Money and banking exam 2

If interest rates are expected to rise, banks will want liabilities of ____________

duration and ____________ rate sensitivity.

a. Longer ; greater

b. Longer ; smaller

c. Shorter ; greater

d. Shorter ; smaller

B

Asymmetric information issues are mitigated by collateralized debt contracts for

all of the following reasons EXCEPT:

a. Borrowers have more to lose when default involves loss of collateral.

b. Lenders can more easily identify good risk borrowers by their ability to

put up collateral.

c. Both (a) and (b) are true.

d. Neither (a) nor (b) is true.

C

Rising market interest rates in the 1960s and 1970s, combined with regulated

deposit rate ceilings:

a. Worked to give mortgage-issuing institutions a source of low-cost funds.

b. Led eventually to an outflow of deposits from depository institutions.

c. Led to financial innovations that worked to undo the deposit rate

ceilings.

d. All of the above are true.

D

The process of transforming otherwise illiquid financial assets into marketable

capital market instruments is known as:

a. Internationalization

b. Securitization

c. Arbitrage

d. Program Trading

B

Which of the following is NOT a liability for the banking system?

a. Checkable deposits

b. U.S. Treasury securities

c. Discount Loans

d. All of the above are banking system liabilities

B

Of the following sources of external finance for American nonfinancial

businesses, the least important is

a. loans from banks

b. stocks

c. bonds and commercial paper.

d. loans from other financial intermediaries.

B

Direct finance involves the sale to ________ of marketable securities such as

stocks and bonds.

a. households

b. insurance companies

c. pension funds

d. financial intermediaries

A

A ________ is a provision that restricts or specifies certain activities that a

borrower can engage in.

a. residual claimant.

b. risk hedge

c. restrictive barrier

d. restrictive covenant.

D

Adverse selection is a problem associated with equity and debt contracts arising

from

a. the lender's relative lack of information about the borrower's potential

returns and risks of his investment activities.

b. the lender's inability to legally require sufficient collateral to cover a

100% loss if the borrower defaults.

c. the borrower's lack of incentive to seek a loan for highly risky

investments.

d. the lender's inability to restrict the borrower from changing his behavior

once given a loan.

A

The concept of adverse selection helps to explain all of the following EXCEPT

a. why firms are more likely to obtain funds from banks and other financial

intermediaries, rather than from the securities markets.

b. why indirect finance is more important than direct finance as a source of

business finance.

c. why direct finance is more important than indirect finance as a source of

business finance.

d. why the financial system is so heavily regulated.

C

Moral hazard in equity contracts is known as the ________ problem because the

manager of the firm has fewer incentives to maximize profits than the

stockholders might ideally prefer.

a. principal-agent

b. adverse selection

c. free-rider

d. debt deflation

A

Venture-capital firms and private-equity firms protect their equity investment

from moral hazard through which of the following means?

a. They place people on the board of directors to better monitor the

borrowing firm's activities.

b. They write contracts that prohibit the sale of an equity investment to the

venture-capital firms and the private-equity firms.

c. They prohibit the borrowing firms from replacing their management.

d. They require a 50% stake in the company.

A

Because checking accounts are ________ liquid for the depositor than savings

accounts, they earn ________ interest rates.

a. less ; higher

b. less ; lower

c. more ; higher

d. more ; lower

D

Bank loans from the Federal Reserve are called ________ and represent a

________ of funds.

a. discount loans ; use

b. discount loans ; source

c. fed funds ; use

d. fed funds ; source

B

Which of the following are NOT reported as assets on a bank's balance sheet?

a. cash items in the process of collection

b. deposits with other banks

c. U.S. Treasury securities

d. checkable deposits

D

Of the following, which would be the last choice for a bank facing a reserve

deficiency?

a. Call in loans

b. Borrow from the Fed

c. Sell securities

d. Borrow from other banks

A

Holding large amounts of bank capital helps prevent bank failures because

a. it means that the bank has a higher income.

b. it makes loans easier to sell.

c. it can be used to absorb the losses resulting from bad loans.

d. it makes it easier to call in loans.

C

For a given return on assets, the lower is bank capital

a. the lower is the return for the owners of the bank.

b. the higher is the return for the owners of the bank.

c. the lower is the credit risk for the owners of the bank.

d. the lower the possibility of bank failure.

B

Conditions that likely contributed to a credit crunch during the global financial

crisis include

a. capital shortfalls caused in part by falling real estate prices.

b. regulated hikes in bank capital requirements.

c. falling interest rates that raised interest rate risk, causing banks to choose

to hold more capital.

d. increases in reserve requirements

A

From the standpoint of ________, specialization in lending is surprising but

makes perfect sense when one considers the ________ problem.

a. moral hazard; diversification

b. diversification; moral hazard

c. adverse selection; diversification

d. diversification; adverse selection

D

If a bank has $50 million in rate-sensitive assets and $20 million in ratesensitive liabilities then

a. an increase in interest rates will reduce bank profits.

b. a decrease in interest rates will reduce bank profits.

c. interest rate changes will not impact bank profits.

d. a decrease in interest rates will increase bank profits.

B

If a banker expects interest rates to fall in the future, her best strategy for the

present is

a. to increase the duration of the bank's liabilities.

b. to buy short-term bonds.

c. to sell long-term certificates of deposit.

d. to increase the duration of the bank's assets.

D

Examples of off-balance-sheet activities include

a. trading activities.

b. extending loans to depositors.

c. borrowing from other banks.

d. selling negotiable CDs.

A

The primary difference between the "payoff" and the "purchase and assumption"

methods of handling failed banks is

a. that the FDIC guarantees all deposits when it uses the "payoff" method.

b. that the FDIC guarantees all deposits when it uses the "purchase and

assumption" method.

c. that the FDIC is more likely to use the "payoff" method when the bank is

large and it fears that depositor losses may spur business bankruptcies

and other bank failures.

d. that the FDIC is more likely to use the purchase and assumption method

for small institutions because it will be easier to find a purchaser for

them compared to large institutions.

B

A system of deposit insurance

a. attracts risk-taking entrepreneurs into the banking industry.

b. encourages bank managers to decrease risk.

c. increases the incentives of depositors to monitor the riskiness of their

bank's asset portfolio.

d. increases the likelihood of bank runs.

A

A problem with the too-big-to-fail policy is that it ________ the incentives for

________ by big banks.

a. increases ; moral hazard

b. decreases ; moral hazard

c. decreases ; adverse selection

d. increases ; adverse selection

A

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

based on

a. risk-weighted assets.

b. the total value of assets.

c. liabilities.

d. deposits.

A

The ________ that required separation of commercial and investment banking

was repealed in 1999.

a. the Federal Reserve Act

b. the Glass-Steagall Act

c. the Bank Holding Company Act

d. the Monetary Control Act

B

Both ________ and ________ were financial innovations that occurred because

of interest rate volatility.

a. adjustable-rate mortgages; commercial paper

b. adjustable-rate mortgages; financial derivatives

c. sweep accounts; financial derivatives

d. sweep accounts; commercial paper

B

The development of money market mutual funds contributed to the growth of

________ since the money market mutual funds need to hold liquid, highquality, short-terms assets.

a. the commercial paper market

b. the municipal bond market

c. the corporate bond market

d. the junk bond market

A

Securitization is a process of asset transformation that involves a number of

different financial institutions working together. These financial institutions are

known collectively as the

a. transformers.

b. amalgamation.

c. movers and shakers.

d. shadow banking system.

D

Financial innovations that grew out of the bank branching restrictions were

a. bank holding companies and automated teller machines.

b. bank holding companies and securitization.

c. automated teller machines and sweep accounts.

d. automated teller machines and bank credit cards.

A

A possible sequence for the three stages of a financial crisis might be ________

leads to ________ leads to ________.

a. asset price declines; banking crises; unanticipated decline in price level

b. unanticipated decline in price level; banking crises; increase in interest

rates

c. banking crises; increase in interest rates; unanticipated decline in price

level

d. banking crises; increase in uncertainty; increase in interest rates

A

Agency problems in the subprime mortgage market included all of the following

EXCEPT

a. homeowners could refinance their houses with larger loans when their

homes appreciated in value.

b. mortgage originators had little incentives to make sure that the

mortgagee is a good credit risk.

c. underwriters of mortgage-backed securities had weak incentives to make

sure that the holders of the securities would be paid back.

d. the evaluators of securities, the credit rating agencies, were subject to

conflicts of interest.

A

The recession caused by the global financial crisis was severe, but much smaller

in magnitude than the Great Depression because

a. of massive intervention by governments to prop up financial markets.

b. of the larger world population.

c. modern technological inventions makes sustaining a crisis difficult.

d. the Federal Reserve stayed out of the way during the most recent crisis.

A

Firms that are designated as systemically important financial institutions (SIFIs)

are subject to all of the following additional Federal Reserve regulations

EXCEPT

a. higher capital standards.

b. stricter liquidity requirements.

c. providing a plan for orderly liquidation if necessary.

d. interest rate ceilings on time deposits.

D

One suggested method of reducing excessive risk-taking by SIFIs is to require

them to hold ________ capital when credit is expanding rapidly and ________

capital when credit is contracting.

a. less ; more

b. more ; no

c. more ; less

d. less ; no

C

In the U.S., loans from ____________ are far ______ important for corporate

finance than are securities markets.

a. Government agencies ; more

b. Government agencies ; less

c. Financial intermediaries ; more

d. Financial intermediaries ; less

C

Prior to 1980, member banks left the Federal Reserve System largely due to:

a. The high cost of discount loans from the Fed.

b. The high cost of holding required reserves.

c. A desire to avoid interest rate regulations

d. A desire to avoid credit controls.

B

The Federal Open Market Committee (FOMC) consists of:

a. Five senior members of the seven-member Board of Governors.

b. Seven members of the Board of Governors and seven regional Fed bank

presidents.

c. Seven members of the Board of Governors and five regional Fed bank

presidents.

d. Twelve regional Fed bank presidents and the Chair of the Board of

Governors.

C

The strongest argument for an independent Federal Reserve rests on the view

that subjecting the Fed to, say, the pressures of the political business cycle

would impart:

a. An inflationary bias to monetary policy.

b. A deflationary bias to monetary policy

c. A disinflationary bias to monetary policy.

d. A countercyclical bias to monetary policy.

A

Which of the following is NOT an appropriate analogous pair of bodies of the

Federal Reserve System and the European Central Bank System?

a. Board of Governors ; Executive Board

b. FOMC ; Governing Council

c. Regional Federal Reserve Banks ; Member National Banks

d. All of the above are appropriate analogous pairs.

D

If interest rates are expected to fall, banks will want assets of ------

duration and rate sensitivity.

a. Longer ; smaller

b. Longer ; greater

C. Shorter smaller

d. Shorter ; greater

C

Securitization over the past few decades has resulted in new financial instruments, including one in which an investor makes a series of payments in return for receiving a payment should a default occur on the debt contract underlying this financial instrument. This type of financial instrument is called a:

a. Mortgage-backed security

b. Credit default swap

c. Money market mutual fund

d. Junk bond

D

AIG's position in the CDS (credit default swap) market contributed to the worsening of the financial crisis because:

a. They were able to include CDS sale revenue off balance sheet.

b. The high credit rating on their CDS's allowed for margin requirements that masked their true systemic risk exposure.

c. Both (a) and (b) are true.

d. Neither (a) nor (b) is true.

C

Which of the following is NOT an asset for the banking system?

a. Checkable deposits

b. U.S. Treasury securities

c. Mortgage Loans

d. All of the above are banking system assets.

A

A bank facing a reserve deficiency can borrow overnight from another bank on the market.

a. U.S. Treasury

b. Commercial paper

c. Federal funds market

d. None of the other choices are true.

C

Countercyclical capital requirements have been suggested as one way to reduce the risk that a small shock to the financial system becomes a broader financial crisis. The idea behind the countercyclical capital requirement is that banks should hold capital during a _

a. More ; credit crunch

b. Less ; credit boom

c. Both (a) and (b) are true.

d. Neither (a) nor (b) is true.

C

Originate-to-distribute models of mortgage markets involve multiple degrees of separation between the initial borrower and ultimate investor, causing _

a. More widespread principal-agent problems.

b. Greater difficulties in hedging mortgage default risk.

c. Fewer challenges for the regulating authorities.

d. All of the above are true.

A

Interbank loans are called and represent a of funds for the borrowing bank.

a. discount loans ; use

b. discount loans ; source

c. fed funds ; use

d. fed funds ; source

C

A rise in interest rates will favor:

a. A bank with a particularly high average duration of assets.

b. A bank with a particularly large amount of rate sensitive assets.

c. A bank with a particularly low average duration of liabilities.

d. All of the above are true.

D

For a given return on assets, the higher is bank capital

a. the lower is the return for the owners of the bank.

b. the higher is the return for the owners of the bank.

c. the higher is the credit risk for the owners of the bank.

d. None of the above are true.

B

Which of the following does NOT mitigate (reduce) moral hazard in financial markets?

a. Greater collateral requirements in debt contracts.

b. Venture capital firms' placement of their representatives on corporate boards.

c. A stricter regulatory process of orderly liquidation

d. Expanded deposit insurance

B

Which of the following does NOT mitigate (reduce) moral hazard in financial markets?

a. Greater collateral requirements in debt contracts.

b. Venture capital firms' placement of their representatives on corporate boards.

c. A stricter regulatory process of orderly liquidation

d. Expanded deposit insurance

C

If a bank has a gap of -$30 million,

a. an increase in interest rates will reduce bank profits.

b. a decrease in interest rates will increase bank profits.

c. Both (a) and (b) are true.

d. Neither (a) nor (b) is true

A

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

a. Discount loans

b. Reserves

c. U.S. Treasury bonds

d. Real estate loans

C

A deposit outflow at a bank results in equal reductions in

a. Loans and reserves.

b. Assets and liabilities.

c. Reserves and capital.

d. Assets and capital.

D

Increased size of financial institutions resulting from financial consolidation increases the problem, because there are now more large institutions whose failure would expose the financial system to systemic risk.

a. Too:..big-to-fail

b. Asset transformation

c. Transaction costs

d. Economies of scale

C

The Dodd-Frank legislation of 2010 requires the largest banks in the United States to conduct annual

a. Stress tests to see if these banks have sufficient capital to operate under dire scenarios.

b. Stress tests to see if their physical infrastructure can withstand natural disasters.

c. Management evaluations to determine CEO bonuses.

d. Liability evaluations to make sure they're sufficiently insured.

B

Adjustable rate mortgages

a. Reduce interest-rate risk for financial institutions.

b. Benefit homeowners when interest rates rise.

c. Both (a) and_ (b) are true.

d. Neither (a) nor (b) is true.

D

A drop in loan values often causes the net worth of financial institutions to fall and results in their cutting back on lending. This process is called _

a. Deflation

b. Deleveraging

C. Disinflation

d. Dollarization

C

Given the fundamental factors in place that should support the demand for housing, we believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited."

Then Fed Chair Ben Bernanke in a speech to the Federal Reserve Bank of Chicago in May, 2007

With the benefit of hindsight, and noting the date of this speech, one might conclude:

a. Fed Chair Bemanke should have fired the next day.

b. Always downplay financial market risk when speaking at the Federal Reserve bank of Chicago.

c. Fed Chair Bernanke was trading on inside information in the mortgage-backed securities markets.

d. The Fed, too, underestimated the systemic risks caused by the subprime sector.

B