Eco 321 Exam 2

In general, banks would prefer to acquire funds quickly by ____ rather than ____.

borrowing from the Fed; reducing loans

In order to reduce the ____ problem in loan markets, bankers collect info from prospective borrowers to screen out the bad credit risks from the good ones.

adverse selection

Property promised to the lender as a compensation if the borrower defaults is called?

collateral

Since depositors, like any lender, only receive fixed payments while the bank keeps any surplus profits, they face the ___ problem that banks may take on too ____ risk.

moral hazard; much

using the Gordon Growth Model, a stocks current price decreases when?

the growth rate of dividends decreases

If during the past decade, the average rate of monetary growth has been 5% and the average inflation rate has been 5% everything else held constant, when the Federal Reserve announces that the new rate of monetary growth will be 10% the adaptive expectation forecast of the inflation rate is?

5%.

debt contracts

are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals.

measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap (times the change in the interest rate is called)

basic gap analysis

If interest rates rise by 5% points, say from 10% to 15%, bank profits (measured using gap analysis) will?

decline by $0.5 million.

assuming that the average duration of its assets is four years, while the average duration of its liabilities is three years, then a 5% point increase in interest rates will cause the net worth of First National to ____ by ___ of the total original asset value

decline; 5 percent

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

principal-agent

according to the liquidity premium theory of the term structure

the interest rate on long-term bonds will equal an average of short-term interest rates that people expect to occur over the life of the long-term bonds plus a term premium.

if, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can

sell $3 million of securities that the bank currently owns.

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

the higher is the return for the owners of the bank

which of the following is NOT part if the shadow banking system?

the transformer

The too-big-to-fail-policy

treats large depositors of small banks inequitably when compared to depositors of large banks.

The Federal Reserve Act of 1913 required that

national banks join the Federal Reserve System.

if 1 year interest rates for the next 5 years are expected to be 4,2,5,4, and 5%, and the 5-year term premium is 1% , than the 5- year bond rate will be

5 percent

Financial innovation has caused

banks to suffer a simultaneous decline of cost and income advantages.

Before 1863

banks acquired funds by issuing banknotes.

the presence of ____ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets

asymmetric information

In the one-period valuation model, the value of a share of stock today depends upon

the present value of both the dividends and the expected sales price.

The typical shape for a yield curve is

gently upward sloping.

Adjustable rate mortgages

reduce the interest-rate risk for financial institutions

If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits

more; an increase

When you deposit $50 in currency at Old National Bank

its liabilities increase by $50.

A stockholder's ownership of a company's stock gives her the right to

vote and be the residual claimant of all cash flows.

Although the National Bank Act of 1863 was designed to eliminate state-chartered banks by imposing a prohibitive tax on banknotes, state banks were able to stay in business by

acquiring funds through deposits.

Collateral requirements lessen the consequences of ________ because the collateral reduces the lender's losses in the case of a loan default and it reduces ________ because the borrower has more to lose from a default.

adverse selection; moral hazard

New computer technology has

reduced the cost of financial innovation

The Federal Reserve Act of 1913 required all ________ banks to become members of the Federal Reserve System, while ________ banks could choose to become members of the system

national; state

Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions

liquidity

An expectation may fail to be rational if

relevant information is available but ignored at the time the forecast is made.

The process in which people seeking higher yielding securities take their funds out of the banking system thus restricting the amount of funds banks can lend is called

disintermediation.

A deposit outflow results in equal reductions in

assets and liabilities.

All else the same, if a bank's liabilities are more sensitive to interest rate fluctuations than are its assets, then ________ in interest rates will ________ bank profits.

an increase; reduce

Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are TRUE?

Stocks and bonds, combined, supply less than one-half of the external funds

If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is

$25,000

The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance

are likely to take on greater risks than they otherwise would.

Prior to 1980, the Fed set an interest rate ________, a maximum limit, on the interest rate that could be paid on time deposit

ceiling

From the standpoint of ________, specialization in lending is surprising but makes perfect sense when one considers the ________ problem.

diversification; adverse selection

Adjustable rate mortgages

benefit homeowners when interest rates are falling

The declining cost of computer technology has made ________ a reality.

virtual banking

Using the Gordon growth model, if D1 is $.50, ke is 7%, and g is 5%, then the present value of the stock is

$25

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals times the change in the interest rate is called

basic gap analysis

State banks that are not members of the Federal Reserve System are most likely to be examined by the

FDIC

Commercial and farm mortgages, in which property is pledged as collateral, account for

one-quarter of borrowing by non-financial businesses

Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that

borrowers may find loopholes that make the covenants ineffective.

Because of an expected rise in interest rates in the future, a banker will likely

buy short-term rather than long-term bonds

When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of

moral hazard

The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry

an adverse selection

A problem for equity contracts is a particular type of ________ called the ________ problem

moral hazard; principal-agent

Which of the following statements concerning bank regulation in the United States is TRUE?

The Federal Reserve and the state banking authorities jointly have responsibility for the state banks that are members of the Federal Reserve System

According to rational expectations

expectations will not differ from optimal forecasts using all available information

In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment-grade status.

Michael Milken

The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as a

dual banking system

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

a decrease in interest rates will reduce bank profits.

Although the FDIC was created to prevent bank failures, its existence encourages banks to

take too much risk.

When banks offer borrowers smaller loans than they have requested, banks are said to

ration credit.

The primary loan customer of state-owned banks in developing and transition economies is often

the government that owns the institutions

When Jane Brown writes a $100 check to her nephew and he cashes the check, Ms. Brown's bank ________ assets of $100 and ________ liabilities of $100.

loses; loses

In the Gordon Growth Model, the growth rate is assumed to be ________ the required return on equity

less than

Moral hazard is an important concern of insurance arrangements because the existence of insurance

provides increased incentives for risk taking

Government regulations designed to reduce the moral hazard problem include

laws that force firms to adhere to standard accounting principles

Which bank regulatory agency has the sole regulatory authority over bank holding companies?

the Federal Reserve System

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

Call in loans

Economists have focused more attention on the formation of expectations in recent years. This increase in interest can probably best be explained by the recognition that

expectations influence the behavior of participants in the economy and thus have a major impact on economic activity.

If a bank has $10 million of checkable deposits, a required reserve ratio of 10 percent, and it holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow of

$1.2 million

As the costs associated with deposit outflows ________, the banks willingness to hold excess reserves will ________.

increase; increase

New information that might lead to a decrease in a stock's price might be

an expected decrease in the level of future dividends

If interest rates increase from 9 percent to 10 percent, a bank with a duration gap of 2 years would experience a decrease in its net worth of

1.8 percent of its assets

The term structure of interest rates is

the relationship among interest rates on bonds with different maturities.

Net profit after taxes per dollar of equity capital is a basic measure of bank profitability called

return on equity

A change in perceived risk of a stock changes

the required rate of return

In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent; in the 1980s it fluctuated between ________ percent and ________ percent.

5; 15

The principal-agent problem would not occur if ________ of a firm had complete information about actions of the ________.

owners; managers

With regard to external sources of financing for nonfinancial businesses in the United States, which of the following are accurate statements?

Marketable securities account for a larger share of external business financing in the United States than in Germany and Japan

If expectations are formed rationally, then individuals

change their forecast when faced with new information.

The global financial crisis lead to a decline in stock prices because

of a lowered expected dividend growth rate

Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the

moral hazard problem

In May 1991, the FDIC announced that it would sell the government's final 26% stake in Continental Illinois, ending government ownership of the bank that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois

was too big to fail.

Because of securitization, a new class of residential mortgages offered to borrowers with less-than-stellar credit records developed. These mortgages are known as

subprime mortgages

To eliminate the abuses of the state-chartered banks, the ________ created a new banking system of federally chartered banks, supervised by the ________.

National Bank Act of 1863; Office of the Comptroller of the Currency

A firm issuing credit cards earns income from

loans it makes to credit card holders.

Of the sources of external funds for nonfinancial businesses in the United States, loans from banks and other financial intermediaries account for approximately ________ of the total.

56%

The FDIC must take steps to close down banks whose equity capital is less than ________ of assets

2%

The recent Enron and Tyco International scandals are an example of

the principal-agent problem.

One factor contributing to the rapid growth of the commercial paper market since 1970 is

improved information technology making it easier to screen credit risks.

Regulation of the financial system

ensures the stability of the financial system

Managers (________) may act in their own interest rather than in the interest of the stockholder-owners (________) because the managers have less incentive to maximize profits than the stockholder-owners do.

agents; principals

The government institution that has responsibility for the amount of money and credit supplied in the economy as a whole is the

central bank.

Prior to 2008, the bank's cost of holding reserves equaled

the interest earned on loans times the amount on reserves

Unanticipated moral hazard contingencies can be reduced by

long-term customer relationships

The problem faced by the lender that the borrower may take on additional risk after receiving the loan is called

moral hazard

If a bank has $200,000 of checkable deposits, a required reserve ratio of 20 percent, and it holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is

$50,000.

If you default on your auto loan, your car will be repossessed because it has been pledged as ________ for the loan

collateral

Prior to 2008, bank managers looked on reserve requirement

as a tax on deposits

Improved computer technology has made home banking a reality. Home banking has advantages for both the customer and the bank

It is more convenient for the customer and lowers transactions costs for the bank.

The business term for economies of scope is

synergies.

A bank is insolvent when

its liabilities exceed its assets