Q&A Hero

Q: Banks' asset portfolios include state and local government securities because A. they help to attract business from these government entities. B. banks consider them helpful in attracting accounts of Federal employees. C. the Federal Reserve requires member banks to buy securities from state and local governments located within their respective Federal Reserve districts. D. there is no default-risk with state and local government securities.

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

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

Q: Secondary reserves include A. deposits at Federal Reserve Banks. B. deposits at other large banks. C. short-term U.S. government securities. D. state and local government securities.

Q: Which of the following bank assets is the most liquid? A. consumer loans B. reserves C. state and local government securities D. U.S. government securities

Q: The largest percentage of banks' holdings of securities consist of A. Treasury and government agency securities. B. tax-exempt municipal securities. C. state and local government securities. D. corporate securities.

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

Q: 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

Q: Which of the following are reported as assets on a bank's balance sheet? A. borrowings B. reserves C. savings deposits D. bank capital

Q: The amount of checkable deposits that banks are required by regulation to hold are the A. excess reserves. B. required reserves. C. vault cash. D. total reserves.

Q: Bank reserves include A. deposits at the Fed and short-term treasury securities. B. vault cash and short-term Treasury securities. C. vault cash and deposits at the Fed. D. deposits at other banks and deposits at the Fed.

Q: Bank ________ is/are listed on the liability side of the bank's balance sheet. A. reserves B. capital C. securities D. cash items

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

Q: Which of the following is NOT a source of borrowings for a bank? A. federal funds B. Eurodollars C. transaction deposits D. discount loans

Q: 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

Q: Banks acquire the funds that they use to purchase income-earning assets from such sources as A. cash items in the process of collection. B. savings accounts. C. reserves. D. deposits at other banks.

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

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

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

Q: All of the following are nontransaction deposits EXCEPT A. savings accounts. B. small-denomination time deposits. C. checkable deposits. D. certificates of deposit.

Q: Which of the following are transaction deposits? A. savings accounts B. small-denomination time deposits C. checkable deposits D. certificates of deposit

Q: 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

Q: Which of the following statements are TRUE? A. Checkable deposits are payable on demand. B. Checkable deposits do not include NOW accounts. C. Checkable deposits are the primary source of bank funds. D. Checkable deposits are assets for the bank.

Q: In recent years the interest paid on checkable and nontransaction deposits has accounted for around ________ of total bank operating expenses, while the costs involved in servicing accounts have been approximately ________ of operating expenses. A. 45 percent; 55 percent B. 55 percent; 4 percent C. 25 percent; 50 percent D. 50 percent; 30 percent

Q: Which of the following statements is FALSE? A. Checkable deposits are usually the lowest cost source of bank funds. B. Checkable deposits are the primary source of bank funds. C. Checkable deposits are payable on demand. D. Checkable deposits include NOW accounts.

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

Q: Which of the following are reported as liabilities on a bank's balance sheet? A. discount loans B. reserves C. U.S. Treasury securities D. real estate loans

Q: Which of the following are reported as liabilities on a bank's balance sheet? A. reserves B. checkable deposits C. consumer loans D. deposits with other banks

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

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

Q: Based on the Net Interest Margin the poor bank performance in the late 1980s A. was not the result of interest-rate movements. B. was not the result of risky loans made in the early 1980s. C. resulted from a narrowing of the gap between interest earned on assets and inters paid on liabilities. D. resulted from a huge decrease in provisions for loan losses.

Q: Interest income minus interest expenses divided by assets is a measure of bank performance known as the A. operating income. B. net interest margin. C. return on assets. D. return on equity.

Q: For banks A. return on assets exceeds return on equity. B. return on assets equals return on equity. C. return on equity exceeds return on assets. D. return on equity is another name for net interest margin.

Q: When a bank suspects that a $1 million loan might prove to be bad debt that will have to be written off in the future the bank A. can set aside $1 million of its earnings in its loan loss reserves account. B. reduces its reported earnings by $1, even though it has not yet actually lost the $1 million. C. reduces its assets immediately by $1 million, even though it has not yet lost the $1 million. D. reduces its reserves by $1 million, so that they can use those funds later.

Q: All of the following are operating expenses for a bank EXCEPT A. service charges on deposit accounts. B. salaries and employee benefits. C. rent on buildings. D. servicing costs of equipment such as computers.

Q: Most of a bank's operating income results from A. interest on assets. B. service charges on deposit accounts. C. off-balance-sheet activities. D. fees from standby lines of credit.

Q: One of the problems in conducting a duration gap analysis is that the duration gap is calculated assuming that interest rates for all maturities are the same. That means that the yield curve is A. flat. B. slightly upward sloping. C. steeply upward sloping. D. downward sloping.

Q: 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 A. 0.9 percent of its assets. B. 0.9 percent of its liabilities. C. 1.8 percent of its liabilities. D. 1.8 percent of its assets.

Q: Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of liabilities with a duration of 1.05. The duration gap for this bank is A. 0.5 year. B. 1 year. C. 1.5 years. D. 2 years.

Q: Assume a bank has $200 million of assets with a duration of 2.5, and $190 million of liabilities with a duration of 1.05. If interest rates increase from 5 percent to 6 percent, the net worth of the bank falls by A. $1 million. B. $2.4 million. C. $3.6 million. D. $4.8 million.

Q: When banks calculate the losses the institution would incur if an unusual combination of bad events happened, the bank is using the ________ approach. A. stress-test B. value-at-risk C. trading-loss D. maximum value

Q: Banks develop statistical models to calculate their maximum loss over a given time period. This approach is known as the A. stress-testing approach. B. value-at-risk approach. C. trading-loss approach. D. doomsday approach.

Q: The principal-agent problem that exists for bank trading activities can be reduced through A. creation of internal controls that combine trading activities with bookkeeping. B. creation of internal controls that separate trading activities from bookkeeping. C. elimination of regulation of banking. D. elimination of internal controls.

Q: One way for banks to reduce the principal-agent problems associated with trading activities is to A. set limits on the total amount of a traders' transactions. B. make sure that the person conducting the trades is also the person responsible for recording the transactions. C. encourage traders to take on more risk if the potential rewards are higher. D. reduce the regulations on the traders so that they have more flexibility in conducting trades.

Q: A reason why rogue traders have bankrupt their banks is due to A. the separation of trading activities from the bookkeepers. B. stringent supervision of trading activities by bank management. C. accounting errors. D. a failure to maintain proper internal controls.

Q: Traders working for banks are subject to the A. principal-agent problem. B. free-rider problem. C. double-jeopardy problem. D. exchange-risk problem.

Q: When banks involved in trading activities attempt to outguess markets, they are A. forecasting. B. diversifying. C. speculating. D. engaging in riskless arbitrage.

Q: Why does the free-rider problem occur in the debt market?

Q: The high growth rate in China in the last twenty years has similarities to the high growth rate of ________ during the 1950s and 1960s. A) the United States B) the Soviet Union C) Brazil D) Mexico

Q: One reason China has been able to grow so rapidly even though its financial development is still in its early stages is A) the high savings rate of around 40%. B) the shift of labor to the agricultural sector. C) the stringent enforcement of financial contracts. D) the ease of obtaining high-quality information about creditors.

Q: In developing countries, it can be expensive and time-consuming for the poor to legalize their property ownership. Without legal title, the property cannot be used as ________ to borrow funds. A) collateral B) points C) interest D) restrictive covenants

Q: Because of the weak systems of property rights in many developing and transition economies, the financial system is unable to use collateral effectively worsening the ________ problem. A) adverse selection B) moral hazard C) principal/agent D) diversification

Q: One reason financial systems in developing and transition countries are underdeveloped is A) they have weak links to their governments. B) they make loans only to nonprofit entities. C) the legal system may be poor making it difficult to enforce restrictive covenants. D) the accounting standards are too stringent for the banks to meet.

Q: One possible reason for slower growth in developing and transition countries is A) capital may not be directed to its most productive use. B) strict accounting standards are too stringent for the banks to meet. C) the weak link between government and financial intermediaries. D) the lack of adverse selection and moral hazard problems.

Q: A key finding of the economic analysis of financial structure is that A) the existence of the free-rider problem for traded securities helps to explain why banks play a predominant role in financing the activities of businesses. B) while free-rider problems limit the extent to which securities markets finance some business activities, nevertheless the majority of funds going to businesses are channeled through securities markets. C) given the great extent to which securities markets are regulated, free-rider problems are not of significant economic consequence in these markets. D) economists do not have a very good explanation for why securities markets are so heavily regulated.

Q: Solutions to the moral hazard problem include A) low net worth. B) monitoring and enforcement of restrictive covenants. C) greater reliance on equity contracts and less on debt contracts. D) greater reliance on debt contracts than financial intermediaries.

Q: Although restrictive covenants can potentially reduce moral hazard, a problem with restrictive covenants is that A) borrowers may find loopholes that make the covenants ineffective. B) they are inexpensive to monitor and enforce. C) too many resources may be devoted to monitoring and enforcing them, as debtholders duplicate others' monitoring and enforcement efforts. D) they reduce the value of the debt contract.

Q: For restrictive covenants to help reduce the moral hazard problem, they must be ________ by the lender. A) monitored and enforced B) written in all capitals C) easily changed D) impossible to remove

Q: Professional athletes often have contract clauses prohibiting risky activities such as skiing and motorcycle riding. These clauses are A) limited-liability clauses. B) risk insurance. C) restrictive covenants. D) illegal.

Q: A clause in a debt contract requiring that the borrower purchase insurance against loss of the asset financed with the loan is called a A) collateral-insurance clause. B) prescription covenant. C) restrictive covenant. D) proscription covenant.

Q: One way of describing the solution that high net worth provides to the moral hazard problem is to say that it A) collateralizes the debt contract. B) makes the debt contract incentive compatible. C) state verifies the debt contract. D) removes all of the risk in the debt contract.

Q: High net worth helps to diminish the problem of moral hazard problem by A) requiring the state to verify the debt contract. B) collateralizing the debt contract. C) making the debt contract incentive compatible. D) giving the debt contract characteristics of equity contracts.

Q: A debt contract is incentive compatible A) if the borrower has the incentive to behave in the way that the lender expects and desires, since doing otherwise jeopardizes the borrower's net worth in the business. B) if the borrower's net worth is sufficiently low so that the lender's risk of moral hazard is significantly reduced. C) if the debt contract is treated like an equity. D) if the lender has the incentive to behave in the way that the borrower expects and desires.

Q: Although debt contracts require less monitoring than equity contracts, debt contracts are still subject to ________ since borrowers have an incentive to take on more risk than the lender would like. A) moral hazard B) agency theory C) diversification D) the "lemons" problem

Q: Explain the principal-agent problem as it pertains to equity contracts.

Q: Solutions to the moral hazard in equity contracts include all of the following EXCEPT A) government regulations to increase information. B) the use of financial intermediaries. C) the use of debt contracts. D) government ownership of resources.

Q: Since they require less monitoring of firms, ________ contracts are used more frequently than ________ contracts to raise capital. A) debt; equity B) equity; debt C) debt; loan D) equity; stock

Q: Debt contracts A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals. B) have a higher cost of state verification than equity contracts. C) are used less frequently to raise capital than are equity contracts. D) never result in a loss for the lender.

Q: Equity contracts account for a small fraction of external funds raised by American businesses because A) costly state verification makes the equity contract less desirable than the debt contract. B) of the reduced scope for moral hazard problems under equity contracts, as compared to debt contracts. C) equity contracts do not permit borrowing firms to raise additional funds by issuing debt. D) there is no moral hazard problem when using a debt contract.

Q: One way the venture capital firm avoids the free-rider problem is by A) prohibiting the sale of equity in the firm to anyone except the venture capital firm. B) prohibiting members from serving on the board of directors. C) prohibiting the borrowing firm from replacing management. D) requiring collateral equal to the value of the borrowed funds.

Q: A venture capital firm protects its equity investment from moral hazard through which of the following means? A) It places people on the board of directors to better monitor the borrowing firm's activities. B) It writes contracts that prohibit the sale of an equity investment to the venture capital firm. C) It prohibits the borrowing firm from replacing its management. D) It requires a 50% stake in the company.

Q: One financial intermediary in our financial structure that helps to reduce the moral hazard from arising from the principal-agent problem is the A) venture capital firm. B) money market mutual fund. C) pawn broker. D) savings and loan association.

Q: Government regulations designed to reduce the moral hazard problem include A) laws that force firms to adhere to standard accounting principles. B) light sentences for those who commit the fraud of hiding and stealing profits. C) state verification subsidies. D) state licensing restrictions.

Q: Because information is scarce A) helps explain why equity contracts are used so much more frequently to raise capital than are debt contracts. B) monitoring managers gives rise to costly state verification. C) government regulations, such as standard accounting principles, have no impact on problems such as moral hazard. D) developing nations do not rely heavily on banks for business financing.

Q: The name economists give the process by which stockholders gather information by frequent monitoring of the firm's activities is A) costly state verification. B) the free-rider problem. C) costly avoidance. D) debt intermediation.

Q: The recent Enron and Tyco scandals are an example of A) the free-rider problem. B) the adverse selection problem. C) the principal-agent problem. D) the "lemons problem."

Q: The principal-agent problem would not occur if ________ of a firm had complete information about actions of the ________. A) owners; customers B) owners; managers C) managers; customers D) managers; owners

Q: The principal-agent problem A) occurs when managers have more incentive to maximize profits than the stockholders-owners do. B) in financial markets helps to explain why equity is a relatively important source of finance for American business. C) would not arise if the owners of the firm had complete information about the activities of the managers. D) explains why direct finance is more important than indirect finance as a source of business finance.

Q: 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. A) principals; agents B) principals; principals C) agents; agents D) agents; principals

Q: 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