. extending asset maturities.

B. increasing short-term interest-sensitive liabilities.

C. using financial futures or options contracts.

D. All of the options are correct

E. None of the options are correct

76. If a bank has a positive gap, that is, if it is asset sensitive, the bank can hedge its interest-rate risk by which of the following activities?

A. Reducing maturities of its assets

B. Reducing maturities of its liabilities

C. Using a long hedge

D. All of the options are correct

E. Reducing maturities of its assets and liabilities

77. A significant limitation to financial futures as an interest-rate hedging device is a special form of risk known as ___________ risk. Which of the following terms correctly completes the statement?

A. default

B. basis

C. credit

D. market

E. None of the options are correct

78. The realized return to a bank from a combined cash and futures market trading operation is composed of which of the following elements?

A. Returns earned in the cash market

B. Profit or loss from futures trading

C. Difference between the opening and closing basis between cash and futures markets

D. All of the options are correct

E. Profit or loss from futures trading and the difference between the opening and closing basis between cash and futures markets

79. Which of the following is an advantage of trading financial futures to hedge interest-rate risk?

A. Only a fraction of the value of the contract must be pledged as collateral

B. Brokers’ commissions are relatively low

C. There is no market risk in trading futures contracts

D. All of the options are correct

E. Only a fraction of the value of the contract must be pledged as collateral and brokers’ commissions are relatively low

80. An option buyer can:

A. exercise the option.

B. sell the option to another buyer.

C. allow the option to expire.

D. All of the options are correct.

E. exercise the option or must sell it to another buyer.

81. A bank wishing to avoid higher borrowing costs is most likely to use:

A. a short position or selling hedge in futures.

B. a long position or buying hedge in futures.

C. a long position in call option on futures contracts.

D. a long position or buying hedge in futures and a long position in call option on futures contracts.

E. None of the options are correct.

82. A bank seeking to avoid lower than expected yields from loans and security investments is most likely to use:

A. a short position or selling hedge in futures.

B. a long position or buying hedge in futures.

C. a long position in put option on futures contracts.

D. a long position or buying hedge in futures and a long position in put option on futures contracts.

E. None of the options are correct.

83. The gain or loss to a bank from the use of a financial futures contract depends upon:

A. the duration of the underlying security named in the futures contract.

B. the initial futures price.

C. the change expected in interest rates.

D. All of the options are correct.

E. None of the options are correct.

84. The number of futures contracts that a bank will need in order to fully hedge its overall interest rate risk exposure and protect the net worth depends upon (among other factors):

A. the relative duration of bank assets and liabilities.

B. the duration of the underlying security named in the futures contract.

C. the price of the futures contract.

D. All of the options are correct

E. None of the options are correct

85. A put option on Eurodollar deposit futures is most likely to be used by a bank to:

A. reduce its interest sensitive liabilities.

B. protect variable-rate loans and securities.

C. offset a positive interest-sensitive gap.

D. offset a negative interest-sensitive gap.

E. None of the options are correct.

86. A call option on Eurodollar deposit futures is most likely to be used by a bank to:

A. protect the value of its fixed-rate loans and securities.

B. offset a negative interest-sensitive gap.

C. offset a positive duration gap.

D. offset a negative duration gap.

E. speculate on the rising interest rates.

87. According to the textbook, the most actively traded futures contract in the world is:

A. Federal Funds futures contracts.

B. Eurodollar time deposit futures contracts.

C. U.S. Treasury bond futures contract.

D. U.S. Treasury bills futures contract.

E. U.S. Treasury notes futures contract.

88. A futures contract which calls for the delivery of a $100,000 T-bond with a minimum of 15 years to maturity is called a:

A. U.S. Treasury bond futures contract.

B. One-month LIBOR futures contract.

C. Eurodollar time deposit futures contract.

D. Federal Funds futures contract.

E. None of the options are correct.

89. A financial institution that sells a particular futures contract and later purchases the same contract back is executing:

A. a long hedge.

B. a short hedge.

C. a sideways hedge.

D. an up-side-down hedge.

E. None of the options are correct

90. A financial institution that uses a long hedge is most likely:

A. trying to avoid higher borrowing costs.

B. trying to avoid declining asset values.

C. trying to avoid lower than expected yields from loans and securities.

D. trying to avoid higher borrowing costs or trying to avoid declining asset values.

E. trying to offset a positive duration gap.

91. A bank that uses a short hedge is most likely:

A. trying to avoid higher borrowing costs.

B. trying to avoid declining asset values.

C. trying to avoid lower than expected yields from loans and securities.

D. trying to avoid higher borrowing costs or trying to avoid declining asset values.

E. trying to offset a negative duration gap.

92. Suppose a bank has an asset duration of 5 years and a liability duration of 2.5 years. The bank has $1,000 million in assets and $750 million in liabilities. It is planning to trade in Treasury bond futures whose underlying’s duration is 8.5 years and is currently selling at $99,000 for a $100,000 contract. How many futures contracts does the bank need to fully hedge itself against interest rate risk?

A. 3,714 contracts

B. 3,125 contracts

C. 2,971 contracts

D. 371 contracts

E. None of the options are correct

93. A bank wishes to sell $350 million in new 30-day time deposits next month. Today interest rates are 7 percent. However, in the next month interest rates are expected to rise to 7.75 percent. What is the potential loss in profit for the month from this increase in interest rates? (Use a 360 day year)

A. $27.125 million

B. $24.500 million

C. $0.21875 million

D. $2.625 million

E. There is no potential loss from this increase

94. A futures contract on a 30-day Eurodollar time deposit is currently selling at an IMM index of 95.75 percent. The IMM index on a 30-day Eurodollar time deposit for immediate delivery is 95.10 percent. What is the basis?

A. 65 basis points

B. -65 basis points

C. 650 basis points

D. 850 basis points

E. There is no basis risk on this contract

95. Suppose a $100,000 T-Bond futures contract whose underlying’s duration is 9 years and has a current market price of $98,750. Market interest rates are 6 percent today but are expected to rise to 7.5 percent. What is the expected change in this futures contract’s market price as a result of this change in interest rates?

A. $12,577

B. -$12,577

C. $62,883

D. -$62,883

E. None of the options are correct

96. Suppose a Eurodollar time deposit futures contract whose underlying’s duration is 0.5 years and has a current market price of $950,000. Market interest rates are 8.5 percent and are expected to fall to 7.5 percent. What is the expected change in this futures contract’s market price as a result of this change in interest rates?

A. $4,378

B. -$4,378

C. $30,645

D. -$30,645

E. None of the options are correct

97. A financial institution that goes long in the futures market:

A. has the right to accept delivery of the underlying security at the contract price if they wish.

B. has the right to make delivery of the underlying security at the contract price if they wish.

C. is obligated to accept delivery of the underlying security at the contract price.

D. is obligated to make delivery of the underlying security at the contract price.

E. is exposed to limited losses and unlimited gains.

98. A bank that goes short in the futures market:

A. has the right to accept delivery of the underlying security at the contract price if they wish.

B. has the right to make delivery of the underlying security at the contract price if they wish.

C. is obligated to accept delivery of the underlying security at the contract price.

D. is obligated to make delivery of the underlying security at the contract price.

E. is exposed to limited losses and unlimited gains.

99. A financial institution that buys a put option:

A. has the right to accept delivery of the underlying security at the contract price if they wish.

B. has the right to make delivery of the underlying security at the contract price if they wish.

C. is obligated to accept delivery of the underlying security at the contract price.

D. is obligated to make delivery of the underlying security at the contract price.

E. is exposed to unlimited losses and limited gains.

100. A bank that buys a call option:

A. has the right to accept delivery of the underlying security at the contract price if they wish.

B. has the right to make delivery of the underlying security at the contract price if they wish.

C. is obligated to accept delivery of the underlying security at the contract price.

D. is obligated to make delivery of the underlying security at the contract price.

E. is exposed to unlimited losses and limited gains.

101. Interest rate hedging devices used by banks today include which of the following?

A. Financial futures contracts.

B. Interest-rate options contracts.

C. Interest rate swaps.

D. Interest rate caps, floors, and collars.

E. All of the options are correct

102. An advantage of interest rate swap is that:

A. it can help protect from interest rate fluctuations.

B. it can help achieve lower borrowing costs.

C. it can help closely match the maturities of assets and liabilities.

D. it can help transform actual cash flows to more closely match desired cash flow patterns.

E. All of the options are correct

103. An interest rate collar:

A. combines a rate floor and a rate cap into one agreement.

B. ranges in maturity from a few days to a few weeks.

C. protects a lender from rising interest rates.

D. All of the options are correct.

E. ranges in maturity from a few days to a few weeks and protects the lender from rising interest rates.

104. The part of an agreement which allows one or both parties to make certain changes to the agreement or eliminate the agreement is called:

A. an interest rate swap.

B. a currency swap.

C. a swaption.

D. a quality swap.

E. None of the options are correct

105. An agreement where a party with a lower credit rating enters into an agreement to exchange interest payments with a borrower having a higher credit rating is known as:

A. an interest rate swap.

B. a currency swap.

C. a swaption.

D. a quality swap.

E. None of the options are correct

106. Which of the following is an advantage of an interest rate swap agreement?

A. Little or no basis risk

B. Low brokerage fees

C. Increased flexibility as compared to other hedging techniques

D. Little or no credit risk

E. All of the options are advantages of interest rate swap agreements.

107. Which of the following is a disadvantage of an interest rate swap agreement?

A. Basis risk

B. High brokerage fees

C. Default risk

D. Interest rate risk

E. All of the options are disadvantages of interest rate swap agreements.

108. Interest rate swaps:

A. can change exposure to interest-rate fluctuations.

B. are one of the oldest interest rate hedging devices.

C. allows for the exchange of amounts in different currencies by two parties.

D. are rigid and inflexible.

E. None of the options are correct.

109. Interest rate caps:

A. first developed in the 1980s.

B. protect the borrower from rising interest rates.

C. allow for the exchange of amounts in different currencies by two parties.

D. protect the lenders from falling interest rates.

E. allow for the exchange of amounts in different currencies by two parties and protect the lenders from falling interest rates.

110. The approximate percentage of banks operating in the U.S. who reportedly use derivative contracts for risk reduction is:

A. 15%.

B. 25%.

C. 50%.

D. 75%.

E. 100%.

111. All of the following interest-rate futures contracts are traded on exchanges, except:

A. Eurodollar futures contract.

B. Treasury bond futures contract.

C. Eurodollar time deposit futures contract.

D. Federal funds futures contract.

E. Corporate bond futures contract.

112. A bank with a leverage-adjusted duration gap of 2 years and total assets of $100 million uses a futures contract whose underlying’s duration is 5 years and has a price of $100,000 to hedge its exposure. The number of contracts needed is:

A. 2,000

B. 4,000

C. 8,000

D. 10,000

E. 20,000

113. The floating-rate payer in a swap would most likely want to buy an interest-rate:

A. floor.

B. cap.

C. collar.

D. deposit contract.

E. futures contract.

114. When an investor first purchases or sells a futures contract, she must make a deposit to the exchange. This is called the:

A. initial margin.

B. variation margin.

C. premium.

D. open interest.

E. margin call.

115. The person who executes orders in the futures market for the public is called a:

A. day trader.

B. floor broker.

C. clearing member.

D. speculator.

E. scalper.

116. The amount that is used to determine the mark-to-market for a futures contract at the end of each day is called the:

A. open price.

B. high price.

C. settlement price.

D. low price.

E. day average.

117. The number of contracts that have been established and not yet offset or exercised is called __________________.

A. trade contracts

B. unexpired contracts

C. accumulated contracts

D. open interest

E. uncleared contracts

118. The amount of initial margin, the settlement price, and other rules regarding trading futures contracts are determined by the:

A. SEC.

B. floor brokers.

C. dealers.

D. open interest.

E. clearinghouse.

119. Julie Wells has found a Treasury Bond futures contract whose underlying’s duration is 8.5 years and is currently selling for $97,500. Interest rates are currently 8% and are expected to rise by 1.5%. What is the expected change in the future contract’s price for this change in interest rates?

A. $1,462.50

B. $12,431.25

C. -$11,510.42

D. -$1,462.50

E. -$12,431.25

120. The Kromwell Community Bank’s asset portfolio has an average duration of 6 years and its liability portfolio has an average duration of 2.5 years. The bank has $500 million in total assets and $450 million in liabilities. The Kromwell Community Bank is thinking about hedging its risk by using a Treasury Bond futures contract whose underlying’s duration is 7.5 years and has a price of $98,000. How many futures contracts will it need to hedge its risk?

A. 2,381 contracts

B. 2,551 contracts

C. 3,061 contracts

D. 4,464 contracts

E. 5,221 contracts

121. A Treasury Bond futures contract is selling in the market for $98,225 and has a duration of 8 years. The same Treasury Bond is selling in the cash market for $98,625 and has a duration of 8.25 years. What is the basis for this futures contract?

A. $400

B. 0.25 years

C. $28,156.25

D. $1,600

E. None of the options are correct

122. Which of the following tends to accurately predict the consensus opinion as to actions expected to be taken by the Federal Open Market Committee in the future?

A. U.S. Treasury bond futures contract

B. Eurodollar time deposit futures contract

C. One month LIBOR futures contract

D. Federal Funds futures contract

E. All of the options are correct

123. Which of the following is one of the risks the OCC requires banks to measure and set limits on?

A. Strategic risk

B. Reputation risk

C. Price risk

D. Liquidity risk

E. All of the options are correct

124. What is the objective of a fair value hedge?

A. To offset the losses due to changes in the value of an asset or liability

B. To reduce the risk associated with future cash flows

C. To predict future cash flows

D. To predict the value of an asset or minimize the value of a liability

E. None of the options are correct

125. What is the objective of a cash flow hedge?

A. To offset the losses due to changes in the value of an asset or liability

B. To reduce the risk associated with future cash flows

C. To predict future cash flows

D. To predict the value of an asset or minimize the value of a liability

E. None of the options are correct

126. Which of the following is a characteristic of a swap buyer?

A. Prefers floating rate loans

B. Generally has a higher credit rating

C. Often has a positive duration gap

D. Generally has a large holding of short-term assets

E. All of the options are correct

127. Which of the following is a characteristic of a swap seller?

A. Prefers fixed-rate loans

B. Generally has a lower credit rating

C. Often has a positive duration gap

D. Generally has a large holding of short-term assets

E. All of the options are correct

128. Which of the following is a characteristic of a swap buyer?

A. They generally have a lower credit rating

B. They prefer fixed rate longer term loans

C. They often have a positive duration gap

D. They generally have substantial holdings of longer term assets

E. All of the options are correct

129. Which of the following is a characteristic of a swap seller?

A. They generally have a higher credit rating

B. They prefer flexible short-term interest rate

C. They often have a negative duration gap

D. They generally have large holdings of short-term assets

E. All of the options are correct

130. A swap where the notional amount is constant is called:

A. a quality swap

B. a bullet swap

C. an amortizing swap

D. an accruing swap

E. None of the options are correct

131. A swap where the notional amount declines over time is called:

A. a quality swap

B. a bullet swap

C. an amortizing swap

D. an accruing swap

E. None of the options are correct

132. A swap where the notional amount accumulates over time is called:

A. a quality swap

B. a bullet swap

C. an amortizing swap

D. an accruing swap

E. None of the options are correct

133. Which of the following is true with respect to the difference between futures and forward contracts?

A. Futures contracts are marked-to-market daily, while forward contracts are not

B. Buyers and sellers deal directly with each other on forward contracts but go through organized exchanges in futures contracts

C. Futures contracts are standardized, forward contracts generally are not

D. Forward contracts are generally more risky because no exchange guarantees the settlement of each contract if one or the other party to the contract defaults

E. All of the options describe differences between futures and forward contracts

134. The daily settlement process that credits gains or deducts losses from a futures customer’s account is called:

A. factoring.

B. marking-to-market.

C. margining.

D. maintenance.

E. realizing.

135. Assume that two firms, one considered a high credit risk (HCR) and the other a low credit risk (LCR), are considering an interest rate swap. Each can borrow at the following rates:

An interest rate swap would be beneficial to both parties if:

A. the LCR firm wants to borrow at the fixed rate and the HCR firm wants to borrow at the variable rate.

B. the HCR firm wants to borrow at the fixed rate and the LCR firm wants to borrow at the variable rate.

C. both firms want to borrow at the variable rate.

D. both firms want to borrow at the fixed rate.

E. an interest rate swap would be never beneficial in this situation.

136. An investor purchases one September T-bond futures contract at 115-110. The settlement price for the contract on next day is 117-225. What is the marked-to-market gain/loss for the investor?

A. $2,359.38

B. -$2,539.38

C. $2.36

D. -$2,115

E. $2.115

137. The underlying on the Eurodollar futures contract is the:

A. U.S. dollar.

B. Euro.

C. U.S. T-bills.

D. Eurodollar CD paying three-month LIBOR rate.

E. 10-year U.S. treasuries.

138. The 30-day Federal funds futures contracts are traded in the units of:

A. $100,000

B. $1,000,000

C. $3,000,000

D. $5,000,000

E. $500,000

139. Eurodollar contracts are quoted using:

A. an index price which is 100 minus the yield on a bank discount basis.

B. an index price which is 100 minus the yield on a ten-year U.S. treasuries.

C. interest rate derived from one-month federal funds futures.

D. interest rate derived from three-month U.S. T-bill futures.

E. interest rate derived from one-year U.S. T-bond futures.

140. Current selling price on a futures contract reflects what investors in the market expect cash prices to be:

A. at the end of the day.

B. at the end of the week.

C. at the end of the month.

D. at the end of the year.

E. at the time of delivery.

141. The September T-bond futures contract is currently selling at 111-05 and September call option on T-bond futures for a strike price of 115-00 is currently quoting at 2-24. If an investor purchases one contract of the call option at the current market price and if the T-bond futures contract settles at 118-05 on the expiration day, what will be the net gain/loss for the investor?

A. $781.25

B. $281.25

C. -$359.38

D. $791.25

E. $566.25

142. If a financial institution agrees to guarantee a swap agreement negotiated between two of its customers, usually:

A. it will mark the transaction as a deferred asset.

B. it will mark the transaction as a deferred liability.

C. it will mark the transaction as a contingent asset.

D. it will mark the transaction as a contingent liability.

E. it does not record the transaction in its books.

143. ________ in a swap refers to the risk arising from the difference in the interest rate defined in the terms of a swap and the interest rates of the assets and liabilities held by the parties to swap.

A. Default risk

B. Liquidity risk

C. Interest rate risk

D. Basis risk

E. Transaction risk

144. A buyer of a call option on fixed-income securities is most likely to:

A. exercise the option if interest rates rise.

B. let the option expire if the interest rates fall.

C. exercise the option if interest rates fall.

D. exercise the option if interest rates remain constant.

E. buy a put option also on the same securities.

145. A buyer of a put option on fixed-income securities is most likely to:

A. exercise the option if interest rates rise.

B. let the option expire if the interest rates rise.

C. exercise the option if interest rates fall.

D. exercise the option if interest rates remain constant.

E. buy a call option also on the same securities.

146. Zenith Company has borrowed $1 million from Strong Capital Bank at an interest rate of LIBOR plus 2 percent. However, the CFO of Zenith fears that the short-term interest rates may rise in the near future and purchases an interest-rate cap of 5 percent from Strong Capital Bank. What will be the annual interest outflow for Zenith, if the LIBOR rate rises to 3.5 percent?

A. $50,000

B. $45,000

C. $55,000

D. $5,000

E. Zero

147. The American Commerce Bank (ACB) lends $1.5 million to Unity International Company for six months. The bank usually changes a rate of LIBOR plus 3 percent to companies with similar credit ratings. However, since the bank’s economists are of the view that short-term interest rates may fall in the near future, ACB decided to lend money to Unity at a discounted rate of LIBOR plus 2 percent in return for an interest-rate floor of 4.5 percent. What amount of interest rebate will the bank receive, if LIBOR drops to 1.5 percent from 2.5 percent immediately after lending the amount?

A. $7,500

B. $20,000

C. $22,500

D. $17,500

E. Zero

148. Large depository institutions tend to act:

A. both as dealers and end users.

B. only as dealers.

C. only as end users.

D. neither as dealers nor end users.

E. largely as speculators.

Chapter 9
Risk Management: Asset-Backed Securities, Loan Sales, Credit Standbys, and Credit Derivatives

Fill in the Blank Questions

1. When a bank sets aside a group of income-earning assets and then sells securities based upon those assets, it is ________________________ those assets.

________________________________________

2. Often when loans are securitized, they are passed on to a(n) ________________ which pools the loans and sells securities.

________________________________________

3. A(n) _________________________ allows homeowners to borrow against the residual value of their residence.

________________________________________

4. _________________________ allow the banks to generate fee income after they have sold a loan. The bank continues to collect interest and principal from the borrowers and passes these collections to the loan buyers.

________________________________________

5. In a(n) _________________________ an outsider purchases part of a loan from the selling financial institution. Generally the purchaser has no influence over the terms of the loan contract.

________________________________________

6. A(n) _________________________ is a contingent claim of the firm that issues it. The issuing firm, in return for a fee, guarantees the repayment of a loan received by its customer or the fulfillment of a contract made by its customer to a third party.

________________________________________

7. A(n) _________________________ occurs when two banks agree to exchange a portion or all of the loan repayments of their customers.

________________________________________

8. A(n) __________________ guards against the losses in the value of a credit asset. It would pay off if the asset declines significantly in value or if it completely turns bad.

________________________________________

9. A(n) _________________________ combines a normal debt instrument with a credit option. It allows the issuer of the debt instrument to lower its loan repayments if some significant factor changes.

________________________________________

10. The _________________________ of a standby letter of credit is a bank or other investor who is concerned about the safety of funds committed to the account party.

________________________________________

11. A(n) _________________________ guarantees the swap parties a specific rate of return on their credit assets. Bank A may agree to pay the total return on the loan to Bank B plus any appreciation in the market value of the loan. In return Bank A will often get LIBOR plus a fixed spread plus any depreciation in the value of the loan.

________________________________________

12. The customer that is requesting a standby letter of credit is known as the __________.

________________________________________

13. A(n) __________________ is the party, often a bank or a financial institution, which guarantees the payment of the loan in a standby letter of credit.

________________________________________

14. A(n) _________________________ is a form of loan sale where the ownership of a loan is transferred to the buyer of the loan, who then has a direct claim against the borrower.

________________________________________

15. A(n) _________________________ is a type of loan sale which is a short-dated piece of a longer maturity loan, entitling the purchaser to a fraction of the expected loan income.

________________________________________

16. A relatively new type of credit derivative is a CDO which stands for _______________.

________________________________________

17. Insurance companies are the principal __________ of credit derivatives.

________________________________________

18. A(n) _______________ is an over-the-counter agreement offering protection against loss when default occurs on a loan or other debt instrument.

________________________________________

19. A(n) __________________________ is related to a credit option and is usually aimed at lenders who are able to handle comparatively limited declines in value but want insurance against serious losses.

________________________________________

20. There has been an exponential growth in the ___________________ market in recent years. These instruments rest on pools of credit derivatives that mainly insure against defaults on corporate bonds. The creators of these instruments do not have to buy and pool actual bonds but can create these instruments and generate revenues from selling and trading in them.

________________________________________

21. A(n) __________________ rates the securities to be sold from a pool of securitized loans so that investors have a better idea of what the new securities are likely to be worth.

________________________________________

22. In securitization, a cash reserve which is created to give an impression to the buyers that the investment carries low risk is an example of ____________.

________________________________________

23. When the FHLMC creates CMOs, they often use different _________________ to issue the securities, which are characterized by the differences in coupon rate, maturity and risk profile.

________________________________________

24. Lenders can set aside a group of loans on their balance sheet, issue bonds, and pledge the loans as collateral against the bonds in a type of securitization known as ___________. These usually stay on the bank’s balance sheet as liabilities.

________________________________________

25. FNMA (Fannie Mae) and FHLMC (Freddie Mac) are examples of ____________. They appear to have the unofficial backing of the federal government in the event of default.

________________________________________

True / False Questions

26. Securitization is designed to turn illiquid loans into liquid assets in the form of securities sold in the open market.

True False

27. Securitization has the added advantage of generating fee income for banks.

True False

28. Securitized assets cannot be removed from a bank’s balance sheet until they mature.

True False

29. Securitization raises the level of competition for the best-quality loans among banks.

True False

30. Servicing rights on loans sold consist of the collection of interest and principal payments from borrowers and monitoring borrower compliance with loan terms.

True False

31. A loan sold by a bank to another investor with recourse means the bank has given the investor a call option on the loan.

True False

32. An account party will seek a standby credit guarantee if the bank’s fee for issuing the guarantee is less than the value assigned to the guarantee by its beneficiary.

True False

33. Securitization tends to lengthen the maturity of a bank’s assets.

True False

34. Securitized assets, as a source of bank funds, are subject to reserve requirements set by the Federal Reserve Board.

True False

35. Securitizations of commercial loans usually carry the same regulatory capital requirements for a bank as the original loans themselves.

True False

36. Most loans that banks sell off their balance sheets have minimum denominations of at least a million dollars.

True False

37. Most loans that banks sell off their balance sheets carry interest rates that usually are connected to long-term interest rates (such as the 30-year Treasury bond rate).

True False

38. In a participation loan, the purchaser is an outsider to the loan contract between the financial institution selling the loan and the borrower.

True False

39. The buyer of a participation loan must watch both the borrower and the seller bank closely.

True False

40. Under an assignment ownership, a loan is transferred to the buyer, though the buyer still holds only an indirect claim against the borrower.

True False

41. Loan sales are generally viewed as a risk-reducing mechanism for the selling financial institution.

True False

42. In a CMO, the buyers of different tiers (or tranches) of securities face the same degree of prepayment risk.

True False

43. A standby letter of credit substantially reduces the issuing bank’s interest rate risk and liquidity risk.

True False

44. Securitization of loans can easily be applied to business loans since these loans tend to have similar cash flow schedules and comparable risk structures.

True False

45. The advantage of a credit swap is that it allows each bank in the swap to broaden its market area and spread out its credit risk on its loans.

True False

46. The credit derivatives market has grown many-fold during the recent years.

True False

47. Banks are the principal sellers of credit derivatives.

True False

48. Banks are one of the principal buyers of credit derivatives.

True False

49. Insurance companies are one of the principal sellers of credit derivatives.

True False

Multiple Choice Questions

50. Securitized assets carry a unique form of risk called:

A. default risk.

B. inflation risk.

C. interest-rate risk.

D. prepayment risk.

E. None of the options is correct.

51. Short-dated pieces of a longer-term loan, usually maturing in a few days or weeks, are called:

A. loan participations.

B. servicing rights.

C. loan strips.

D. shared credits.

E. None of the options is correct.

52. The party for whom a standby credit letter is issued by a bank is known as the:

A. account party.

B. beneficiary.

C. representative.

D. credit guarantor.

E. None of the options is correct.

53. When a bank issues a standby credit guarantee on behalf of one of its customers, the party receiving the guarantee is known as the:

A. account party.

B. beneficiary.

C. obligator.

D. servicing agent.

E. None of the options is correct.

54. Securitization had its origin in the selling of securities backed by ____________.

A. credit card receivables

B. residential mortgage loans

C. computer leases

D. automobile loans

E. truck leases

55. Loan-backed securities, which closely resemble traditional bonds, carry various forms of credit enhancements, which may include all of the following, except:

A. credit letter guaranteeing repayment of the securities.

B. set aside of a cash reserve.

C. division into different risk classes.

D. early payment clauses.

E. None of the options is correct.

56. In some instances, banks sell loans and agree to give the loan purchaser recourse to the seller for all or a portion of those loans that become delinquent. In this case, the purchaser, in effect, gets a:

A. call option.

B. put option.

C. forward contract.

D. futures contract.

E. None of the options is correct.

57. Which of the following is a key advantage(s) of issuing standby letters of credit?

A. Letters of credit generate fee income for the bank.

B. Letters of credit typically reduce the borrower’s cost of borrowing.

C. Letters of credit can usually be issued for a relatively low cost.

D. The probability is low that the issuer of the letter of credit will be called upon to pay.

E. All the options are correct.

58. Banks that issue standby letters of credit may face which of the following types of risk?

A. Prepayment risk

B. Interest-rate risk

C. Liquidity risk

D. Options B and C only

E. All the options are correct.

59. By agreeing to service any assets that are packaged together in the securitization process a bank can:

A. ensure the assets that are packaged and securitized remain in the package and are not sold off.

B. choose the best loans to go through the securitization process.

C. earn added fee income.

D. liquidate any assets it chooses.

E. None of the options is correct.

60. The difference in interest rates between securitized loans themselves and the securities issued against the loans is referred to as:

A. the funding gap.

B. residual income.

C. service returns.

D. security income.

E. None of the options is correct.

61. If a credit letter is issued to backstop payments on loan-backed securities, the credit letter is a form of:

A. collateralized asset.

B. residual income.

C. direct loan obligation.

D. credit enhancement.

E. None of the options is correct.

62. Loan sales by banks are generally of two types: (a) participation loans; and (b) _________. The term that correctly fills in the blank above is:

A. assignments

B. recourse loans

C. direct loans

D. subscription loans

E. None of the options is correct

63. For an issuer, a standby credit letter is a(n):

A. securitized strip.

B. loan strip.

C. contingent obligation.

D. indirect loan.

E. None of the options is correct.

64. A bank that wants to protect itself from higher borrowing costs due to a decrease in its credit rating might purchase:

A. a credit risk option.

B. a standby letter of credit.

C. a credit linked note.

D. a credit swap.

E. None of the options is correct

65. When two banks simply agree to exchange a portion of their customers’ loan repayments, they are using:

A. a credit option.

B. a standby letter of credit.

C. a credit linked note.

D. a credit swap.

E. None of the options is correct.

66. A hybrid instrument which allows the issuer to lower its coupon payments if some significant factor changes is called:

A. a credit option.

B. a standby letter of credit.

C. a credit-linked note.

D. a credit swap.

E. None of the options is correct.

67. Which of the following is a risk of using credit derivatives?

A. Credit derivatives do not protect against credit risk exposure.

B. The partner in a swap or an option contract may fail to perform.

C. Regulators may decide to lower the amount of capital needed for banks using these derivatives.

D. Regulators may decide that these derivatives make the bank more stable and efficient.

E. All the options are risks of using credit derivatives

68. A securitized asset where the asset used to back the securities is a loan based on the residual value of a homeowner’s residence is called:

A. a mortgage-backed security.

B. a credit-card-backed security.

C. an automobile-backed security.

D. a loan-backed bond.

E. a home-equity-loan-backed-security.

69. A financial institution plans to issue a group of bonds backed by a pool of automobile loans. However, they fear that the default rate on the automobile loans will rise well above 4 percent of the portfolio—the projected default rate. The financial institution wants to lower the interest payments if the loan default rate rises too high. Which type of credit derivative contract would you most recommend for this situation?

A. Credit-linked note

B. Credit option

C. Credit risk option

D. Total-return swap

E. Credit swap

70. A bank is about to make a $50 million project loan to develop a new oil field and is worried that the petroleum engineer’s estimates of the yield on the field are incorrect. The bank wants to protect itself in case the developer cannot repay the loan. Which type of credit derivative contract would you most recommend for this situation?

A. Credit-linked note

B. Credit option

C. Credit risk option

D. Total-return swap

E. Credit swap

71. A bank plans to offer new subordinated notes in the open market next month but knows that its credit rating is being reviewed by a credit rating agency. The bank wants to avoid paying sharply higher credit costs. Which type of credit derivative contract would you most recommend for this situation?

A. Credit-linked note

B. Credit option

C. Credit risk option

D. Total-return swap

E. Credit swap

72. A bank is concerned about excess volatility in its cash flows from some recent business loans it has made. Many of these loans have a fixed rate of interest and the bank’s economics department has forecast a sharp increase in interest rates. The bank wants more stable cash flows. Which type of credit derivative contract would you most recommend for this situation?

A. Credit-linked note

B. Credit option

C. Credit risk option

D. Total-return swap

E. Credit swap

73. A bank has a limited geographic area of operations. It would like to diversify its loan income with loans in other market areas but does not want to actually make loans in those areas because of its limited experience in those areas. Which type of credit derivative contract would you most recommend for this situation?

A. Credit-linked note

B. Credit option

C. Credit risk option

D. Total return swap

E. Credit swap

74. A bank has a long-term relationship with a particular business customer. However, recently the bank has become concerned because of a potential deterioration in the customer’s income. In addition, regulators have expressed concerns about the bank’s capital position. The business customer has asked for a renewal of its $25 million dollar loan with the bank. Which of the following can be used to help this situation?

A. Standby letter of credit

B. Loan sale

C. Loan securitization

D. Credit risk option

E. Credit-linked notes

75. A bank has placed 5,000 consumer loans in a package to be securitized. These loans have an annual yield of 15.25 percent. The bank estimates that the securities on these loans are priced to yield 10.95 percent. The bank’s default (charge-off) rate on the pooled loans is expected to be 1.45 percent. Underwriting and advisory services will cost 0.25 percent, and a credit guarantee, if more loans default than expected, will cost 0.35 percent. What is the residual income from this loan securitization?

A. 3.70 percent

B. 4.30 percent

C. 2.25 percent

D. 5.15 percent

E. None of the options is correct

76. According to the text, in 2005 the securitization of loans reached:

A. million dollar market.

B. billion dollar market.

C. trillion dollar market.

D. market unknown in value.

E. small but growing market.

77. Securitization is used by the banks to:

A. fund a portion of a loan portfolio.

B. allocate capital more efficiently.

C. diversify funds sources.

D. lower the cost of fund raising.

E. All the options are correct.

78. The principal sellers of risk protection via credit derivatives include all of the following except:

A. insurance companies.

B. securities dealers.

C. fund management firms.

D. banks.

E. None of the options is correct.

79. A bank or any other lender whose loans are pooled is called:

A. the originator.

B. the special-purpose entity.

C. the trustee.

D. the servicer.

E. the credit enhancer.

80. Loans that are to be securitized are passed on to ____________. This helps ensure that if the lender goes bankrupt, it does not affect the credit status of the pooled loans.

A. the originator

B. a special-purpose entity

C. the trustee

D. a servicer

E. the credit enhancer

81. In a securitization process, someone appointed to ensure that the issuer fulfills all the requirements of transfer of loans to the pool, and provides all of the services promised to investors in the securities is called:

A. the originator.

B. the special-purpose entity.

C. the trustee.

D. the servicer.

E. the credit enhancer.

82. Someone who collects the payments on the securitized loans and passes on those payments to the trustee is called:

A. the originator.

B. the special-purpose entity.

C. the trustee.

D. the servicer.

E. the credit enhancer.

83. Investors in securitized loans normally receive added assurance that they will be repaid in the form of guarantees against default issued by:

A. the originator.

B. the special-purpose entity.

C. the trustee.

D. the servicer.

E. a credit enhancer.

84. When an issuer of securitized loans divides them into different risk classes or tranches, they are providing an:

A. internal credit enhancement

B. external credit enhancement

C. internal liquidity enhancement

D. external liquidity enhancement

E. None of the options is correct.

85. When an issuer of securitized loans includes a standby letter of credit with the securitized loans, they are providing an:

A. internal credit enhancement.

B. external credit enhancement.

C. internal liquidity enhancement.

D. external liquidity enhancement.

E. None of the options is correct.

86. When an issuer of securitized loans sets aside a cash reserve to cover loan defaults, they are providing an:

A. internal credit enhancement.

B. external credit enhancement.

C. internal liquidity enhancement.

D. external liquidity enhancement.

E. None of the options is correct

87. Which of the following is an advantage of securitizing loans?

A. Diversifying a lender’s credit risk exposure

B. Reducing the need to monitor each individual loan’s payment stream

C. Transforming illiquid assets into liquid securities

D. Serving as a new source of funds for lenders and attractive investments for investors

E. All the options are advantages of securitizing loans

88. Why are securitized loans often issued through a special-purpose entity?

A. Because the securitized loans often add risk to the bank and need to be held separately

B. Because the securitized loans are not profitable for the bank and need to be held separately

C. Because the special-purpose entity might fail and this prevents the failure of the bank

D. Because the bank might fail and this protects the credit status of the securitized loans

E. All of the options are correct

89. A group of loans pooled for securitization is expected to yield a return of 23%. The coupon rate promised to investors on securities issued against the pool of loans is 8%. The default (charge-off) rate on the pooled loans is expected to be 4.5%. The fee to compensate a servicing institution for collecting payments on the loans is 2%. Fees to set up credit and liquidity enhancements are 3%. The fee for advice on how to set up the pool of securitized loans is 1%. What is the residual income on this pool of loans?

A. 18.5%

B. 9%

C. 4.5%

D. 2%

E. None of the options is correct

90. The coupon rate promised to investors on securities issued against a pool of loans is 6.5%. The default rate on the pool of loans is expected to be 3.5%. The fee to compensate a servicing institution for collecting payments on the loan is 2%. Fees to set up credit and liquidity enhancements are 5%. The residual income on this pool of loans is 7%. What is the expected yield on this pool of loans?

A. 24%

B. 12%

C. 10%

D. 6.5%

E. None of the options is correct.

91. In a collateralized mortgage obligation (CMO), a tranche:

A. promises a different return (coupon) to investors.

B. acts as a liquidity enhancement.

C. carries a different risk exposure.

D. options A and C are correct.

E. All of the options are correct.

92. Which of the following is an advantage of using loan-backed bonds for a bank?

A. Loans used as collateral for the bonds can be sold before the maturity of the bonds

B. Loan-backed bonds have longer maturities than deposits

C. Banks do not have to meet regulatory capital requirements on loans used as collateral

D. Banks can use fewer loans as collateral than the amount of bonds issued

E. All the options are advantages of loan-backed bonds

93. Which of the following is a disadvantage of using loan-backed bonds for a bank?

A. The cost of funding often rises

B. There is greater default risk on the bonds

C. Loans used as collateral for the bonds must be held until the bonds reach maturity

D. Loan-backed bonds have shorter maturities than deposits

E. All the options are disadvantages of loan-backed bonds

94. According to the textbook, what is the minimum size of the loan-backed securities offerings that are likely to be successful?

A. $1 million

B. $10 million

C. $25 million

D. $100 million

E. $1 trillion

95. Which of the following is a concern regulators have about securitization?

A. The risk of being an underwriter for asset-backed securities that cannot be sold

B. The risk of acting as a credit enhancer and underestimating the need for loan-loss reserves

C. The risk that unqualified trustees will fail to protect investors in asset-backed instruments

D. The risk that loan servicers will be unable to satisfactorily monitor loan performance

E. All of the options are concerns regulators have about securitization

96. What prompted a surge in loan sales in the 1980s?

A. A wave of corporate buyouts

B. An increase in lesser-developed country loans

C. A loosening of government regulations

D. An increase in international lending

E. None of the options is correct

97. Which of the following is a reason for standby credit letters’ growth in the recent years?

A. The growth of bank loans sought by companies in recent years

B. The decreased demand for risk-reduction devices

C. Regulatory embargo on traditional lenders

D. The rapid growth of direct financing by companies

E. All of the options are correct

98. Which of the following is true regarding regulatory rules for standby credit letters issued by banks?

A. They must list the standby credit letter as a liability on their balance sheet

B. They must count standby credit letters as loans when assessing how risk-exposed the institution is to a single customer

C. They do not have to apply the same credit standards for approving standby credit letters as direct loans

D. They can apply lower capital standards to standbys than loans

E. They must provide capital reserve against issued standby letters of credit

99. Which of the following is true regarding regulatory rules for standby credit letters issued by banks?

A. They must list the standby credit letter as a liability on their balance sheet

B. They do not have to list standby credit letters when assessing the risk exposure to a single credit customer

C. They must apply the same credit standards for approving standby credit letters as direct loans

D. They can apply lower capital standards to standby credit letters than loans

E. None of the options is true

100. Recently, the regular collateralized debt obligations (CDO) market has been surpassed by:

A. credit swaps.

B. credit options.

C. credit-default swaps.

D. total-return swaps.

E. synthetic collateralized debt obligations.

101. According to research, off-balance-sheet standby credit letters reduce risk by:

A. increasing the diversification of assets.

B. reducing the need for documentation.

C. reducing probability of losses.

D. avoiding capital requirements.

E. increasing concentration of risk exposure.

102. Which of the following is an advantage of credit swaps for each partner?

A. Broaden the number of markets

B. Broaden the variety of markets from which they collect loan revenues and principal

C. Spread out the risk in the loan portfolio

D. Avoiding capital requirements

E. Options A, B, and C are all advantages of a credit swap for each partner.

103. Which of the following is a way to reduce the risk of standby credit letters?

A. Avoid renegotiating the terms of loans of SLC customers

B. Specialize in SLCs issued by the same region and industry

C. Selling participations in standbys in order to share risk with other lending institutions

D. Do not count standbys as loans when assessing the bank’s risk exposure

E. All the options are ways to reduce the risk of standby credit letters

104. The lesson(s) of the credit crisis of 2007-2009 is that the “bankruptcy remote” arrangement of the special-purpose entity (SPE):

A. reduces the need for securitization.

B. eliminates the probability of bankruptcy of the originator institution.

C. may create problems if the underlying loans go bad in great numbers.

D. eliminates the need for a trustee.

E. All of the options are correct.

105. The lesson from the credit crisis of 2007-2009 is that securitized assets and credit swaps:

A. are complex financial instruments.

B. are difficult to correctly value and measure in terms of risk exposure.

C. are a part of cyclically sensitive markets.

D. possible vehicles to set in motion a financial contagion that cannot be easily stopped without active government intervention.

E. All of the options are correct.

106. The Government National Mortgage Association (GNMA, or Ginnie Mae):

A. guarantees the issuance of securities by private lenders.

B. creates its own mortgage-backed securities.

C. acquires pools of home-mortgage loans from private lenders.

D. developed a new mortgage-backed instrument—the CMO.

E. is not a government-sponsored enterprise.

107. Which of the following developed a new mortgage-backed instrument—the collateralized mortgage obligation (CMO)—in which investors were offered different classes of mortgage-backed securities with different expected payout schedules?

A. Freddie Mac

B. Fannie Mae

C. Ginnie Mae

D. Credit Suisse

E. Federal Housing Administration

108. Bonds backed by pools of home equity loans often carry higher yields than other loan-backed securities because of their substantial:

A. market risk.

B. credit risk.

C. liquidity risk.

D. basis risk.

E. prepayment risk.

109. Credit ratings for loan-backed bonds are often:

A. lower than the issuing institution.

B. higher than the issuing institution.

C. at par with the issuing institution.

D. based on the total loans issued by the bank.

E. based on the assets under management of the bank.

110. Catastrophe-linked securities (“cat bonds”) have been developed to shift risk from ________ to the financial markets.

A. real-estate developers

B. bankers

C. oil companies engaged in mid-sea explorations

D. insurers

E. rating agencies

111. Most loans sold in the open market usually mature within _______.

A. 30 days

B. 60 days

C. 90 days

D. 180 days

E. 360 days

112. Saleable loans appear to have several advantages over bonds for many investors due to:

A. strict loan covenants.

B. floating interest rates.

C. market for shorter maturity loans.

D. market for longer maturity bonds.

E. All the options are advantages of saleable loans over bonds.

113. In a loan strip, the risk of the borrower default:

A. is retained by the seller.

B. is transferred to an SPE.

C. is transferred to the buyer.

D. is negligible and therefore, a non-issue.

E. is very high and always secured by a credit-default swap.

114. If P is the price of the standby, NL is the cost of a nonguaranteed loan, and GL is the cost of a loan backed by a standby guarantee, then a borrower is likely to seek an SLC if:

A. P < (NL – GL). B. P > (NL – GL).

C. P = (NL – GL).

D. P < (NL + GL). E. P > (NL + GL).

Chapter 10
The Investment Function in Financial-Services Management

Fill in the Blank Questions

1. A(n) _________________________ is a security issued by the federal government which has less than one year to maturity when it is issued.

________________________________________

2. Debt instruments issued by cities, states, and other political entities and which are exempt from federal taxes are collectively known as ________________________.

________________________________________

3. An investment maturity strategy which calls for a bank to have one-half of its investment portfolio in very short term assets and the other half in long term assets is known as the ________________________.

________________________________________

4. A(n) _________________________ is one where the interest portion of a security is sold separately from the principal portion.

________________________________________

5. _________________________ are imposed by the federal, state, and local governments to guarantee the safety of their deposits with banks.

________________________________________

6. The most aggressive investment maturity strategy calls for a bank to continually shift the maturities of its securities in response to changes in forecasts of interest rates and is called the _________________.

________________________________________

7. _________________________ is the risk that a bank may have to sell a part of its investment portfolio before maturity for a capital loss.

________________________________________

8. _________________________ is the risk that the economy of the market area in which a bank service, may take a down turn in the future.

________________________________________

9. __________________ is the risk that a company whose bonds a financial institution owns, may retire the entire issue in advance of its maturity, leaving the bank with the risk of earnings losses resulting from reinvesting the cash at lower interest rates.

________________________________________

10. A security issued by the federal government with 1 to 10 years to maturity when it is issued is called a(n) ________________________.

________________________________________

11. A short term debt security issued by major corporations is known as _________________.

________________________________________

12. An investment maturity strategy which calls for a bank to have all of its investment assets in very short term maturities is called the ________________________.

________________________________________

13. A money market security which represents a bank’s commitment to pay a stipulated amount of money, on a specific future date, under specific conditions, and which is often used in international trade is known as a(n) ________________________.

________________________________________

14. A(n) _________________________ is an interest-bearing receipt for the deposit of funds in a bank for a stipulated time period. Ones that are oriented towards business customers or institutions are known as jumbos.

________________________________________

15. _________________________ are instruments which have less than one year to reach maturity.

________________________________________

16. _________________________ are instruments which have more than one year to reach maturity.

________________________________________

17. Securities sold by Fannie Mae, Freddie Mac, and other similar agencies owned or sponsored by the federal government are known as ________________________.

________________________________________

18. Claims against the expected income and principal generated by a pool of similar type of loans are known as ________________________.

________________________________________

19. Long-term debt obligations of major corporations (with maturities beyond five years) are known as _______________________.

________________________________________

20. An investment maturity strategy which calls for a bank to have all of its investment assets in very long term maturities is known as the ________________________.

________________________________________

21. Banks may invest in municipal bonds issued by smaller local governments and claim 80 percent of deductions for tax purposes on the interest amount of funds borrowed to purchase these securities. These bonds are known as ____________ bonds.

________________________________________

22. Marketable notes and bonds sold by agencies owned by the government or sponsored by the government are known as _______________.

________________________________________

23. A security issued by the federal government with greater than 10 years to maturity at the time of issue is called a(n) _______________.

________________________________________

24. ________________ are time deposits of fixed maturity issued by the world’s largest banks, headquartered in financial centers around the globe. The heart of this market is in London.

________________________________________

25. ________________ are a type of municipal bond that are backed by the full faith and credit of the issuing government.

________________________________________

26. ________________ are a type of municipal bond that are paid only from certain stipulated sources of funds.

________________________________________

27. ________________ are instruments that are closely related to CMOs that also partition the cash flow from a pool of mortgage loans or mortgage-backed securities into multiple maturity classes in order to reduce the cash-flow uncertainty of investors.

________________________________________

28. ________________ is the risk that loans will be terminated or paid off ahead of schedule. This is a particular problem with home mortgages and other consumer loans that are pooled and used as collateral in securitized assets.

________________________________________

29. A lending institution that sells lower-yielding securities at a loss in order to reduce current taxable income, while simultaneously purchasing higher-yielding new securities in order to boost future returns is doing a(n) _______________.

________________________________________

30. A(n) ________________ is a picture of how market interest rates differ across loans and securities of varying times to maturity.

________________________________________

True / False Questions

31. Investments in securities provide diversification for a bank’s assets because most loans come from the local areas served by a bank’s offices.

True False

32. Bank income from loans is usually taxable.

True False

33. Investment securities are expected to “dress up” a bank’s balance sheet, according to the textbook.

True False

34. Investment securities are expected to help stabilize a financial institution’s income.

True False

35. A short-term IOU offered by major corporations that is of short maturity (most of these lOUs mature in 90 days or less) is known as a CMO.

True False

36. Prepayment risk on securitized assets generally increases when interest rates rise.

True False

37. Stripping a security eliminates prepayment risk.

True False

38. According to the textbook, a majority of securities held in U.S. banks’ investment portfolios are state and local government bonds.

True False

39. Interest income and capital gains from a bank’s portfolio of investment securities are taxed in the United States as ordinary income.

True False

40. Eurocurrency deposits that some banks purchase as investments generally carry higher market yields than domestic time deposits issued by comparable-size U.S. banks.

True False

41. Bankers’ acceptances are considered to be among the safest of all money market instruments.

True False

42. An eligible acceptance is one that can be used as collateral for borrowing from the Federal Reserve Banks.

True False

43. When a bank irrevocably guarantees a commercial paper issue, the bank’s credit rating substitutes for the borrower’s credit rating.

True False

44. The principal risk banks face from investing in structured notes is credit (default) risk.

True False

45. The principal risk to a financial institution buying CMOs is market risk.

True False

46. Stripped mortgage-backed securities fully protect investors from having to reinvest their income at lower interest rates.

True False

47. Stripped mortgage-backed securities make maturity matching of bank assets and liabilities easier to accomplish than do most other investment securities that banks buy.

True False

48. Lower interest rates increase the present value of all projected cash flows from a loan-backed security resulting in a rise in its market value.

True False

49. Treasury bills are the long term debt obligations issued by the federal government.

True False

50. Commercial paper is a short-term debt instrument issued by major banks.

True False

51. Treasury notes and bonds are issued by the federal government and are coupon paying instruments.

True False

52. Interest rate risk is the risk financial institutions face due to changes in market interest rates.

True False

53. One investment maturity strategy popular among smaller institutions is the ladder or spaced-maturity policy. It is popular because it does not take much expertise to implement.

True False

54. One investment maturity strategy, called the front-end loaded policy, requires that the bank put all of its investment portfolio in long-term securities.

True False

55. Business risk is the risk that a bank may experience a cash shortage and will have to sell some of its investments securities.

True False

56. Inflation risk is the possibility that the purchasing power of interest income and repaid principal from a security or loan will be eroded by rising prices for goods and services.

True False

57. Call risk refers to the right of debt collectors to call in the loans in advance of maturity and get an early repayment.

True False

58. The yield to maturity is the discount rate that equates a security’s purchase price with the stream of income expected until it is sold to another investor.

True False

Multiple Choice Questions

59. An important investment security popular with banks that must, by law, mature within one year from the date of issue and which has a high degree of safety and marketability is the:

A. Treasury bill.

B. Treasury note.

C. FNMA note.

D. bankers’ acceptance.

E. Eurodollar CD.

60. A bank’s promise to pay the holder a designated amount of money, on a designated future date, and often used in international trade is known as a(n):

A. promissory guarantee.

B. discount security.

C. bankers’ acceptance.

D. in-the-money option.

E. accretion note.

61. Pools of mortgages put together, either by a government agency or by a private investment banking corporation, to raise more loanable funds for the issuer are known as a(n):

A. accretion bond.

B. participation certificate.

C. CMO.

D. stripped security.

E. commercial paper.

62. Fluctuations in the timing of cash-flows arising out of an underlying pool of securitized assets is referred to as:

A. income risk.

B. prepayment risk.

C. liquidity risk.

D. capital risk.

E. None of the options is correct.

63. Principal roles that a financial institution’s investment portfolio plays include which of the following?

A. Income stability

B. Geographic diversification

C. Hedging interest rate risk

D. Backup liquidity

E. All of the options are correct

64. _____________ is the method by which banks can provide a safeguard for the deposits of governmental units.

A. Hedging

B. Loan sale

C. Pledging

D. Securitization

E. Window dressing

65. The most aggressive investment maturity strategy that calls for the bank to continually shift the maturities of its securities in response to changes in forecasts of interest rates and other economic conditions is known as:

A. barbell strategy.

B. rate expectations approach.

C. front-end loaded policy.

D. ladder approach.

E. None of the options is correct.

66. Which of the following statements is (are) correct regarding duration?

A. In comparing two bonds with the same yield to maturity and the same maturity, a bond with a higher coupon rate will have a longer duration.

B. In comparing two loans with the same maturity and the same interest rate, a fully amortized loan will have a shorter duration than a loan with a balloon payment.

C. The duration will always be shorter than the maturity for all debt instruments.

D. All of the options are correct.

E. B and C

67. Which of the following is not one of the capital market instruments?

A. U.S. Treasury notes

B. Corporate notes and bonds

C. U.S. Treasury bonds

D. Municipal bonds

E. Commercial paper

68. Which of the following is true of Treasury bills?

A. Interest on Treasury bills is not exempt from state income taxes.

B. Interest on Treasury bills is exempt from federal income taxes.

C. Treasury bills pay a lower pre-tax yield than comparable corporate securities.

D. All the options are true.

E. None of the options is correct.

69. In recent years security dealers have assembled pools of federal agency securities whose interest yield may be periodically reset based on what happens to a stated interest rate, or may carry multiple coupon rates that are periodically adjusted; the foregoing describes a:

A. financial futures contract.

B. revenue-anticipation note.

C. zero coupon instrument.

D. structured note.

E. None of the options is correct.

70. Banks are generally not allowed to invest in speculative grade bonds. What kind of risk is this designed to limit?

A. Liquidity risk

B. Business risk

C. Credit risk

D. Operational risk

E. Interest rate risk

71. A security where the interest payments and the principal payments are sold separately is called:

A. a Treasury note.

B. an accretion.

C. a structured note.

D. a stripped security.

E. None of the options is correct.

72. Mortgage prepayment risk:

A. is higher on high interest rate mortgages.

B. is felt most dramatically when interest rates rise.

C. is eliminated by the use of mortgage backed securities.

D. is eliminated by the purchase of a stripped mortgage obligation.

E. All the options are true.

73. A bank replaces 5-year corporate bonds with a coupon rate of 9.75 percent with 5-year municipal bonds with a coupon rate of 7 percent. The bank is in the 35 percent tax bracket and these bonds have the same default risk. What is the most likely reason the bank changed from the corporate to the municipal bonds?

A. Liquidity risk

B. Business risk

C. Credit risk

D. Tax exposure

E. Interest rate risk

74. Suppose a bank has found bank-qualified municipal bonds which have a nominal gross rate of return of 8 percent and that it can borrow funds needed for this purchase at a rate of 6.25 percent. The bank is in the 35 percent tax bracket. What is the net after-tax return on this bond?

A. 5.20 percent

B. 3.5 percent

C. 1.75 percent

D. 0 percent

E. None of the options is correct

75. An investor can invest in either a tax-exempt security that pays 5%, or a taxable corporate security of comparable risk and maturity that pays 8%. At what marginal tax rate will the investor be indifferent between these two securities?

A. 25.0%

B. 32.5%

C. 37.5%

D. 57.5%

E. 62.5%

76. Which of the following would not be considered a bank-qualified municipal security?

A. A Columbia County general obligation bond to modernize the county fire department

B. A Bucks County general obligation bond to build a new sewer plant

C. A City of San Marcos general obligation bond to pay for street repairs

D. A City of Chicopee general obligation bond to pay for a new city jail

E. A Treasury bond to finance government debt

77. A $1,000 bond has three years to maturity and has a coupon rate of 15 percent. Coupon payments are made annually. The bond is currently selling in the market for $1,072 and has a yield-to-maturity of 12%. What is the duration of this bond?

A. 3 years

B. 1 year

C. 1.92 years

D. 2.45 years

E. 2.64 years

78. A bond has six years to maturity and has a coupon rate of 7.5 percent. Coupon payments are made annually and the bond has a face value of $1,000. The bond is currently selling in the market for $1,127. What is the yield-to-maturity on this bond?

A. 7.5 percent

B. 5 percent

C. 11.5 percent

D. 2.5 percent

E. None of the options is correct

79. A bond has eight years to maturity and a coupon rate of 6.5 percent. Coupon payments are made annually and the bond has a face value of $1,000. This bond is currently selling in the market for $862. What is the yield-to-maturity on this bond?

A. 6.5 percent

B. 10 percent

C. 8.5 percent

D. 9 percent

E. None of the options is correct

80. A bond has eight years to maturity and a coupon rate of 6.5 percent. Coupon payments are made annually and the bond has a face value of $1,000. The bond is currently selling in the market for $862. If this bond is sold at the end of four years for $1046 (ex-interest), what is the holding period return on this bond?

A. 6.5 percent

B. 12 percent

C. 9 percent

D. 6 percent

E. None of the options is correct

81. A security which was created by the United States Treasury department to protect against inflation risk is called:

A. CMO.

B. FNMA.

C. GNMA.

D. TIPS.

E. CD.

82. A financial institution that is concerned about the possibility that the purchasing power of both the interest income and repaid principal on a loan will decline is concerned about which of the following?

A. Business risk

B. Liquidity risk

C. Tax exposure

D. Credit risk

E. Inflation risk

83. A bank that is concerned that the economic conditions of the market area they serve may take a downturn with falling demand for loans and higher bankruptcies in the areas, is concerned about which of the following?

A. Business risk

B. Liquidity risk

C. Tax exposure

D. Credit risk

E. Inflation risk

84. Which of the following is a characteristic of Treasury bills?

A. They are coupon instruments

B. They are short-term debt instruments issued by major corporations

C. They are discount securities

D. They have more risk than other money market securities

E. All the options are characteristics of Treasury bills

85. An investment maturity strategy which calls for a bank to put all of its investment assets into very long-term securities is called the:

A. front-end loaded maturity policy.

B. back-end loaded maturity policy.

C. ladder or spaced maturity policy.

D. barbell investment portfolio strategy.

E. rate expectation approach.

86. The Lancaster State Bank is thinking about purchasing a corporate bond that pays a coupon of 8.5%. The bank has a marginal tax rate of 25%. What is the after-tax yield on this bond?

A. 11.33%

B. 8.5%

C. 6.375%

D. 2.125%

E. None of the options is correct

87. The Ferson National Bank is thinking about purchasing a municipal bond that pays a coupon of 5.5%. This bank has a marginal tax rate of 30%. What is the after-tax yield on this bond?

A. 7.86%

B. 5.5%

C. 3.85%

D. 1.65%

E. None of the options is correct

88. The Stumbaugh State Bank is thinking about purchasing a corporate bond that pays a coupon of 9%. The bank has a marginal tax rate of 40%. What is the after-tax yield on this bond?

A. 15%

B. 9%

C. 5.4%

D. 3.6%

E. None of the options is correct

89. The Price Perpetual Bank has purchased a bond that has a coupon rate of 5.5% and a face value of $1000. It has 11 years to maturity and is currently selling in the market for $887.52. The bond makes annual coupon payments. What is the yield-to-maturity on this bond?

A. 7%

B. 5.5%

C. 11%

D. 4.70%

E. None of the options is correct

90. The Price Perpetual Bank has purchased a bond that has a coupon rate of 5.5% and a face value of $1,000. It has 11 years to maturity and is currently selling in the market for $887.52. The bond makes annual coupon payments. The Price Perpetual Bank is planning on selling this bond at the end of 5 years for $1,036.50 (ex-interest). What is the holding period return on this bond?

A. 5.5%

B. 7%

C. 11%

D. 9.82%

E. None of the options is correct

91. The Farmer National Bank has purchased a bond that has a coupon rate of 11.5% and a face value of $1,000. It has 16 years to maturity and is currently selling in the market for $1,309.80. The bond makes annual coupon payments. What is the yield-to-maturity on this bond?

A. 11.5%

B. 16%

C. 8%

D. 12.21%

E. None of the options is correct

92. The Farmer National Bank has purchased a bond that has a coupon rate of 11.5% and a face value of $1000. It has 16 years to maturity and is currently selling in the market for $1309.80. The bond makes annual coupon payments. The Farmer National Bank plans on selling this bond at the end of 8 years for $1071 (ex-interest). What is the holding period return on this bond?

A. 7%

B. 8%

C. 11.5%

D. 16%

E. None of the options is correct

93. The Johnson National Bank has purchased a bond that has a coupon rate of 5.5% and a face value of $1000. It has 4 years to maturity and is selling in the market for $917. The bond makes annual coupon payments. What is the yield-to-maturity on this bond?

A. 5.5%

B. 4.0%

C. 1.5%

D. 8%

E. None of the options is correct

94. The Johnson National Bank has purchased a bond that has a coupon rate of 5.5% and a face value of $1000. It has 4 years to maturity and is currently selling in the market for $917. The bond makes annual coupon payments. What is the duration of this bond?

A. 3.38 years

B. 3.6 years

C. 4.00 years

D. 5.50 years

E. None of the options is correct

95. The Sheets Savings and Loan Association has purchased a bond that has a coupon rate of 7.5% and a face value of $1000. It has 5 years to maturity and is currently selling in the market for $1063. The bond makes annual coupon payments. What is the duration of this bond?

A. 7.50 years

B. 5.00 years

C. 4.65 years

D. 4.37 years

E. None of the options is correct

96. The Dillinger State Bank has purchased a bond issued by the Interstate Manufacturing Company that has 15 years to maturity and has a coupon rate of 12.5%. Market interest rates have recently declined to 8% and the Dillinger State Bank is worried that the Interstate Manufacturing Company will retire the bond and issue new ones with a lower coupon rate. What type of risk is the Dillinger State Bank worried about?

A. Credit risk

B. Interest-rate risk

C. Business risk

D. Call risk

E. Inflation risk

97. The Terrell State Bank is a small bank located in Guyman, Oklahoma. All of its loans are agriculture and small business loans in Guyman. It wants to buy a municipal bond from the state of South Carolina. What type of risk is it likely trying to reduce with this purchase?

A. Credit risk

B. Interest-rate risk

C. Business risk

D. Call risk

E. Prepayment risk

98. The Caldwell National Bank has purchased a bond that pays a coupon rate of 10.5%. It is a little concerned because it believes rates will decrease in the future and they will not be able to reinvest the coupon payments at the same rate. What type of risk are they concerned about?

A. Credit risk

B. Reinvestment risk

C. Business risk

D. Call risk

E. Prepayment risk

99. Moody’s Investor Service has added the numbers 1, 2, and 3 to some of their ratings. What type of risk are these ratings attempting to measure?

A. Credit risk

B. Interest rate risk

C. Business risk

D. Call risk

E. Prepayment risk

100. The Roy State Bank has just purchased a portfolio of asset-backed securities. What type of risk do these securities have that other securities do not have?

A. Credit risk

B. Interest rate risk

C. Business risk

D. Call risk

E. Prepayment risk

101. The Carey State Bank has purchased a bank-qualified municipal bond with a coupon rate of 6%. The bank has had to borrow funds to make this purchase at a cost of 5.25%. The bank is in the 40% tax bracket. What is the net after-tax return on this bank-qualified municipal bond?

A. 6.00%

B. 0.75%

C. 2.85%

D. 2.43%

E. None of the options is correct

102. The Wesson Wisconsin State Bank has purchased a bank-qualified municipal bond with a coupon rate of 7.5%. The bank had to borrow funds to make this purchase at a cost of 6%. The bank is in the 25% tax bracket. What is the net after-tax return on this bank-qualified municipal bond?

A. 7.5%

B. 2.7%

C. 3.0%

D. 1.5%

E. None of the options is correct

103. The Goodknight Company has issued securities with 45 days to maturity. What type of security has it issued?

A. Commercial Paper

B. Banker’s Acceptance

C. Corporate Bond

D. Treasury Bonds

E. Municipal Bond

104. The Dakota National Bank has purchased a security issued by the state of Tennessee that has 20 years to maturity. What type of security has it purchased?

A. Commercial Paper

B. Banker’s Acceptance

C. Corporate Bond

D. Certificate of Deposit

E. Municipal Bond

105. Which of the following asset classes is considered as the riskiest for a bank?

A. Corporate bonds

B. Equities

C. Real-estate

D. Loans

E. Municipal bonds

106. Which of the following is also referred to as a bank’s crossroads account?

A. Investments

B. Capital

C. Total assets

D. Total liabilities

E. Shareholders’ equity

107. An investor’s return on a T-bill consists purely of:

A. cash dividends.

B. coupon payments.

C. price appreciation.

D. stock dividends

E. special dividends.

108. The Treasury Direct system:

A. provides the owners of treasury securities with statement of holdings.

B. deposits any income earned directly into the owners’ accounts.

C. provides greater convenience to the investors.

D. provides increased protection against theft.

E. All the options are correct.

109. Bankers’ acceptances:

A. can be sold in the open market.

B. are non-negotiable instruments.

C. are always sold at a price above par value.

D. if sold, erases the issuer’s obligation to pay off at maturity.

E. never qualify for discounting at the Federal Reserve Banks.

110. Capital gains on municipal bonds are:

A. fully taxable without any exceptions.

B. tax exempt.

C. tax deductible.

D. fully taxable except for appreciation to par for bonds originally issued at a discount.

E. tax exempt for bonds issued at a premium.

111. Range notes are:

A. securities that usually pay low interest rates.

B. securities that pay interest only if the underlying index moves out of the predetermined range.

C. securities that pay interest only if the underlying index stays in the predetermined range.

D. usually issued as putable securities.

E. securities with pay-off similar to a financial future.

112. If the yield curve is upward sloping:

A. investors expect the short-term interest rates to fall in the future.

B. investors often shift their investment holdings away from long-term securities.

C. investors often short sell short-term securities.

D. no portfolio management is required.

E. investors often shift their investment holdings away from short-term securities.

113. _____________ is a strategy of protecting securities purchased from loss of return, no matter which way interest rates go.

A. Duration

B. Immunization

C. Front-end loading

D. Back-end loading

E. Factorization

Chapter 11
Liquidity and Reserves Management: Strategies and Policies

Fill in the Blank Questions

1. A(n) __________________ is an asset which can be converted into cash easily, which has a relatively stable price, and is reversible so that the sellers can recover their original investment with little risk of loss.

________________________________________

2. When a financial institution sells assets to manage liquidity, it faces ________________________. It loses future earnings on those assets, incurs transaction costs on those sales, and the assets most easily sold often have the lowest return.

________________________________________

3. _________________________ is a strategy in which a financial institution borrows in the money market to meet its liquidity needs.

________________________________________

4. A _________________________ is the difference between an institution’s sources and uses of funds.

________________________________________

5. _________________________ are the deposits and other borrowings of a bank which are very interest sensitive or the ones bank is sure will be withdrawn during the current period.

________________________________________

6. _________________________ are the assets a bank must, by law, hold behind its deposits. In the U.S., only vault cash and deposits held with the Federal Reserves can be used to meet these requirements.

________________________________________

7. A(n) _________________________ is an account many banks hold at the Federal Reserve to cover any checks drawn against the bank.

________________________________________

8. A(n) _________________________ is a service developed by banks where a bank shifts money overnight out of accounts with reserve requirements into savings accounts and other similar accounts with no reserve requirements

________________________________________

9. _________________________ is a 14 day period stretching from a Thursday to a Wednesday. This is the period in which a bank has to keep its average daily level of required reserves for a particular computation period with the Federal Reserve bank in the region.

________________________________________

10. _________________________ is the availability of cash in the amount needed at a reasonable cost.

________________________________________

11. The oldest approach to meeting liquidity needs, which relies on the sale of liquid assets to meet liquidity demands is called ________________________.

________________________________________

12. Under a _________________________ strategy, some of the expected demands for liquidity are stored in assets, while others are backstopped by arrangements for lines of credit from banks or other suppliers of funds.

________________________________________

13. A(n) _________________________ is the person in a bank, responsible for the bank’s cash position and meeting legal reserve requirements.

________________________________________

14. The method used in the U.S. to determine a bank’s legal reserve requirement, in which the period for holding legal reserves follows the period used to calculate the required amount of legal reserves, is called ________________________.

________________________________________

15. The fed funds rate is generally most volatile on a bank’s __________ day.

________________________________________

16. Many depository institutions hold __________ balances (extra reserves) to help prevent overdraft penalties.

________________________________________

17. Not all _____________ banks around the world have reserve requirements.

________________________________________

18. For several decades, the largest banks around the world have chosen _____________, which calls for borrowing immediately spendable funds to cover all anticipated demands for liquidity.

________________________________________

19. The ________________ approach to managing liquidity starts with two simple facts, liquidity rises as deposits increase and loans decrease, and liquidity falls when deposits fall and loans increase.

________________________________________

20. In the _____________ approach to managing liquidity, deposits and other sources of funds are divided into categories and, then liquidity managers must set aside liquid funds according to some desired operating rule.

________________________________________

21. Many financial service institutions estimate their liquidity needs based upon experience and industry averages. This approach to managing liquidity is called the ____________ approach.

________________________________________

22. Many analysts believe there is only one ultimate sound method for assessing a financial institution’s liquidity needs. This method centers on ___________.

________________________________________

23. The daily average amount of deposits and other reservable liabilities are computed using information gathered over a two-week period extending from a Tuesday to a Monday two weeks later. This interval is known as ___________.

________________________________________

24. If total legal reserves held are greater than required reserves, a bank has ____________.

________________________________________

25. If total legal reserves held are less than required reserves, a bank has ___________.

________________________________________

26. The ____________ is where a money position manager can cover a large reserve deficit quickly. It is usually one of the cheapest places to borrow but is also frequently volatile.

________________________________________

27. One of the ratios used in the liquidity indicator approach to managing a financial institution’s liquidity needs is ___________. This ratio is cash and deposits due from depository institutions divided by total assets, where a greater ratio indicates a stronger liquidity position.

________________________________________

True / False Questions

28. Liquid assets must have a reasonably stable price so that the market is deep enough to absorb the sale without a significant loss of value.

True False

29. Asset liquidity management (asset conversion) involves storing liquidity in assets, such as land and buildings.

True False

30. Asset liquidity management (asset conversion) involves storing liquidity in assets, such as cash and marketable securities.

True False

31. Liquid assets generally have a stable price but are not necessarily reversible.

True False

32. Asset conversion is considered to be a costless approach to liquidity management.

True False

33. One principle of sound bank liquidity management is to be sure to first sell those assets which have least profit potential.

True False

34. Borrowed liquidity (liability) management is less risky for a financial institution than is asset conversion.

True False

35. A financial institution’s liquidity gap represents the difference between its sources and uses of liquid funds.

True False

36. According to the textbook, the management of a bank expects to lose its “hot money” liabilities during a period.

True False

37. A U.S. bank can run up to a 5-percent deficit in its legal reserve requirement unconditionally without incurring an interest penalty from the Federal Reserve System.

True False

38. Most liquidity problems in banking arise from inside a bank, not from its customers.

True False

39. Volume of legal reserves held at the Federal Reserve by depository institutions has declined sharply in recent years.

True False

40. The Federal Reserve has been lowering deposit reserve requirements in recent years.

True False

41. The liquidity indicator, core deposits divided by total assets, is a measure of stored liquidity.

True False

42. A bank’s money position manager is responsible for ensuring that the bank maintains an adequate level of legal reserves.

True False

43. If a bank in the United States runs a legal reserve deficit of more than 2 percent of its required daily average legal reserve position, it will be assessed an interest penalty equal to the Federal Reserve’s discount rate plus 5 percent.

True False

44. If a bank receives more checks deposited to the accounts it holds than checks drawn against its deposit accounts, the bank’s legal reserves will tend to increase.

True False

45. According to the textbook, if a bank’s liquidity deficit is expected to last for only a few hours, the Federal funds market or the central bank’s discount window is normally the preferred source of funds.

True False

46. According to the textbook, banks making heavy use of borrowed sources of liquidity must wrestle with the problem of interest cost uncertainty.

True False

47. All central banks impose reserve requirements on the banks they regulate.

True False

48. The sources and uses of funds method of estimating a bank’s liquidity requirements divides the bank’s liabilities into three categories—hot money, vulnerable funds, and stable funds—and estimates the probability of each being withdrawn from the bank.

True False

49. One of the problems with liquidity management for a bank is that rarely does the demand for funds equals the supply of funds at a given time.

True False

50. One of the problems with liquidity management for a bank is that there is a trade-off between liquidity and profitability.

True False

51. The liquidity problem for banks is made easier because most of their liabilities are not subject to immediate repayment.

True False

52. The liquidity problem for banks is made easier because depositors and borrowers are not sensitive to changing interest rates.

True False

53. The oldest approach to liquidity management is the asset liquidity management approach.

True False

54. Some central banks around the world impose reserve requirements on bank loans.

True False

55. Interest in banks’ and financial service institutions’ liquidity management is a relatively new phenomenon which arose following the 9/11 crisis.

True False

56. Robberies of cash from banks have declined in recent years.

True False

57. Discount window loans jumped dramatically the day following 9/11.

True False

58. A bank or financial service institution can meet reserve requirements by selling Treasury securities in its portfolio.

True False

59. All central banks around the world have some specified reserve requirement.

True False

60. Core deposit ratio is used as one of the liquidity indicators for depository institutions and is defined as ratio of the core deposits to total assets.

True False

61. Loan commitments ratio measures the volume of promises a lender has made to its customers to provide credit up to pre-specified amount over a given time period.

True False

Multiple Choice Questions

62. A financial institution that has ready access to immediately spendable funds at reasonable cost and at precisely the time those funds are needed is considered:

A. risk-free.

B. liquid.

C. efficient.

D. profitable.

E. None of the options is correct.

63. Which of the following is not a reason for banks to hold liquid assets?

A. To meet customers’ needs for currency

B. To meet capital requirements

C. To meet required reserves

D. To compensate for correspondent bank services

E. To assist in the check clearing process

64. The two most pressing demands for liquidity from a bank come from, first, customers withdrawing their deposits and, second, from:

A. credit requests from customers the bank wishes to keep.

B. checks being cashed at local stores and directly from the bank.

C. demands for wired funds from correspondent banks.

D. legal reserve requirements set by the Federal Reserve Board.

E. None of the options is correct.

65. In the week about to begin, a bank expects $30 million in incoming deposits, $20 million in deposit withdrawals, $15 million in revenues from the sale of nondeposit services, $25 million in customer loan repayments, $5 million in sale of bank assets, $45 million in money market borrowings, $60 million in acceptable loan requests, $10 million in repayments of bank borrowings, $5 million in cash outflows to cover other operating expenses, and $10 million in dividend payments to its stockholders. The bank’s net liquidity position for the week is expected to be:

A. $30 million surplus.

B. $20 million deficit.

C. $10 million deficit.

D. $15 million surplus.

E. None of the options is correct.

66. For a bank, there is always a trade-off problem between liquidity and:

A. risk exposure.

B. revenue generation.

C. profitability.

D. efficiency.

E. None of the options is correct.

67. Financial institutions face significant liquidity problems because of:

A. imbalances between the maturities of their assets and liabilities.

B. their high proportion of liabilities subject to immediate withdrawal.

C. the sensitivity of their business to changes in interest rates.

D. imbalances between the maturities of their assets and liabilities and their high proportion of liabilities subject to immediate withdrawal.

E. All of the answer options are correct.

68. Sources of liquidity for banks include:

A. deposit inflows.

B. money market borrowings.

C. sale of marketable securities.

D. repayments of loans disbursed.

E. All of the options are correct.

69. Which of the following is not a source of liquidity for financial institutions?

A. Deposits

B. Money market borrowings

C. Sale of marketable securities

D. Dividend payments to stockholders

E. All the options are correct.

70. Due to the inherent risks in relying on borrowed liquidity and costs of storing liquid assets, most financial firms compromise by using:

A. asset management.

B. liability management.

C. balanced liquidity management.

D. asset and liability management.

E. All the options are correct.

71. When a bank’s sources of liquidity exceed it uses of liquidity, the bank will have a:

A. positive liquidity gap.

B. negative liquidity gap.

C. cyclical liquidity gap.

D. seasonal liquidity gap.

E. None of the options is correct.

72. “Core deposits”, “hot money”, and “vulnerable money” are categories of funds under which of the following methods of estimating a bank’s liquidity needs?

A. Sources and uses of funds approach

B. Structure of funds approach

C. Liquidity indicator approach

D. Sources and uses of funds approach and liquidity indicator approach

E. None of the options is correct

73. Factors that influence a bank’s choice among the various sources of reserves include which of the following?

A. Immediacy of the need

B. Duration of the need

C. Interest rate outlook

D. Regulations

E. All of the options are correct

74. The risk that liquid funds will not be available in the volume needed by a bank is often called:

A. market risk.

B. price risk.

C. availability risk.

D. interest-rate risk.

E. None of the options is correct.

75. A bank following a(n) _________________________ liquidity management strategy must take care that assets with the least profit potential are sold first.

A. asset conversion

B. liability management

C. availability

D. funds source

E. None of the options is correct

76. When some of a bank’s expected demand for liquidity are stored in its assets, while other unexpected cash needs are met from near-term borrowings, the approach to liquidity management is known as:

A. liability management.

B. asset conversion.

C. borrowed liquidity management.

D. balanced liquidity management.

E. None of the options is correct

77. A person responsible for overseeing an institution’s legal reserve account is called:

A. reserve manager.

B. money market manager.

C. money position manager.

D. legal counselor.

E. None of the options is correct.

78. If a bank’s management uses “the discipline of the financial marketplace” to gauge its liquidity position, one of the indicators of this market test of adequacy of a bank’s liquidity position is:

A. the bank’s return on equity capital.

B. the volume of bank stock outstanding.

C. the bank’s return on assets.

D. the size of risk premiums on CDs the bank issues.

E. None of the options is correct.

79. Which of the following is an example of a use of funds?

A. A customer withdraws $1,000 from their account

B. A borrower repays $1,500 of a loan they have received

C. A bank issues a $1,000,000 CD

D. A bank sells $5,000,000 of T-Bills

E. None of the options is a use of funds

80. Which of the following is an example of a source of funds?

A. A customer withdraws $1,000 from his account

B. A borrower repays $1,500 of a loan he had taken

C. A bank increases its Fed funds sold account by $1,000,000

D. A bank purchases $5,000,000 in T-Bills

E. None of the options is a source of funds

81. A bank currently has $150 million in “hot money” deposits against which it wants to hold an 80 percent reserve and $90 million in vulnerable deposits against which it wants to hold a 30 percent reserve. It also has $45 million in stable deposits against which it wants to hold a 5 percent reserve. Legal reserves for the bank are 5 percent of all deposits. What is the bank’s liability liquidity reserve?

A. $149.25 million

B. $285 million

C. $141.7875 million

D. $216.60 million

E. None of the options is correct

82. A bank maintains an average clearing balance of $5,000,000 with the Federal Reserve. The Federal funds rate is currently 6.5 percent. What amount of credit will the bank earn over the reserve maintenance period that can be used to offset any fees charged by the Federal Reserve?

A. $325,000

B. $8,357,143

C. $194,444

D. $12,639

E. None of the options is correct

83. A bank maintains an average clearing balance of $1,000,000 with the Federal Reserve. The Federal funds rate is currently 4.5 percent. What amount of credit will the bank earn over the reserve maintenance period that can be used to offset any fees charged by the Federal Reserve?

A. $17,500

B. $1,750

C. $45,000

D. $12,500

E. None of the options is correct

84. A bank currently holds $105 million in transaction deposits subject to legal reserves but has managed to enter into sweep account arrangements affecting $55 million of these accounts. Given that the bank must hold 3 percent legal reserves up to $47.8 million of transaction deposits and 10 percent legal reserves on any amount above that, how much has this bank reduced its total legal reserves as a result of these sweep arrangements?

A. $5.500 million

B. $1.449 million

C. $7.119 million

D. $1.619 million

E. None of the options is correct

85. A bank money manager estimates that the bank will experience a liquidity deficit of $400 million with a probability of 10 percent, a liquidity deficit of $900 million with a probability of 20 percent, a liquidity surplus of $600 million with a probability of 30 percent, and a liquidity surplus of $1,200 with a probability of 40 percent over the next month. What is this bank’s expected liquidity deficit or surplus next month?

A. $880 million liquidity surplus

B. $440 million liquidity deficit

C. $440 million liquidity surplus

D. $880 million liquidity deficit

E. None of the options is correct

86. In the week to come, a bank expects $55 million in incoming deposits, $75 million in acceptable loan requests, $35 million in money market borrowings, $10 million in deposit withdrawals, and $30 million in loan repayments. The bank is expecting a:

A. liquidity deficit.

B. liquidity surplus.

C. balanced liquidity position.

D. liquidity reversal.

E. None of the options is correct.

87. A financial institution has estimated that its growth rate in deposits over the last ten years has averaged 6 percent per year. This is the _________________________ of estimating future deposits.

A. trend component

B. seasonal component

C. cyclical component

D. stationary component

E. None of the options is correct

88. A financial institution has estimated that over the last ten years the deposit withdrawals during Christmas time is about 25% higher than during any other time of the year. This is the _________________________ of estimating future deposits.

A. trend component

B. seasonal component

C. cyclical component

D. stationary component

E. None of the options is correct

89. Which of the following is a guideline for liquidity managers of banks?

A. A liquidity manager must keep track of activities of all departments of the bank

B. A liquidity manager must know in advance (if possible) the plans of major creditors and depositors

C. A liquidity manager should make sure the bank has clear priorities and objectives for liquidity management

D. A liquidity manager must analyze the liquidity needs of the bank on a continuous basis

E. All the options are guidelines for liquidity managers

90. A manager that uses ratios such as cash and deposits due from banks to total assets and U.S. government securities to total assets to measure a firm’s liquidity position is using:

A. the sources and uses of funds approach.

B. the structured funds approach.

C. the liquidity indicator approach.

D. signals from the market place.

E. None of the options is correct.

91. A manager that examines the bank’s stock price behavior and risk premium on the CDs to measure liquidity position is using:

A. the sources and uses of funds approach.

B. the structured funds approach.

C. the liquidity indicator approach.

D. signals from the marketplace.

E. None of the options is correct.

92. A manager that looks at loans and deposits increases and decreases among other things to measure the bank’s liquidity position is using:

A. the sources and uses of funds approach

B. the structured funds approach

C. the liquidity indicator approach

D. signals from the marketplace

E. None of the options is correct.

93. Which of the following statements is correct?

A. Demand for liquidity and sources of liquidity for a bank are generally equal to each other.

B. Most liquidity problems in the banking system arise from outside a bank.

C. Liquidity problems for a bank are made easier because most of their liabilities are not subject to immediate repayment.

D. Liquidity management is easy for a bank because a bank that is very liquid is also very profitable.

E. All of the options are correct.

94. The Fed funds market is most volatile on a bank:

A. computation day.

B. settlement day.

C. reserve day.

D. maintenance day.

E. holiday.

95. The Fed funds rate usually hovers around the Fed’s:

A. target rate.

B. set rate.

C. quoted rate.

D. limit rate.

E. average rate.

96. A bank or financial service institution can generally meet reserve requirements using all of the following except:

A. selling liquid investments.

B. borrowing in the fed funds market.

C. drawing on any excess correspondent balances.

D. borrowing in the repo market.

E. selling new shares.

97. The Shirley State Bank has $90 million in transaction deposits subject to legal reserves. The bank must hold 3 percent legal reserves up to $43.9 million of transaction deposits and 10 percent legal reserves on any amount above this. What is the bank’s total legal reserve requirement?

A. $2.700 million

B. $1.449 million

C. $5.927 million

D. $4.170 million

E. None of the options is correct

98. John Camey, the money manager of the First State Bank, has estimated that the bank has a 20 percent chance of a liquidity deficit of $700 million, a 30 percent chance of a liquidity deficit of $200 million, a 30 percent chance of a liquidity surplus of $400 million and a 20 percent chance of a liquidity surplus of $900 million over the next week. What is the bank’s expected liquidity deficit or surplus over the next week?

A. $100 million liquidity surplus

B. $100 million liquidity deficit

C. $400 million liquidity surplus

D. $500 million liquidity surplus

E. $0 liquidity surplus

99. A bank currently has $50 million in stable deposits against which they want to keep 10% reserves, $100 in vulnerable deposits against which they want to keep 40% reserves, and they have $50 million in “hot money” deposits against which they want to keep 90% reserves. The legal reserves for this bank are 10% of all deposits. What is the bank’s liability liquidity reserve?

A. $90 million

B. $81 million

C. $70 million

D. $20 million

E. None of the options is correct

100. The Hollingsworth National Bank maintains an average clearing balance of $7,000,000 with the Federal Reserve. The Federal Funds rate is currently 5.25 percent. What is the credit the bank will earn over the maintenance period that can be used to offset any fees charged by the Federal Reserve?

A. $367,500

B. $1,021

C. $14,292

D. $30,625

E. None of the options is correct

101. A bank is required to maintain an average daily balance at the Fed of $600 million. In the first 2 days of the maintenance period, it maintains a balance of $450 million, the next three days it maintains a balance of $700 million, the next two days it maintains a balance of $650 million, the next three days it maintains a balance of $450 million, and the next three days it maintains a balance of $650 million. What does its balance at the Fed has to be on the last day of the maintenance period in order to have a zero cumulative reserve deficit?

A. $600 million

B. $400 million

C. $500 million

D. $800 million

E. None of the options is correct

102. A bank is required to maintain an average daily balance at the Fed of $700 million. On the first day of the maintenance period it maintains a balance of $750 million, the next two days it maintains a balance of $725 million, the next three days it maintains a balance of $625 million, the next three days it maintains a balance of $775 million, the next two days it maintains a balance of $700 million, and the next two days it maintains a balance of $675 million. What does its balance at the Fed has to be on the last day of the maintenance period in order to have a zero cumulative reserve deficit?

A. $700 million

B. $650 million

C. $750 million

D. $325 million

E. None of the options is correct

103. David Ashby has just paid off the balance on his home mortgage with First American Bank. What source of liquidity does this represent to the bank?

A. Incoming customer deposit

B. Revenues from the sale of nondeposit services

C. Customer loan repayment

D. Sale of an asset

E. Borrowings from the money market

104. The Harmony Bank of the South has just increased its Federal Funds Purchases. What source of liquidity does this represent to the bank?

A. Incoming customer deposit

B. Revenues from the sale of nondeposit services

C. Customer loan repayment

D. Sale of an asset

E. Borrowings from the money market

105. The Peace Bank of Ohio has just received a $50 million credit at the local clearing house. Which type of factor affecting legal reserves is this for the bank?

A. A controllable factor increasing legal reserves

B. A noncontrollable factor increasing legal reserves

C. A controllable factor decreasing legal reserves

D. A noncontrollable factor decreasing legal reserves

E. None of the options is correct

106. The Sasser State Bank has just sold $25 million in Treasury Bills. Which type of factor affecting legal reserves is this for the bank?

A. A controllable factor increasing legal reserves

B. A noncontrollable factor increasing legal reserves

C. A controllable factor decreasing legal reserves

D. A noncontrollable factor decreasing legal reserves

E. None of the options is correct

107. The Hora National Bank has just received notice that a large depositor with the bank wants to close its account immediately. Which type of factor affecting legal reserves is this for the bank?

A. A controllable factor increasing legal reserves

B. A noncontrollable factor increasing legal reserves

C. A controllable factor decreasing legal reserves

D. A noncontrollable factor decreasing legal reserves

E. None of the options is correct

108. The Simpson State Bank of Stillwater has just sold Federal funds to another bank in its Federal Reserve district. Which type of factor affecting legal reserves is this for the bank?

A. A controllable factor increasing legal reserves

B. A noncontrollable factor increasing legal reserves

C. A controllable factor decreasing legal reserves

D. A noncontrollable factor decreasing legal reserves

E. None of the options is correct

109. The Burr Bank has just calculated the ratio of its U.S. Government Securities to Total Assets. Which liquidity indicator is this?

A. Cash position indicator

B. Liquid securities indicator

C. Net federal funds and repurchase agreement position

D. Capacity ratio

E. Hot money ratio

110. The HTR Bank of Summerville has just calculated the ratios of its money market (short term) assets to volatile liabilities. Which liquidity indicator is this?

A. Cash position indicator

B. Liquid securities indicator

C. Net federal funds and repurchase agreement position

D. Capacity ratio

E. Hot money ratio

111. Which of the following is an option when a liquidity deficit arises and a bank wants to borrow liquidity to cover the deficit?

A. Selling Treasury Bills

B. Reducing its correspondent deposits with another bank

C. Selling a municipal bond

D. Issuing a jumbo CD

E. All the options are correct

112. Which of the following is an option when a liquidity deficit arises and a bank wants to use stored liquidity in its assets to cover the deficit?

A. Borrowing in the Federal Funds market

B. Issuing a jumbo CD

C. Selling Treasury Bills

D. Increasing their correspondent deposits with another bank

E. All the options are correct

113. The Taylor Treadwell Bank has just calculated the ratio of its net loans and leases to total assets. Which liquidity indicator is this?

A. Cash position indicator

B. Liquid securities indicator

C. Net federal funds and repurchase agreement position

D. Capacity ratio

E. None of the options is correct

114. The Taylor Treadwell Bank has just calculated the ratio of its demand deposits to total time deposits. Which liquidity indicator is this?

A. Deposit composition ratio

B. Liquid securities indicator

C. Net federal funds and repurchase agreement position

D. Capacity ratio

E. None of the options is correct

115. The most important source of liquidity for a depository institution is:

A. Federal funds loan.

B. new customer deposits.

C. sale of liquid securities.

D. money market loans.

E. sale of equity.

116. _____________ indicators tend to be highly sensitive to the season of the year and stage of the business cycle.

A. Stored liquidity

B. Purchased liquidity

C. Balanced liquidity

D. Asset liquidity

E. Liability liquidity

117. While the largest U.S. depositories are required to settle their legal reserve requirements with the Federal Reserve over successive bi-weekly periods, the more numerous but smaller banks are required to do so:

A. once every day.

B. once every week.

C. once every month.

D. once every quarter.

E. once every year.

118. The base amount of transaction deposits for a depository institution above which the legal reserve requirement changes to ten percent is known as:

A. reserve base.

B. reserve tranche.

C. base limit.

D. limit tranche.

E. cut-off tranche.

119. Recent research on money position management suggests that the reserve deficits of smaller depository institutions normally occur:

A. early in the reserve maintenance period.

B. early in the reserve computation period.

C. late in the reserve maintenance period.

D. late in the reserve computation period.

E. during low credit demand periods.

Chapter 12
Managing and Pricing Deposit Services

Fill in the Blank Questions

1. A(n) _________________________ requires a bank to honor withdrawals immediately upon request.

________________________________________

2. A(n) _________________________ is an interest bearing checking account that gives the offering bank the right to insist on prior notice before customer withdrawals can be honored.

________________________________________

3. A(n) _________________________ is a short-maturity deposit which pays a competitive interest rate. Only six preauthorized drafts per month are allowed but only three withdrawals can be made by writing checks.

________________________________________

4. _________________________ are designed to attract funds from customers who wish to set aside money in anticipation of future expenditures or financial emergencies.

________________________________________

5. _________________________ are a stable base of deposited funds that are not highly sensitive to movements in market interest rates and tend to remain with the depository institution.

________________________________________

6. Some people feel that everyone is entitled access to a minimum level of financial service, no matter what their income level is. This issue is called the issue of ________________________.

________________________________________

7. _________________________ is a way of pricing deposit services in which the rate, or return, or the fees charged on the deposit accounts are based on the cost of offering the service plus a profit margin.

________________________________________

8. When financial institutions tempt customers by paying postage both ways in bank-by-mail services or by offering free gifts such as teddy bears, they are practicing __________.

________________________________________

9. The _________________________ is the added cost of bringing in new funds.

________________________________________

10. _________________________ pricing is where a financial institution sets up a schedule of fees in which a customer pays a low or no fee if the deposit balance stays above some minimum level and pays a higher fee if the balance declines below that minimum level.

________________________________________

11. When a customer is charged a fixed cost per check, per period, or both, it is called __________________ pricing.

________________________________________

12. When a customer is charged based on the number and kinds of services used, with the customers that use a number of services being charged less or having some fees waived, this is called __________________ pricing.

________________________________________

13. _________________________ is part of a new technology for processing checks where the bank takes a picture of the back and the front side of an original check and which can then be processed as if it were the original.

________________________________________

14. A(n) _________________________ is a thrift account which carries a fixed maturity date and generally carries a fixed interest rate for that time period.

________________________________________

15. A(n) _________________________ is a conditional method of pricing deposit services in which the fees paid by the customer depend mainly on the account balance and volume of activity.

________________________________________

16. The _________________________ Act was passed in 1991 and specifies the information that institutions must disclose to their customers about deposit accounts.

________________________________________

17. Depositors must send their customers the amount of interest earnings received, along with the _________________ earned. It is the interest rate the customer has actually earned on the account.

________________________________________

18. A(n) _________________________ is a retirement plan that is designed for self-employed individuals.

________________________________________

19. Research suggests that a depository institution’s location is most important to _____ -income consumers.

________________________________________

20. Research suggests that _________ -income consumers appear to be more influenced by the size of the financial institution.

________________________________________

21. For decades, depository institutions offered only one type of savings plan—____________. One that could be opened with as little as $5 and withdrawal privileges were unlimited.

________________________________________

22. __________ CDs allow depositors to switch to a higher interest rate if market interest rates rise.

________________________________________

23. ________________ CDs permit periodic upward adjustments in promised interest rates.

________________________________________

24. ________________ CDs allow the depositor to withdraw some funds without a withdrawal penalty.

________________________________________

25. The _______________, which was created under Tax Relief Act of 1997, allows individuals to make non-tax-deductible contributions to a retirement fund that can grow tax free and also pay no taxes on their investment earnings when withdrawn.

________________________________________

26. Due to the fact that they may be perceived as more risky, ________________ banks generally offer higher deposit rates than traditional brick and mortar banks.

________________________________________

27. ________________ are accounts in domestic banking institutions where the U.S. Treasury keeps most of their operating funds.

________________________________________

28. ________________ is a process where merchants and utility companies take the information from a check an individual has just written, and electronically debit the individual’s account instead of sending the check through the regular check clearing process.

________________________________________

29. On October 28, 2004, ________________ became law, permitting depository institutions to electronically transfer check images instead of the checks themselves.

________________________________________

True / False Questions

30. The volume of core deposits at U.S. banks has been growing in recent years relative to other categories of deposits.

True False

31. According to the textbook, the U.S. Treasury keeps most of its operating funds in TT&L deposits.

True False

32. Deposits held by banks with others are called correspondent deposits.

True False

33. The implicit interest rate on checkable deposits equals the difference between the cost of supplying deposit services to a customer and the amount of the service charge actually assessed to that customer.

True False

34. Legally imposed interest-rate ceilings on deposits were first set in place in the United States after passage of the Bank Holding Company Act.

True False

35. Gradual phase-out of legal interest-rate ceilings on deposits offered by U.S. banks was first authorized by the Glass-Steagall Act.

True False

36. The contention that there are certain banking services (such as small loans or savings and checking accounts) that every citizen should have access to is usually called socialized banking.

True False

37. Domestic deposits generate legal reserves.

True False

38. Excess legal reserves are the sources out of which new bank loans are created.

True False

39. Demand deposits are among the most volatile and least predictable of a bank’s sources of funds with the shortest potential maturity.

True False

40. IRA and Keogh deposits have great appeal for bankers principally because they can be sold bearing relatively low (often below-market) interest rates.

True False

41. In general, the longer the maturity of a deposit, the lower the yield a financial institution must offer to its depositors because of the greater interest-rate risk the bank faces with longer-term deposits.

True False

42. The availability of a large block of core deposits decreases the duration of a bank’s liabilities.

True False

43. Interest-bearing checking accounts, on average, tend to generate lower net returns for banks than regular (non-interest-bearing) checking accounts.

True False

44. Personal checking accounts tend to be more profitable for banks than commercial checking accounts.

True False

45. NOW accounts can be held by businesses and individuals and are interest-bearing checking accounts.

True False

46. An MMDA is a short-term deposit where the bank can offer a competitive interest rate and which allows up to six preauthorized drafts per month.

True False

47. A Roth IRA allows an individual to accumulate investment earnings tax free and also pay no tax on their investment earnings when withdrawn provided the taxpayer follows the rules on this new account.

True False

48. Competition tends to raise deposit interest costs.

True False

49. Competition lowers the expected return to a bank from putting its deposits to work.

True False

50. A bank has full control over its deposit prices in the long run.

True False

51. Nonprice competition for deposits has tended to distort the allocation of scarce resources in the banking sector.

True False

52. Deposits are usually priced separately from loans and other bank services.

True False

53. According to the text, no-fee savings accounts are on the decline.

True False

54. The Truth in Savings Act requires a bank to disclose to its deposit customers, the frequency with which interest is compounded on all interest-bearing accounts.

True False

55. Under the Truth in Savings Act, customers must be informed of the impact of any early deposit withdrawals on the annual percentage yield they expect to receive from an interest-bearing deposit.

True False

56. According to recent studies cited in this chapter, the number one factor that households consider in selecting a bank to hold their checking account is low fees and low minimum balance.

True False

57. According to recent studies cited in this chapter, the number one factor that households consider in choosing a bank to hold their savings deposit is location.

True False

58. Conditionally free deposits for customers mean that as long as the customers do not hold above a certain level of deposit, there are no monthly fees or per transaction charges.

True False

59. When a bank temporarily offers higher than average interest rates or lower than average customer fees in order to attract new business, they are practicing conditional pricing.

True False

60. Web-centered banks with little or no physical facilities are known as virtual banks.

True False

61. The total dollar value of checks paid in the United States has grown modestly in recent years.

True False

62. There are still a number of existing problems with online bill-paying services which has limited its growth.

True False

63. The depository institutions which tend to have the highest deposit yields are credit unions.

True False

64. Urban markets are more responsive to deposit interest rates and fees than rural markets.

True False

65. Research indicates that at least half of all households and small businesses hold their primary checking account at a depository institution situated within 3 miles of their location.

True False

Multiple Choice Questions

66. Deposit accounts whose principal function is to make payments for purchases of goods and services are called:

A. drafts.

B. second-party payments accounts.

C. thrift deposits.

D. transaction accounts.

E. None of the options is correct.

67. Interest payments on regular checking accounts were prohibited in the United States under terms of the:

A. Glass-Steagall Act.

B. McFadden-Pepper Act.

C. National Bank Act.

D. Garn-St. Germain Depository Institutions Act.

E. None of the options is correct.

68. Money market deposit accounts (MMDAs), offering flexible interest rates, accessible for payments purposes, and designed to compete with share accounts offered by money market mutual funds, were authorized by the:

A. Glass-Steagall Act.

B. Depository Institutions Deregulation and Monetary Control Act (DIDMCA).

C. Bank Holding Company Act.

D. Garn-St. Germain Depository Institutions Act.

E. None of the options is correct.

69. A stable and predictable base of deposited funds that is not highly sensitive to movements in market interest rates and tend to remain with the bank is called:

A. TT&L deposits.

B. core deposits.

C. consumer CDs.

D. correspondent deposits.

E. None of the options is correct.

70. Negotiable Order of Withdrawal (NOW) accounts—interest-bearing savings accounts that can be used essentially the same as checking accounts—were authorized by:

A. Glass-Steagall Act.

B. Depository Institutions Deregulation and Monetary Control Act (DIDMCA).

C. Bank Holding Company Act.

D. Garn-St. Germain Depository Institutions Act.

E. None of the options is correct.

71. A deposit which offers flexible money market interest rates but is accessible for spending by writing a limited number of checks or executing preauthorized drafts is known as a(n):

A. demand deposit.

B. NOW account.

C. MMDA.

D. time deposit.

E. None of the options is correct.

72. The types of deposits that will be created by the banking system depend predominantly upon:

A. the level of interest rates.

B. the state of the economy.

C. the monetary policies of the central bank.

D. public preference.

E. None of the options is correct.

73. __________ are often the most profitable deposit services for a bank.

A. Time deposits

B. Transaction deposits

C. Thrift deposits

D. Passbook savings deposits

E. Certificates of deposits

74. Some people feel that all individuals are entitled to some minimum level of financial services, no matter what their income level is. This issue is often called:

A. lifeline banking.

B. preference banking.

C. nondiscriminatory banking.

D. lifeboat banking.

E. None of the options is correct.

75. The formula—operating expense per unit of deposit service plus estimated overhead expense plus planned profit from each deposit service unit sold—reflects which of the deposit pricing method listed below?

A. Marginal cost pricing

B. Cost plus pricing

C. Conditional pricing

D. Upscale target pricing

E. None of the options is correct

76. Using deposit fee schedules that vary deposit prices according to the number of transactions, average balance in the deposit account, and maturity of the deposits represents which of the deposit pricing method listed below?

A. Marginal cost pricing

B. Cost plus pricing

C. Conditional pricing

D. Upscale target pricing

E. None of the options is correct.

77. The deposit pricing method that favors large-denomination deposits because services are free if the deposit account balance stays above some minimum figure is called:

A. free pricing.

B. conditionally free pricing.

C. flat-rate pricing.

D. upscale target pricing.

E. marginal cost pricing.

78. The Federal law that requires U.S. depository institutions to make greater disclosure of the fees, interest rates, and other terms attached to the deposits they sell to the public is called the:

A. Consumer Credit Protection Act.

B. Fair Pricing Act.

C. Consumer Full Disclosure Act.

D. Truth in Savings Act.

E. None of the options is correct.

79. Depository institutions selling deposits to the public in the United States must quote the rate of return pledged to the owner of the deposit, which reflects the customer’s average daily balance kept in the deposit. This quoted rate of return is known as:

A. annual percentage rate (APR).

B. annual percentage yield (APY).

C. daily deposit yield (DDY).

D. daily average return (DAR).

E. None of the options is correct.

80. According to recent studies cited in this book, in selecting a bank to hold their checking accounts, which of the following factors do household customers rank first?

A. Safety.

B. High deposit interest rates.

C. Convenient location.

D. Availability of other services.

E. Low fees and low minimum balance.

81. According to recent studies cited in this chapter, in choosing a bank to hold their savings deposits, which of the following factors do household customers rank first?

A. Familiarity

B. Interest rate paid

C. Transactional convenience

D. Location

E. Fees charged

82. According to recent studies cited in this chapter, in choosing a bank to supply their deposits and other services, which of the following factors do business firms rank first?

A. Quality of financial advice given

B. Financial health of lending institution

C. Whether loans are competitively priced

D. Whether cash management and operations services are provided

E. Quality of bank officers

83. A financial institution that charges its customers based on the number of services they use and grants lower deposit fees or waives some fees for a customer that purchases two or more services is practicing:

A. marginal cost pricing.

B. conditional pricing.

C. relationship pricing.

D. upscale target pricing.

E. None of the options is correct.

84. From an analysis on its deposits, a bank determines that account processing and other operating expenses cost the bank $3.95 per month. It has also determined that non-operating expenses on its deposits are $1.35 per month. The bank wants to have a profit margin which is 10 percent of monthly costs. What monthly fee should the bank charge on its deposit accounts?

A. $5.30 per month

B. $3.95 per month

C. $5.83 per month

D. $5.70 per month

E. None of the options is correct

85. From an analysis on its deposits, a bank determines that account processing and other operating expenses cost the bank $4.45 per month. The bank has also determined that non-operating expenses on its deposits are $1.15 per month. It has also decided that it wants a profit of $0.45 on its deposits. What monthly fee should the bank charge on its deposit accounts?

A. $6.05

B. $5.60

C. $5.15

D. $4.45

E. None of the options is correct

86. A customer makes a savings deposit for 45 days. During that time he earns $5 in interest and maintains an average daily balance of $1,000. What is the annual percentage yield on this savings account?

A. 0.5%

B. 4.13%

C. 4.07%

D. 4.5%

E. None of the options is correct

87. A customer has a savings account for one year. During the year he earns $65.50 in interest. For 180 days he has $2,000 in the account and for another 180 days he has $1,000 in the account. What is the annual percentage yield on this savings account?

A. 6.55%

B. 3.28%

C. 4.42%

D. 8.73%

E. None of the options is correct

88. If you deposit $1,000 into a certificate of deposit that quotes you a 5.5% APY, how much will you have at the end of 1 year?

A. $1,050.00

B. $1,055.00

C. $1,550.00

D. $1,005.50

E. None of the options is correct.

89. A bank quotes an APY of 8%. A small business that has an account with the bank had $2,500 in their account for half the year and $5,000 in their account for the other half of the year. How much in total interest earnings did the business make during the year?

A. $300

B. $200

C. $400

D. $150

E. None of the options is correct

90. Conditional deposit pricing may involve all of the following factors except:

A. the level of interest rates.

B. the number of transactions passing through the account.

C. the average balance in the account.

D. the maturity of the account.

E. All of the options are used.

91. Deposits designed to attract customers who wish to set aside money in anticipation of future expenditures or financial emergencies are called:

A. drafts.

B. second-party payment accounts.

C. thrift deposits.

D. transaction accounts.

E. None of the options is correct.

92. A savings account evidenced only by a computer entry for which the customer gets a monthly printout is called:

A. passbook savings account.

B. statement savings deposits.

C. negotiable order of withdrawal.

D. money market mutual fund.

E. None of the options is correct.

93. A traditional savings account with transactions and balances evidenced by the entries recorded in a booklet kept by the customer is called:

A. passbook savings account.

B. statement savings plan.

C. negotiable order of withdrawal.

D. money market mutual fund.

E. None of the options is correct.

94. An account at a bank that carries a fixed maturity date, with a fixed interest rate, and which often carries a penalty for early withdrawal of money is called a:

A. demand deposit.

B. transaction deposit.

C. time deposit.

D. money market mutual deposit.

E. None of the options is correct.

95. A time deposit that has a denomination greater than $100,000 and is generally for wealthy individuals and corporations is known as a:

A. negotiable CD.

B. bump-up CD.

C. step-up CD.

D. liquid CD.

E. None of the options is correct.

96. A time deposit that is non-negotiable but allows a depositor to switch to a higher interest rate if market interest rates rise is called a:

A. negotiable CD.

B. bump-up CD.

C. step-up CD.

D. liquid CD.

E. None of the options is correct.

97. A time deposit that allows for a periodic upward adjustment to the promised rate is called a:

A. negotiable CD.

B. bump-up CD.

C. step-up CD.

D. liquid CD.

E. None of the options is correct.

98. A time deposit that allows the depositor to withdraw some of the funds without a withdrawal penalty is called a:

A. negotiable CD.

B. bump-up CD.

C. step-up CD.

D. liquid CD.

E. None of the options is correct.

99. Which of the following is a reason that has made IRA and Keogh accounts more attractive to depositors recently?

A. Most of these accounts carry floating interest rates

B. These accounts now represent more than half of total deposits of FDIC insured banks

C. Individuals can deposit unlimited amounts in these accounts

D. Banks need to pay at least 6% on these accounts to depositors

E. Increase in FDIC insurance coverage to $250,000 on these accounts

100. The dominant holder of bank deposits in the U.S.:

A. is the private sector.

B. are state and local governments.

C. are foreign governments.

D. are foreign banks.

E. None of the options is correct.

101. A checking account price schedule characterized by absence of any monthly account maintenance fee or per-transaction fee is called:

A. free pricing.

B. conditionally free pricing.

C. flat-rate pricing.

D. marginal cost pricing.

E. nonprice competition.

102. A checking account price schedule that charges a fixed charge per check, or per period, or both is called:

A. free pricing.

B. conditionally free pricing.

C. flat-rate pricing.

D. marginal cost pricing.

E. nonprice competition.

103. The deposit pricing method that focuses on the added cost of bringing in new funds is called:

A. free pricing.

B. conditionally free pricing.

C. flat-rate pricing.

D. marginal cost pricing.

E. nonprice competition.

104. Prior to Depository Institution Deregulation and Control Act (DIDMCA) being passed, banks used ______________. This tended to distort the allocation of scarce resources.

A. free pricing

B. conditionally free pricing

C. flat-rate pricing

D. marginal cost pricing

E. nonprice competition

105. A customer makes a savings deposit for 60 days. During that time he earns $11 in interest and maintains an average daily balance of $1,500. What is the annual percentage yield on this savings account?

A. 0.73%

B. 4.32%

C. 4.54%

D. 4.78%

E. None of the options is correct

106. A customer makes a savings deposit for 15 days. During that time he earns $15 in interest and maintains an average daily balance of $2,200. What is the annual percentage yield on the savings account?

A. 0.68%

B. 16.36%

C. 16.59%

D. 17.98%

E. None of the options is correct

107. From an analysis on its deposits, a bank determines that account processing and other operating expenses cost the bank $4.15 per month. It has also determined that non-operating expenses on its deposits are $1.65 per month. The bank wants to have a profit margin which is 10 percent of monthly costs. What monthly fee should the bank charge on its deposit accounts?

A. $6.38 per month

B. $5.80 per month

C. $4.57 per month

D. $4.15 per month

E. None of the options is correct

108. A bank has $200 million in checking deposits with interest and non-interest costs of 4%, $400 million in savings and time deposits with interest and non-interest costs of 8%, and $200 million in equity capital with a cost of 24%. The bank has estimated that reserve requirements, deposit insurance fees, and uncollected balances reduce the amount of money available on checking deposits by 10% and on savings and time deposits by 5%. What is the bank’s before-tax cost of funds?

A. 11.00%

B. 11.26%

C. 11.50%

D. 12.00%

E. None of the options is correct

109. A bank has $100 million in checking deposits with interest and non-interest costs of 8%, $600 million in savings and time deposits with interest and non-interest costs of 12%, and $100 million in equity capital with a cost of 26%. The bank has estimated that reserve requirements, deposit insurance fees and uncollected balances reduce the amount of money available on checking deposits by 20% and on savings and time deposits by 5%. What is the bank’s before-tax cost of funds?

A. 13.44%

B. 13.25%

C. 15.33%

D. 19.17%

E. None of the options is correct

110. A bank has $500 million in checking deposits with interest and non-interest costs of 6%, $250 million in savings and time deposits with interest and non-interest costs of 14%, and $250 million in equity capital with a cost of 25%. The bank has estimated that reserve requirements, deposit insurance fees and uncollected balances reduce the amount of money available on checking deposits by 15% and on savings and time deposits by 4%. What is the bank’s before-tax cost of funds?

A. 15.00%

B. 12.75%

C. 13.29%

D. 15.74%

E. None of the options is correct

111. A bank expects to raise $30 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $80 million in new money if it pays a deposit rate of 8%, and $100 million in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9% on all money that it receives in new deposits. What deposit rate should the bank offer on its deposits, if it uses the marginal cost method of determining deposit rates?

A. 7%

B. 7.5%

C. 8%

D. 8.5%

E. None of the options is correct

112. A bank expects to raise $30 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $80 million in new money if it pays a deposit rate of 8%, and $100 million in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9% on all money that it receives in new deposits. What is the marginal cost of deposits if the bank raises its deposit rate from 7 to 7.5%?

A. 0.5%

B. 7.5%

C. 8.0%

D. 9.5%

E. 10.5%

113. Under the Truth in Savings Act, a bank must inform its customers of the terms being quoted on their deposits. Which of the following is not one of the terms listed?

A. Interest rate information

B. Balance computation method

C. Early withdrawal penalty

D. Transaction limitations

E. Minimum balance requirements

114. Which of these Acts is attempting to address the low savings rate of workers in the U.S. by including an automatic enrollment (“default option”) in employees’ retirement accounts?

A. The Economic Recovery Tax Act of 1981

B. The Tax Reform Act of 1986

C. The Tax Relief Act of 1997

D. The Pension Protection Act of 2006

E. None of the options is correct

115. According to the textbook, business (commercial) transaction accounts are generally more profitable than personal checking accounts. Which of the following explains the reason(s) behind this statement?

A. The average size of a business transaction is smaller than a personal transaction.

B. Interest expenses associated with a commercial deposit transaction are higher.

C. The bank receives less investable funds in the commercial deposit transactions.

D. The average size of a business transaction is smaller than a personal transaction and interest expenses associated with commercial deposit transactions are higher.

E. Interest expenses associated with commercial deposit transactions are lower and a bank receives more investable funds in the commercial deposits transactions.

116. A bank expects to raise $30 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $80 million in new money if it pays a deposit rate of 8%, and it can raise $100 million in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9% on all money that it receives in new deposits. What is the marginal cost of deposits if this bank raises its deposit rate from 7.5% to 8%?

A. 0.5%

B. 7.5%

C. 8.0%

D. 9.5%

E. 10.5%

117. A bank expects to raise $30 million in new money if it pays a deposit rate of 7%. It can raise $60 million in new money if it pays a deposit rate of 7.5%. It can raise $80 million in new money if it pays a deposit rate of 8% and $100 million in new money if it pays a deposit rate of 8.5%. This bank expects to earn 9% on all money that it receives in new deposits. What is the marginal cost of deposits if this bank raises their deposit rate from 8% to 8.5%?

A. 0.5%

B. 7.5%

C. 8.0%

D. 9.5%

E. 10.5%

118. A bank expects to raise $20 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $100 million in new money if it pays a deposit rate of 8%, and $120 in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9.5% on all money that it receives in new deposits. What deposit rate should the bank offer on its deposits, if it uses the marginal cost method of determining deposits rates?

A. 7%

B. 7.5%

C. 8%

D. 8.5%

E. None of the options is correct

119. A bank expects to raise $20 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $100 million in new money if it pays a deposit rate of 8%, and $120 in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9.5% on all money that it receives in new deposits. What is the marginal cost of deposits if the bank raises their deposit rate from 8 to 8.5%?

A. 11%

B. 8.75%

C. 7.75%

D. 7%

E. 0.5%

120. A bank expects to raise $20 million in new money if it pays a deposit rate of 7%, $60 million in new money if it pays a deposit rate of 7.5%, $100 million in new money if it pays a deposit rate of 8%, and $120 in new money if it pays a deposit rate of 8.5%. The bank expects to earn 9.5% on all money that it receives in new deposits. What is the marginal cost of deposits if the bank raises their deposit rate from 7.5% to 8%?

A. 11%

B. 8.75%

C. 7.75%

D. 7%

E. 0.5%

121. _____________________ permits a customer to preauthorize a depository institution to move funds from a savings account to a transaction account in order to cover overdrafts.

A. Automatic transfers (ATS)

B. Sweep account

C. NOW account

D. SNOW account

E. MMDA

122. Offering institutions post lower yields on SNOWs than on MMDAs because:

A. ratings on institutions issuing SNOWs are higher.

B. SNOWs can be drafted more frequently by customers.

C. federal regulatory authorities classify MMDAs as transaction deposits.

D. MMDAs carry unlimited check-writing privileges.

E. MMDAs have longer maturities than SNOWs.

123. Recently, time deposits have been issued with interest rates adjusted periodically (such as every 90 days). This time period is known as:

A. roll period.

B. maintenance period.

C. computation period.

D. maturity period.

E. reserve period.

124. Returns on certificates of deposits linked to performance of stock markets are known as:

A. equity CDs.

B. stock CDs.

C. market CDs.

D. index CDs.

E. exchange CDs.

125. According to the textbook, one of the reasons why large banks in the recent years have acquired many smaller banking firms is:

A. to avoid stringent regulatory norms.

B. to gain access to more stable and less expensive deposits.

C. to increase their credit ratings.

D. to increase their geographical presence.

E. to diversify their customer base.

126. When the government collects taxes or sells Treasuries, it usually directs these funds into TT&L deposits first:

A. as per the directions of the supreme court.

B. to repay for the money borrowed earlier.

C. to minimize the impact of operations on the financial system.

D. to decrease the money supply in the economy.

E. to neutralize the impact of operations on the financial system.

127. While demand deposits have about the same gross expenses per dollar of deposit as time deposits do, the _____________ levied against transaction account customers help to lower the net cost of checkable deposits.

A. higher account opening fees

B. higher service fees

C. higher pre-closure fees

D. lower interest rates

E. less number of services

128. The degree of risk exposure, based on which the amount of insurance premiums paid by each FDIC-insured depository is determined, is an interplay of two factors—risk class to which the institution belongs to and:

A. capital adequacy

B. net non-performing assets

C. gross non-performing assets

D. percentage of total liabilities hedged

E. open swap exposures

129. In determining the balance on which interest earnings are figured, a depository institution must use the ___________________ in the deposit.

A. minimum balance amount

B. maximum balance amount

C. full amount of the principal

D. average monthly balance

E. average daily balance

Chapter 13

Managing Non deposit Liabilities

Fill in the Blank Questions

1. Dollar-denominated CDs issued outside the U.S. are called ______________________.

________________________________________

2. The CDs that large foreign banks sell through their U.S. branches are called ________________________.

________________________________________

3. When a bank buys funds from other financial institutions in order to cover good quality loan demand and to satisfy deposit reserve requirements, it is practicing _________________________ management.

________________________________________

4. When the first priority of a bank is to make loans to all good quality loan customers it is following the _________________________ doctrine.

________________________________________

5. Originally, __________________ funds consisted exclusively of deposits held by U.S. banks at the Federal Reserve banks which were loaned from one bank to another.

________________________________________

6. _________________________ are short-term notes, with maturities ranging from 3 days to 9 months, issued by well-known companies.

________________________________________

7. A _________________________ is a temporary sale of high-quality, easily-liquidated assets accompanied by an agreement to buy back those assets on a future specific date at a predetermined price.

________________________________________

8. Volatility in funding and credit costs to banks due to fluctuating supply and demand conditions in the market is known as __________________ risk.

________________________________________

9. The spread between current and expected loans and investments and the current and expected inflows from deposits and other sources of funds is known as the __________.

________________________________________

10. A(n) _________________________ is an interest bearing receipt for funds issued by a bank with a minimum denomination of $100,000.

________________________________________

11. The danger that a bank in need of funds will not be able to find someone willing to grant a loan at a reasonable rate, is known as _________________________ risk.

________________________________________

12. For a bank with immediate reserve requirements, a viable alternative to Fed funds market and RPs is to use the _______________ window operated by the Federal Reserve to provide loans.

________________________________________

13. The securities most often used in a repurchase agreement are ____________________.

________________________________________

14. Common nondeposit borrowings of a bank are _____-term rather than ______-term debt.

________________________________________

15. Repurchase Agreements (RPs) are very similar to Federal funds and are often viewed as ____________ Federal funds transactions.

________________________________________

16. A repurchase agreement (RP) whereby the collateral is specifically identified is known as a conventional or ____________ RP.

________________________________________

17. A ______________ repurchase agreement (RP) is one in which the underlying collateral is not identified precisely and thus allows some substitution at the time of delivery.

________________________________________

18. The type of discount window loan available at higher interest rates to depository institutions not qualifying for primary credit is known as ___________ credit.

________________________________________

19. The type of discount window loan with generally the lowest rate of interest is known as __________ credit.

________________________________________

20. Federal Reserve balances of banks can be transferred from one institution to another in seconds through the Fed’s wire transfer network called the ______________________.

________________________________________

21. One of the three types of loans in the Fed Funds market, __________________ loans are unwritten agreements, negotiated via wire or telephone, with the borrowed funds returned the next day.

________________________________________

22. One of the three types of loans in the Fed Funds market, __________________ loans are longer-term Fed funds contracts lasting several days, weeks or months, often accompanied by a written contract.

________________________________________

23. One of the three types of loans in the Fed Funds market, __________________ contracts are automatically renewed each day unless either the borrower or lender decides to end this agreement.

________________________________________

24. When financial institution borrows in the RP market, this loan is listed as _________________________ under agreements to repurchase.

________________________________________

25. The ___________________________ System provides access to nondeposit borrowings to depository institutions. These borrowings are fully collateralized by home mortgages and have maturities ranging from overnight to 20 years.

________________________________________

True / False Questions

26. The traditional and principal source of bank funds is deposits.

True False

27. Asset management is regarded as an interest-sensitive approach to raising funds.

True False

28. In recent years, deposits have been growing faster than nondeposit sources of funds among U.S. banks.

True False

29. Federal funds today consist exclusively of deposits held at the Federal Reserve banks.

True False

30. There are no reserve requirements on Federal funds borrowings in the U.S.

True False

31. Accommodating banks buy and sell Federal funds simultaneously to make a market for the reserves of its customer institutions.

True False

32. Loans of Federal funds under a continuing contract are automatically renewed each day unless either the borrower or the lender decides to end the agreement.

True False

33. The loan from a Federal Reserve bank which normally lasts only a few days and is designed to provide immediate aid in meeting a bank’s legal reserve requirement is known as extended credit.

True False

34. Yankee CDs are issued by savings and loan associations and other nonbank savings institutions.

True False

35. The volume of variable-rate CDs exceeds the volume of fixed-rate CDs among U.S. banks.

True False

36. Liability management is considered to be an interest-sensitive approach to raising bank funds.

True False

37. Funds raised by the use of liability management techniques are considered to be flexible.

True False

38. Liability management banking calls for using price (the interest rate offered) as the control lever to regulate incoming funds.

True False

39. The most common type of Federal funds loans are term loans.

True False

40. Longer-term federal funds contracts lasting several days, weeks, or months, often accompanied by a written contract, are called continuing contracts.

True False

41. According to the FDIC Improvement Act, undercapitalized U.S. banks cannot be granted discount window loans for more than 60 days in each 120-day period.

True False

42. CDs sold by some of the largest foreign banks active in the United States through their branches are called Yankee CDs.

True False

43. Under current federal law, commercial banks in the United States can issue commercial paper as direct obligations of the banks.

True False

44. Nondeposit funds do have the advantage of quick availability compared to most types of deposits, but are not as stable a funding source for banks as are time and savings deposits.

True False

45. Longer-term federal funds contracts which are automatically renewed each day unless either the borrower or the lender decides to end the agreement are called term loans.

True False

46. The main use of federal funds today is still the traditional one. Federal funds provide a mechanism that allows banks short of legal reserves to satisfy the reserve requirements or to satisfy a loan demand by tapping into immediately available funds from other institutions possessing temporarily idle funds.

True False

47. One of the factors to consider when a bank chooses among the nondeposit funding sources is the relative cost. In general, managers prefer to borrow from the cheapest source of funds, although other factors do play a role.

True False

48. There are no restrictions on getting a Federal Reserve loan and because it is the cheapest source of short-term funds, most banks use this source of funds exclusively.

True False

49. Negotiable CDs are restricted to short maturities—from seven days to one or two years.

True False

50. Loans from the Fed funds market must be backed by collateral.

True False

51. In recent years, financial institutions have gotten better at managing interest rate risk.

True False

52. Large banks depend more on nondeposit borrowings than small banks.

True False

53. Although there is an active federal funds spot market, there is currently no associated futures market for federal funds.

True False

54. Repurchase Agreement (RPs) transactions are perceived to be less risky than equivalent Federal funds transactions.

True False

55. Interest rates in the Repurchase Agreement (RP) market are quoted on a 360-day basis.

True False

56. Seasonal credit discount window loans generally have the highest interest rates.

True False

57. Primary credit is defined as loans available for short terms and normally considered beneficial for the borrower because it carries an interest rate slightly below the target Fed funds rate.

True False

58. When the general credit conditions are tight, there is a possibility that not every borrower will be accommodated by lenders. This chance of credit rationing is referred to as credit availability risk.

True False

59. The size of a financial institution has an effect on the type of nondeposit funding source it considers. For example, larger depository institutions have the credit standing to sell the largest negotiable CDs, while the Fed funds market is suitable for smaller institutions.

True False

60. Only federal regulators can limit the terms (amount, frequency, and use) of borrower funds by the U.S. depository institutions.

True False

Multiple Choice Questions

61. The doctrine that the first priority of a bank is to make loans to all those customers from whom the bank expects to receive positive net earnings is called the:

A. funds management doctrine.

B. customer relationship doctrine.

C. loan priority doctrine.

D. revenue flows doctrine.

E. None of the options is correct.

62. The strategy that banks should buy the reserves they need to cover good-quality loan requests is known as:

A. funds management.

B. asset management.

C. liability management.

D. asset-liability coordinated management.

E. None of the options is correct.

63. As per liability management banking, the control lever to regulate the liabilities and assets on the balance sheet is

A. management discretion.

B. the volume of loan demand the bank faces.

C. deposit growth.

D. market interest rates.

E. None of the options is correct.

64. The most popular domestic source of borrowed reserves for U.S. banks is:

A. Federal funds market.

B. money market negotiable CDs.

C. Eurodollar market.

D. borrowings from the Federal Reserve Banks.

E. commercial paper market.

65. Depository institutions hold deposits with the Federal reserve:

A. to satisfy legal reserve requirements.

B. to clear checks.

C. to pay for purchases of government securities.

D. for inter-bank lending through Fed’s wire system.

E. All of the options are correct.

66. Time deposits with minimum denominations of $100,000 are generally referred to as:

A. mini CDs.

B. jumbo CDs.

C. large CDs.

D. giant CDs.

E. super CDs.

67. The source of short-term funds for commercial banks that was developed to tap temporary surplus funds held by large corporate and wealthy individual customers is:

A. Federal funds.

B. commercial paper.

C. Eurodollar deposits.

D. negotiable CDs.

E. None of the options is correct.

68. First National Bank has new loan requests of $225 million, needs to purchase $100 million in U.S. Treasury securities to meet pledging requirements, and anticipates draws against credit lines of $135 million. Deposits received today total $215 million and the bank expects to bring in an additional $100 million next week. What is First National’s estimated funds gap for the coming week?

A. -$225 million

B. $145 million

C. $135 million

D. -$100 million

E. None of the options is correct.

69. First National Bank has new loan requests of $175 million, needs to purchase $50 million in U.S. Treasury securities to meet pledging requirements, and anticipates draws against credit lines of $45 million. Deposits received today total $140 million and the bank expects to bring in an additional $230 million next week. What is First National’s estimated funds gap for the coming week?

A. $225 million.

B. -$145 million.

C. $135 million.

D. -$100 million.

E. None of the options is correct.

70. Which of the following is a factor that affects a bank’s decision as to which nondeposit sources of funds to use to cover its projected funds gap?

A. The relative cost of raising the funds.

B. The length of time the funds will be required.

C. The risk associated with each source of funds.

D. The size of the bank.

E. All of the options are correct.

71. First National Bank is planning to raise $30 million through an offering of negotiable CDs. The current rate for similar CDs is 5.5 percent. Noninterest cost rate for CDs is 0.25 percent. First National pays a deposit insurance premium of 0.0023 per dollar of insured deposits. Due to other immediate cash needs, only $25 million will be fully invested. What is the effective cost rate of borrowing in the CD market for the bank?

A. 6.9 percent

B. 7.2 percent

C. 6.0 percent

D. 5.5 percent

E. None of the options is correct.

72. CDs that are sold by some of the largest foreign banks through their U.S. branches are called:

A. thrift CDs.

B. domestic CDs.

C. EuroCDs.

D. Yankee CDs.

E. None of the options is correct.

73. Which of the following is the role performed by accommodating banks?

A. They act as intermediaries in the Eurodollar market.

B. They issue negotiable CDs for themselves and for other banks.

C. They sell commercial paper to raise funds for themselves and other firms belonging to their bank holding company.

D. They buy and sell federal funds simultaneously in order to make a market for reserves of customer banks.

E. None of the options is correct.

74. A federal funds loan that is automatically renewed each day unless either the borrower or the lender decides to end the loan agreement is known as a(n):

A. overnight loan.

B. continuing contract.

C. term loan.

D. rollover loan agreement.

E. None of the options is correct.

75. Longer-term federal funds contracts lasting several days, weeks, or months, often accompanied by a written contract, are known as:

A. term loans.

B. continuing contracts.

C. rollover loans.

D. federal funds mutuality agreements.

E. None of the options is correct.

76. Which of the following laws restricts Federal Reserve lending to undercapitalized banks and allows for long-term Fed support only to borrowing institutions that are considered “viable entities”?

A. Riegle Community Development and Regulatory Improvement Act

B. FDIC Improvement Act

C. Financial Institutions Reform, Recovery, and Enforcement Act

D. Depository Institutions Deregulation and Monetary Control Act

E. None of the options is correct

77. Which of the following source of bank funding is considered a hybrid account because though legally a deposit, it is considered as just another form of IOU?

A. Federal funds loan

B. Repurchase agreement

C. Negotiable CD

D. Eurodollar deposit

E. None of the options is correct

78. A bank plans on borrowing $150 million through an RP transaction collateralized by T-bills. It plans on borrowing the money for 5 days and the current RP rate is 5.25 percent. What is the bank’s total interest cost in dollars?

A. $7,875,000

B. $107,877

C. $21,875

D. $109,375

E. None of the options is correct

79. Suppose a bank promises an annual return of 6.5 percent on a three month (90-day $150,000 CD), what will be the total amount due to the customer at the end of the three month period?

A. $152,437.50

B. $2,437.50

C. $150,000

D. $152,404.11

E. None of the options is correct

80. Short-term notes, with maturities ranging from 3 days to 9 months, issued by well-known companies are known as:

A. negotiable CDs.

B. commercial paper.

C. federal funds.

D. repurchase agreements.

E. None of the options is correct.

81. The TRC Bank is planning on raising $500 million in a new offering of commercial paper through its holding company. It plans on using $475 million of it to fund new loans. The current interest rate for similar commercial paper is 6.45 percent and it expects 0.25 percent in issuing costs. What is the effective rate of interest on this issue of commercial paper?

A. 6.65 percent

B. 6.45 percent

C. 7.05 percent

D. 6.79 percent

E. None of the options is correct

82. An agreement where one party agrees to sell T-bills to another party and at the same time agrees to buy them back at a future date for set price is known as a:

A. repurchase agreement.

B. commercial paper.

C. term loan.

D. negotiable CD.

E. None of the options is correct

83. Which of the following is not an advantage of using a repurchase agreement?

A. The bank gains excess reserves which can be used to make new deposits.

B. The bank makes use of high-quality but low yielding assets without losing them permanently.

C. If the agreement is made with a bank which keeps a checkable deposit with another bank, it can reduce both the bank’s deposits and reserve requirements.

D. The interest rate the bank has to pay is usually low.

E. All of the options are advantages of using a repurchase agreement.

84. Which of the following is an example of a longer-term nondeposit funding source?

A. Money market funds

B. Repurchase agreements

C. Capital notes and debentures

D. Negotiable CDs

E. None of the options is correct

85. Suppose a bank expects to issue 45-day negotiable CDs for $150 million. The interest rate on these CDs is 6.35 percent. What is the dollar amount in interest the bank will owe on these CDs at the end of the 45-day period?

A. $9,525,000

B. $1,190,625

C. $76,200,000

D. $6,750,000

E. None of the options is correct

86. Dollar denominated CDs issued by banks outside the United States are known as:

A. Domestic CDs.

B. Euro CDs.

C. Yankee CDs.

D. Commercial paper.

E. None of the options is correct.

87. A repurchase agreement (RP) in which the collateral is specifically identified is known as a(n):

A. conventional RP.

B. General Collateral Finance RP.

C. specific RP.

D. general RP.

E. individual RP.

88. A conventional Repurchase Agreement (RP) is ________ for the borrower than (as) a General Collateral Finance RP.

A. more flexible

B. less flexible

C. as flexible

D. less rigid

E. None of the options is correct

89. All of the following types of loans are available through the discount window except:

A. adjustment credit.

B. primary credit.

C. secondary credit.

D. seasonal credit.

E. None of the options is correct.

90. In addition to the Federal Reserve, the other governmental agency that has also been loaning large amounts of money to banks and thrift institutions is the:

A. FDIC.

B. OCC.

C. OTS.

D. FHLB.

E. RTC.

91. The Bridges State Bank has new loan requests of $315, needs to purchase $125 million in U.S. Treasury securities for reserve requirements, and anticipates draws on lines of credit in the amount of $65 million. If total deposits received today are $205 million and the bank expects to bring in an additional $185 million in deposits next week, what is the estimated funds gap for the Bridges State Bank?

A. $505 million

B. -$390 million

C. $115 million

D. -$315 million

E. None of the options is correct

92. The Williams National Bank has new loan requests of $585 million, needs to purchase $160 in U.S. Treasury securities for reserve requirements, and anticipates draws on lines of credit in the amount of $120 million. If deposits received today total $300 million and it expects to bring in an additional $340 million in deposits next week, what is the estimated funds gap of the Williams National Bank?

A. $225 million

B. $585 million

C. $640 million

D. $865 million

E. None of the options is correct

93. The Willis Savings Bank is comparing the prevailing interest rate in the Fed Funds market with that of the negotiable CD market. It is making sure to include the noninterest costs, the deposit insurance costs, and the amount of money that will actually be available for new loans. Which factor that affects a bank’s use of nondeposit sources of funds is the bank examining?

A. The relative cost of raising the funds

B. The length of time the funds will be required

C. The risk associated with each source of funds

D. The size of the bank

E. Regulations

94. The First State Bank of Summerville knows that, if it issues commercial paper through a subsidiary, tight money supply conditions in the market may result in the interest rate on the commercial paper to be very high. What factor that affects a bank’s use of nondeposit sources of funds is the bank concerned about?

A. The relative cost of raising the funds

B. The length of time the funds will be required

C. The risk associated with each source of funds

D. The size of the bank

E. Regulations

95. The First State Bank of Summerville knows that, if it issues a large amount of the negotiable CD, the interest cost on the CD may be very high due to tight money supply conditions. As a result, it chooses to ration the credit and lend only to its most loyal clients. What risk factor that affects a bank’s use of nondeposit sources of funds is the concern here?

A. Interest rate changes

B. The length of time the funds will be required

C. The relative cost of raising the funds

D. Credit availability

E. Regulations

96. The First State Bank of Summerville needs to raise $500,000 in nondeposit sources of funds. It knows that the Eurodollar market requires a minimum denomination of $1 million. What factor that affects a bank’s use of nondeposit sources of funds is this bank concerned about?

A. The relative cost of raising the funds

B. The length of time the funds will be required

C. The risk associated with each source of funds

D. The size of the bank

E. Regulations

97. Bank of America is concerned that the Federal Reserve Board may impose legal reserve requirements on money borrowed in the Fed funds market. Which factor that affects a bank’s use of nondeposit sources of funds is this bank concerned about?

A. The relative cost of raising the funds

B. The length of time the funds will be required

C. The risk associated with each source of funds

D. The size of the bank

E. Regulations

98. The Bank of Boulder is planning on issuing $45 million in negotiable CDs. Currently other similar CDs bear an interest rate of 4.75 percent. The bank has estimated that its noninterest costs of issuing these CDs are 0.15 percent, and it expects to pay a deposit insurance premium of 0.0023 per dollar of insured funds. Due to other immediate cash needs, only $40 million of the funds raised will be fully invested. What is the effective cost rate for the Bank of Boulder to borrow in the CD market? (Round your answer to the nearest 0.01 percent)

A. 4.75 percent

B. 4.90 percent

C. 5.10 percent

D. 5.77 percent

E. None of the options is correct

99. The Lawrence Bank of Cleveland is planning on issuing $60 million in negotiable CDs. Currently other similar CDs bear an interest rate of 5.15 percent. The bank has estimated that its noninterest costs of issuing these CDs will be 0.2 percent, and expects to pay a deposit insurance premium of 0.0023 per dollar of insured funds. Due to other immediate cash needs, only $50 million of the funds raised will be fully invested. What is the effective cost rate for the Lawrence Bank of Cleveland to borrow in the CD market? (Round your answer to the nearest .01 percent)

A. 6.70 percent

B. 6.42 percent

C. 5.58 percent

D. 5.15 percent

E. None of the options is correct

100. CDs issued by nonbank savings institutions are called:

A. thrift CDs.

B. domestic CDs.

C. EURO CDs.

D. Yankee CDs.

E. variable rate CDs.

101. When a foreign branch lends a Euro deposit to its home office in the U.S., how is this listed on the balance sheet of the home office?

A. Loan from subsidiary

B. Liabilities to foreign branches

C. Securities sold under agreement to repurchase

D. Bankers acceptance

E. None of the options is correct

102. A Fed Funds loan that is an unwritten agreement, negotiated via wire or telephone, and with the borrowed funds returned the next day is known as a(n):

A. overnight loan.

B. continuing contract.

C. term loan.

D. daytime loan.

E. None of the options is correct.

103. A bank plans on borrowing $225 million for 10 days through an RP transaction collateralized by T-Bills. The current RP rate is 4.5 percent. What is the bank’s total interest cost in dollars?

A. $10,125,000

B. $1,125,000

C. $281,250

D. $28,125

E. None of the options is correct

104. A bank plans on borrowing $450 million for 20 days through a RP transaction collateralized by T-Bills. The current RP rate is 6.25 percent. What is the bank’s total interest cost in dollars?

A. $28,125,000

B. $78,125

C. $1,406,250

D. $1,562,500

E. None of the options is correct

105. A bank promises an annual return of 7.75 percent on a 180 day, $250,000 CD. What will be the total amount due the customer at the end of the six-month period?

A. $269,375.00

B. $259,687.50

C. $9,687.50

D. $250,000.00

E. None of the options is correct

106. A bank promises an annual return of 4.85 percent on a 60 day, $300,000 CD. What will be the total amount due to the customer at the end of the two-month period?

A. $302,425

B. $314,550

C. $14,550

D. $2,425

E. None of the options is correct

107. The HTR Bank is planning on raising $750 million in a new offering of commercial paper through its holding company. It plans on using $725 million of it to fund new loans. The current interest rate for similar commercial paper is 7.15 percent and it expects 0.15 percent in issuing costs. What is the effective rate of interest on this issue of commercial paper?

A. 7.30 percent

B. 7.15 percent

C. 7.40 percent

D. 7.55 percent

E. None of the options is correct

108. The Carter State Bank is planning on raising $600 million in a new offering of commercial paper through its holding company. It plans on using $500 million of it to fund new loans. The current interest rate for similar commercial paper is 4.85 percent and it expects 0.3 percent in issuing costs. What is the effective rate of interest on this issue of commercial paper?

A. 5.15 percent

B. 6.18 percent

C. 5.82 percent

D. 4.85 percent

E. None of the options is correct

109. Setting the Federal Reserve primary-credit discount rate above the Fed Funds rate mirrors what credit facilities used by several European central banks?

A. The Vince credit facilities

B. The Adam Smith credit facilities

C. The Lombard credit facilities

D. The Lower Back credit facilities

E. None of the options is correct

110. Which of the following is one of the disadvantages of following the customer relationship doctrine?

A. High interest costs on loans

B. Negative returns on loans

C. Poor credit scores of customers

D. Fewer loyal customers

E. Low service fees

111. Money market suppliers of funds typically have a(n) ______________ response to changes in the market interest rates.

A. elastic

B. inelastic

C. slow

D. marginal

E. opposite

112. With liability management, institutions in need of more funds to cover expanding loan commitments or deficiencies in the cash reserves can ______________________ to reduce their volume of money market borrowings.

A. lower their offer rate

B. lower their bid rate

C. raise their bid rate

D. raise their offer rate

E. reduce cutoff for minimum credit score required to grant loans

113. The interest rate on a Fed funds loan is:

A. decided by the Federal Reserve Board.

B. based on LIBOR.

C. decided by the U.S. Treasury Department.

D. subject to negotiation between the borrower and the lender.

E. based on Euribor.

114. Which of the following is an advantage of a General Collateral Finance RP?

A. The securities pledged in the first leg need not necessarily be the same to be returned.

B. It can be settled on the books of the FICC which allows for netting of transactions.

C. It entails lower transaction costs.

D. It helps make RP market more liquid.

E. All of the options are correct.

115. In the United States, legal reserve requirements on certificates of deposits is currently:

A. zero.

B. 5 percent.

C. 10 percent.

D. 15 percent.

E. 10 percent of the instruments maturing in the next three months.

116. The largest unregulated financial market place in the world is the:

A. U.S. treasuries.

B. Eurocurrency market.

C. agro-commodities market.

D. inter-bank loan market.

E. Fed funds market.

Chapter 14
Investment Banking, Insurance, and Other Sources of Fee Income

Fill in the Blank Questions

1. When bank purchases stocks, bonds, mutual funds, and annuities on behalf of their customers, these products are referred to as _______________________.

________________________________________

2. A(n) __________________ fund, is a type of mutual fund offered through a bank’s affiliated company. The bank acts as a transfer agent, custodian, and offers investment advice in this type of mutual fund.

________________________________________

3. When a financial institution offers a(n) __________________ mutual fund, it acts as broker for an unaffiliated mutual fund or group of funds and does not act as an investment advisor.

________________________________________

4. A(n) _________________________ promises a customer, who deposits a lump sum, a guaranteed rate of return over the life of the contract.

________________________________________

5. A(n) _________________________ gives the bank the right to manage the estate of a living person without a court order. This can be amended by the customer as desired.

________________________________________

6. A(n) _________________________ is a savings instrument in which the customer makes cash payments to an investment manager who invests them in an earning asset. Later the purchaser receives a stream of income from those assets.

________________________________________

7. _________________________ is the bringing together of two or more firms from different industries in order to offer multiple services.

________________________________________

8. The _________________________ effect brings more than one financial-service industries together to reduce the overall risk of the revenue flows through the company.

________________________________________

9. _______________________ emerge when financial organization grows in size and is able to reduce its cost of production per unit of output.

________________________________________

10. _________________________ arise from the potential cost savings that result from being able to use the same management, advertising, and physical resources to offer multiple services.

________________________________________

11. A(n) _________________________ is a contract that promises to make a cash payment to the beneficiary in the event of the death of the policy holder.

________________________________________

12. A(n) _________________________ is a contract that promises to reimburse policy holders for personal injury, property damage, and other losses, in exchange for the policy holder’s premium payments.

________________________________________

13. The most rapidly growing source of income for banks is ________ income.

________________________________________

14. __________________ are one of the earliest services provided by banks and involves the management of customer’s property and other assets.

________________________________________

15. Trust department activities usually center upon establishing a ____________ relationship with a customer.

________________________________________

16. The trust department can be a significant source of ____________ for a bank or financial holding company.

________________________________________

17. _______________ are financial advisors to corporations, governments, and other large institutions. They advise their clients on issues relating to raising new capital, entering new market areas, etc.

________________________________________

18. _________________ is the purchase for resale of new stocks, bonds, and other financial instruments in the money and capital markets on behalf of clients who need to raise new money.

________________________________________

19. Under law and industry practice, a __________ is supposed to be set up between an IB’s security underwriting and client advising divisions and the internal unit where proprietary trading of stocks and bonds take place, to prevent the transfer of insider information about clients.

________________________________________

20. Passage of the __________________ of 1999 granted banks, securities firms, and insurance companies the right to apply to the Federal Reserve Board to become financial holding companies (FHCs).

________________________________________

21. ________________ is the value of a share in a mutual fund. It is the value of the assets held by the mutual fund less any liabilities, divided by the number of mutual fund shares outstanding.

________________________________________

22. ______________ are private investment pools which primarily offer to wealthy investors and major institutions higher investment returns by taking on relatively risky assets.

________________________________________

23. One of the advantages offered by mutual funds is having a ____________ who monitors the performance of each security held by the fund.

________________________________________

24. According to the textbook, one likely outcome of the 2007-2009 financial crisis for both commercial and investment banks is _________________.

________________________________________

True / False Questions

25. A bank’s nondeposit investment products include IRAs, Keoghs, and MMDAs.

True False

26. A nonproprietary mutual fund is where the bank acts as a broker for a nonaffiliated mutual fund but does not act as an investment advisor.

True False

27. Trust services have no impact on the deposits of the bank.

True False

28. Trust services are a relatively new service for banks.

True False

29. The product-line diversification effect occurs when the revenues generated by traditional banking service and a nontraditional banking service are not very correlated with each other and reduce the overall risk of the bank.

True False

30. While the trust department performs a variety of roles, their activities center on establishing a fiduciary relationship with the customer.

True False

31. A proprietary mutual fund is where the bank sells a mutual fund through one of their affiliated companies and where the bank can act as an investment advisor.

True False

32. An annuity is a product that offers shares in a pool of securities (stocks, bonds, etc.) and flows through any earnings generated to the shareholding customer.

True False

33. A mutual fund is a savings instrument where the customer makes cash payments to an investment manager who invests them in earning assets. Later the purchaser receives a stream of income from these assets.

True False

34. Customers have no rights to opt out of having their private information collected by banks and other financial-service firms and being shared with other financial-service firms.

True False

35. One attractive feature of investment banking is that it is generally less risky than commercial banking.

True False

36. Mutual funds were first set up in France.

True False

37. State Street Bank in Boston is a good example of a fee-focused banking company.

True False

38. An insurance product or annuity sold by a depository institution is not insured by the FDIC.

True False

39. As a consequence of recent legislation, banks cannot offer insurance products or services.

True False

40. As a consequence of recent legislation, banks, securities firms, and insurance companies have the right to apply to the Federal Reserve Board to become financial holding companies.

True False

41. Investment bankers are financial advisors to individuals and act as brokers and dealers for those individuals.

True False

42. Traditionally, the most profitable and best-known investment banking activity is providing client advice.

True False

43. The prohibition against combining investment banking and commercial banking activity during the Depression-era, centered on possibly forcing customers seeking loans to buy securities that the IB was trying to sell and increasing the risk exposure of commercial banking firms.

True False

44. A ‘Chinese wall’ is supposed to prevent the transfer of insider information about clients between the investment banker’s security underwriting division and the internal unit where proprietary trading of stocks and bonds takes place.

True False

Multiple Choice Questions

45. Customers purchasing nondeposit investment accounts sold by a bank operating in the United States must be told in writing that:

A. investment accounts are not federally insured.

B. investment accounts are neither deposits nor guaranteed by a depository institution.

C. investment accounts could suffer loss of principal.

D. All of the options are correct.

E. None of the options is correct.

46. A trust department’s activities often center around establishing:

A. an independent relationship with the customer.

B. a partnership relationship with the customer.

C. a fiduciary relationship with the customer.

D. a subservient relationship with the customer.

E. None of the options is correct.

47. A bank would offer insurance services in addition to traditional banking services if it believed in the potential benefits of:

A. reputation.

B. economies of scale.

C. economies of scope.

D. investment services.

E. None of the options is correct.

48. Which of the following is an example of a nondeposit investment product of the bank?

A. Time deposit

B. NOW account

C. Passbook savings account

D. Proprietary mutual fund

E. All of the options are correct.

49. Which of the following trust agreements allows wealth to be passed free of gift and estate taxes?

A. Revocable trust

B. Irrevocable trust

C. Charitable trust

D. Indenture trust

E. None of the options is correct.

50. Which of the following trust agreements allows the bank trust officer to act on behalf of a living customer?

A. Revocable trust

B. Irrevocable trust

C. Charitable trust

D. Indenture trust

E. None of the options is correct.

51. Which of the following trust agreements is used to back the issue of securities by a corporation?

A. Revocable trust

B. Irrevocable trust

C. Charitable trust

D. Indenture trust

E. None of the options is correct.

52. A bank is considering adding life insurance underwriting to the services it offers. It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively. It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively. The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services. What is the expected return of the new combination of services?

A. 17.40 percent

B. 12.60 percent

C. 5.59 percent

D. 15.00 percent

E. None of the options is correct.

53. A bank is considering adding life insurance underwriting to the services it offers. It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively. It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively. The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services. What is the expected standard deviation of the new combination of services?

A. 6.40 percent

B. 12.60 percent

C. 5.59 percent

D. 9.08 percent

E. None of the options is correct.

54. A bank is considering adding life insurance underwriting to the services it offers. It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively. It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively. The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services. If the bank is expecting that the overall risk of the bank will be reduced by adding the life insurance underwriting to the bank, what type of effect are they expecting?

A. Product-line diversification effect

B. Income diversification effect

C. Market diversification effect

D. Geographic diversification effect

E. None of the options is correct.

55. When a bank is expecting that the overall risk of FHC will be reduced when they combine investment banking services with the traditional banking services, what type of effect are they expecting?

A. Product-line diversification effect

B. Market diversification effect

C. Income diversification effect

D. Geographic diversification effect

E. None of the options is correct.

56. When a bank is expecting to be able to employ the same managers, employees, and physical resources to offer multiple products and generate costs savings they are expecting which of the following effects?

A. Product-line diversification effect

B. Economies of scope effect

C. Economies of scale effect

D. Geographic diversification effect

E. None of the options is correct.

57. Trust department activities include all of the following except:

A. safeguarding customers’ assets.

B. generating earnings.

C. generating large deposits.

D. lending.

E. preparing wills.

58. A financial holding company may include all of the following services except:

A. corporate liquidation.

B. consumer lending.

C. trust services.

D. investment banking.

E. insurance.

59. Among potential advantages of combining various financial services activities in one FHC, all of the following can be included except:

A. supplementing traditional sources of funds with new funds.

B. supplementing traditional revenue with new revenue sources.

C. lowering the cost of service production through economies of scale and scope.

D. reducing the risk of failure.

E. increasing earnings fluctuations.

60. If the correlation between revenues from traditional banking and nontraditional services offered by a bank rises, potential diversification benefits:

A. will rise.

B. will fall.

C. will remain the same.

D. will remain the same but only under certain conditions.

E. cannot be determined.

61. A company that offers shares in a pool of securities and the returns to the shareholders flow through any earnings generated is called:

A. a mutual fund.

B. an annuity.

C. the net asset value.

D. a leveraged buyout.

E. None of the options is correct.

62. A savings instrument where the customer makes a lump sum payment to the investment manager who invests the payment in earning assets and later receives a stream of income from the assets is called:

A. a leveraged buyout.

B. an annuity.

C. the net asset value.

D. a hedge fund.

E. None of the options is correct.

63. A customer’s pro rata value of a share in a mutual fund, if the assets of the fund were liquidated and liabilities paid off, is called:

A. a mutual fund.

B. an annuity.

C. the net asset value.

D. a hedge fund.

E. None of the options is correct.

64. A virtually regulated private investment pool, which primarily offers its wealthy investors and large institutions, the possibility of higher investment returns by taking on relatively risky assets is called:

A. a mutual fund.

B. an annuity.

C. the net asset value.

D. a hedge fund.

E. None of the options is correct.

65. A bank is considering adding security underwriting services to the services it offers. It has estimated that the expected return and standard deviation of its traditional service are 8% and 10% respectively. It has estimated that the expected return and standard deviation of its new securities underwriting services are 16% and 20% respectively. The correlation between these services has been estimated to be -0.3 and the bank estimates that 80% of its business will be from traditional services and 20% from the new services. What is the expected return of the new combined firm?

A. 8.0 percent

B. 9.6 percent

C. 12.0 percent

D. 14.4 percent

E. 16 percent

66. A bank is considering adding security underwriting services to the services it offers. It has estimated that the expected return and standard deviation of its traditional service are 8% and 10% respectively. It has estimated that the expected return and standard deviation of its new securities underwriting services are 16% and 20% respectively. The correlation between these services has been estimated to be -0.3 and the bank estimates that 80% of its business will be from traditional services and 20% from the new services. What is the standard deviation of the new combined firm?

A. 7.8 percent

B. 10.0 percent

C. 12.0 percent

D. 15.5 percent

E. 20.0 percent

67. A bank is considering adding security brokerage services to the services it offers. It has estimated that the expected return and standard deviation of its traditional service are 6% and 14% respectively. It has estimated that the expected return and standard deviation of its new securities brokerage services are 14% and 24% respectively. The correlation between these services has been estimated to be -0.4 and the bank estimates that 60% of its business will be from traditional services and 40% from the new services. What is the expected return of the new combined firm?

A. 14.0 percent

B. 10.8 percent

C. 10.0 percent

D. 9.2 percent

E. 6.0 percent

68. A bank is considering adding security brokerage services to the services it offers. It has estimated that the expected return and standard deviation of its traditional service are 6% and 14% respectively. It has estimated that the expected return and standard deviation of its new securities brokerage services are 14% and 24% respectively. The correlation between these services has been estimated to be -0.4 and the bank estimates that 60% of its business will be from traditional services and 40% from the new services. What is the standard deviation of the new combined firm?

A. 24.00 percent

B. 18.00 percent

C. 15.07 percent

D. 14.00 percent

E. 9.91 percent

69. Recently, both investment banks and commercial banks have come under a pressure to raise large amounts of capital, which is designed to:

A. increase their interest income.

B. reduce their high volume of assets.

C. increase their leverage ratio.

D. reduce their non-performing assets.

E. reduce their high debt ratio.

70. The trusts that arise under a probated will and are often used to save on estate taxes are called:

A. revocable trusts.

B. irrevocable trusts.

C. indenture trusts.

D. testamentary trusts.

E. living trusts.

71. For which of the following banking services can the bank be legally liable for losses due to failure to act as a prudent decision maker?

A. Underwriting insurance services

B. Insurance sales services

C. Trust services

D. Exchange-traded-funds services

E. None of the options is correct

72. Which of the following activities of a bank falls under the insurance sales and underwriting services?

A. Providing risk management services for persons and property.

B. Security underwriting.

C. Brokering securities for clients.

D. Providing credit guarantees.

E. Distributing new securities and interest.

73. Which of the following activities of investment banking often leads to large speculative gains or losses during the first few hours of the sale of offering new shares of stock?

A. Leveraged buyouts

B. Security underwriting

C. Initial public offering

D. Hedge funds

E. Annuities

Chapter 15

The Management of Capital

Fill in the Blank Questions

1. The risk that has to do with banks trading in foreign currencies is called ________________________.

________________________________________

2. The risk that has to do with fraud, embezzlement and bank robberies is called _________________.

________________________________________

3. _________________________ is measured by the par value of the shares of common equity outstanding.

________________________________________

4. __________________ is the amount in excess of stock’s par value paid by the bank’s shareholders.

________________________________________

5. _________________________ are the net earnings of a bank, which have been kept by the bank rather than being distributed as dividends to stockholders.

________________________________________

6. Core capital such as common stock and surplus, undivided profits, qualifying noncumulative perpetual preferred stock, etc. is referred to as __________________ capital, as defined by the Basel agreement.

________________________________________

7. The international treaty involving representatives from the U.S. and 12 other leading industrialized countries to impose common capital requirements on all banks is known as the ________________________.

________________________________________

8. Supplemental capital such as the allowance for loan and lease losses, subordinated debt capital instruments, mandatory convertible debt, intermediate-term preferred stock, cumulative perpetual preferred stock with unpaid dividends, and equity notes and other long-term capital instruments that combine both debt and equity features is more commonly known as ________________________.

________________________________________

9. When the assets items on a bank’s balance sheet and each off-balance-sheet commitment it has made are multiplied by the appropriate risk-weighting factor, they are often called ________________________.

________________________________________

10. The fact that a bank may suffer deficiencies in quality control, inefficiencies in producing and delivering of services, natural disasters, terrorist acts, weather damage, aging or faulty computer systems, errors in judgment by management, and fluctuations in economy that could adversely affect the bank’s performance, is known as _________________________ risk.

________________________________________

11. One defense against risk for a bank is to spread out its credit accounts and deposits among a wide variety of customers, including large and small business accounts, different industries, etc. This defense is known as ________________________.

________________________________________

12. One defense against risk for a bank is to seek out customers located in different communities or in different countries. This defense is known as ________________________.

________________________________________

13. When all else fails, the ultimate defense against risk in banking is ________________________.

________________________________________

14. The largest component of capital among thrift institutions is ____________.

________________________________________

15. The largest component of capital among commercial banks is ___________.

________________________________________

16. ____________ models attempt to measure price or market risk of a portfolio of assets and attempt to determine the maximum loss they might sustain over a designated period of time.

________________________________________

17. The latest revision to the Basel accord is known as __________ and will cover capital, liquidity, and debt positions of individual international banks and also the much broader issues associated with controlling global business cycles and financial system-wide risks.

________________________________________

18. ____________ models measure a lender’s exposure to defaults or credit downgrades.

________________________________________

19. _________________ risk measures are being developed to be used when Basel III takes effect.

________________________________________

20. At the center of the debate of the Basel Agreement is the ____________, headquartered in Basel, Switzerland, which assists central banks in their transactions with each other and serves as a forum for international financial issues.

________________________________________

21. _____________ represents funds set aside for contingencies, such as legal action against the institution, as well as providing a reserve for dividends expected to be paid but not yet declared, and a sinking fund to retire stock or debt in the future.

________________________________________

22. _________ are debt securities repayable from the sale of stock.

________________________________________

23. __________ is a hybrid form of debt and equity capital issued to investors.

________________________________________

24. _________ are a type of long-term debt capital whose claims legally follow after the claims of depositors.

________________________________________

25. _________ for banks include assets like mortgage servicing rights and purchased credit card relationships and such assets can be counted as part of bank capital.

________________________________________

True / False Questions

26. In the field of banking, capital refers principally to those funds contributed by a bank’s owners.

True False

27. According to the textbook, capital and risk are intimately related to each other.

True False

28. One fundamental purpose for regulating capital is to limit losses to the government and other institutions arising from deposit insurance claims.

True False

29. Deposit insurance subsidized by government encourages banks to increase their ratios of capital to deposits.

True False

30. Under the terms of Basel I, Tier 2 capital includes undivided profits.

True False

31. Core capital includes the surplus value of common stock.

True False

32. Under the international capital (Basel) agreement, Tier 2 capital must be raised to a minimum of 4 percent of risk-weighted assets.

True False

33. Off-balance-sheet commitments of banks carry capital requirements under the international (Basel) capital standards.

True False

34. Portfolio diversification refers to seeking out customers located in different communities or countries, which presumably will experience different economic conditions.

True False

35. Geographic diversification refers to the spreading out credit accounts and deposits among a wide variety of customers within a country, including large and small business accounts, different industries, and households with a variety of sources of income and collateral.

True False

36. The last line of defense against bank failure is owner’s capital, according to the textbook.

True False

37. Under the FDIC Improvement Act of 1991, a U.S. bank possessing a leverage ratio greater than 4 percent would be considered well capitalized.

True False

38. Under the FDIC Improvement Act of 1991, a bank whose leverage ratio drops to 2 percent or less is considered to be critically undercapitalized.

True False

39. Recent research suggests that interest-rate contracts display considerably less risk exposure than do foreign-currency contracts.

True False

40. The Basel Agreement on new capital standards, as drafted in the 1980s, failed to deal with market risk.

True False

41. If the ratio of tangible equity capital to total assets is 2 percent or less, it is subject to being placed in conservatorship or receivership unless the institution’s principal regulator and the FDIC determine that it would be in the public interest to allow the institution to continue under present ownership and management.

True False

42. According to recent research, bank stock prices usually drop within a week after a dividend cut is announced.

True False

43. Equity notes are considered to be part of Tier 1 capital.

True False

44. The largest source of thrift capital in terms of dollar volume is common stock (par value).

True False

45. Recently, the daily rate at which robberies have occurred in the U.S. has continued to climb.

True False

46. One of the reasons to regulate the capital position of banks is to limit the risk of bank failures, especially large bank failures.

True False

47. Deposits with the Federal Reserve banks are considered to have moderate credit risk and are therefore placed in the 50 percent risk-weight category.

True False

48. The largest component of capital among banks is retained earnings.

True False

49. VaR models measure the market risk and indicate the potential for losses on a portfolio of assets.

True False

50. VaR models are most successful in assessing potential risk when the assets are non-traded.

True False

51. Credit risk models measure the market risk of a portfolio whose value may decline due to adverse movements in interest rates, stock prices, currency values, or commodity prices.

True False

52. One of the key pillars for capital regulation in Basel II was to require banks to hold capital against its own estimated risk exposure from operational risk.

True False

53. Basel II requires each bank to determine its own capital requirements based on its own calculated risk exposure.

True False

54. It is anticipated that Basel III may increase capital requirements for banks.

True False

55. The global financial crisis of 2007-2009 highlighted the importance of taking into consideration a bank’s exposure to market risk that arise from changes in interest rates, security prices, and currency.

True False

56. Smaller banks rely more heavily on internally generated capital than larger banks.

True False

57. A well-capitalized institution has a ratio of capital to risk-weighted assets of at least 10 percent and faces no significant regulatory restrictions on its expansion.

True False

58. Regulatory capital focuses on the market value of equity.

True False

Multiple Choice Questions

59. According to the textbook, the role(s) of capital is to:

A. provide a cushion against failure risk.

B. provide funds needed to charter, organize, and operate a bank.

C. promote public confidence.

D. support growth and the development of new services.

E. All of the options are correct.

60. The textbook discusses several alternative defenses banks have against risk. These defenses include:

A. quality management.

B. portfolio diversification.

C. geographic diversification.

D. deposit insurance.

E. All of the options are correct.

61. Measured by dollar volume, the largest category of capital at U.S. banks is:

A. par value of common stock.

B. subordinated notes and debentures.

C. surplus.

D. undivided profits and capital reserves.

E. None of the options is correct.

62. The fundamental purposes of regulating bank capital cited in the textbook include which of the following?

A. To reduce liquid funds held by the banks.

B. To preserve public confidence in banks.

C. To limit losses to the public arising from insurance claims.

D. To increase the risk taking ability of the banks.

E. To reduce liquid funds held by the banks and to increase the risk taking ability of the banks.

63. The internal capital growth rate for a bank is a function of which of the following factors?

A. Profit margin.

B. Asset utilization.

C. Equity multiplier.

D. Earnings retention ratio.

E. All of the options are correct.

64. Second National Bank is forecasting a return on equity of 15 percent for this year. The board of directors wants to maintain its current policy of paying the bank’s stockholders 40 percent of any net earnings the bank will earn. How fast can the bank’s assets grow this year without jeopardizing its ratio of capital to assets?

A. 15 percent

B. 9 percent

C. 8 percent

D. 6 percent

E. None of the options is correct.

65. Possible breakdowns in quality control, inefficiencies in producing and delivering financial services, weather damage, aging or faulty computer systems, and errors in judgment by bank management illustrate what form of risk faced by banks?

A. Credit risk

B. Liquidity risk

C. Interest-rate risk

D. Operational risk

E. None of the options is correct.

66. The ratio of core capital to average total assets is called the:

A. supplemental capital ratio.

B. leverage ratio.

C. long-term capital ratio.

D. GAAP capital ratio.

E. None of the options is correct.

67. The risk that a customer with whom the bank has entered into a contract with, will fail to pay or to perform, forcing the bank to find a replacement contract with another party that may be less satisfactory is what form of risk listed below?

A. Counterparty risk

B. Interest-rate risk

C. Operating risk

D. Credit risk

E. Liquidity risk

68. In the United States a ‘well capitalized’ bank must have a ratio of capital to risk-weighted assets of at least:

A. 6 percent.

B. 8 percent.

C. 10 percent.

D. 5 percent.

E. None of the options is correct.

69. In the United States a bank to be considered ‘adequately capitalized’ must have a ratio of Tier 1 (or core) capital to risk-weighted assets of at least:

A. 8 percent

B. 6 percent

C. 10 percent

D. 4 percent

E. None of the options is correct.

70. A ‘well capitalized’ bank in the United States must have a leverage ratio of at least:

A. 4 percent

B. 5 percent

C. 6 percent

D. 8 percent

E. None of the options is correct.

71. A bank has $100 million in assets in the 0 percent risk-weight category, $200 million in assets in the 20 percent risk-weight category, $500 million in assets in the 50 percent risk-weight category, and $750 million in assets in the 100 percent risk-weight category. This bank has $57 million in core (Tier 1) capital. What is this bank’s ratio of Tier 1 capital to risk-weighted assets?

A. 3.68 percent

B. 7.60 percent

C. 18.25 percent

D. 5.48 percent

E. None of the options is correct.

72. A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent, an equity multiplier of 12, and a retention ratio of 60 percent. What is this bank’s ICGR?

A. 6.60 percent

B. 3.96 percent

C. 7.20 percent

D. 0.33 percent

E. None of the options is correct.

73. Which of the following would be an example of Tier 1 capital?

A. Subordinated debt capital instruments with an original maturity of at least 5 years

B. Allowance for loan and lease losses

C. Minority interest in the equity accounts of consolidated subsidiaries

D. Intermediate-term preferred stock

E. All of the options are correct.

74. Which of the following would be an example of Tier 2 capital?

A. Subordinated debt capital instruments

B. Undivided profits

C. Minority interest in the equity accounts of consolidated subsidiaries

D. Qualifying noncumulative preferred stock

E. All of the options are correct.

75. Which of the following would be an example of crime risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest and principal has been collected in 2 years.

D. A bank manager predicts that interest rates will rise. However, interest rates fall causing the bank ‘s net income to fall by $250,000.

E. All of the options are examples of crime risk.

76. Which of the following assets fit(s) into the 0 percent risk-weight category?

A. Cash

B. Deposits at the Federal Reserve

C. Treasury Bills

D. GNMA mortgage-backed securities

E. All of the options are assets that fit into the 0 percent risk-weight category.

77. A bank that is ‘well-capitalized’:

A. faces no significant regulatory restriction on its expansion.

B. cannot accept broker placed deposits without regulatory approval.

C. has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions.

D. will be placed into conservatorship or receivership if its capital level is not increased within a certain time limit.

E. None of the options is correct.

78. A bank that is ‘critically undercapitalized’:

A. faces no significant regulatory restrictions.

B. can only grant loan to highly leveraged borrowers.

C. cannot avoid seizure in all circumstances.

D. will be placed into conservatorship or receivership if its capital level is not increased within a certain time limit.

E. None of the options is correct.

79. A bank that is adequately capitalized:

A. faces no significant regulatory restrictions.

B. cannot accept broker-placed deposits without regulatory approval.

C. has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions.

D. will be placed into conservatorship or receivership if its capital level is not increased within a certain time limit.

E. None of the options is correct.

80. Which of the following is in the 100 percent risk-weight category?

A. Cash

B. General obligation municipal bonds

C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

81. Which of the following is in the 50 percent risk-weight (moderate credit risk) category?

A. Cash

B. General obligation municipal bonds

C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

82. Which of the following is in the 20 percent risk-weight (low credit risk) category?

A. Cash

B. General obligation municipal bonds

C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

83. A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank’s equity capital to total assets ratio?

A. 7.00 percent

B. 14.29 percent

C. 28.00 percent

D. 16.00 percent

E. None of the options is correct.

84. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank’s ratio of Tier 1 capital to risk assets?

A. 6.08 percent

B. 3.04 percent

C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

85. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank’s ratio of Tier 2 capital to risk assets?

A. 6.08 percent

B. 3.04 percent

C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

86. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank’s ratio of total capital to risk assets?

A. 6.08 percent

B. 3.04 percent

C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

87. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent and has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this bank’s internal capital growth rate?

A. 28.35 percent

B. 2.36 percent

C. 11.34 percent

D. 4.80 percent

E. None of the options is correct.

88. The revised Basel I rules imposed capital requirements for market risk on:

A. only the largest banks.

B. only the smallest banks.

C. only moderate size banks.

D. all banks.

E. no banks.

89. Which of the following is a bank debt that appears to be highly sensitive to the market perception of the bank’s risk?

A. Deposits

B. Fed funds

C. Repos

D. Subordinated debt capital

E. Preferred stock

90. As per the Basel Committee, a bank’s operational risk includes:

A. employee fraud.

B. accounting errors.

C. computer breakdowns.

D. natural disasters.

E. All of the options are correct.

91. The task of correctly adding up all of the different types of bank risk exposures is known as:

A. risk tallying.

B. summing risk.

C. risk aggregation.

D. risk accumulation.

E. risk totality.

92. For a bank with deficient capital ratios, which of the following actions could be required by regulators to increase the capital ratios, all else constant?

A. Cut the bank’s dividend payment.

B. Increase the bank’s leverage.

C. Reduce the bank’s holdings of cash.

D. Increase the bank’s growth rate by making additional commercial loans.

E. Reduce the bank’s holdings of Treasury securities.

93. Basel II had a different set of capital rules for different banks, and the number of categories is:

A. two.

B. three

C. four.

D. five.

E. ten.

94. Which of the following would be an example of exchange risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank’s net income to fall by $250,000.

E. All of the options are examples of exchange risk.

95. Which of the following would be an example of credit risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank’s net income to fall by $250,000.

E. All of the options are examples of credit risk.

96. Which of the following would be an example of interest rate risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest or principal has been collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank’s net income to fall by $250,000.

E. All of the options are examples of interest rate risk.

97. Which of the following would be an example of operational risk?

A. A robber steals $250,000 from the bank locker.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of depositors.

D. A $500,000 loan that the bank has made has been deemed uncollectible.

E. None of the examples are of operational risk.

98. Which of the following would be an example of liquidity risk?

A. A bank teller manages to steal $250,000 over a period of several months.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of depositors.

D. A $500,000 that loan the bank has made has been deemed uncollectible.

E. None of the examples are of liquidity risk.

99. Which of the following would not be an example of operational risk?

A. A bank, on the coast of Louisiana, is hit by a hurricane and is flooded for 6 weeks.

B. A bank employee working as a derivatives trader, is also the one who writes the reports on profits and losses in derivatives trading every day.

C. The banks older computer system breaks down causing a loss of service to customers for 2 weeks.

D. A bank robber robs a teller at gun point and gets away before police can get to the bank.

E. All of the examples are of operational risk.

100. The Jennings Bank of Texas, wants to protect itself from credit risk by making large loans to corporate customers, by making residential mortgages to families, by making agriculture loans to farmers and ranchers in the area, by making small business loans to business along main street and by making automobile loans for the car dealership across the street from the bank. What defense against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners’ capital

E. None of the options is correct.

101. The Michelson Bank of Stetson, wants to protect itself from risk. It decides to make loans in Florida, Georgia, Texas, and Oklahoma as well as invest in municipal bonds from California and Oregon. What defense against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners’ capital

E. None of the options is correct.

102. The Perdue Bank of Houston, has just hired a new manager who has a reputation of anticipating potential problems and acting quickly to prevent those problems so that the bank stays healthy and profitable. What defense against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners’ capital

E. None of the options is correct.

103. The Norton Bank of Illinois, has just issued trust preferred stock. What defense against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners’ capital

E. None of the options is correct.

104. What type of preferred stock has appeared recently that carry a lower cost?

A. Cumulative preferred stock

B. Noncumulative preferred stock

C. Convertible preferred stock

D. Trust preferred stock

E. None of the options is correct.

105. Even if individual banks are good at forecasting risk using VaR models, there may still be problems because losses may occur at several banks at the same time due to the interdependency of the financial system, magnifying each bank’s risk exposure and possibly causing a major problem for regulators. The book calls this:

A. systemic risk.

B. operational risk.

C. credit risk.

D. market risk.

E. liquidity risk.

106. There are three pillars of Basel II. One of them is to make market discipline a powerful force compelling risky banks to lower their risk exposure. What does Basel II want to do to make this happen?

A. Require minimum capital requirement based on the bank’s own evaluation of its risk.

B. Require greater public disclosure of each bank’s true financial condition.

C. Expand the risks to be evaluated to include credit risk market risk, and operational risk.

D. Require a supervisory review of each bank’s risk evaluation procedures.

E. All of the options are correct.

107. A bank has capital to risk-weighted assets of 11.5%, Tier 1 capital to risk-weighted assets of 7.2% and a leverage ratio of 5.8%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

108. A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of 5% and a leverage ratio of 4.8%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

109. A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of 4.5% and a leverage ratio of 3.7%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

110. A bank has capital to risk-weighted assets of 5.5%, Tier 1 capital to risk-weighted assets of 2.8% and a leverage ratio of 2.6%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

111. A bank has capital to risk-weighted assets of 1.8%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

112. Which of the following is not a weakness of Basel I risk-based capital standards?

A. They ignore interest rate risk

B. They ignore changes in value due to currency value changes

C. They ignore changes in value due to commodity price changes

D. They ignore credit risk

E. They ignore the market value

113. A bank has decided to retain more of their earnings, moving their retention ratio from 40% to 70%. What way of meeting their capital needs is the bank taking?

A. Changing their dividend policy

B. Issuing common stock

C. Issuing preferred stock

D. Issuing subordinated notes and debentures

E. Selling assets and leasing facilities

114. The First National Bank of Tucson has determined that the value of their property in Tucson has tripled in the last three years. They decide that they would like to use this property to raise funds and will rent space from the new owners of the building. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

115. The Second National Bank of Lincoln has decided that, to raise funds it is going to issue new common equity through a pre-emptive rights offering, so that current owners will not have that ownership diluted. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

116. The Third State Bank of Denton has decided to issue stock through a trust company and borrow the funds from the trust company. This stock pays a fixed dividend and because of the way the stock has been issued it is tax deductible. What way of meeting their capital needs in the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

117. The Northwest Bank of Charlotte has decided to issue new securities that have five years to maturity that have claims to assets that follow the claims of depositors. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

118. Why do regulators prefer higher capital requirements?

A. It justifies the existence of regulatory agencies.

B. It protects the deposit insurance fund from serious losses.

C. It enhances bank asset quality.

D. It decreases bank profitability.

E. It increases bank leverage.

119. Why do banks generally prefer lower capital requirements?

A. To minimize the impact shareholders have on management decisions

B. To increase the influence of bank regulators

C. To increase a bank’s return on equity

D. To increase depositor protection

E. To maximize operating leverage

120. A bank has issued $5,000,000 in long term debt and since that time interest rates have risen so that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides to issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

121. Which of the following are the reasons for having the government set capital standards for financial institutions as opposed to letting the private marketplace set those standards?

A. To preserve public confidence

B. To remove each bank’s unique asset risk exposure

C. To limit losses to the federal government arising from deposit insurance claims

D. To preserve public confidence and to limit losses to the federal government arising from deposit insurance claims

E. None of the options is correct.

122. The following are the advantages of Basel II over Basel I except that:

A. it performs supervisory review of each bank’s risk-assessment procedures.

B. it provides for greater sensitivity to arbitrage and financial innovations.

C. it applies the same minimum capital requirements to all banks.

D. it broadens the types of risk considered.

E. All are advantages of using Basel II.

123. Which of the following is an internal assessment tool that is used by the participating banks to ensure that they are prepared for the possibly damaging impact of ever changing market conditions?

A. Backtesting

B. Risk aggregation

C. Stress testing

D. Systemic testing

E. Damage testing

124. According to the text, Basel II agreement had resulted in less total capital and:

A. less concentration on operating risk.

B. a weaker mix of capital.

C. more retention ratio.

D. less concentration on assets.

E. a weaker leverage ratio.

125. A standby letter of credit, backing the issue of state and local government general obligation bonds, is given a credit risk-weight of 20 percent because of its:

A. modest credit risk.

B. zero credit risk.

C. moderate credit risk.

D. low credit risk.

E. highest credit risk.

126. Along with the value at risk model, which is the other model that determines each bank’s unique market risk exposure and the amount of capital it needs?

A. Internal modeling.

B. Systemic modeling.

C. Credit risk modeling.

D. Borrower credit ratings.

E. Damage testing.

127. ________________________ represent(s) funds set aside for contingencies, such as legal action against the institution or a sinking fund to retire stock or debt in the future.

A. Undivided profits

B. Surplus

C. Preferred stock

D. Common stock

E. Equity reserves

128. Interbank deposits generally carry:

A. low credit risk.

B. high credit risk.

C. highest credit risk.

D. moderate credit risk.

E. zero credit risk.

129. Under Basel III, more flexible capital standards which includes the “buffer concept” means involvement of which two ratios?

A. Base capital and leverage ratio

B. Base capital and buffer ratio

C. Capital and risk-weighted assets ratio

D. Leverage and buffer ratio

E. Risk-weighted assets ratio and buffer ratio

Chapter 16
Lending Policies and Procedures: Managing Credit Risk

Fill in the Blank Questions

1. The ______________ is a uniform rating system developed by regulators where banks are given a rating between one and five in each of the six categories and an overall rating.

________________________________________

2. One of the 6 Cs of lending is ______________ which suggests that the lender must look at the position of the business firm in the industry and the outlook of the industry to evaluate a loan.

________________________________________

3. One of the 6 Cs of lending is ______________ which suggests that a lender must ensure that the borrower is legally entitled to sign a binding loan agreement. For an individual this entails making sure the borrower is of a legal age to sign a contract.

________________________________________

4. When a bank purchases a whole loan or a piece of a loan from another bank, they are purchasing what is known as a ___________________________.

________________________________________

5. Loans that have minor weaknesses because a bank has not followed its written loan policy or which have missing documentation are called ______________ loans.

________________________________________

6. ____________________________ loans are ones that are extended to farmers and ranchers to assist in planting crops, harvesting crops, and to support the feeding and care of livestock.

________________________________________

7. ___________________________, usually large banks, devote a bulk of their credit portfolio to large-denomination loans directed towards corporations and other businesses.

________________________________________

8. ____________________________ loans are ones that are secured by land, buildings, and other structures. These loans can be short term construction loans or longer term loans to finance the purchase of homes and apartments among others.

________________________________________

9. A(n) ______________ is a written contract signed by a borrower and states the principal amount of the loan, the interest rate on the loan, and the terms under which repayment must take place.

________________________________________

10. ____________________________ are certain actions that a borrower must take during a loan period. Examples include filing periodic financial statements with the bank and purchasing insurance on any collateral pledged.

________________________________________

11. Credit extended to banks, insurance companies, finance companies, and other similar institutions is known as _______________.

________________________________________

12. ______________ loans are ones that carry a strong probability of loss to the bank.

________________________________________

13. A(n) ______________ is the process of resolving a troubled loan so that a bank can recover its loaned funds.

________________________________________

14. ______________ is one of the key features of any loan. This is one of the Cs of lending that examines whether a borrower will be able to generate enough liquid assets to repay the loan.

________________________________________

15. A bank’s _____________________________________ gives its loan officers specific guidelines in making individual loan decisions and in shaping the overall loan portfolio.

________________________________________

16. An approach that divides the cash flows of a firm into three principal sources, namely cash flow from operations, cash flow from financing activities, and cash flow from investing activities, is known as the _____________ cash flow method.

________________________________________

17. ______________________ loans are those that are granted to businesses to cover purchases of inventory, paying taxes, and meeting payrolls.

________________________________________

18. ________________________ include credit to finance the purchase of automobiles, mobile homes, appliances, and other retail goods and services purchased by consumers.

________________________________________

19. ________________________ are types of loans where a lender buys equipment or vehicles and rents them to its customers.

________________________________________

20. Smaller banks tend to emphasize on _________________ in the form of smaller denomination personal cash loans and home mortgage loans extended to individuals and families as well as smaller business loans.

________________________________________

21. The loan mix of any lending institution depends heavily on the _____________________ that each loan offers compared to all other assets a lending institution can acquire.

________________________________________

22. Under the ___________________________ Act, no individual can be denied credit because of race, sex, religious affiliation, age or receipt of public assistance.

________________________________________

23. One of the elements of CAMELS rating system is _____________________ which looks at the quality of a bank’s loans. Examiners look at all loans over a certain size and a random selection of all other loans when looking at this aspect of a bank.

________________________________________

24. One of the six Cs of lending is ______________________ which looks at whether the borrower has a well-defined purpose for the loan and a serious intent to repay the loan.

________________________________________

25. One of the most widely consulted sources of data on business firms is ______________ which was founded in Philadelphia in 1914 to exchange credit information among business lending institutions and to organize conferences and publish educational materials to train loan officers and credit analysts.

________________________________________

26. One of the problems with the newer lending model called _________________ was found to at least partially contribute to the recent crisis in the mortgage market.

________________________________________

27. In the mortgage environment of the early 2000s, lenders were encouraged to sell individual loans and packages of loans to buy more liquid securities, thus shifting much of the risk of lending to capital markets. This process is referred to as _________________.

________________________________________

28. The risk of change in the quality of assets due to factors such as changes in the economy, natural disasters, and regulations are referred to as __________ factors, while management errors, illegal manipulation, and ineffective lending policies are considered as ___________ factors.

________________________________________

29. In a loan workout process, the preferred option is nearly always to seek a ___________, which gives both the lending institution and its customer a chance to restore normal operations.

________________________________________

True / False Questions

30. The principal reason why banks are chartered by federal and state governments is to make loans to their customers.

True False

31. Risk in banking tends to be concentrated in a bank’s loan portfolio.

True False

32. Real estate lending is popular with banks, in part, due to the growth of the secondary mortgage market.

True False

33. At least once in a year, banks in the United States are required to report the composition of their loan portfolio by purpose of loan on a report form known as Schedule A.

True False

34. Smaller banks tend to emphasize wholesale banking services.

True False

35. Retail credit in banking refers to such loans as residential mortgages and installment loans to individuals.

True False

36. Loans made by a particular bank secured by its own stock are not usually permitted except under special circumstances.

True False

37. According to the Community Reinvestment Act, selected lenders must make an “affirmative effort” to provide loans and other services to all credit-worthy borrowers in their chosen service area.

True False

38. Loans to minors are not legally enforceable contracts in most states.

True False

39. The letter “C” in the CAMELS rating system for banks in the U.S. refers to the “condition” of a bank.

True False

40. The letter “M” in the CAMELS rating system for banks in the U.S. refers to the “management quality” of a bank.

True False

41. The process of loan review means that a loan committee must generally approve a loan before the borrower is told the loan is approved.

True False

42. Troubled loans normally are subject to more frequent reviews than sound loans.

True False

43. Credit card loans are generally more profitable for small and medium-size banks than for the large banks.

True False

44. Banks should concentrate their lending on those types of loans in which they have the greatest cost advantage.

True False

45. Construction loans by a bank fall under the loan category known as commercial and industrial loans.

True False

46. If the economy slows down, a bank should review its outstanding loans more frequently.

True False

47. Loans granted to businesses appear to convey positive information to the market place about a borrower’s credit quality, enabling a borrower to obtain more and cheaper funds from other sources.

True False

48. Loans to a bank’s officers, extended for purposes other than purchase of a home or funding education and those that are not fully backed by government securities, cannot exceed 2.5 percent of the bank’s capital and unimpaired surplus or $25,000 whichever is larger but cannot exceed $100,000.

True False

49. Financial institutions that disagree with an examiner’s classifications of their loans can appeal against these ratings.

True False

50. A rating of “5” is the highest and the best rating that a U.S. bank can receive under the CAMELS rating system.

True False

51. Accounts receivable financing entails a bank actually taking over the ownership of receivables, whereas factoring entails a bank merely lending money against a borrowing customer’s receivables and the customer still retains the ownership of the receivables.

True False

52. A restriction against a borrower taking on new debt during a loan period is an affirmative covenant in a loan contract.

True False

53. Loan review is considered to be a luxury, not a necessity for most banks, especially those with sound lending policies.

True False

54. Cash is one of the six Cs of lending and refers to the fact that the lender wants to make sure that the borrower has the ability to generate enough cash to repay the loan.

True False

55. There are three principal sources of cash to repay a loan. These are cash flows generated from sales or income, funds generated from the liquidation of assets, and, funds raised by selling debt or equity securities.

True False

56. Negative covenants require the borrower to take certain actions, such as periodically filing of financial statements and maintaining insurance coverage.

True False

57. Affirmative covenants restrict a borrower from doing certain things, like taking on new debt without the lender’s approval.

True False

58. For ease and convenience, most banks have the loan review conducted by the same person who makes the loan. This is particularly true of large banks.

True False

59. A loan workout is when a bank and its customer initially negotiate the terms of a loan.

True False

60. A written loan policy gives loan officers and the bank’s management specific guidelines in making individual loan decisions and in forming the bank’s loan portfolio.

True False

61. Commercial and industrial loans are loans to businesses to cover such things as purchasing inventory, paying taxes, and meeting payroll expenses.

True False

62. Agriculture loans are ones that are made to individuals to finance vacations, purchase durable goods, and other retail goods.

True False

63. The “A” in the CAMELS rating system stands for asset quality.

True False

64. Net cash flow from operations is a borrower’s net income expressed in cash rather than on an accrual basis.

True False

65. The “direct cash flow” method and “cash flow by origin” are two very different ways of assessing the cash flows of a potential borrower.

True False

66. Commercial banks are the largest originator of household loans.

True False

67. Following the recent global credit crisis, regulators have begun to emphasize the need for loan originators to know their borrowers better and retain some of the risk on loans that they sell.

True False

Multiple Choice Questions

68. The principal economic function of banks is to:

A. take deposits.

B. make loans.

C. sell financial services.

D. encourage spending.

E. None of the options is correct.

69. Loans extended to finance the purchase of automobiles, mobile homes, home appliances, and vacations are classified as:

A. real estate loans.

B. financial institution loans.

C. agricultural loans.

D. commercial and industrial loans.

E. None of the options is correct.

70. According to the textbook, the largest category (by dollar volume) of loans extended by U.S. banks is:

A. real estate loans.

B. financial institution loans.

C. agricultural loans.

D. commercial and industrial loans.

E. None of the options is correct.

71. Banks that emphasize on lending to commercial customers are categorized as:

A. wholesale banks.

B. retail banks.

C. personal banks.

D. investment banks.

E. regional banks.

72. The maximum outstanding loans for all FDIC-insured institutions are classified as:

A. lease financing receivables.

B. miscellaneous loans.

C. loans to depository institutions.

D. real estate loans.

E. agricultural loans.

73. In the United States, national banks cannot extend an unsecured loan to a single borrower that exceeds _____________ of the bank’s capital and surplus.

A. 25 percent

B. 10 percent

C. 15 percent

D. 20 percent

E. None of the options is correct

74. Real estate loans made by national banks in the U.S. cannot exceed:

A. 15 percent of that bank’s total assets or 25 percent of its total capital.

B. that bank’s total capital and surplus or 70 percent of its time and savings deposits, whichever is greater.

C. 20 percent of that bank’s capital and surplus or 80 percent of its savings deposits, whichever is lesser.

D. 25 percent of capital or 10 percent of core deposits of the bank, whichever is higher.

E. None of the options is correct.

75. Loans to finance one-to-four family homes fall under which loan category?

A. Commercial and industrial loans

B. Real estate loans

C. Loans to individuals

D. Single-payment loans

E. None of the options is correct.

76. Loans providing credit to finance the purchase of automobiles, mobile homes, appliances, and other retail goods to repair and modernize homes are classified under the category:

A. financial institution loans.

B. commercial industrial.

C. loans to individuals.

D. miscellaneous loans.

E. None of the options is correct.

77. Loans extended to farm and ranch operations to assist in planting and harvesting crops and to support the feeding and care of livestock are known as:

A. real estate loans.

B. commercial and industrial loans.

C. land loans.

D. agricultural loans.

E. None of the options is correct.

78. Loans granted to businesses to cover such expenses as purchasing inventories, paying taxes, and meeting payrolls are known as:

A. commercial and industrial loans.

B. agricultural loans.

C. real estate loans.

D. loans to individuals.

E. None of the options is correct.

79. A lender that makes a loan to a minor would be violating which of the 6 Cs of lending?

A. Character

B. Capacity

C. Cash

D. Control

E. Collateral

80. A lender that makes a loan that violates its written loan policy would be violating which of the 6 Cs of lending?

A. Character

B. Capacity

C. Cash

D. Control

E. Collateral

81. Which of the following is a factor in determining the mix of loans that a bank has?

A. Location of the bank

B. Size of the bank

C. Written loan policy of the bank

D. Experience and expertise of the management

E. All of the options are factors in determining the mix of loans for a bank

82. A loan to a local business to purchase a new machine would be categorized as:

A. a consumer loan.

B. an agriculture loan.

C. a commercial and industrial loan.

D. a real estate loan.

E. None of the options is correct.

83. A lender’s secondary source of repayment in case of a default is:

A. capacity.

B. collateral.

C. character.

D. capital.

E. credit.

84. A lender that makes a loan to an individual whose only income is commission based and who hasn’t made a sale in six weeks may be violating which of the 6 Cs of lending?

A. Character

B. Capacity

C. Cash

D. Control

E. Collateral

85. Sean Carter has an excellent credit rating. Which of the 6 Cs of lending would this piece of information belong to?

A. Character

B. Capacity

C. Cash

D. Collateral

E. Conditions

86. First National Bank of Edmond asks a prospective customer for her driver’s license. Which of the 6 Cs of lending would this piece of information belong to?

A. Character

B. Capacity

C. Cash

D. Collateral

E. Conditions

87. A loan officer of Second National Bank of Laramie decides to review the insurance coverage of one of its business customers. Which of the 6 Cs of lending would this piece of information belong to?

A. Character

B. Capacity

C. Cash

D. Collateral

E. Conditions

88. The TRC Company is required by its bank to pay no dividend over $3 per share. What is this restraint known as?

A. An affirmative covenant

B. A negative covenant

C. A special covenant

D. A horizontal covenant

E. None of the options is correct

89. A bank that primarily makes its loans to individuals, families, and small businesses is categorized as:

A. a retail bank

B. a wholesale lender

C. a money center bank

D. a money market bank

E. None of the options is correct

90. The process of resolving a troubled loan so that a lender can recover its funds is called:

A. loan review.

B. written loan policy.

C. loan workout.

D. loan commitment agreement.

E. None of the options is correct.

91. Which of the following is a sign of a potential loan problem?

A. Timely receipt of financial statements from the company that has taken a loan

B. Regular increase in the stock price of the company that has taken a loan

C. Increase in earnings for each of the last three years of a company that has taken a loan

D. Changes in the methods used to account for inventory, depreciation, and other items

E. All of the options are signs of problems with the loan

92. Which of the following should be part of the written loan policy?

A. Lending authority of each loan officer and loan committee

B. Lines of responsibility for finding and reporting information within the loan department

C. A statement of quality standards for all loans

D. A statement for the preferred upper limit for total loans outstanding

E. All of the options should be part of the written loan policy

93. A lender reviews the partnership agreement of one of its small business customers. Which of the 6 Cs of lending would this piece of information belong to?

A. Character

B. Capacity

C. Cash

D. Collateral

E. Conditions

94. Which of the following requires that bank loans to insiders be priced at market rates?

A. Community Reinvestment Act of 1977

B. Equal Credit Opportunity Act of 1974

C. Sarbanes-Oxley Act of 2002

D. Bank Lending Act of 2003

E. U.S. Patriot Act

95. A method whereby a loan officer focuses on why a borrower’s cash flows may change over time is known as:

A. indirect cash flow.

B. direct cash flow.

C. pervasive cash flow.

D. variable cash flow.

E. total cash flow.

96. The South Carolina National Bank makes a loan to the Heritage Credit Union. What type of loan did this bank make?

A. Financial institution loan

B. Commercial and industrial loan

C. Loans to individuals

D. Miscellaneous loans

E. Lease financing receivables

97. A loan for Colin Beverly to purchase a new Mazda Miata would fit into which of the following categories of bank loans?

A. Financial institution loan

B. Commercial and industrial loan

C. Loan to an Individual

D. Miscellaneous loan

E. Lease financing receivables

98. The Price Bank of Edmond makes a loan to Home Depot. What type of loan has this bank made?

A. Financial institution loan

B. Commercial and industrial loan

C. Loan to an individual

D. Miscellaneous loan

E. Lease financing receivables

99. The First State Bank of Duncan buys railroad cars and rents them to the Santa Fe Railroad Company. What type of loan has this bank made?

A. Financial institution loan

B. Commercial and industrial loan

C. Loan to an individual

D. Miscellaneous loan

E. Lease financing receivables

100. The Third National Bank of Wichita makes a loan so that Tim Bridges can buy 1,000 shares of Coca Cola stock. Which category of loans would this loan fit in best?

A. Financial institution loan

B. Commercial and industrial loan

C. Loan to an individual

D. Miscellaneous loan

E. Lease financing receivables

101. The First State Bank is located in Guyman which is in the middle of the wheat country of Oklahoma and as a result many of its loans are agriculture loans. What factor determining the growth and mix of loans does this fact reflect?

A. Characteristics of the market area

B. Lender size

C. The experience and expertise of management

D. The written loan policy of the bank

E. Bank regulations

102. The Second State Bank has less than $100 million in assets and as a result primarily makes real estate loans, other consumer loans and loans to very small businesses. What factor determining the growth and mix of loans does this fact reflect?

A. Characteristics of the market area

B. Lender size

C. The experience and expertise of management

D. The written loan policy of the bank

E. Bank regulations

103. Geoff Willis and Mary Williams, president and CEO respectively of the First National Bank of Edmond, come from a background in retail banking. As a strategic initiative, they have decided to focus their lending activities on consumer loans and loans to small business. What factor determining the growth and mix of loans does this fact reflect?

A. Characteristics of the market area

B. Lender size

C. The experience and expertise of management

D. The written loan policy of the bank

E. Bank regulations

104. First State Bank’s loan policy manual states ‘that the goal of the bank is to make high quality loans for home mortgages, the purchase of automobiles and small business accounts receivables’. What factor determining the growth and mix of loans does this fact reflect?

A. Characteristics of the market area

B. Lender Size

C. The experience and expertise of management

D. The written loan policy of the bank

E. Bank regulations

105. The Second National Bank has capital and surplus of $100 million. The bank has decided that the most that it can loan to the Krumlova Manufacturing Company is $15 million. What factor determining the growth and mix of loans does this most likely reflect for the bank?

A. Characteristics of the market area

B. Lender size

C. The experience and expertise of management

D. The written loan policy of the bank

E. Bank regulations

106. Loans that examiners consider as having significant weaknesses or those represent a dangerous concentration of credit in one borrower or industry are called:

A. criticized loans.

B. scheduled loans.

C. substandard loans.

D. doubtful loans.

E. loss loans.

107. A loan that examiners regard as uncollectible and unsuitable to be called a bank asset is called a:

A. criticized loan.

B. scheduled loan.

C. substandard loan.

D. doubtful loan.

E. loss loan.

108. The law that requires banks to make ‘an affirmative effort’ to meet the credit needs of individuals and businesses in their trade territories is called:

A. The Sarbanes-Oxley Act.

B. The Community Reinvestment Act.

C. The Equal Credit Opportunity Act.

D. The Truth in Lending Act.

E. None of the options is correct.

109. The law that prevents individuals from being denied credit because of race, sex, religious affiliation, age or receipt of public assistance is called:

A. The Sarbanes-Oxley Act.

B. The Community Reinvestment Act.

C. The Equal Credit Opportunity Act.

D. The Truth in Lending Act.

E. None of the options is correct.

110. Dan Cross is a junior loan officer with First State Bank of Durant. He has been busy visiting local businesses to see if any of them need credit. Which step in the lending process is Dan performing?

A. Finding prospective customers

B. Evaluating a customer’s character and sincerity

C. Making a site visit and evaluating a customer’s credit history

D. Evaluating a prospective customer’s financial condition

E. Assessing possible collateral and signing the loan agreement

111. Shelby Mann is a loan officer with the First National Bank. She interviews a potential loan customer to find out exactly why the person needs the loan and whether he would be serious about repaying the loan. Which step in the lending process is Shelby performing?

A. Finding prospective customers

B. Evaluating a customer’s character and sincerity

C. Making a site visit and evaluating a customer’s credit history

D. Evaluating a prospective customer’s financial condition

E. Assessing possible collateral and signing the loan agreement

112. Jessica Simpson, a loan officer with First National Bank, visits the Tate Manufacturing Company and talks to other lenders to see their experience with Tate Manufacturing. What step in the lending process is Jessica performing?

A. Finding prospective customers

B. Evaluating a customer’s character and sincerity

C. Making a site visit and evaluating a customer’s credit history

D. Evaluating a prospective customer’s financial condition

E. Assessing possible collateral and signing the loan agreement

113. Terry May, a loan officer with First National Bank, calculates liquidity and debt ratios for the Lava Lamp Company and also examines their cash flow statement. What step in the lending process is Terry performing?

A. Finding prospective customers

B. Evaluating a customer’s character and sincerity

C. Making a site visit and evaluating a customer’s credit history

D. Evaluating a prospective customer’s financial condition

E. Assessing possible collateral and signing the loan agreement

114. Jerry LeGere, a loan officer with First National Bank, checks to see if the house pledged to back up a home mortgage has a clear title and proper insurance. What step in the lending process is Jerry performing?

A. Finding prospective customers

B. Evaluating a customer’s character and sincerity

C. Making a site visit and evaluating a customer’s credit history

D. Evaluating a prospective customer’s financial condition

E. Assessing possible collateral and signing the loan agreement

115. The Tate Manufacturing Company has $150 million in sales revenue with $90 million in cost of goods sold. It has selling and administrative expenses of $10, pays annual taxes in the amount of $10 and has depreciation and other non-cash expenses of $30 million. What are this firm’s annual projected cash flows?

A. $150 million

B. $60 million

C. $70 million

D. $40 million

E. None of the options is correct

116. A depository institution’s _________________ normally determines its legal lending limit to a single borrower.

A. volume of capital

B. number of customers

C. number of employees

D. number of offices

E. profitability

117. Net yield for a bank is calculated as:

A. total revenues received/total loan volume.

B. fee income/total value of services rendered

C. total revenues received/total capital.

D. (total revenues received – expenses and losses)/total loan volume.

E. (total revenues received – expenses and losses)/total capital.

118. Royal Bank of New York, a U.S. national bank, has $25 million in capital and surpluses and $42 million in total time and savings deposits. Average revenue for the bank in the last three years is $8.5 million and a net interest income of $2.1 million. What is the maximum volume of real estate loans that the bank can make?

A. $25 million

B. $29.4 million

C. $8.5 million

D. $25.5 million

E. $2.1 million

119. Standard Bank, a U.S. national bank, has $50 million in unimpaired capital and surpluses and $86 million in total time and savings deposits. Average revenue for the bank in the last three years is $12.5 million and a net interest income of $3.2 million. Pluto Inc. has applied for an unsecured loan of $9 million to the bank. What is the maximum amount of loan the bank can make to Pluto?

A. $9 million

B. $4.5 million

C. $7.5 million

D. $0.9 million

E. The bank cannot make unsecured loans

120. Standard Side Bank, a U.S. national bank, has $50 million in unimpaired capital and surpluses and $86 million in total time and savings deposits. Average revenue for the bank in the last three years is $12.5 million and a net interest income of $3.2 million. Pluto Inc. has applied for a loan of $9 million to the bank against which it is willing to provide $1 million worth of ten-year treasury securities. What is the maximum amount of loan the bank can make to Pluto?

A. $9 million

B. $4.5 million

C. $7.5 million

D. $8.5 million

E. $1 million

121. Timothy Gartner, an employee in the Bank of Trust and Faith, has requested for a loan of $200,000 to buy a private cruise. The bank has an unimpaired capital and surplus of $38 million and $75 million in total time and savings deposits. Average revenue for the bank in the last three years is $18.5 million and a net interest income of $5.2 million. What is the maximum amount of loan the bank can grant to Timothy?

A. $950,000

B. $200,000

C. $25,000

D. $100,000

E. The bank cannot make loans to its own employees

122. Disclosure laws require that a borrower be quoted the “true cost” of a loan, as reflected in the:

A. internal rate of return (IRR).

B. annual percentage rate (APR).

C. net present value (NPV).

D. flat rate of interest.

E. interest rate on reducing balance.

123. Typically, loan examiners place adversely classified loans into three categories. Loans in which the margin of protection is inadequate due to weaknesses in collateral or in the borrower’s repayment abilities are categorized as:

A. substandard loans.

B. loss loans.

C. doubtful loans.

D. unproductive loans.

E. bad loans.

124. A good collateral for the purpose of protecting a lender should be:

A. durable.

B. easy to identify.

C. marketable.

D. stable in value.

E. All the options are qualities of a good collateral.

125. A written document in which a lender promises to make credit available to a borrower, over a designated future period, up to a maximum amount in return for a commitment fee is known as a(n):

A. negative covenant.

B. loan guarantee agreement.

C. loan policy agreement.

D. loan commitment agreement.

E. affirmative covenant.

Chapter 17
Lending to Business Firms and Pricing Business Loans

Fill in the Blank Questions

1. A(n) __________________________________ is generally used to finance the purchase of inventory to sell and take advantage of the firm’s normal cash cycle to repay the loan.

________________________________________

2. A(n) ______________________ is generally used to support the construction of homes, apartments, office buildings, and other permanent structures.

________________________________________

3. Working capital loans often require _____________________. These are required deposits in the bank by the borrower whose size is dependent on the size of the credit line.

________________________________________

4. When the title to accounts receivables pledged in an asset-based loan is passed to the lender and the lender takes the responsibility of collecting the accounts receivables of one of its business customers, this is called ____________________.

________________________________________

5. A(n) ______________________ is the purchase of a publicly traded company by a small group of investors. These investors often borrow very heavily to finance the purchase of the stock of the company.

________________________________________

6. ____________________________________________ are the other potential claims against the borrower which do not show up on the borrower’s balance sheet. One new form of this is due to environmental damage by the borrower.

________________________________________

7. ______________________ are designed to fund long-term investments such as the purchase of equipment. Money is borrowed in one lump sum and repayments are generally made in installments.

________________________________________

8. A(n) _________________________________________ is a contractual promise by a bank to lend to a customer up to a maximum amount of money at a set interest rate (or rate markup over the rate prime or LIBOR). The only way the bank can renege on its promise is if there has been a “material adverse change” in the borrower’s financial condition.

________________________________________

9. ______________________ examines how effectively assets are being utilized to generate sales and how efficiently sales are converted into cash.

________________________________________

10. A(n) ______________________ is a loan extended to a business firm by a group of lenders in order to reduce the risk exposure to any one lending institution and to a earn fee income.

________________________________________

11. ______________________ refers to the protection afforded to creditors of a firm based on the amount of the firm’s earnings.

________________________________________

12. The borrower’s ______________________ position reflects his or her ability to raise cash in a timely fashion at a reasonable cost.

________________________________________

13. _____________________________ are the ultimate standards of performance in a market-oriented economy. These measure the net income that remains for owners after all expenses (except stockholder dividends) have been charged against revenues.

________________________________________

14. ______________________ refers to the borrowers’ use of debt in their firm.

________________________________________

15. Wages and salaries to net sales, overhead expenses to net sales, and cost of goods sold to net sales are all measures of ___________________________________________.

________________________________________

16. _________________________________ is a way to price loans which starts with the costs of making a loan and adds to it a risk premium for default risk and a desired profit margin.

________________________________________

17. The ______________________ approach to pricing a loan starts with a base interest rate and adds a risk premium for default and for time to maturity.

________________________________________

18. The ______________________ is the interest rate charged to the bank’s most creditworthy customers on short-term working capital loans.

________________________________________

19. _____________________ is the rate on short-term Eurocurrency deposits which range in maturity from a few days to a few months.

________________________________________

20. The ______________________________ is a way to price loans which allows banks to compete with the commercial paper rate.

________________________________________

21. The ______________________ is a way of pricing loans that allows a bank to take into account the entire relationship the bank has with the customer when pricing the loan.

________________________________________

22. ______________________ is the average deposit balance by the customer minus the average float adjusted for reserve requirements.

________________________________________

23. The ______________________________________ is the risk premium that has to do with the quality of the borrower.

________________________________________

24. The _______________________ is the risk premium that has to do with the time to maturity on the borrowed funds.

________________________________________

25. ____________________________ is the cost to the lender for borrowing adequate funds in the cost-plus loan pricing model.

________________________________________

26. In the price leadership model, the amount above the prime rate is often called the ____________.

________________________________________

27. A proposed loan is acceptable to the lender when the net rate of return from a customer profitability analysis is _____________________.

________________________________________

28. SNCs are also known as _____________ loans.

________________________________________

29. Weak loans considered to be substandard or doubtful are also known as __________ credits.

________________________________________

30. An interest rate most widely used to price large-denomination business loans extended by banks operating in the U.S. is ________.

________________________________________

31. The ___________ is considered to be the most common base rate figure announced by the majority of the largest banks that publish their loan rates regularly.

________________________________________

32. The advent of inflation and more volatile interest rates gave rise to a(n) ____________, tied to changes in important money market interest rates such as the 90-day commercial paper rate.

________________________________________

33. ___________ loans represent the earliest form of lending that banks have carried out in their more than 2,000-year history.

________________________________________

34. _____________ provide businesses with short-term credit, lasting from a few days to about one year. These loans come close to self-liquidating loans.

________________________________________

35. ____________ is a type of short-term loan, where the business lenders support installment purchases of automobiles, home appliances, furniture, business equipment, and other durable goods by financing the receivables that dealers take on when they write installment contracts to cover customer purchases.

________________________________________

36. The apparent size bias in the financial marketplace led to the creation of the __________ in the 1950s, to guarantee loans made to small businesses by private lending institutions.

________________________________________

37. The most risky of all business loans are __________. This is credit to finance the construction of fixed assets designed to generate a flow or revenue in future periods. This can include financing a new oil refinery, power plant, or other similar fixed assets.

________________________________________

38. A firm’s balance sheet figures expressed as a percentage of total assets are often called __________.

________________________________________

39. A third financial statement, used in addition to the income statement and balance sheet by lenders, is the __________. It is required by FASB and is usually readily available from borrowers.

________________________________________

True / False Questions

40. Foreclosure on property pledged behind a bank loan does not subject a bank to be held liable to clean up any environmental damage the borrower may have caused.

True False

41. A concern in the banking and commercial finance industries today is that traditional inventory loans may be on the decline.

True False

42. Self-liquidating business loans are designed to take advantage of the normal cash cycle in a business firm.

True False

43. An increasing portion of short-term lending in recent years has consisted of asset-based loans.

True False

44. Working capital loans are normally secured by a business firm’s plant and equipment.

True False

45. Working-capital loans, unlike most other types of business loans, usually require the customer to keep a compensating deposit balance with the lending bank.

True False

46. Leveraged buyouts (LBOs) involve the purchase of businesses with at least 75 percent of the cost of the purchase funded by current earnings and sales of stock.

True False

47. A project loan is granted to several companies jointly sponsoring a large project, and the lender can recover funds from such sponsoring companies, if the project does not pay out as planned. This is known as a project loan granted on a recourse basis.

True False

48. Term loans normally are secured by accounts receivable and inventory.

True False

49. Term loans look primarily to the flow of future earnings of the borrowing business firm to amortize and retire its loan.

True False

50. Under recent EPA guidelines, if a lender forecloses on environmentally damaged property, the lender must post that property for sale within 12 months after securing marketable title.

True False

51. To avoid environmental liability under recent EPA guidelines, a lender must hold a deed of trust, lien, or mortgage.

True False

52. Under current federal laws, a lender is required to make an environmental site assessment of the borrower’s property in order to avoid environmental liability.

True False

53. Floor planning agreements typically include a loan-loss reserve, built up from interest earned as borrowers repay their installment loans.

True False

54. If a bank’s agent visits a dealer using floor planning and finds any inventory items sold for which the bank providing finance has not received payment, the loan will be immediately foreclosed upon.

True False

55. When a bank examines a borrower’s operating efficiency, it is looking at the protection afforded to creditors from the borrower’s earnings.

True False

56. The firm’s coverage ratios measure how carefully the firm’s management monitor and control its expenses.

True False

57. Liquidity indicators measure a business firm’s ability to raise cash in a timely fashion at a reasonable cost.

True False

58. The ultimate standard of performance in a market-oriented economy is how much net income remains after all expenses (except stockholder dividends) have been charged against revenues.

True False

59. The business loan pricing method that relies upon banks knowing their costs, is the price leadership model.

True False

60. The price leadership model for long-term loan pricing includes a markup for default risk, but not for term risk.

True False

61. The sum of the default-risk premium plus the term-risk premium on a business loan is one of the elements of the cost-plus loan pricing method.

True False

62. In order to control the risk exposure on their business loans most banks use both price and credit rationing to regulate the size and composition of their loan portfolios.

True False

63. In a period of rising interest rates, the times-prime method causes the customer’s loan rate to rise faster than the prime-plus method.

True False

64. If interest rates fall, a customer’s loan rate will decline more rapidly under the times-prime method than under the prime-plus method of business loan pricing.

True False

65. Banks attempting to compete with the growing commercial paper market developed the cost-plus business loan pricing method.

True False

66. The loan-pricing method, that takes the whole customer relationship into account when pricing each loan request, is known as the cost-benefit loan pricing method.

True False

67. The loan-pricing technique known as CPA, can be used to identify the most profitable types of bank customers, loans, and also the most successful loan officers.

True False

68. The basic strength of the cost-plus loan pricing method is that it considers the competition from other lenders.

True False

69. The basic weakness of the cost-plus loan pricing method is that it gives little regard to the competition from other lenders while setting the loan price.

True False

70. The basic strength of the below-prime market pricing model is that it allows the bank to lend at low money market interest rates plus a small margin to cover risk exposure and provide a profit margin.

True False

71. The basic strength of the below-prime market pricing model is that there are narrow margins or markups on loans.

True False

72. A majority of classified syndicated loans are held by banks.

True False

73. Syndicated loans are a type of working capital loan.

True False

74. According to the textbook, small business lending by banks is on the decline.

True False

75. The amount of business lending tends to rise during periods of expansion.

True False

76. The amount of business lending tends to fall during recessionary periods.

True False

Multiple Choice Questions

77. Short-term lending to support the construction of homes, apartments, office buildings, shopping centers, and other permanent structures is known as a (or an):

A. self-liquidating.

B. working capital loan.

C. interim construction loan.

D. asset-based loan.

E. None of the options is correct.

78. Business loans designed to fund long-term business investments, such as the purchase of equipment or the construction of physical facilities, covering a period longer than one year are known as:

A. working capital loans.

B. term loans.

C. interim construction financing.

D. durable goods loan.

E. None of the options is correct.

79. A loan whose principal is not due to be paid back until the loan’s term ends and in which only interest is paid periodically during the life of the loan is called a (or an):

A. working capital loan.

B. project loan.

C. bullet loan.

D. interim construction loan.

E. None of the options is correct.

80. A credit agreement in which a business customer may borrow up to a pre-specified limit, repay all or a portion of the borrowing, and reborrow as necessary until the credit line matures is known as a(an):

A. interim construction.

B. project loan.

C. working-capital loan.

D. revolving credit line.

E. None of the options is correct.

81. When analyzing a commercial loan credit request, which of the following statements is (are) correct?

A. The lender should check qualifications of the borrowing firm’s management.

B. The lender should evaluate the potential expenses incurred to service the loan.

C. The lender should check whether adequate insurance coverage will be secured.

D. The lender should consider the trends in market demand.

E. All of the options are correct.

82. Banks frequently bid on the opportunity to finance the entire inventory of dealers selling automobiles, business and electronic equipment, and other durable goods through a ___________ arrangement.

A. factoring

B. floor planning

C. project loan

D. revolving line of credit

E. None of the options is correct.

83. The most common sources that lenders look to for repayment of business loans include all of the following except:

A. the borrower’s cash flow.

B. assets pledged as collateral.

C. goodwill of the borrower.

D. the borrower’s net worth.

E. None of the options is correct.

84. When analyzing the financial statements of a business, a credit analyst will look for ratios in which of the following categories?

A. Profitability

B. Coverage

C. Operating efficiency

D. Liquidity

E. All are categories of ratios that bankers will look for.

85. Recent federal guidelines put in place by the Federal Deposit Insurance Corporation require banks to develop written procedures to protect against loss from environmental damage. These procedures are known as the:

A. lender protection program.

B. environmental risk assessment program.

C. lender liability security program.

D. environmental pollution control program.

E. None of the options is correct.

86. Term loans normally are secured by:

A. fixed assets.

B. accounts receivable.

C. inventories.

D. personal property.

E. None of the options is correct.

87. Under court interpretation of the Comprehensive Environmental Response, Compensation, and Liability Act, lenders may be liable for clean-up costs of hazardous substances if:

A. the lender is involved in managing property with hazardous wastes.

B. the lender has a strong association with the property owner.

C. the lender has treated the interest in the borrower’s property as a long-term investment.

D. All of the options are correct.

E. the lender does not take action primarily to protect the credit they have extended.

88. A bank that wants to examine the operating efficiency of a borrower would most likely examine which of the following ratios?

A. Cost of goods sold ÷ Average inventory

B. Income before interest and taxes ÷ Interest payments

C. Cost of goods sold ÷ Net sales

D. Current assets ÷ Current liabilities

E. All of the options are correct.

89. A bank that wants to examine the liquidity of a borrower would most likely examine which of the following ratios?

A. Costs of goods sold ÷ Average inventory

B. Income before interest and taxes ÷ Interest payments

C. Cost of goods sold ÷ Net sales

D. Current assets ÷ Current liabilities

E. All of the options are correct.

90. A bank wants to examine whether the borrower can raise cash in a timely fashion to pay bills that are coming due. This bank would most likely examine which of the following categories of ratios?

A. Customer’s control over expenses

B. Customer’s liquidity

C. Customer’s operating efficiency

D. Customer’s profitability

E. None of the options is correct.

91. A security dealer requires credit to add new government securities to his security portfolio. What type of loan is this?

A. Asset-Based Financing

B. Working capital loan

C. Security dealer financing

D. Revolving credit financing

E. None of the options is correct.

92. Credit is extended to a company up to one year to purchase raw materials and cover a seasonal peak need for cash. What type of loan is this?

A. Interim Construction Financing

B. Working capital loan

C. Security dealer financing

D. Revolving credit financing

E. None of the options is correct.

93. The term of an inventory loan is being set to match the exact length of time needed to generate sufficient cash to repay the loan. What type of loan is this?

A. Self-liquidating inventory loan

B. Working capital loan

C. Security dealer financing

D. Revolving credit financing

E. None of the options is correct.

94. A business receives a three year line of credit against which it can borrow, repay, and borrow again if necessary during the loan’s three year term. What type of loan is this?

A. Self-liquidating inventory loan

B. Working capital loan

C. Security dealer financing

D. Revolving credit financing

E. None of the options is correct.

95. A loan or line of credit extended to a business by a group of lending institutions in order to reduce the risk exposure is known as:

A. an LBO.

B. a revolving line of credit.

C. a working capital loan.

D. a syndicated loan.

E. None of the options is correct.

96. A bank that is examining the ratio of total liabilities to total assets, is examining which category of ratios?

A. Expense control measures

B. Operating efficiency measures

C. Coverage measures

D. Liquidity measures

E. Leverage measures

97. A bank that is examining the ratio of annual costs of goods sold to average inventory, is examining which category of ratios?

A. Expense control measures

B. Operating efficiency measures

C. Coverage measures

D. Liquidity measures

E. Leverage measures

98. A bank that is examining the ratio of overhead expenses to net sales, is examining which category of ratios?

A. Expense control measures

B. Operating efficiency measures

C. Coverage measures

D. Liquidity measures

E. Leverage measures

99. Which dimension of a business firm’s financial and operating performance, would unfunded pension liabilities fit best?

A. Profitability measure

B. Market indicator

C. Contingent liability

D. Marketability of the product or service

E. None of the options is correct.

100. Which dimension of a business firm’s financial and operating performance would the gross profit margin fit best?

A. Liquidity measure

B. Market indicator

C. Contingent liability

D. Marketability of the product or service

E. None of the options is correct.

101. According to the cost-plus model for pricing loans, the factors that should be considered in pricing a loan include:

A. the marginal cost of raising loanable funds to support the loan request.

B. the lender’s nonfunds operating costs.

C. an appropriate margin to compensate the bank for default risk.

D. the bank’s desired profit margin.

E. All of the options are required as factors to price a loan.

102. The business loan pricing method that includes the nonfunds operating costs of making a loan and the bank’s desired profit margin as some of its factors in pricing a loan, is called:

A. the cost-plus loan pricing method.

B. the price leadership model.

C. the markup model.

D. customer profitability analysis.

E. None of the options is correct.

103. The business loan pricing method that estimates the before-tax yield expected from the loan by considering the all revenues and expenses associated with a particular borrower and the net amount of loanable funds that the bank must turn over to the borrower, is called the:

A. the cost-plus loan pricing method.

B. the price leadership model.

C. the below-prime market pricing model.

D. customer profitability analysis.

E. None of the options is correct.

104. Suppose a business borrower is quoted a loan rate of two percentage points above the prevailing prime interest rate posted by leading U.S. banks. This is an example of the:

A. times-prime pricing method.

B. market-based pricing method.

C. cost-plus loan pricing method.

D. prime-plus pricing method.

E. customer profitability analysis.

105. The method of pricing a business loan that contends that a bank should take the whole customer relationship into account when pricing each loan request is the:

A. cost-plus loan pricing method.

B. price leadership model.

C. below-prime rate pricing model.

D. customer profitability analysis.

E. None of the options is correct.

106. The business loan pricing method that bases a loan rate on a relatively low money market interest rate (such as the Federal funds rate) plus a small margin to cover risk exposure and a profit margin is known as the:

A. price leadership model.

B. below-prime pricing model.

C. cost-plus loan pricing method.

D. customer profitability analysis.

E. None of the options is correct.

107. Which of the following is true of the cost-plus loan pricing method?

A. It considers the competition from other lenders.

B. It allows the bank to compete more aggressively with the commercial paper market.

C. It considers the marginal cost of raising loanable funds.

D. It takes the whole customer relationship into account.

E. None of the options is correct.

108. Which of the following is true of the price leadership loan pricing method?

A. It does not consider the marginal cost of raising funds.

B. It does not give much regard for the competition from other lenders.

C. The bank must know what their costs are in order to make correctly priced loans.

D. The bank must consider the revenues and expenses from all of the bank’s dealings with the customer.

E. None of the options is correct.

109. Which of the following is a strength of the markup (or below-prime market) loan pricing method?

A. It considers the competition from other lenders.

B. It allows the bank to compete more aggressively with the commercial paper market.

C. It considers the cost of loanable funds and the operating costs of running the bank.

D. It takes the whole customer relationship into account.

E. None of the options is correct.

110. Which of the following is true of the cost-plus loan pricing method?

A. It takes the whole customer relationship into account.

B. It gives much regard for the competition from other lenders.

C. It assumes the bank’s costs in order to make correctly priced loans.

D. It takes into consideration the prime rate to correctly price a loan.

E. All of the options are correct.

111. Which of the following is a strength of the price leadership loan pricing method?

A. It considers the competition from other lenders.

B. It allows the bank to compete more aggressively with the commercial paper market.

C. It considers the cost of loanable funds and the operating costs of running the bank.

D. It takes the whole customer relationship into account.

E. None of the options is correct.

112. Which of the following is a strength of the customer profitability analysis method for pricing loans?

A. It considers the competition from other lenders.

B. It allows the bank to compete more aggressively with the commercial paper market.

C. It considers the cost of loanable funds and the operating costs of running the bank.

D. It takes the whole customer relationship into account.

E. None of the options is correct.

113. The business loan pricing method which starts with a base rate such as a bank’s prime rate and adds a markup for default and term risk is known as:

A. the cost-plus loan pricing method.

B. the price leadership model.

C. the below-prime rate pricing model.

D. customer profitability analysis.

E. None of the options is correct.

114. A bank has determined that its marginal cost of raising funds is 4.5 percent and that its nonfunds costs to the bank are 0.5 percent. It has also determined that its margin to compensate the bank for default risk for a particular customer is 0.30 percent. It has also determined that it wants to have a profit margin of 0.3 percent. If this customer wants to borrow $10,000,000, how much in total interest costs will this customer pay in one year?

A. $450,000

B. $480,000

C. $510,000

D. $560,000

E. None of the options is correct.

115. A bank has determined that its marginal cost of raising funds is 4.5 percent and that its nonfunds costs to the bank are 0.5 percent. It has also determined that its margin to compensate the bank for default risk for a particular customer is .30 percent. It has also determined that it wants to have a profit margin of .3 percent. What business loan model is this bank using to price the loan for this customer?

A. The cost-plus loan pricing method

B. The price leadership model

C. The below-prime rate pricing model

D. Customer profitability analysis

E. None of the options is correct.

116. A bank has a prime rate of 6 percent for its best customers. It has determined that the default risk premium for a particular customer is 0.4 percent and the term-risk premium for this loan is 0.25 percent. If this customer wants to borrow $5.0 million from the bank, how much in interest will this customer pay in one year?

A. $332,500

B. $665,000

C. $300,000

D. $320,000

E. None of the options is correct.

117. A bank has determined the information below for one of its customers. This customer wants to borrow $1,000,000 but will maintain an average deposit balance in its account of $200,000. What is the expected net rate of return on this loan?

A. 10.00 percent

B. 8.20 percent

C. 10.25 percent

D. 13.75 percent

E. None of the options is correct.

118. Hager Smith, a customer of Standard Bank, maintains an average balance of $420,000. The float from uncollected funds from his balance, accounts for $21,000. The applicable legal reserve requirement at this checking account is 10 percent. Determine Smith’s net usable funds.

A. $359,100

B. $396,900

C. $378,000

D. $399,000

E. $438,900

119. SNCs are also known as:

A. working capital loans.

B. asset-backed loans.

C. syndicated loans.

D. construction loans.

E. inventory loans.

120. Small business lending by banks, in proportion of all loans is:

A. declining.

B. rising.

C. relatively constant.

D. one with no pattern.

E. one with an unknown pattern.

121. The most common type of loans foreign banks make in the U.S. are:

A. commercial loans.

B. retail loans.

C. real estate loans.

D. credit card loans.

E. None of the options is correct.

122. Lloyd Blenman is building a shopping center in Charlotte and needs to get a loan until the shopping center is constructed and he can get a mortgage on the property. What type of loan does he need?

A. Self-liquidating inventory loan

B. Working capital loan

C. Interim construction financing

D. Security dealer financing

E. Retailer and equipment financing

123. Dick Dowen needs a loan to buy plants and fertilizer for his nursery for the spring planting season. This loan will automatically be paid off as the plants and fertilizer are sold to his customers. What type of loan does Dick need?

A. Self-liquidating inventory loan

B. Asset-based financing

C. Interim construction financing

D. Security dealer financing

E. Retailer and equipment financing

124. Randal Ice needs a loan to purchase pet food and other pet supplies for his local pet store over the next six months. He has estimated that the maximum amount of inventory he will need in the next six months is $200,000 and he knows that he will have to use accounts receivables and the inventory he purchases as collateral for the loan. At the end of six months, he hopes he can get the loan renewed. What type of loan does Randal need?

A. Self-liquidating inventory loan

B. Working capital loan

C. Interim construction financing

D. Security dealer financing

E. Retailer and equipment financing

125. Barbara Miller is a small dealer who specializes in healthcare stocks. She needs a loan so that she can sustain her portfolio of stocks until customer-buy orders catch up with what she has already purchased from the market. She only expects to need this loan for a week. What type of loan does Barbara need?

A. Self-liquidating inventory loan

B. Working capital loan

C. Interim construction financing

D. Security dealer financing

E. Retailer and equipment financing

126. Sight n’ Sound is a retail store that sells refrigerators, washers, dryers, and other consumer appliances. They need a loan so that they can place an order with Whirlpool. The appliances will be the collateral for the loan and as an appliance is sold, the money will be passed on to the lender. An employee of the lender will periodically check to make sure what has sold and what remains in the store. What type of loan does Sight n’ Sound need?

A. Self-liquidating inventory loan

B. Working capital loan

C. Interim construction financing

D. Security dealer financing

E. Retailer and equipment financing

127. Mary Williams needs to purchase a new bulldozer and excavator for her construction business and wants to repay the loan over the next three years in regularly scheduled payments. What type of loan does Mary need?

A. Term business loan

B. Revolving credit financing

C. Long-term project loan

D. Leveraged buyout

E. Syndicated loan

128. Ford Motor Company needs to borrow $50 million. The First National Bank creates a packaged loan with several other banks to lend to Ford Motor Company. This loan package can be sold on the secondary market and carries a rate that is 400 basis points above LIBOR. The First National Bank expects this loan package to ultimately be held by a finance company looking for a good return on their money? What type of loan is this most likely to be?

A. Term business loan

B. Revolving credit financing

C. Long-term project loan

D. Leveraged buyout

E. Syndicated loan

129. The Wabash Washing Machine Company has arranged to get a loan from their bank over the next five years. They can borrow up to a pre-specified limit and repay it as many times as they need until the loan matures. The Wabash Washing Machine Company has not pledged any specific collateral for this loan. What type of loan is this most likely to be?

A. Term business loan

B. Revolving credit financing

C. Long-term project loan

D. Leveraged buyout

E. Syndicated loan

130. The Jung Company and the Nguyen Company have combined to build a new container ship docking facility in Charleston Harbor. The facility is expected to take two years to complete and cost $3 billion to construct. These companies want to borrow money in order to build this facility. What type of loan is this most likely to be?

A. Term business loan

B. Revolving credit financing

C. Long-term project loan

D. Leveraged buyout

E. Syndicated loan

131. The management of the Frickel Frontier Freight Company wants to make the company private by borrowing money and using the proceeds of the loan to purchase the shares of the company in the market. Management believes they can increase revenues enough to be able to pay off the loan. What type of loan is management getting?

A. Term business loan

B. Revolving credit financing

C. Long-term project loan

D. Leveraged buyout

E. Syndicated loan

132. A bank wants to examine how well a customer controls their expenses. They are most likely to look at which of the following ratios?

A. Wages and salaries/Net sales

B. Accounts receivables/(Annual credit sales/360)

C. Net income after taxes/Net sales

D. Income before interest and taxes/Interest payments

E. (Current assets – Inventory)/Current liabilities

133. A bank wants to examine how well a customer uses assets to generate sales. They are most likely to look at which of the following ratios?

A. Wages and salaries/Net sales

B. Accounts receivable/(Annual credit sales/360)

C. Net income after taxes/Net sales

D. Income before interest and taxes/Interest payments

E. (Current assets – Inventory)/Current liabilities

134. A bank wants to examine how well a customer markets their goods and services. They are most likely to look at which of the following ratios?

A. Wages and salaries/Net sales

B. Accounts receivables/(Annual credit sales/360)

C. Net income after taxes/Net sales

D. Income before interest and taxes/Interest payments

E. (Current assets – Inventory)/Current liabilities

135. A bank wants to examine the adequacy of a business customer’s earnings based on the coverage ratios. They are most likely to look at which of the following ratios?

A. Wages and salaries/Net sales

B. Accounts receivables/(Annual credit sales/360)

C. Net income after taxes/Net sales

D. Income before interest and taxes/Interest payments

E. (Current assets – Inventory)/Current liabilities

136. A bank wants to know whether a customer can raise cash in a timely fashion at a reasonable cost. They are most likely to look at which of the following ratios?

A. Wages and salaries/Net sales

B. Accounts receivables/(Annual credit sales/360)

C. Net income after taxes/Net sales

D. Income before interest and taxes/Interest payments

E. (Current assets – Inventory)/Current liabilities

137. A bank has a concern about the Wilson Company’s debt level. They feel that it is too high. What ratio are they most likely to examine to answer this question?

A. Selling and administrative expenses/Net sales

B. Net sales/Total assets

C. Current assets – Current liabilities

D. Net income/Total assets

E. Long-term debt/(Long-term debt + Net worth)

138. A bank has a concern because they feel that a firm has an excessive amount of assets. They do not feel that the firm is efficient in generating sales from their current level of assets. What ratio are they most likely to examine to answer this question?

A. Selling and administrative expenses/Net sales

B. Net sales/Total assets

C. Current assets – Current liabilities

D. Net income/Total assets

E. Long-term debt/(Long-term debt + Net worth)

139. A bank feels that a firm has expenses that are too high. What ratio are they most likely to examine to address this concern?

A. Selling and administrative expenses/Net sales

B. Net sales/Total assets

C. Current assets – Current liabilities

D. Net income/Total assets

E. Long-term debt/(Long-term debt + Net worth)

140. A bank is concerned because they feel that a firm will not be able to raise enough cash to pay bills that are due within the next year. What ratio are they most likely to examine to address this concern?

A. Selling and administrative expenses/Net sales

B. Net sales/Total assets

C. Current assets – Current liabilities

D. Net income/Total assets

E. Long-term debt/(Long-term debt + Net worth)

141. A bank wants to examine the financial success of a company by examining the profits of a company. What ratio will help the bank examine this issue?

A. Selling and administrative expenses/Net sales

B. Net sales/Total assets

C. Current assets – Current liabilities

D. Net income/Total assets

E. Long term debt/(Long term debt + Net worth)

142. A firm submits their financial records to a bank. Upon examination, the bank discovers that this firm has $500 in cash, $2,500 in accounts receivables, $1,000 in inventory, $5,000 in plant and equipment, and that their assets totaled $9,000. In addition, this bank discovered that the firm had $2,000 in current liabilities, $2,500 in long-term debt, and $4,500 in net worth. Finally, this bank discovered that this firm had $20,000 in net sales and $2,000 in net income. What is this firm’s net profit margin?

A. 10.00 percent

B. 22.22 percent

C. 44.44 percent

D. 50.00 percent

E. None of the options is correct.

143. A firm submits their financial records to a bank. Upon examination, the bank discovers that this firm has $500 in cash, $2,500 in accounts receivables, $1,000 in inventory, $5,000 in plant and equipment and that their assets totaled $9,000. In addition this bank discovered that the firm had $2,000 in current liabilities, $2,500 in long-term debt, and $4,500 in net worth. Finally, this bank discovered that this firm had $20,000 in net sales (all of which are on credit) and $2,000 in net income. What is this firm’s average collection period?

A. 18 days

B. 45 days

C. 72 days

D. 162 days

E. None of the options is correct.

144. A firm submits their financial records to a bank. Upon examination, the bank discovers that this firm has $500 in cash, $2,500 in accounts receivables, $1,000 in inventory, $5,000 in plant and equipment and that their assets totaled $9,000. In addition this bank discovered that the firm had $2,000 in current liabilities, $2,500 in long-term debt, and $4,500 in net worth. Finally, this bank discovered that this firm had $20,000 in net sales and $2,000 in net income. What is this firm’s net working capital?

A. $9,000

B. $4,500

C. $4,000

D. $2,000

E. None of the options is correct.

145. A firm submits their financial records to a bank. Upon examination, the bank discovers that this firm has $500 in cash, $2,500 in accounts receivables, $1,000 in inventory, $5,000 in plant and equipment and that their assets totaled $9,000. In addition this bank discovered that the firm had $2,000 in current liabilities, $2,500 in long-term debt, and $4,500 in net worth. Finally this bank discovered that this firm had $20,000 in net sales and $2,000 in net income. What is this firm’s leverage ratio?

A. 22.50 percent

B. 44.44 percent

C. 50.00 percent

D. 88.89 percent

E. None of the options is correct.

146. A firm submits their financial records to a bank. Upon examination, the bank discovers that this firm has $500 in cash, $2,500 in accounts receivables, $1,000 in inventory, $5,000 in plant and equipment and that their assets totaled $9,000. In addition this bank discovered that the firm had $2,000 in current liabilities, $2,500 in long-term debt, and $4,500 in net worth. Finally this bank discovered that this firm had $20,000 in net sales and $2,000 in net income. What is this firm’s acid test ratio?

A. 1.00 ×

B. 2.00 ×

C. 0.33 ×

D. 3.00 ×

E. 1.50 ×

147. Banks need to be able to compare the firm they are examining to their industry. One company that provides information to banks about the industries their customers are in is:

A. Standard and Poors

B. Moody’s

C. Dun and Bradstreet

D. Morgan Stanley

E. None of the options is correct.

148. A firm has net sales of $25,000, costs of goods sold of $10,000, selling, general and administrative expenses of $8,000 (of which $2,000 are depreciation expenses), and taxes (in cash) of $3,000. What is this firm’s operating cash flow (using the traditional or direct method)?

A. $4,000

B. $15,000

C. $6,000

D. $8,000

E. None of the options is correct.

149. A bank wants to estimate a firm’s future financial condition. Which of the following is something that allows a bank to do this?

A. Statement of cash flows

B. Pro forma statement

C. Balance sheet

D. Income statement

E. None of the options is correct.

150. A bank has a listed prime rate of 7 percent. They have estimated that the marginal cost of raising funds is 5 percent, their default risk premium on a loan is 1.5 percent and that they want a profit margin of 2 percent. They have also estimated that the term risk premium is 0.5 percent. What is the interest rate this bank will charge if they use the cost-plus pricing model?

A. 8.5 percent

B. 9.0 percent

C. 12.0 percent

D. 9.5 percent

E. None of the options is correct.

151. A bank has a listed prime rate of 7 percent. They have estimated that the marginal cost of raising funds is 5 percent, their default risk premium on a loan is 1.5 percent and that they want a profit margin of 2 percent. They have also estimated that the term risk premium is 0.5 percent. What is the interest rate this bank will charge if they use the price leadership model (and the prime rate is their base rate)?

A. 8.5 percent

B. 9 percent

C. 12 percent

D. 9.5 percent

E. None of the options is correct.

152. Which of the following short-term loans are traded in the secondary market and usually carry an interest rate based upon the London Interbank Offered Rate (LIBOR) on Eurocurrency deposits?

A. Asset-based financing

B. Retailer and equipment financing

C. Syndicated loans

D. Term business loans

E. Revolving credit financing

153. For which of the following types of short-term loans, the lender has to incur the expense of collecting accounts receivable and risk of the loan?

A. Factoring

B. Retailer and equipment financing

C. Syndicated loans

D. Term business loans

E. Revolving credit financing

154. A ‘blind spot’ may be built into the repayment schedule of a term loan wherein:

A. no installment will be due because of prepayment.

B. no installment will be due because of timely payment of the loan.

C. no installment will be due because of shortage of cash with the borrower.

D. installment will be collected before they are due.

E. no installment will be collected because of loan foreclosure.

155. The increasingly popular type of financing, in which merchants receive cash advances and pay them off from their credit card sales, is called:

A. asset-based financing.

B. retailer credit financing.

C. operating capital credit financing.

D. credit card receivables financing.

E. revolving credit financing.

156. A project loan granted on its own merits and which does not have a sponsor to guarantee the loan is known as a project loan granted on:

A. recourse basis.

B. resort basis.

C. nonrecourse basis.

D. sponsorship basis.

E. leverage basis.

157. Which of the following is an important asset-based balance sheet composition ratio?

A. Notes payable/Total liabilities and net worth

B. Gross profit/Sales

C. Net operating profit/Total assets

D. Inventories/Total assets

E. Net income after taxes/Total assets

158. Which of following contingent liabilities may be required to be recorded on a balance sheet and not to be hidden as a footnote?

A. Environmental liabilities

B. Limiting regulations

C. Unfunded pension liabilities

D. Litigation or pending lawsuits against firms

E. Underfunded pension liabilities

Chapter 18
Consumer Loans, Credit Cards, and Real Estate Lending

Fill in the Blank Questions

1. The purchase of a house or a multifamily dwelling such as a duplex, triplex or apartment building is usually financed through the use of a ______________________ loan.

________________________________________

2. A(n) ______________________ loan is a short-term or a medium-term loan repayable in two or more consecutive payments, usually monthly or quarterly.

________________________________________

3. Household borrowings tend to be relatively interest ______________________ by nature, that is, consumers are more concerned about the size of the debt repayments than the interest rate charged.

________________________________________

4. The fact that a consumer feels a strong moral and ethical responsibility to repay a loan on time refers to the ______________________ of the borrower. The loan officer must be assured that the borrower is serious about repaying the loan before the lending institution makes a loan.

________________________________________

5. When a borrower receives a loan at one lending institution to repay another, it is called ___________________________ of debt.

________________________________________

6. The right of ______________________ allows a bank to call a loan that is in default and seize any checking or savings deposits the customer may hold with the bank in order to recover its funds.

________________________________________

7. ______________________ is a method to evaluate a large volume of consumer loans quickly with minimum labor. It is a statistical model which predicts whether the ability of a consumer to repay the loan.

________________________________________

8. A(n) __________________________ loan is one where a customer can use the difference between the appraised value of their home and the amount of mortgage remaining against it to secure a loan.

________________________________________

9. The law that requires full disclosure of credit terms and which promotes the informed use of credit is the ______________________ Act. This law requires banks to report the APR of the loan, the dollar amount of all finance charges and, where appropriate, all fees.

________________________________________

10. The law that limits how far a creditor or credit collection agency can go in pressing a customer to pay a past due debt is the ______________________ Act. It does not allow a debt collector to “harass” a debtor.

________________________________________

11. Short-term credit to finance the building of homes or other dwellings is called a _____________________.

________________________________________

12. A(n) ______________________ is a credit-rating agency that keeps records of borrowers’ loan payment histories.

________________________________________

13. The ________________________________ Act permits consumers to dispute billing errors with a merchant or credit card company and receive a prompt investigation into any such disputes.

________________________________________

14. The ___________________________________ Act prevents banks from redlining of certain neighborhoods and refusing to provide loans and other services in those areas.

________________________________________

15. ______________________________________ is a practice of granting loans to weaker borrowers and charging them excessive fees and interest rates, increasing their risk of default.

________________________________________

16. The ______________________ is the internal rate of return that equates present value of the payments with the amount of the loan. It is the rate required to be reported under the Truth in Lending Act.

________________________________________

17. The interest rate method which requires the interest amount on a loan to be paid upfront is called the ______________________ method.

________________________________________

18. The interest rate method that adds the interest amount owed to the principal before calculating required installment payments is called the __________ method.

________________________________________

19. A rule of thumb used to determine how much interest income a bank is allowed to accrue at any point in time from a consumer loan that is being paid off in monthly installments is known as the ____________.

________________________________________

20. A(n) ____________________________________________ mortgage is an agreement drawn up by a bank that gives the bank control of the property if the loan cannot be repaid as planned.

________________________________________

21. The interest rate on most consumer loans is based on the cost of loanable funds to the bank, plus nonfunding cost, plus premiums for default and time to maturity, and also includes the desired profit margin on the loan. This method of pricing loans is known as _____________________.

________________________________________

22. ______________________ is a basic method for calculating the interest owed on a loan that adjusts for declining balances and the time remaining on the loan.

________________________________________

23. A variable rate loan on a residential mortgage is known as a(n) ______________________.

________________________________________

24. Many home mortgage agreements include an additional charge levied up front called _____________________. Generally, each of these corresponds to one percent of the face value of the amount borrowed.

________________________________________

25. A popular prepaid card which carry balances that can be spent electronically in stores until the balance entered on the card is fully used up, often used like a credit card, especially popular in Europe, is known as a _________ card.

________________________________________

26. A popular credit scoring system developed and sold by Fair Isaac Corporation is known as ___________.

________________________________________

27. Traditional home equity loans are usually priced using _______-term interest rates while home equity lines of credit are priced using _________-term interest rates.

________________________________________

28. _________________________ loans are ones that families and individuals can draw upon for immediate cash needs and are repayable in a lump sum. These loans often cover the cost of a vacation, medical care, the purchase of a home appliance, or home repairs.

________________________________________

29. Credit cards are the best example of ______________________ that offer consumers convenience and flexibility. Consumers can access them whenever the need arises.

________________________________________

30. ________________________ are plastic cards that can be used to pay for goods and services but where credit is not extended. They are a convenient way to make deposits into and withdrawals from an ATM.

________________________________________

31. Consumer loans tend to be _____________________ sensitive. They tend to rise in periods of economic expansion and tend to fall in periods of economic downturn.

________________________________________

32. In the case of a borrower without a credit record or a very poor track record, a _______________ may be requested to support repayment. Technically if the borrower defaults on the payment, they are obligated to repay the loan.

________________________________________

33. While considering an individual’s income levels, a bank generally prefers the borrower report ______________________ rather than gross salary.

________________________________________

34. Equifax, Transunion, and _________________ are the three biggest credit bureaus in the United States.

________________________________________

35. The ___________________________ Act prohibits lenders from asking certain questions to a customer, such as a customer’s age or race.

________________________________________

36. The fastest rising financial crime against individuals today is __________________ theft. This is a deliberate attempt to take unauthorized use of someone else’s personal information in order to fraudulently obtain money, credit, or other property.

________________________________________

37. The ________________________ Act provides consumers with an opportunity to order one free credit report annually from each of the three nationwide credit bureaus.

________________________________________

38. _____________________________ is the granting of loans to borrowers with below-average credit records. These loans tend to go to borrowers with a record of delinquent payments, previously charged-off loans, bankruptcies or court judgments.

________________________________________

39. In real estate lending, competent property __________________ is vitally important to a loan decision. The value and condition of the property are determined by an independent party. These must conform to industry and government standards.

________________________________________

40. One new type of mortgage where no principal payments are made for an initial period is called a(n) _______________.

________________________________________

True / False Questions

41. Finance companies are the most dominant lenders of credit to households in the United States with commercial banks ranked second as consumer lenders.

True False

42. Nonresidential consumer loans include credit to finance the purchase of home appliances.

True False

43. Credit cards offer convenience to customers plus a revolving line of credit.

True False

44. Consumer loans appear to have virtually no sensitivity to the business cycle, staying relatively stable through both recessions and expansions.

True False

45. Households tend to be interest-inelastic borrowers.

True False

46. Lenders in the consumer loan field prefer to measure a borrowing customer’s income by the amount of take-home pay.

True False

47. The “right of offset” allows a bank to auction a customer’s property to the highest bidder to recover a loan in default.

True False

48. “Pyramiding of debt” refers to borrowing from one lender to repay another lender.

True False

49. Credit-scoring systems tend to be valid over long periods of time (usually several years) and need not be periodically retested.

True False

50. The Truth-in-Lending Act of 1968 gave consumers the right to access the information from their credit files kept at local and regional credit bureaus.

True False

51. Customers who apply for credit have the right to receive a written notice along with the reasons for denial if their loan request is turned down by a bank.

True False

52. The symbol “SN” assigned as a rating indicates that a bank has been judged to be an outstanding performer under the terms of the Community Reinvestment Act.

True False

53. The board of directors and senior management of the banks that are awarded top CRA ratings are often committed to promote community involvement.

True False

54. FNMA purchases home mortgages only if the borrower’s monthly house payment does not exceed 35 percent of his monthly gross income.

True False

55. Under FNMA rules for buying home mortgages, FNMA does not purchase a borrower’s mortgage if the borrower’s credit report is more than 45 days old.

True False

56. An installment loan is one where the customer repays the loan in two or more consecutive payments. These payments are often made monthly or quarterly.

True False

57. The Equal Credit Opportunity Act authorizes individuals and families to review their credit file for accuracy and to demand an investigation and correction of any apparent inaccuracies.

True False

58. The burden of proof is on a bank to demonstrate that its credit scoring system successfully identifies quality loan applications at a statistically significant level.

True False

59. Real estate loans are smaller in size and shorter in maturity than most other types of bank loans.

True False

60. The Community Reinvestment Act is designed to prevent a lender from arbitrarily marking out certain neighborhoods as undesirable and refusing to lend to people who live in those neighborhoods.

True False

61. Competition for consumer loans tends to drive the interest rates on these loans down closer to loan production costs.

True False

62. Shorter-term cash loans to consumers are normally secured, but longer-term consumer loans are usually unsecured.

True False

63. An auto loan usually carries with it a chattel mortgage, giving the bank a claim against the property covered by the loan.

True False

64. Most consumer loans are priced off some base or cost rate.

True False

65. The APR is the internal rate of return on a loan that equates total payments with the amount of the loan.

True False

66. According to recent research findings, the quotation of the APR to customers on the loan they are requesting usually discourages consumers from shopping around.

True False

67. Unlike the APR method for calculating consumer loan rates, the simple interest approach adjusts for the length of time a borrower actually has use of the credit.

True False

68. Under the simple interest method, a customer saves on interest as an installment loan approaches maturity.

True False

69. Under the discount rate method, interest amount is required to be paid upfront and the customer receives the loan amount net of any interest owed.

True False

70. A majority of installment and lump-sum payment loans to families and individuals are made on floating interest rates.

True False

71. Points on a home mortgage loan results in a lender earning a higher effective interest rate on the loan than just the loan rate quoted to the borrower.

True False

72. According to the textbook, personal loans tend to have lower interest rates than automobile loans.

True False

73. According to the textbook, credit card loans tend to have the highest interest rates of all consumer loans.

True False

74. According to the textbook, new car loans have a lower interest rate than used car loans.

True False

75. There are very little economies of scale (cost savings) in the credit card business.

True False

76. Currently the debit card market is one of the fastest growing of all household financial services, substantially exceeding the recent growth of credit cards.

True False

77. One of the elements used in the FICO credit scoring system is the borrower’s employment history and salary.

True False

78. The most important factor used in the FICO credit score appears to be the borrower’s payment history.

True False

79. Home mortgage real estate loans soared to record levels at the beginning of the 21st century.

True False

Multiple Choice Questions

80. Short-term to medium-term loans repayable in two or more consecutive payments are known as:

A. noninstallment loans.

B. installment loans.

C. residential mortgage loans.

D. nonresidential cash loans.

E. None of the options is correct.

81. Loans to individuals and families to finance the purchase of new homes are known as:

A. noninstallment loans.

B. installment loans.

C. residential mortgage loans.

D. nonresidential cash loans.

E. None of the options is correct.

82. Short-term loans drawn upon by individuals and families for immediate cash needs and repayable in a lump sum are known as:

A. noninstallment loans.

B. installment loans.

C. residential mortgage loans.

D. nonresidential cash loans.

E. None of the options is correct

83. The federal law that requires banks to notify in writing to their credit customers when a loan request is denied is known as the:

A. Equal Credit Opportunity Act.

B. Competitive Equality in Banking Act.

C. Truth-in-Lending Act.

D. Community Reinvestment Act.

E. None of the options is correct.

84. Regulations under which of the following law(s) must be complied with by the banks dealing in mortgage lending?

A. National Affordable Housing Act

B. Community Reinvestment Act

C. Financial Institutions Reform, Recovery, and Enforcement Act

D. Truth-in-Lending Act

E. All of the options are correct

85. Which of the following has(have) proven to be important factor(s) in credit scoring models?

A. Credit Bureau ratings

B. Income bracket

C. Home ownership

D. Number and type of deposit accounts owned

E. All of the options are correct.

86. The requirement that banks must provide their consumer loan customers with a statement of the APR for the proposed loan was established by the:

A. Fair Credit Reporting Act.

B. Equal Credit Opportunity Act.

C. Truth-in-Lending Act.

D. Community Reinvestment Act.

E. None of the options is correct

87. Which of the following consumer loans has grown in popularity as a result of the passage of the Tax Reform Act of 1986?

A. Credit card loans

B. Home equity loans

C. Long-term, noninstallment loans

D. Short-term, installment loans

E. All of the options are correct

88. A bank that is judged as needing to improve under the performance requirements of the Community Reinvestment Act will receive an examiner rating of:

A. 0.

B. S.

C. N.

D. SN.

E. None of the options is correct

89. FNMA does not purchase home mortgages in the secondary market if the borrower’s monthly total debt repayments (including housing costs) exceed _________ percent of the borrower’s monthly gross income.

A. 28

B. 30

C. 36

D. 40

E. None of the options is correct

90. How did the Tax Reform Act of 1986 increase the appeal of home equity loans?

A. It allowed customers to borrow up to 100 percent of the value of their home.

B. It eliminated bank income taxes from this type of loan.

C. It protected homes under Chapter 13 bankruptcy.

D. It allowed the difference between the market value and amount of loans against a mortgage to be used as a borrowing base.

E. It required banks to lend on homes in the geographic area of their deposits.

91. The federal law that permits consumers to dispute billing errors with a merchant or credit card company and receive a prompt investigation of any billing disputes is the:

A. Fair Credit Reporting Act.

B. Fair Credit Billing Act.

C. Fair Debt Collection Practices Act.

D. Truth in Lending Act.

E. None of the options is correct.

92. Which of the following aspects of a customer’s loan application should a bank’s real estate loan officer consider carefully when making a home mortgage?

A. The amount and stability of the borrower’s income

B. The borrower’s available savings and where the down payment is coming from

C. The borrower’s track record in caring for and managing property

D. The outlook for real estate sales in the local market area

E. All of the options are factors that need to be looked into carefully

93. An abusive practice in which lenders grant loans to weak borrowers and charge them high fees and interest rates, which may cause the borrower to default on the loan is known as:

A. installment loaning.

B. credit card loaning.

C. predatory lending.

D. herbivore lending.

E. None of the options is correct.

94. The law which was passed to curtail predatory lending is known as the:

A. Community Reinvestment Act.

B. Home Ownership and Equity Protection Act.

C. Equal Credit Opportunity Act.

D. Fair Debt Collection Practices Act.

E. None of the options is correct.

95. Which of the following is true regarding credit card loans?

A. There is evidence that considerable economies of scale exist in credit card loans.

B. Credit cards loans cannot act as installment loans.

C. Credit cards loans are very inconvenient for consumers.

D. Credit cards loans are very inflexible for consumers.

E. All of the options are true.

96. A loan officer asks a customer what race she belongs to. Which law prohibits the loan officer from asking such question?

A. The Truth in Lending Act

B. The Equal Credit Opportunity Act

C. The Community Reinvestment Act

D. The Fair Debt Collection Practices Act

E. None of the options is correct

97. Which of the following is not a factor considered in the evaluation process of an installment loan?

A. Evidence of caring for and maintaining property

B. Evidence of stable employment

C. Evidence of residence stability

D. Evidence of income stability

E. All of the options are factors considered in the evaluation of an installment loan

98. Which of the following is an advantage of a credit scoring model?

A. Credit scoring models rely on the evaluation of an experienced credit officer

B. Credit scoring models are immune from charges of discrimination

C. Credit scoring models never make mistakes

D. Credit scoring models can handle a large volume of applications in a short period of time

E. All of the options are advantages of credit scoring models

99. The method for figuring out the loan rate wherein the interest amount owed on a loan is added to the principal amount of the loan to determine a borrowing customer’s required installment payments is known as:

A. simple interest.

B. APR.

C. discount rate.

D. add-on rate.

E. None of the options is correct.

100. In lending, ARM is an abbreviation used for:

A. automatic rate modulation.

B. amortization rate method.

C. adjustable rate mortgage.

D. adaptable readjusted mortgage.

E. None of the options is correct.

101. An additional charge on a home mortgage loan that a borrower may be asked to pay up front is referred to as:

A. loan interest owed.

B. points.

C. loading.

D. tax equity.

E. None of the options is correct.

102. According to the text, which of the following types of loan has the highest interest rate?

A. New automobile loan

B. Used automobile loan

C. Personal loan

D. Credit card loan

E. All of the options have the same interest rate

103. According to the text, which of the following types of loan has the lowest interest rate?

A. New automobile loan

B. Used automobile loan

C. Personal loan

D. Credit card loan

E. All of the options have the same interest rate

104. A customer is seeking a $150,000 home mortgage. The bank requires the customer to pay 1¾ points up front. How much of the loan amount will actually be available to the customer if the bank approves the loan?

A. $150,000

B. $152,625

C. $147,375

D. $148,000

E. None of the options is correct

105. A customer wants to borrow $1,200 from Edmond State Bank. Edmond State Bank has an add-on loan with an interest rate of 12 percent and monthly payments for one year. What are the monthly payments this customer will need to make on this loan?

A. $100 per month

B. $112 per month

C. $107 per month

D. $88 per month

E. None of the options is correct

106. A customer wants to borrower $25,000 for one year from TRC State Bank. The bank offers a discount loan with an interest rate of 15 percent. How much of the loan will be available to the customer?

A. $25,000

B. $28,750

C. $22,500

D. $21,250

E. None of the options is correct

107. A customer wants to borrow $125,000 to purchase a new home. The APR on this loan is 10 percent and it is a 30-year mortgage with monthly payments. What is the monthly payment the customer will have to make on this loan?

A. $1,097

B. $55

C. $12,500

D. $13,260

E. None of the options is correct

108. Mark Brown receives a $2,000 loan with the intention of repaying the loan in 12 months. However, at the end of one month, Mr. Brown discovers that he can repay the loan in full. According to the rule of 78s, what percentage of the interest charge is he entitled to receive as a rebate?

A. 36.67 percent

B. 50.00 percent

C. 91.67 percent

D. 84.62 percent

E. None of the options is correct

109. Paul Carter requests an automobile loan of $15,000 that will be repaid over the next four years in monthly repayments. The First National Bank tells Mr. Carter that his total finance charges will be $4675.20. What is the APR on this loan?

A. 16 percent

B. 1 percent

C. 14 percent

D. 7 percent

E. None of the options is correct

110. Jane Smith has asked for a 30 year mortgage (repayable in monthly installments) to purchase a home in Oklahoma City, Oklahoma. The purchase price of the home is $150,000 of which $125,000 must be borrowed. If the APR on this loan is 8 percent, how much will Jane’s total financing charges be?

A. $246,233

B. $205,194

C. $180,194

D. $165,097

E. None of the options is correct

111. Beverly Frickerson asks for a $15,000 loan for one year. The bank tells her that it will give her $13,050 and deduct $1,950 in interest upfront. What is the effective rate of interest on this loan?

A. 14.94 percent

B. 13.00 percent

C. 19.50 percent

D. 11.50 percent

E. None of the options is correct

112. Which of the following makes the most amount of credit card loans in the United States?

A. Thrifts

B. Insurance companies

C. Finance companies

D. Credit Unions

E. Commercial banks

113. Prepaid cards which carry balances that can be spent electronically in stores until the balance entered in such cards is fully used up are known as:

A. smart cards.

B. deposit cards.

C. match cards.

D. credit cards.

E. All of the options are correct.

114. The first major bank within the U.S. to establish a separate department for granting loans to consumers was:

A. First National City Bank of New York.

B. BankAmerica.

C. Bank One.

D. State Street Bank.

E. Bank of New York.

115. According to the text, which of the following has been the fastest growing consumer loan category in the last few decades inside the United States?

A. Credit card loans

B. Auto loans

C. Home mortgages

D. Personal loans

E. Education loans

116. FICO credit scoring system provides credit scores in the range of:

A. 0 to 10

B. 0 to 1000

C. 100 to 1000

D. 300 to 850

E. 20 to 80

117. According to the text, which of the following appears to be the most important factor used in the FICO credit scoring system?

A. The borrower’s payment history

B. The amount of money owed

C. Marital status

D. Employment history and salary

E. Age

118. Jeremiah Uselton needs a loan to purchase a condo in Sarasota, Florida. Which of the following categories will this loan fall into?

A. Residential mortgage loan

B. Home equity loan

C. Noninstallment loan

D. Revolving line of credit

E. None of the options is correct

119. Tammy Payne wants to buy a used car and wants a loan that she will pay off over the next three years with monthly payments. Which of the following categories will this loan fall into?

A. Residential mortgage loan

B. Installment loan

C. Noninstallment loan

D. Revolving line of credit

E. None of the options is correct

120. Emily Barnes has gone to the First State Bank and gotten a loan of $5,000 so she can go on vacation. She plans on paying the loan back in one payment in three months. Which of the following categories will this loan fall into?

A. Residential mortgage loan

B. Installment loan

C. Noninstallment loan

D. Revolving line of credit

E. None of the options is correct

121. Bill Wells uses his Discover card to buy new furniture for his apartment. The interest rate on this card is 18 percent and the minimum payment that is due is $100. Which of the following categories will this loan fall into?

A. Residential mortgage loan

B. Home equity loan

C. Noninstallment loan

D. Revolving line of credit

E. None of the options is correct

122. Jerry McGuire uses his Visa card to buy a new washer and dryer and a new refrigerator for his home. He plans on paying off the credit card over the next two years. How is Jerry using his credit card?

A. As an installment loan

B. As a noninstallment loan

C. As a lump sum payer

D. As a debit card

E. None of the options is correct

123. The most profitable credit card customers for a bank are those that:

A. use their credit card frequently.

B. pay off any charges incurred within a few days.

C. charge at least $10,000 per year.

D. use their credit card as a source of installment loans.

E. None of the options is correct

124. Alexis Downs uses her credit card to buy furniture but pays off the credit card at the end of the month before she incurs any interest costs. How is Alexis using her credit card?

A. As an installment loan

B. As a noninstallment loan

C. As a home equity loan

D. As a debit card

E. None of the options is correct

125. Donna Carlon is using her plastic card to buy groceries. The money is taken from her checking account immediately to pay for her groceries. How is Donna using her card?

A. As an installment loan

B. As a noninstallment loan

C. As a lump sum payer

D. As a debit card

E. None of the options is correct

126. A bank is considering making a loan to Alice Granger. The bank is looking at her credit report from Equifax and also examining the reason Alice has put on the loan application for needing the loan. According to the text, what aspect of evaluating a consumer loan application is the bank looking at?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

127. A bank is considering making a loan to Ron Weasley. Ron has a gross salary per month of $4,000 but has take-home pay of $2,800 per month. What aspect of evaluating a consumer loan application is this fact most concerned with?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

128. A bank is considering making a loan to Sean Finnigan. Sean owns his own home and has lived there for the past four years. What aspect of evaluating a consumer loan application is this fact most concerned with?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

129. A bank is considering making a loan to Sam Snape. Mr. Snape has $1,000 in the bank right now but generally keeps a balance of $4,500 most of the year. What aspect of evaluating a consumer loan application is this fact concerned with?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

130. A bank is considering making a loan to Neville Langdon. Neville has bounced three checks in the last year and already has $10,000 on a credit card and an automobile loan with a large balance due. What aspect of evaluating a consumer loan application is this fact concerned with?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

131. A bank is considering making a loan to John Carter. John is a commissioned sales broker. Some months he earns as much as $10,000 and in other months he earns virtually nothing. Which aspect of evaluating a consumer loan would this be concerned with?

A. Character and purpose

B. Income level

C. Deposit balance

D. Employment and residential stability

E. Pyramiding of debt

132. Which of the following is a challenge in making a consumer loan?

A. Audited financial statements are provided by consumers quarterly.

B. Consumers must disclose publicly any changes in their health that would affect the loan.

C. Consumers can hide pertinent information more easily than corporations.

D. Consumers can adjust to financial setbacks more easily than businesses.

E. All of the options are challenges of making a consumer loan.

Mark Green is considering buying a new Honda Accord. The purchase price of the car is $21,000 but Mark has a trade-in worth $4,500. Mark needs a loan to buy the car and knows that his local bank requires him to put down 10 percent of the purchase price after the value of the trade-in is considered. Mark also knows that bank will charge 8 percent for the loan and require monthly payments over the next 4 years.

133. What is the minimum down payment that Mark must make?

A. $2,100

B. $450

C. $1,650

D. $2,550

E. None of the options is correct

134. If Mark makes the minimum down payment on the car, what is the amount of the loan that Mark will receive?

A. $18,900

B. $14,850

C. $16,500

D. $14,400

E. None of the options is correct

135. What is the size of Mark’s monthly payments if he makes the minimum down payment on the car?

A. $362.53

B. $301.67

C. $512.67

D. $402.81

E. None of the options is correct

136. If Mark’s monthly payments are 362.53 per month, what is the total finance charge if he takes the full 4 years to pay off the loan?

A. $468

B. $4,032

C. $4,500

D. $2,551.53

E. None of the options is correct

137. The Equal Credit Opportunity Act requires that:

A. a bank make loans to all minority applicants.

B. a bank only make loans to people owning large businesses.

C. a bank give reasons in writing for denying the loan.

D. a bank deny loans if the borrower has only been employed for three months.

E. None of the options is correct

138. Credit reports provided by credit bureaus provide lenders with:

A. personal identifying data.

B. personal credit histories derived from data submitted by lenders.

C. public information that may bear on a borrower’s honesty and stability.

D. the volume of inquiries from lenders about the borrower.

E. All of the options are correct.

139. Which of the following regulations requires lending institutions to delineate the trade territory it plans to serve and to offer all of its services without discrimination to all the residents in that particular trade territory?

A. Equal Credit Opportunity Act

B. National Bank Act

C. Federal Lending Act

D. Fair Credit Reporting Act

E. Community Reinvestment Act

140. A bank customer is granted credit for a $2,000 loan at 10 percent to be repaid in 12 equal installments. If the loan is a discount loan, what is the monthly payment?

A. $200.00

B. $192.35

C. $184.20

D. $173.12

E. $166.67

141. A bank customer is granted credit for a $2,000 loan at 10 percent to be repaid in 12 equal installments. If the loan quoted has an add-on rate, what are the net proceeds of the loan?

A. $2,200

B. $2,100

C. $2,000

D. $1,800

E. Cannot be determined

142. A bank customer is granted credit for a $2,000 loan at 10 percent to be repaid in 12 equal installments. If the loan quoted has an add-on rate, which of the following is the approximate annual percentage rate (APR) on the loan?

A. 20 percent

B. 18 percent

C. 14 percent

D. 12 percent

E. 10 percent

143. As part of the new regulations of the mortgage market, the Federal Reserve Board moved to tighten the rules on mortgage lending in 2008. All of the following would improve transparency of the market except for:

A. lenders must verify the borrower’s reported income.

B. lenders cannot rely on a home’s current market value to judge a borrower’s creditworthiness.

C. lenders must rely on a borrower’s stated income.

D. lenders must disclose more about the actual terms of a home mortgage loan to a borrower.

E. All of the options are included in the new rules.

144. According to the text, which of the following is often the most profitable credit service a lender can offer?

A. Government loans

B. Business loans

C. Consumer loans

D. Loans extended to not-for-profit organizations

E. Money market loans

145. In a revolving line of credit, where a customer is subject to high fees and interest costs and is required to make only a small portion of total debt owed, usually called “minimum payment”, often results in:

A. amortization of debt.

B. negative amortization of debt.

C. depreciation of debt.

D. cumulative depreciation of debt.

E. prepayment of debt.

146. Which of the following bodies is created under the recently passed Dodd-Frank Wall Street Reform and Consumer Protection Act?

A. Federal Reserve Board

B. Securities and Exchange Commission

C. Federal Deposit Insurance Commission

D. Comptroller of the Currency

E. Consumer Financial Protection Bureau

147. The principal task of the Consumer Financial Protection Bureau (CFPB) is to:

A. design the monetary policy.

B. ensure safety and soundness of the banking system.

C. write new rules to protect customers of the financial services industry.

D. provide insurance to the investors’ funds in the banks.

E. ensure that the banks conform to the international banking regulations.

148. The ______________________ Act requires that applicants for mortgage loans must be given a disclosure statement indicating whether the servicing rights could be transferred to another institution that borrowers will have to deal with during the loan tenure.

A. Equal Credit Opportunity

B. National Bank

C. Federal Lending

D. National Affordable Housing

E. Fair Credit Reporting

149. Richard Thornton has applied for a home equity loan from Capital Two Bank. The bank on its part has estimated the market value of Richard’s property at $750,000. If the amount of existing mortgage loan on the property is $500,000 and Capital Two as a policy lends only up to 70 percent of the borrowing base, what is the maximum amount of loan will Richard get?

A. $100,000

B. $250,000

C. $175,000

D. $750,000

E. $500,000

150. Michelle Woods, a 64 year old retired professor, has applied for a home equity loan from a bank in her neighborhood. The bank structured a loan against her property in a manner that she receives $5,000 every month. This is an example of:

A. mortgage loan.

B. construction loan.

C. retirement benefits.

D. reverse mortgage loan.

E. pass-through loan.

151. Which of the following is the principal risk faced by a home equity lender?

A. Interest rates in the economy may rise

B. Interest rates in the economy may fall

C. Home prices in the area may rise

D. Home prices in the area may decline

E. There is no risk associated with home equity lending.

152. According to a proposal under Dodd-Frank Wall Street Reform and Consumer Protection Act, lenders who are pooling and securitizing the mortgage loans they create and then selling them off should remain responsible for at least:

A. 10 percent of market risk attached to these loans.

B. 5 percent of market risk attached to these loans.

C. 10 percent of credit risk attached to these loans.

D. 5 percent of credit risk attached to these loans.

E. 50 percent of the credit risk attached to these loans.

153. The net effect of the new code under Bankruptcy Abuse Prevention and Consumer Protection Act, 2005 has generally been to make filing for bankruptcy:

A. more expensive and time consuming.

B. less expensive and seamless.

C. easier for home owners.

D. paperless and completely online.

E. easier for corporations.

154. A ____________ uses an average of a debtor’s last six months of gross income to determine whether an applicant must file for bankruptcy under chapter 7 or 13 of the bankruptcy code.

A. ways test

B. means test

C. income test

D. feasibility test

E. bankruptcy test

155. A bankruptcy filing usually remains in the credit report of the filer for up to:

A. 2 years.

B. 5 years.

C. 10 years.

D. 20 years.

E. the individual’s life.

Chapter 19
Acquisitions and Mergers in Financial-Services Management

Fill in the Blank Questions

1. The _____________________ Act requires each merging bank to seek approval from its principal federal regulating agency before a merger can take place.

________________________________________

2. Under the terms of Bank Merger Act, federal regulating agencies must give top priority to the ______________________ of a proposed merger.

________________________________________

3. In the ______________________ method of acquisition, a bank purchases all or a portion of another bank’s assets.

________________________________________

4. In the ____________________________ method of acquisition, a bank assumes all of the assets and liabilities of the other bank which ceases to exist.

________________________________________

5. The degree of dilution in earnings of a combined firm is a function of a differential in the _________ and relative size of the two merging companies.

________________________________________

6. The ______________________ is the proportion of shares of stock the shareholders of an acquired firm receive from the acquiring firm.

________________________________________

7. The amount paid over the current stock price to shareholders of the acquired firm by the acquiring bank in a merger is known as ___________________________.

________________________________________

8. The _________________________________ is a measure of the market concentration in a given market area. The larger this number, the more concentrated the market.

________________________________________

9. A large metropolitan or money center bank is often called a(n) ______________.

________________________________________

10. A(n) ______________________ takeover is a merger which is resisted by the existing management and stockholders.

________________________________________

11. If a bank can show that the merger it proposes results in significant ______________________________, it may be able to overcome anticompetitive problems of the merger. This is the impact the merger has upon the convenience and service needs of the community.

________________________________________

12. To most authorities, the recent upsurge in mergers reflects the expectation of the stockholders that the profit potential will _____________ once the merger is completed.

________________________________________

13. One reason banks pursue mergers is for _____________________. This allows the bank to reduce fluctuations in revenues and net income.

________________________________________

14. One reason banks pursue mergers is for _____________________. This allows the bank to enter new markets and find new sources of revenue.

________________________________________

15. When the existing ownership of a bank experiences a loss in their share of the company due to an increased number of shares going to new stockholders, it is known as _____________________.

________________________________________

16. The Financial Accounting Standards Board labels ____________ as the “intangible synergies” of a combined firm resulting from a merger.

________________________________________

17. One of the reasons for a merger is _________________. This is where the merger is encouraged by the FDIC as a way to conserve scarce federal deposit insurance resources.

________________________________________

18. Many mergers arise from expected ___________________________ benefits. This takes place particularly when an acquired firm has earnings losses that can be used to offset taxable profits of the acquirer.

________________________________________

19. Increase in earnings of a bank as a result of consolidation of operations and elimination of unnecessary duplication usually exhibits improving ___________ efficiency.

________________________________________

20. When a bank expands the number of service options it offers after acquiring another financial firm, they have practiced __________________ diversification.

________________________________________

21. When a bank enters into a new market area as the result of a merger with another financial institution, they have practiced __________________ diversification.

________________________________________

22. When a national bank wants to acquire another bank, it must apply to the __________________ for approval.

________________________________________

23. The degree of __________________ in a market is measured by the proportion of assets controlled by the largest institutions serving that market. In the banking industry, this is measured but the Herfindahl-Hirschman Index.

________________________________________

24. The European Commission has emerged as a key arbiter for mergers involving European businesses. The commission is principally against the doctrine of _________________.

________________________________________

25. When a merger takes place, some banks have been asked by the regulators to __________________ themselves of some of their branches to avoid anticompetitive activities. Many of these are sold to third parties.

________________________________________

True / False Questions

26. In recent years, financial services industry has consistently ranked in the top five of all U.S. industries in the number or value of merger transactions every year.

True False

27. If a bank with a higher stock price-to-earnings ratio acquires a bank with a lower price-earnings ratio, earnings per share of the combined organization will increase, even if combined earnings fall after the merger.

True False

28. In the United States, regulations require bank merger premiums to range between 150 to 250 percent.

True False

29. According to the textbook, the financial success of a bank merger depends heavily upon the comparative dollar amounts of earnings reported by the two banking organizations and their relative price-earnings ratios.

True False

30. A proposed merger between two or more banks must be ratified by the board of directors of each bank involved, followed by the management of each of the banks, and then all the shareholders of all the banks. The merger can proceed thereafter once regulators’ approval is received.

True False

31. Under the terms of the Bank Merger Act, each federal agency must give top priority to the competitive effects of a proposed merger.

True False

32. Mergers with anticompetitive effects can only be approved at the federal level if one of the banks involved is failing.

True False

33. A market area served by one bank which is the only provider of financial services in that market would have an HHI of 100 percent.

True False

34. A market served by just two banks, equal to each other in size, would have an HHI of 5,000.

True False

35. According to a recent survey, many European bank mergers in the 1980s and 1990s were motivated by the desire to reduce operating costs(economies of scale).

True False

36. The acquisition of First City Bancorporation of Texas by Chemical Bank of New York was motivated by both banks seeking market-positioning benefits.

True False

37. The merger of Bank of America and Security Pacific in 1992 resulted in an expansion of branch offices for both banks.

True False

38. Under the purchase-of-stock method, the acquired bank ceases to exist as a separate corporation.

True False

39. Bank executives identify the most important factor in choosing a merger target as the ability of the merged bank to better accommodate their corporate customers.

True False

40. One of the major reasons behind the rapid growth of mergers in recent years is that stockholders expect the profit potential to increase once the merger is completed.

True False

41. Some merger partners anticipate reduced earnings risk as a result of the merger. One reason for this may be that the merger opens up new markets with different economic characteristics.

True False

42. If one of the banks is in financial stress, a merger is not allowed to take place.

True False

43. The most important goal of any merger should be to increase the market value of the surviving firm.

True False

44. Mergers with anticompetitive effects cannot go unchallenged by federal authorities unless the banks can show that the combined bank would have significant public benefits.

True False

45. As a result of many bank mergers in the last few decades, research indicates that goodwill as an asset on many bank’s balance sheets has grown exponentially.

True False

46. According to FASB, goodwill must now be amortized over its useful life.

True False

47. In order to get regulatory approval for a merger, many a times banks have been required to open up a number of new branch offices.

True False

48. A study by the Federal Reserve Board indicates that there are economies of scale (cost savings) resulting from mergers among relatively smaller banks and insurance companies.

True False

49. There is little evidence for cost savings resulting from large financial institution mergers.

True False

50. Recent research indicates that some merger activity may actually stimulate “de novo” bank entry into the marketplace.

True False

51. The 2007-2009 credit crunch resulted in numerous banks experiencing financial distress for which mergers and acquisitions were often the only option.

True False

52. The agency problem described in the textbook is referred to the idea of bank managers driven primarily by their own interest to increase salaries and benefits at the expense of company stockholders.

True False

53. One of the most common motives for large banks to acquire smaller banks is to gain access to capable new management which is always in short supply at larger institutions.

True False

54. Bank regulators may challenge a merger between two institutions but can never require banks to divest themselves of some of their offices in order to secure regulators’ approval.

True False

Multiple Choice Questions

55. According to the textbook, bank mergers are often motivated by:

A. profit potential.

B. expected reduction in the risk of fluctuations in cash flow and earnings.

C. expected tax benefits.

D. market-positioning strategies.

E. All of the options are correct.

56. According to the textbook, the principal beneficiaries of most bank mergers appear to be:

A. the stockholders of the acquired bank.

B. the stockholders of the acquiring bank.

C. the public (in the form of new services offered and lower service fees).

D. the staff of the acquired bank.

E. None of the options is correct.

57. According to the textbook, the lackadaisical profit performance surrounding a merger may be explained by the:

A. tax inefficiencies due to a merger.

B. lenders cutting off credit lines due to the merger.

C. accounting irregularities when reporting earnings of the combined entity.

D. managerial hubris and sizeable merger premium that acquirers have to pay to shareholders of the acquired firms.

E. All of the options are correct.

58. The ratio of an acquired bank’s current stock price per share plus the additional amount paid by the acquirer for each share of the acquired bank’s stock, divided by the acquired bank’s current stock price is the:

A. price-earnings ratio.

B. merger premium.

C. exchange rate (of a merger transaction).

D. combined stock price of the merging banks.

E. None of the options is correct.

59. _________________ is a danger faced by the stockholders of an acquiring firm in a merger if excessive numbers of new shares are issued relative to the value of their old shares.

A. Earnings volatility

B. Reduction of the exchange ratio

C. Dilution of ownership

D. Increased risk of bankruptcy

E. None of the options is correct

60. The federal law that requires each U.S. merging bank to notify its principal federal regulatory agency and request for an approval before a merger can take place is the:

A. Bank Merger Act.

B. Glass-Steagall Act.

C. Depository Institutions Deregulation and Monetary Control Act.

D. Garn-St Germain Depository Institutions Act.

E. Gramm-Leach-Bliley Act.

61. A merger may increase a bank’s expected future earnings or reduce its level of risk exposure by:

A. improved operating efficiency.

B. increased earnings per share.

C. geographic or product diversification.

D. product diversification.

E. All of the options are correct.

62. The Herfindahl-Hirschman Index is a measure of:

A. market concentration.

B. merger premium.

C. synergies gained from a merger.

D. employee strength of the combined firm after merger.

E. All of the options are correct.

63. There are three banks in East Panhandle. First National Bank which currently has 40 percent of the deposits in the area, Second State Bank which currently has 30 percent of the deposits, and New State Bank and Trust which also has 30 percent of the deposits. What is the Herfindahl-Hirschman Index for East Panhandle?

A. 100

B. 1,200

C. 3,400

D. 2,400

E. None of the options is correct

64. There are three banks in East Panhandle. First State Bank which currently has 25 percent of the deposits in the area, Second State Bank which currently has 40 percent of the deposits, and Third State Bank which has the rest. What is the Herfindahl-Hirschman Index for East Panhandle (compute the share of Third State Bank first)?

A. 100

B. 2,200

C. 3,450

D. 3,640

E. None of the options is correct

65. There are three banks in East Panhandle. First State Bank which currently has 25 percent of the deposits, Second State Bank which currently has 40 percent of the deposits, and Third State Bank which has the rest. According to the Department of Justice Guidelines, this market will be identified as:

A. unconcentrated.

B. mildly concentrated.

C. moderately concentrated.

D. highly concentrated.

E. monopoly.

66. There are three banks in East Panhandle. First State Bank which currently has 25 percent of the deposits, Second State Bank which currently has 40 percent of the deposits and Third State Bank which has the rest. Compute the share of the Third State Bank in the market. Suppose First State Bank and Third State Bank propose to merge in order to compete with Second State Bank. According to the Department of Justice Guidelines, would this merger be allowed?

A. Very likely

B. Likely, but with certain regulatory restrictions

C. Highly unlikely

D. Not enough information to make the determination

E. None of the options is correct

67. First National Bank’s stock is currently selling at $40 per share and the bank recently reported earnings per share of $4.50 on its 200,000 shares outstanding. Second National Bank has 150,000 shares outstanding, with a current market price of $30 per share. It just reported its earnings per share of $5. If First National acquires Second National in a stock purchase, with the two banks agreeing to exchange stock at the current market prices, and post-merger earnings are expected to be $1,800,000, what is the expected EPS post merger?

A. $4.36

B. $5.76

C. $5.28

D. $5.14

E. None of the options is correct

68. Recent research on interstate bank mergers suggests that generally such mergers have resulted in:

A. increased earnings.

B. improved employee productivity.

C. faster growth.

D. improved cost control.

E. All of the options are correct.

69. Suppose Bank A’s stock price is $75 and Bank B’s stock price is $25. Bank A is planning to purchase Bank B by paying Bank B’s shareholders a bonus of $10 per share. What is the merger premium that Bank B’s shareholders will receive?

A. 110 percent

B. 46.6 percent

C. 200 percent

D. 140 percent

E. None of the options is correct

70. Suppose Bank A’s stock price is $75 and Bank B’s stock price is $25. Bank A is planning to purchase Bank B by paying Bank B’s shareholders a bonus of $10 per share. If Bank B has 100,000 shares outstanding, how many shares of Bank A will the shareholders of Bank B receive?

A. 100,000 shares

B. 33,333 shares

C. 46,667 shares

D. 214,286 shares

E. None of the options is correct

71. The most important goal of any merger should be to:

A. increase the market value of the surviving firm.

B. reduce the risk of the surviving firm through geographic diversification.

C. increase managerial compensation.

D. increase the efficiency of the target firm.

E. None of the options is correct.

72. Which of the following is(are) reason(s) that many bank mergers do not work?

A. Ill-prepared management

B. A mismatch of corporate cultures

C. Excessive price paid by the acquirer

D. A failure to take into account customers’ feelings and concerns

E. All of the options are reasons bank mergers do not work.

73. Andover Bank is planning to purchase Berkley Bank. The current market value of Andover’s stock is $55 per share while that of Berkley’s stock is $15 per share. Andover plans to pay Berkley’s stockholders a $5 bonus per share. Currently, Andover has 100,000 shares outstanding and earnings per share of $12, while Berkley has 50,000 shares outstanding and earnings per share of $5. What is the merger premium that Andover will end up paying on Berkley’s shares if the merger goes through?

A. 367 percent

B. 275 percent

C. 133 percent

D. 100 percent

E. None of the options is correct

74. Andover Bank is planning to purchase Berkley Bank. The current market value of Andover’s stock is $55 per share while that of Berkley’s stock is $15 per share. Andover plans to pay Berkley’s stockholders a $5 bonus per share. Currently, Andover has 100,000 shares outstanding and earnings per share of $12, while Berkley has 50,000 shares outstanding and earnings per share of $5. What is the exchange ratio for this transaction?

A. 3:11

B. 4:3

C. 5:2

D. 4:11

E. None of the options is correct

75. Andover Bank is planning to purchase Berkley Bank. The current market value of Andover’s stock is $55 per share while that of Berkley’s stock is $15 per share. Andover plans to pay Berkley’s stockholders a $5 bonus per share. Currently, Andover has 100,000 shares outstanding and earnings per share of $12, while Berkley has 50,000 shares outstanding and earnings per share of $5. What will be the total number of shares outstanding for the new bank?

A. 118,182 shares

B. 150,000 shares

C. 166,667 shares

D. 200,000 shares

E. None of the options is correct

76. Andover Bank is planning to purchase Berkley Bank. The current market value of Andover’s stock is $55 per share while that of Berkley’s stock is $15 per share. Andover plans to pay Berkley’s stockholders a $5 bonus per share. Currently, Andover has 100,000 shares outstanding and earnings per share of $12, while Berkley has 50,000 shares outstanding and earnings per share of $5. Suppose that the earnings of the new bank are $1,600,000 and the combined bank will have 118,182 shares outstanding. What will be the earnings per share for the new bank?

A. $17.00 per share

B. $13.54 per share

C. $9.67 per share

D. $12.27 per share

E. None of the options is correct

77. Andover Bank is planning to purchase Berkley Bank. The current market value of Andover’s stock is $55 per share while that of Berkley’s stock is $15 per share. Andover plans to pay Berkley’s stockholders a $5 bonus per share. Currently, Andover has 100,000 shares outstanding and earnings per share of $12, while Berkley has 50,000 shares outstanding and earnings per share of $5. Suppose the earnings of the combined bank do not increase over the total earnings of the two banks before the merger. In addition assume that the new bank will have 118,182 shares outstanding. What will be the earnings per share for the new bank?

A. $17.00 per share

B. $13.54 per share

C. $9.67 per share

D. $12.27 per share

E. None of the options is correct

78. Suppose there are four banks in a local community. Each of these banks has 25 percent of the deposits in this community. What is the Herfindahl-Hirschman Index (HHI) for this community?

A. 10,000

B. 100

C. 2,500

D. 625

E. None of the options is correct

79. Suppose there are four banks in a local community. Each of these banks has 25 percent of the deposits in this community. According to the Department of Justice guidelines, this market is:

A. unconcentrated.

B. mildly concentrated.

C. moderately concentrated.

D. highly concentrated.

E. None of the options is correct

80. Suppose there are four banks in a local community. Each of these banks has 25 percent of the deposits in this community. Calculate the change in the Herfindahl-Hirschman Index (HHI) if two of these banks merge.

A. 625

B. 1,000

C. 1,150

D. 1,200

E. 1,250

81. In the United States, most bank mergers have occurred in which of the following geographic region of the country?

A. Southeastern U.S.

B. Northeastern U.S.

C. The West

D. The Midwest

E. Southwestern U.S.

82. Research indicates that economies of scale (cost savings) often results in mergers of financial institutions which are relatively:

A. small in size.

B. large in size.

C. medium in size.

D. undercapitalized.

E. overcapitalized.

Dorchester County has the following five banks in its market area:

83. What is the market share of the First National Bank?

A. 100.00 percent

B. 75.00 percent

C. 46.15 percent

D. 15.38 percent

E. None of the options is correct

84. What is the Herfindahl-Hirschman Index for this market area?

A. 3,017

B. 5,000

C. 10,000

D. 3,187,000

E. None of the options is correct

85. If Summerfield and Charlestown banks merge, what would be the Herfindahl-Hirschman Index after the merger?

A. 3,017

B. 3,136

C. 5,000

D. 10,000

E. None of the options is correct

86. There are 10 banks in a particular market area all with a market share of 10 percent. What is the Herfindahl-Hirschman Index for this market area?

A. 10,000

B. 5,000

C. 1,000

D. 0

E. None of the options is correct

87. There are 10 banks in a particular market area all with a market share of 10 percent. Two of the banks plan to merge. What would the Herfindahl-Hirschman Index be after the merger?

A. 5,000

B. 1,200

C. 1,000

D. 0

E. None of the options is correct

88. There are 10 banks in a particular market area, all with a market share of 10 percent. Two of the banks plan to merge and the Herfindahl-Hirschman Index moves from 1,000 to 1,200. The Justice Department:

A. will treat this market as unconcentrated.

B. will not be concerned and no further review is likely.

C. may raise competitive concerns depending on the circumstances.

D. will treat the market as highly concentrated.

E. will block the merger by filing a suit.

89. According to the text, which of the following is a trigger that created a wave of mergers in Europe?

A. Passage of the Riegle-Neal Interstate Banking Act

B. Passage of the Gramm-Leach-Bliley Act

C. Passage of the Bank Merger Act

D. Formation of the European Union

E. Unicredito Italiano’s take-over of Germany’s HUB Group AG

90. The First State Bank of Wyoming wants to acquire the First State Bank of Oklahoma. The management of the bank feels that this will increase earnings as new markets will be exploited and new services will be offered to all of their bank customers. Which motive for a merger does this most likely reflect?

A. Profit potential

B. Risk reduction

C. Rescue of failing institution

D. Cost savings

E. Maximizing management welfare

91. The First State Bank of Wyoming wants to acquire the Second National Bank of South Carolina. It wants to do this because the management feels that South Carolina faces very different economic conditions than Wyoming and that this acquisition will reduce variability in earnings in the future. What motive for a merger does this most likely reflect?

A. Profit potential

B. Risk reduction

C. Rescue of failing institution

D. Cost savings

E. Maximizing management welfare

92. The First National Bank of Edmond wants to acquire the First State Bank of Oklahoma City. The management believes that this merger will enhance their reputation in the labor market because the new firm will be twice as big as what they are managing now. In addition, the First National Bank of Edmond has promised to pay $10,000,000 in compensation to the top managers of the First State Bank of Oklahoma City and help it cover any resulting tax liability. What motive for a merger does this most likely reflect?

A. Profit potential

B. Risk reduction

C. Rescue of failing institution

D. Tax and market positioning

E. Maximizing management welfare

93. The First National Bank of Edmond had decided to purchase The First National Bank of Plano in Texas. The bank is interested in this purchase because The First National Bank of Plano is in financial distress and the First National Bank of Edmond thinks this is a cheap way to get a start in the large Texas market. The FDIC supports this acquisition because it won’t have to make any insurance payouts. What motive for a merger does this most likely reflect?

A. Profit potential

B. Risk reduction

C. Rescue of failing institution

D. Tax and market positioning

E. Maximizing management welfare

94. The State Bank of Stillwater has had record profits this year. It is interested in purchasing the National Bank of Durant because it has had losses this year. The State Bank of Stillwater feels that it can turn around the National Bank of Durant and in the meantime they can enjoy a reduced tax burden after this acquisition. What motive for a merger does this most likely reflect?

A. Profit potential

B. Risk reduction

C. Rescue of failing institution

D. Tax and market positioning

E. Maximizing management welfare

95. The passage of _______________________ Act in the United States allowed various combinations of bank-nonbank financial services and permitted banks, insurance companies, and securities firms to acquire each other.

A. Gramm-Leach-Bliley

B. Riegle-Neal Interstate Banking

C. Sherman Antitrust

D. Bank Merger

E. Community Reinvestment

96. ____________________ refers to a declining population of businesses in any one industry.

A. Convergence

B. Consortium

C. Consolidation

D. Divergence

E. Expansion

97. ________________________ refers to the movement of two or more industries over time toward each other, resulting in different firms offering many of the same services.

A. Divergence

B. Convergence

C. Consortium

D. Diversification

E. Consolidation

98. According to the text, many European bank mergers in recent years is motivated by the search of:

A. cost efficiency.

B. failing institutions.

C. cash-rich banks.

D. complementarity.

E. tax efficiency.

99. A merger where the institutions involved don’t overlap much or at all in terms of geographic area served is known as:

A. convergence.

B. consolidation.

C. market extension merger.

D. market making merger.

E. market pooling merger.

100. The federal agency that is the merging banks’ principal supervisor must review the banks’ record to determine if they have made an affirmative effort to serve all segments of the population in their trade area without any discrimination. This assessment is required under the terms of:

A. Gramm-Leach-Bliley Act.

B. Riegle-Neal Interstate Banking Act.

C. Sherman Antitrust Act.

D. Community Reinvestment Act.

E. Sarbanes-Oxley Act.

101. Marking off a certain neighborhood by a bank within their trade area and declining to extend financial services (especially credit) to the residents of that neighborhood is known as:

A. redlining.

B. redlisting.

C. protectionism.

D. collective dominance.

E. managerial hubris.

102. Empirical evidence suggests that earnings outcomes from mergers exhibit:

A. a symmetric distribution.

B. a positively skewed distribution.

C. a negatively skewed distribution.

D. a leptokurtic distribution.

E. no fixed pattern of distribution.

103. The approach in which the merger partners merely sum the volume of their assets, liabilities, and equity in the amounts recorded just before their merger takes place is known as the:

A. purchase accounting method.

B. merger accounting method.

C. pooling of interest method.

D. pooling of equity method.

E. pooling of accounting method.

104. The approach in which the firm to be acquired is valued at its purchase price and that price is added to the total assets of the acquirer is known as the:

A. purchase accounting method.

B. merger accounting method.

C. pooling of interest method.

D. pooling of equity method.

E. pooling of accounting method.

Chapter 20
International Banking and the Future of Banking and Financial Services

Fill in the Blank Questions

1. A(n) ___________________________________ is the simplest organizational form for an international bank. This is a limited service office that markets the services provided by the home office and identifies new customers but does not take deposits or book loans.

________________________________________

2. A(n) ______________________ is a more complete organizational form for international banks than a representative office. It does not generally take deposits from the public but gives commitments to make or purchase loans, among other things.

________________________________________

3. A(n) ______________________ is the most common organizational form for an international bank. It offers the bank’s full range of services but is not a separate legal entity from its parent bank.

________________________________________

4. When an international bank acquires majority ownership of a separate, legally incorporated foreign bank under host-country rules, this foreign bank is called a(n) ______________________ of the international bank.

________________________________________

5. ____________________________ are domestic U.S. companies owned by U.S. or foreign banks, located outside the home state of the bank that owns them. These organizations are limited primarily to international business transactions.

________________________________________

6. A(n) ______________________ branch is a special foreign office which merely records the receipt of deposits and other international transactions. Often these branches contain little more than a desk, a telephone, fax machine, and computer and are used as a way around regulations.

________________________________________

7. A(n) ___________________________________________ is an organization which has over half its income from activities associated with exporting goods and services from the U.S. They can offer export insurance coverage, transportation, warehousing, and other services.

________________________________________

8. The ____________________________________________ is the first major federal law regulating foreign bank activity in the U.S. It requires foreign banks accepting deposits to meet reserve requirements and allows foreign banks to be eligible for federal deposit insurance under stipulated conditions.

________________________________________

9. A(n) ______________________________________ is a receipt issued by a U.S. bank which makes it easier for a foreign business borrower to sell securities in the U.S.

________________________________________

10. A(n) ______________________ is where a bank customer, anticipating a future need to make foreign currency purchase, will negotiate a contract for the delivery of the currency at a set price on a set date.

________________________________________

11. A(n) ______________________________________________ is where computerized records of transactions involving banks and their international customers are kept separate from the rest of the domestic accounts. These are more lightly regulated than regular bank offices.

________________________________________

12. The ______________________________________________ requires regulators to determine if foreign banks selling their services in the U.S. are adequately regulated by their home governments and to close those not adequately supervised or in violation of U.S. law.

________________________________________

13. The ___________________________________________ is an agreement between the U.S., Japan, Canada, and several other nations of Western Europe to adopt common capital standards for all of their banks.

________________________________________

14. ____________________________________________ refers to the market for foreign currency or trading one currency for another.

________________________________________

15. ____________________________________________ is the risk that has to do with the fluctuations in currency prices.

________________________________________

16. A(n) ____________________________________________ grants the buyer the right to deliver or take delivery of a designated currency at a specified price until it expires.

________________________________________

17. A(n) ____________________________________________ is the exchange of different national currencies between two parties who need foreign currencies to repay loans or cover other expenses.

________________________________________

18. The ____________________________________________ is an international market for long-term debt denominated in foreign currency units.

________________________________________

19. A(n) _________________________________________________________________ is a contractual agreement between two parties to exchange interest payments in order to hedge against interest rate risk.

________________________________________

20. A device which aids customers in selling goods abroad is known by the acronym _________ and was originally developed by the Japanese.

________________________________________

21. When dealers speculate on trends in the prices of selected currencies, it is called ______________.

________________________________________

22. _______________ are primarily medium-term credit agreements between international banks and their larger corporate and government customers. The customer is authorized to periodically offer short term notes that come due in 90 to 180 days over a stipulated period.

________________________________________

23. A(n) _______________ is a draft for payment due and payable upon presentation to the bank.

________________________________________

24. A(n) _______________ is a draft for payment due and payable only on a specific future date.

________________________________________

25. When a loan is made in a foreign country and where the court system and bankruptcy laws needed to support the enforcement of contracts and loans are missing, it causes a special type of risk called ______________.

________________________________________

26. When a foreign government takes actions that interfere with the repayment of an international loan, it causes a special type of risk called ______________.

________________________________________

27. An international loan risk evaluation system that lists economic and political factors believed to be correlated with loan risk is called the ______________. It may apply comparative weights to each factor or consider each factor equally.

________________________________________

28. An international loan risk evaluation system that uses expert opinion is the ______________.

________________________________________

29. One of the most comprehensive country-risk indicators is provided by ______________. This guide supplies political, economic, and financial risk ratings and an overall composite rating for about 100 countries monthly.

________________________________________

True / False Questions

30. The barriers between securities dealers and international banks are falling in many countries, making it harder for the public to see real differences between financial institutions.

True False

31. Under U.S. regulations, a U.S. international bank can invest more than 50 percent of its consolidated capital and surplus in an export trading company.

True False

32. Under U.S. regulations, Edge Act subsidiaries must devote at least 50 percent of their business to assist customers with export-import trade and international credit.

True False

33. The International Banking Act of 1978, prohibited foreign-owned banks from crossing state lines unless the state or states involved allow cross-border entry.

True False

34. Foreign banks taking retail deposits in the U.S. can qualify for federal deposit insurance.

True False

35. The International Lending and Supervision Act does not require federal regulators to supervise the U.S. banks under their jurisdiction more closely but to give banks and the private marketplace more freedom in deciding what their capital requirements should be.

True False

36. The Basel Agreement, on international capital standards, does not cover Japanese banks but does cover major banks in the U.S. and Western Europe.

True False

37. Long hedges in currency futures are designed to protect a bank or its customer from increases in the price of the currency it must eventually acquire.

True False

38. Currency options give their buyer the right, but not the obligation, to deliver or take delivery of a foreign currency or currency futures contract.

True False

39. ADRs are issued by foreign banks operating outside the U.S. and sold to investors in the Eurodollar market.

True False

40. The Federal Reserve Board can terminate the operations of a foreign bank in the United States if it finds that the bank is not being operated in a manner consistent with the public interest.

True False

41. Under the terms of the International Lending and Supervision Act, the size of loan rescheduling fees that U.S. banks charge their international borrowers, is restricted.

True False

42. An international bank with a positive net exposure in a given foreign currency is said to be in a net short position in that particular currency.

True False

43. An international bank’s net position in a foreign currency is measured by the difference between the volume of that currency purchased and the volume of that currency sold.

True False

44. If an international bank has gone net long in a particular currency, it will score a positive gain if the value of that currency declines.

True False

45. If an international bank has adopted a net short position in a particular currency, and that currency’s exchange value increases, the bank will achieve a profit from trading the currency.

True False

46. A bank’s net foreign-currency-denominated assets in a given currency are equal to the volume of its assets denominated in that currency less any liabilities that the bank has issued denominated in the same currency.

True False

47. Short hedges in currency futures contracts are used to protect a bank or bank customer against rising currency prices.

True False

48. A put option on currency futures is often used to protect against a rise in currency prices.

True False

49. A call option is often employed to protect a bank or bank customer against losses from falling currency prices.

True False

50. A foreign currency swap fully removes the borrower’s currency risk exposure.

True False

51. In a foreign currency swap, a customer who needs to borrow in foreign currency, receives the domestic currency today and swaps it back for the foreign currency just in time to repay the loan in the foreign currency.

True False

52. A sight draft is a payment for purchase of goods and services across national borders which is payable only on a specific future date.

True False

53. A time draft is a payment for purchase of goods and services across national borders which is payable upon presentation to the bank.

True False

54. One way to determine the soundness of an international loan is to use the Delphi method which uses the consensus opinion of a panel of experts to develop a measure of a country’s risk exposure.

True False

55. The top trading firms in the global currency markets are all banks.

True False

56. Internet-based banks are not allowed in some countries such as Japan.

True False

57. The currency swap market is in decline following the introduction of the Euro.

True False

58. China has the highest overall savings rate in the world.

True False

59. An ETC is a device which aids customers in selling goods abroad.

True False

60. The Eurobond market provides a firm with access to funds outside its home country.

True False

Multiple Choice Questions

61. A limited service facility that can market services supplied by the home office of an international bank and identify new customers, but cannot take deposits or book loans is known as a:

A. branch office.

B. agency office.

C. subsidiary.

D. representative office.

E. None of options is correct.

62. Separate corporate entities affiliated either with a U.S. bank or with a foreign bank operating in the U.S. that can cross state lines, but must devote the majority of their accounts to international activities are known as:

A. joint ventures.

B. representative office.

C. Agreement corporations.

D. Edge Act corporations.

E. None of options is correct.

63. An organizational form used by international banks, that was created by U.S. regulations and authorized by the Federal Reserve Board, consisting of computerized account records is known as:

A. international banking facility (IBF).

B. export trading company (ETC).

C. Edge Acts.

D. agencies.

E. None of options is correct.

64. The specialized firms that can be operated by U.S. banking companies and Edge Act corporations are called:

A. international banking facilities (IBFs).

B. export trading companies (ETCs).

C. shell branches.

D. subsidiaries.

E. None of options is correct.

65. Organizational devices used by international banks to take deposits offshore and avoid regulations (such as deposit insurance assessments) are known as:

A. international banking facilities (IBFs).

B. export trading companies (ETCs).

C. shell branches.

D. subsidiaries.

E. None of options is correct.

66. International banking activities are regulated for many of the same reasons that shape domestic banking regulation. These common reasons for regulation include:

A. restricting bank risk exposure.

B. protecting the safety of depositor funds.

C. promoting stable growth in money and credit.

D. avoiding massive threats to economic health in individual nations.

E. All of the options are correct.

67. International banking regulation(s) that do not apply to most domestic banking activity include:

A. foreign exchange controls.

B. restricting the outflow of scarce capital.

C. protecting domestic financial institutions from foreign competition.

D. protecting domestic markets from foreign competition.

E. All of the options are correct.

68. Which of the following is (are) the key component(s) included in the International Banking Act (IBA) of 1978?

A. Foreign banks are required to follow the same branching laws as U.S. banks.

B. Legal reserves requirements determined by the Federal Reserve Board are compulsory against deposits accepted by U.S. branch or agency offices of foreign banks with consolidated assets of $1 billion or more.

C. U.S. branches of foreign banks are eligible for deposit insurance under stipulated conditions.

D. U.S. branches of foreign banks have access to certain Federal Reserve services, such as the ability to borrow from the Federal Reserve banks.

E. All of the options are correct.

69. The Foreign Bank Supervision Enhancement Act of 1991 places the responsibility for supervising U.S. branches of foreign banks with the:

A. Office of the Comptroller of the Currency.

B. Federal Reserve Board.

C. Federal Deposit Insurance Corporation.

D. Secretary of Commerce.

E. None of options is correct.

70. A call currency option:

A. obligates the holder to purchase currency or currency futures contracts at a fixed price any time before the option expires.

B. gives the holder the right to purchase currency or currency futures contracts at a fixed price any time before the option expires.

C. obligates the holder to sell currency or currency futures contracts at a fixed price any time before the option expires.

D. gives the holder the right to sell currency or currency futures contracts at a fixed price any time before the option expires.

E. None of options is correct.

71. Business corporations that are subsidiaries of a bank organized under Section 25 of the Federal Reserve Act and must devote the bulk of their activities to serving international customers are known as:

A. IBFs.

B. shell branches.

C. ETCs.

D. agreement corporations.

E. None of options is correct.

72. ____________ are often used to protect a nation against loss of its foreign currency reserves, which might damage its prospects for repaying international loans and purchasing goods and services abroad.

A. Export loan rate restrictions

B. Foreign exchange controls

C. Minimum capitalization requirements for domestic banks

D. Examination and supervision regulations for local branch offices

E. None of options is correct

73. Which U.S. federal law required branches and agency offices of foreign banks to secure federal licenses for their U.S. operations for the first time?

A. International Banking Act

B. International Lending and Supervision Act

C. Bank Holding Company Act

D. International Bank Supervision and Examination Procedures Act

E. None of options is correct.

74. Under current U.S. law, the Federal Reserve Board must be notified a minimum of __________ days in advance if a foreign bank wishes to close any of its U.S. offices.

A. 30

B. 60

C. 90

D. 180

E. None of options is correct.

75. A foreign currency contract that obligates the holder of the contract to take delivery of a foreign currency sometime in the future is called a:

A. call currency option.

B. put currency option.

C. long-hedge currency futures contract.

D. short-hedge currency futures contract.

E. None of options is correct.

76. A foreign currency contract that obligates the holder of the contract to make delivery of a foreign currency sometime in the future is called a:

A. call currency option.

B. put currency option.

C. long-hedge currency futures contract.

D. short-hedge currency futures contract.

E. None of options is correct.

77. A foreign currency contract that gives the holder of the contract the right to purchase a currency at a fixed price any time before the published expiration date is called a:

A. call currency option.

B. put currency option.

C. long-hedge currency futures contract.

D. short-hedge currency futures contract.

E. None of the options is correct.

78. A foreign currency contract that gives the holder of the contract the right to sell a foreign currency at a specified price on or before the published expiration date is called a:

A. call currency option.

B. put currency option.

C. long hedge currency futures contract.

D. short-hedge currency futures contract.

E. None of the options is correct.

79. A foreign currency contract where one party trades currencies with another and trades it back at the end of the contract is called a:

A. currency option contract.

B. currency forward contract.

C. currency swap contract.

D. currency futures contract.

E. None of the options is correct.

80. Banks have been heavily involved in selling their services across national boundaries since:

A. the industry’s very beginning.

B. the 1950s.

C. the 1980s.

D. the turn of the century.

E. None of the options is correct.

81. A full-service facility operated by a bank away from its home office but is merely a local office that represents a single large financial-service corporation is known as a(n):

A. branch office.

B. agency office.

C. subsidiary.

D. representative office.

E. None of the options is correct.

82. Which of the following is one of the customer services supplied by banks in international markets?

A. Underwriting notes and bond issues in the U.S. bond market

B. Helping customer market their products in the domestic market

C. Helping customers hedge against foreign currency risk

D. Making loans to domestic customers

E. All of the options are customer services offered by banks in the international market.

83. Which of the following is a risk evaluation system in international lending today?

A. The Seat-of-the-pants method

B. The Discrimination method

C. The Delphi method

D. The State-risk indicator method

E. None of the options is correct.

84. The Hagard Mercantile Company has made a $30 million investment in a mill in Germany and fears a substantial decline in the mark’s current spot rate from $0.63 to $0.56 lowering the value of the company’s investment in the mill. Which of the following currency contracts can help Hagard solve this problem?

A. Call currency option

B. Put currency option

C. Long-hedge currency futures contract

D. Currency swap contract

E. None of the options is correct.

85. The Goudge Grilling Company has just ordered a shipment of grills from Frankfurt. Payment for the grills must be in euros when the grills are delivered. Euros have changed in value in the last 30 days. They have gone from $1.42 to $1.44. If this trend continues which of the following currency contracts can help the Goudge Grilling Company hedge their currency risk?

A. Put currency option

B. Short-hedge currency futures contract

C. Long-hedge currency futures contract

D. Currency swap contract

E. None of the options is correct.

86. As the text suggests, all of the following areas of the world have significant opportunities for foreign banks except:

A. Asia.

B. China.

C. Russia.

D. Japan.

E. South Korea.

87. The primary source for international bank statistics is:

A. the FDIC.

B. the OCC.

C. the BIS.

D. the ETC.

E. the United Nations.

88. The market for banking in China exhibits all of the following except:

A. high savings rate.

B. a well-qualified management.

C. a large percentage of troubled loans.

D. a general lack of access from outside the country.

E. a growing economy.

89. The biggest problem for international banks at the beginning of the 21st century is:

A. the Internet.

B. interest rate risk.

C. foreign exchange risk.

D. non-performing loans.

E. None of the options is correct.

90. The First National Bank of Summerville has opened an office in Turkey. This is a limited service office that can market services of the home office in Turkey and can identify Turkish customers but cannot take deposits or book loans. What type of office has the First National Bank of Summerville opened in Turkey?

A. A representative office

B. A shell branch

C. A branch office

D. A subsidiary

E. An export trading company

91. The Third State Bank of Laramie has opened an office in Morocco. This office does not take deposits but makes commitments to make loans, issues letters of credit, and provides technical assistance to companies in Morocco. What type of office has the Third State Bank of Laramie opened in Morocco?

A. A representative office

B. An agency office

C. A branch office

D. A subsidiary

E. An export trading company

92. The Second National Bank of Guthrie has opened an office in Chile. This office offers a full line of services and is not a separate legal entity from the Second National Bank of Guthrie. What type of office has the Second National Bank of Guthrie opened in Chile?

A. A representative office

B. An agency office

C. A branch office

D. A subsidiary

E. An export trading company

93. The State Bank of Virginia owns 55 percent of the shares of the Bank of Budapest. What type of arrangement is this?

A. A representative office

B. An agency office

C. A branch office

D. A subsidiary

E. An export trading company

94. The State Bank of Nebraska owns a company that has more than half of its income from activities associated with exporting goods and services from the U.S. This company offers export insurance coverage, transportation and warehousing in Europe, trade financing, and other services. What type of company does the State Bank of Nebraska own?

A. A representative office

B. An agency office

C. A branch office

D. A subsidiary

E. An export trading company

95. If Denmark requires that all foreign banks operating in Denmark have at least ten percent capital, what reason for regulating international banks is this action most likely in support of?

A. Protecting the safety of depositor funds

B. Promoting stable growth in money and credit

C. Providing foreign currency controls

D. Protecting domestic financial institutions

E. Restricting the outflow of scarce capital

96. Suppose the international banks operating in Venezuela have to meet the same legal reserve requirements as domestic banks to avoid massive threats to economic health in the nation. This would be in support of which reason for regulating international banks?

A. Protecting the safety of depositor funds

B. Promoting stable growth in money and credit

C. Providing foreign currency controls

D. Protecting domestic financial institutions

E. Restricting the outflow of scarce capital

97. Suppose Brazil decides to restrict the export of the real by international banks so that the real does not leave the country and reduce currency reserves for repayment of Brazilian debt. This would be in support of which reason for regulating international banks?

A. Protecting the safety of depositor funds

B. Promoting stable growth in money and credit

C. Providing foreign currency controls

D. Protecting domestic financial institutions

E. Restricting the outflow of scarce capital

98. Suppose India restricts entry of foreign banks until the end of the decade. This would be in support of which reason for regulating international banks?

A. Protecting the safety of depositor funds

B. Promoting stable growth in money and credit

C. Providing foreign currency controls

D. Protecting domestic financial institutions

E. Restricting the outflow of scarce capital

99. Suppose South Korea limits the amount of deposits made in South Korea that can be used to make loans in other countries. This would be in support of which reason for regulating international banks?

A. Protecting the safety of depositor funds

B. Promoting stable growth in money and credit

C. Providing foreign currency controls

D. Protecting domestic financial institutions

E. Restricting the outflow of scarce capital

100. Suppose Bank of America holds assets denominated in yen of 150 million and liabilities denominated in yen of 90 million. They also have yen purchases of 70 million and yen sales of 50 million. What is Bank of America’s net exposure to currency risk?

A. + 150 million yen

B. + 60 million yen

C. + 80 million yen

D. – 80 million yen

E. – 60 million yen

101. Suppose Bank of America holds assets denominated in yen of 150 million and liabilities denominated in yen of 90 million. They also have yen purchases of 70 million and yen sales of 50 million. When would Bank of America experience a loss in the currency market?

A. When the yen declines in value relative to U.S. dollars

B. When the yen increases in value relative to U.S. dollars

C. When U.S. dollar declines in value relative to the yen

D. When the euro declines in value

E. None of the options is correct.

102. Suppose Citibank holds assets denominated in euros of 120 million and liabilities denominated in euros of 180 million. They also have euro purchases of 40 million and euro sales of 70 million. What is Citibank’s net exposure to currency risk?

A. + 120 million euros

B. – 90 million euros

C. + 90 million euros

D. – 60 million euros

E. + 60 million euros

103. Suppose Citibank holds assets denominated in euros of 120 million and liabilities denominated in euros of 180 million. They also have euro purchases of 40 million and euro sales of 70 million. When would Citibank experience a loss in the currency market?

A. When the euro declines in value relative to the dollar

B. When the dollar increases in value relative to the euro

C. When the yen increases in value

D. When the euro increases in value relative to the dollar

E. None of the options is correct.

104. Suppose a U.S. bank borrows money in London while a British company borrows money in New York. At the end of the loan period the U.S. company needs pounds to repay their loan and the British company needs dollars to repay their loan. Which of the following might be a good tool for these companies to reduce their currency risk?

A. Currency futures contract

B. Currency option contract

C. Interest rate futures contract

D. Interest rate swap contract

E. Currency swap contract

105. Which of the following is a reason for the growth of the currency swap market in recent years?

A. It has helped thousands of businesses and governments hedge currency risk.

B. It has provided central banks with a new instrument to trade.

C. It has helped shape money and credit conditions in various countries.

D. It has helped strengthen home nations’ economies.

E. All of the options are reasons for the growth of the currency swap market in recent years.

106. A multinational company raises short-term credit through London’s financial district. They are most likely using:

A. Eurocommercial paper (ECP)

B. Depository receipt (DR)

C. Note issuance facility

D. Currency swap

E. None of the options is correct.

107. Suppose the Bank of America provides a 5 year credit guarantee for Dillard’s Department Stores. Dillard’s Department Stores periodically issues short term notes with due dates of 90 days after they are issued in the international market. Bank of American has most likely provided a(n):

A. Eurocommercial paper (ECP)

B. Depository receipt (DR)

C. Note issuance facility

D. Currency swap

E. None of the options is correct.

108. A broker has purchased stock in Sony Corporation and has asked Citibank to act as a custodian of this stock. Citibank has issued a negotiable instrument representing ownership interest in the stock of the Japanese company. These negotiable instruments are denominated in dollars and not in yen. This is an example of a(n):

A. Eurocommercial paper (ECP).

B. Depository receipt (DR).

C. Note issuance facility.

D. Currency swap.

E. None of the options is correct

109. Which of the following is a way in which a bank can deal with a troubled international loan?

A. The loan can be restructured generally with a lower interest rate and longer time to repay

B. The loan can be sold in the secondary market

C. The bank can write off all or part of the loan

D. The bank can accept exit bonds in lieu of loan repayment

E. All of the options are ways to deal with a troubled international loan

110. A bank, concerned about risk exposure in entering a foreign market, lacking the necessary expertise and customer contacts abroad, or wishing to offer services restricted to banks alone, may choose to:

A. set up a branch office.

B. enter into a joint venture with a foreign financial firm.

C. set up an agency office.

D. set up a representative office.

E. set up a shell branch.

111. Which of the following types of bank possesses its own charter and capital stock and is legally incorporated under host-country rules?

A. A branch office

B. A joint venture

C. A representative office

D. A subsidiary

E. A shell branch

112. An increasing number of nations are recognizing the need of coordinating the regulatory activities so that all financial firms, serving international markets, operate under similar rules. This is known as:

A. reconciliation

B. accord

C. consolidation

D. convergence

E. harmonization

113. Recently, FOREX trading activity among leading commercial and investment bank dealers has sharply increased due to:

A. volatility among leading currencies.

B. increase in security underwriting for corporations.

C. provision of foreign marketing assistance to customers.

D. introduction of payments and cash management services.

E. supply of foreign currencies directly to customers.

114. An investor takes a call option on euro futures contracts at strike price of $0.65. If the market price of euro futures increases to $0.67, the call option will be called:

A. “out of the money.”

B. “in the money.”

C. “long-hedge.”

D. “passing option.”

E. “swap money.”

115. An investor takes a call option on euro futures contracts at strike price of $0.65. If the market price of euro futures reduces to $0.62, the call option will:

A. be “in the money.”

B. be exercised before the option expires.

C. go unexercised.

D. increase upside profits.

E. increase downside risk.

116. Banks and other financial firms continue to substantially consolidate and converge, resulting in more diverse service providers. This is because of:

A. the Foreign Bank Supervision Enhancement Act.

B. introduction of depository receipts.

C. increase in currency swaps.

D. increased consolidation and convergence.

E. the Basel Agreement.