Q&A Hero

Q: An important factor in producing the subprime mortgage crisis was A) lax consumer protection regulation. B) onerous rules placed on mortgage originators. C) weak incentives for mortgage brokers to use complicated mortgage products. D) strong incentives for the mortgage brokers to verify income information.

Q: Consumer protection legislation includes legislation to A) reduce discrimination in credit markets. B) require banks to make loans to everyone who applies. C) reduce the amount of interest that bank's can charge on loans. D) require banks to make periodic reports to the Better Business Bureau.

Q: During times of financial crisis, mark-to-market accounting A) requires that a financial firms' assets be marked down in value which can worsen the lending crisis. B) leads to an increase in the financial firms' balance sheets since they can now get assets at bargain prices. C) leads to an increase in financial firms' lending. D) results in financial firms' assets increasing in value.

Q: With ________, firms value assets on their balance sheet at what they would sell for in the market. A) mark-to-market accounting B) book-value accounting C) historical-cost accounting D) off-balance sheet accounting

Q: Regulations designed to provide information to the marketplace so that investors can make informed decisions are called A) disclosure requirements. B) efficient market requirements. C) asset restrictions. D) capital requirements.

Q: The current supervisory practice toward risk management A) focuses on the quality of a bank's balance sheet. B) determines whether capital requirements have been met. C) evaluates the soundness of a bank's risk-management process. D) focuses on eliminating all risk.

Q: Regular bank examinations and restrictions on asset holdings help to indirectly reduce the ________ problem because, given fewer opportunities to take on risk, risk-prone entrepreneurs will be discouraged from entering the banking industry. A) moral hazard B) adverse selection C) ex post shirking D) post-contractual opportunism

Q: Banks are required to file ________ usually quarterly that list information on the bank's assets and liabilities, income and dividends, and so forth. A) call reports B) balance reports C) regulatory sheets D) examiner updates

Q: The federal agencies that examine banks include A) the Federal Reserve System. B) the Internal Revenue Service. C) the SEC. D) the U.S. Treasury.

Q: Banks will be examined at least once a year and given a CAMELS rating by examiners. The L stands for A) liabilities. B) liquidity. C) loans. D) leverage.

Q: The chartering process is similar to ________ potential borrowers and the restriction of risk assets by regulators is similar to ________ in private financial markets. A) screening; restrictive covenants B) screening; branching restrictions C) identifying; branching restrictions D) identifying; credit rationing

Q: The chartering process is especially designed to deal with the ________ problem, and regular bank examinations help to reduce the ________ problem. A) adverse selection; adverse selection B) adverse selection; moral hazard C) moral hazard; adverse selection D) moral hazard; moral hazard

Q: Overseeing who operates banks and how they are operated is called A) prudential supervision. B) hazard insurance. C) regulatory interference. D) loan loss reserves.

Q: One of the criticisms of Basel 2 is that it is procyclical. That means that A) banks may be required to hold more capital during times when capital is short. B) banks may become professional at a cyclical response to economic conditions. C) banks may be required to hold less capital during times when capital is short. D) banks will not be required to hold capital during an expansion.

Q: Because banks engage in regulatory arbitrage, the Basel Accord on risk-based capital requirements may result in A) reduced risk taking by banks. B) reduced supervision of banks by regulators. C) increased fraudulent behavior by banks. D) increased risk taking by banks.

Q: Banks engage in regulatory arbitrage by A) keeping high-risk assets on their books while removing low-risk assets with the same capital requirement. B) keeping low-risk assets on their books while removing high-risk assets with the same capital requirement. C) hiding risky assets from regulators. D) buying risky assets from arbitragers.

Q: The practice of keeping high-risk assets on a bank's books while removing low-risk assets with the same capital requirement is known as A) competition in laxity. B) depositor supervision. C) regulatory arbitrage. D) a dual banking system.

Q: Under the Basel Accord, assets and off-balance sheet activities were sorted according to ________ categories with each category assigned a different weight to reflect the amount of ________. A) 2; adverse selection B) 2; credit risk C) 4; adverse selection D) 4; credit risk

Q: The Basel Accord requires banks to hold as capital an amount that is at least ________ of their risk-weighted assets. A) 10% B) 8% C) 5% D) 3%

Q: 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.

Q: Off-balance-sheet activities A) generate fee income with no increase in risk. B) increase bank risk but do not increase income. C) generate fee income but increase a bank's risk. D) generate fee income and reduce risk.

Q: The FDIC must take steps to close down banks whose equity capital is less than ________ of assets. A) 4% B) 3% C) 2% D) 1%

Q: To be considered well capitalized, a bank's leverage ratio must exceed A) 10%. B) 8%. C) 5%. D) 3%.

Q: The leverage ratio is the ratio of a bank's A) assets divided by its liabilities. B) income divided by its assets. C) capital divided by its total assets. D) capital divided by its total liabilities.

Q: A bank failure is less likely to occur when A) a bank holds less U.S. government securities. B) a bank suffers large deposit outflows. C) a bank holds fewer excess reserves. D) a bank has more bank capital.

Q: A well-capitalized financial institution has ________ to lose if it fails and thus is ________ likely to pursue risky activities. A) more; more B) more; less C) less; more D) less; less

Q: Regulators attempt to reduce the riskiness of banks' asset portfolios by A) limiting the amount of loans in particular categories or to individual borrowers. B) encouraging banks to hold risky assets such as common stocks. C) establishing a minimum interest rate floor that banks can earn on certain assets. D) requiring collateral for all loans.

Q: The too-big-to-fail policy A) reduces moral hazard problems. B) puts large banks at a competitive disadvantage in attracting large deposits. C) treats large depositors of small banks inequitably when compared to depositors of large banks. D) allows small banks to take on more risk than large banks.

Q: 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

Q: The result of the too-big-to-fail policy is that ________ banks will take on ________ risks, making bank failures more likely. A) small; fewer B) small; greater C) big; fewer D) big; greater

Q: Federal deposit insurance covers deposits up to $250,000, but as part of a doctrine called "too-big-to-fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does this, it uses the A) "payoff" method. B) "purchase and assumption" method. C) "inequity" method. D) "Basel" method.

Q: If the FDIC decides that a bank is too big to fail, it will use the ________ method, effectively ensuring that ________ depositors will suffer losses. A) payoff; large B) payoff; no C) purchase and assumption; large D) purchase and assumption; no

Q: 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 A) was a good investment opportunity for the government. B) could be the Chicago branch of a new governmentally-owned interstate banking system. C) was too big to fail. D) would become the center of the new midwest region central bank system.

Q: The existence of deposit insurance can increase the likelihood that depositors will need deposit protection, as banks with deposit insurance A) are likely to take on greater risks than they otherwise would. B) are likely to be too conservative, reducing the probability of turning a profit. C) are likely to regard deposits as an unattractive source of funds due to depositors' demands for safety. D) are placed at a competitive disadvantage in acquiring funds.

Q: Acquiring information on a bank's activities in order to determine a bank's risk is difficult for depositors and is another argument for government A) regulation. B) ownership. C) recall. D) forbearance.

Q: 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. A) adverse selection; little B) adverse selection; much C) moral hazard; little D) moral hazard; much

Q: The government safety net creates ________ problem because risk-loving entrepreneurs might find banking an attractive industry. A) an adverse selection B) a moral hazard C) a lemons D) a revenue

Q: 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.

Q: Although the FDIC was created to prevent bank failures, its existence encourages banks to A) take too much risk. B) hold too much capital. C) open too many branches. D) buy too much stock.

Q: Deposit insurance is only one type of government safety net. All of the following are types of government support for troubled financial institutions except A) forgiving tax debt. B) lending from the central bank. C) lending directly from the government's treasury department. D) nationalizing and guaranteeing that all creditors will be repaid their loans in full.

Q: When bad drivers line up to purchase collision insurance, automobile insurers are subject to the A) moral hazard problem. B) adverse selection problem. C) assigned risk problem. D) ill queue problem.

Q: Moral hazard is an important concern of insurance arrangements because the existence of insurance A) provides increased incentives for risk taking. B) is a hindrance to efficient risk taking. C) causes the private cost of the insured activity to increase. D) creates an adverse selection problem but no moral hazard problem.

Q: When one party to a transaction has incentives to engage in activities detrimental to the other party, there exists a problem of A) moral hazard. B) split incentives. C) ex ante shirking. D) pre-contractual opportunism.

Q: Deposit insurance has not worked well in countries with A) a weak institutional environment. B) strong supervision and regulation. C) a tradition of the rule of law. D) few opportunities for corruption.

Q: 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.

Q: To prevent bank runs and the consequent bank failures, the United States established the ________ in 1934 to provide deposit insurance. A) FDIC B) SEC C) Federal Reserve D) ATM

Q: During the boom years of the 1920s, bank failures were quite A) uncommon, averaging less than 30 per year. B) uncommon, averaging less than 100 per year. C) common, averaging about 600 per year. D) common, averaging about 1000 per year.

Q: The contagion effect refers to the fact that A) deposit insurance has eliminated the problem of bank failures. B) bank runs involve only sound banks. C) bank runs involve only insolvent banks. D) the failure of one bank can hasten the failure of other banks.

Q: Because of asymmetric information, the failure of one bank can lead to runs on other banks. This is the A) too-big-to-fail effect. B) moral hazard problem. C) adverse selection problem. D) contagion effect.

Q: Depositors have a strong incentive to show up first to withdraw their funds during a bank crisis because banks operate on a A) last-in, first-out constraint. B) sequential service constraint. C) double-coincidence of wants constraint. D) everyone-shares-equally constraint.

Q: The fact that banks operate on a "sequential service constraint" means that A) all depositors share equally in the bank's funds during a crisis. B) depositors arriving last are just as likely to receive their funds as those arriving first. C) depositors arriving first have the best chance of withdrawing their funds. D) banks randomly select the depositors who will receive all of their funds.

Q: Depositors lack of information about the quality of bank assets can lead to A) bank panics. B) bank booms. C) sequencing. D) asset transformation.

Q: 11.1 Asymmetric Information and Financial Regulation

Q: Bank capital has both benefits and costs for the bank owners. Higher bank capital ________ the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given return on assets. A) reduces; reduces B) increases; increases C) reduces; increases D) increases; reduces

Q: 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.

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

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

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

Q: 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.

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

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

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

Q: Banks that actively manage liabilities will most likely meet a reserve shortfall by A) calling in loans. B) borrowing federal funds. C) selling municipal bonds. D) seeking new deposits.

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

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

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

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

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

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

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

Q: If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could A) borrow from another bank in the federal funds market. B) buy U.S. Treasury bills. C) increase loans. D) buy corporate bonds.

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

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

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

Q: Of the following, which would be the first 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

Q: A bank with insufficient reserves can increase its reserves by A) lending federal funds. B) calling in loans. C) buying short-term Treasury securities. D) buying municipal bonds.

Q: If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A) reduce deposits by $3 million. B) increase loans by $3 million. C) sell $3 million of securities. D) repay its discount loans from the Fed.

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

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

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