Q&A Hero

Q: Because of an expected rise in interest rates in the future, a banker will likely A) make long-term rather than short-term loans. B) buy short-term rather than long-term bonds. C) buy long-term rather than short-term bonds. D) make either short or long-term loans; expectations of future interest rates are irrelevant.

Q: Duration analysis involves comparing the average duration of the bank's ________ to the average duration of its ________. A) securities portfolio; non-deposit liabilities B) assets; liabilities C) loan portfolio; deposit liabilities D) assets; deposit liabilities

Q: If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using gap analysis) will A) decline by $0.5 million. B) decline by $1.5 million. C) decline by $2.5 million. D) increase by $1.5 million.

Q: 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 A) basic gap analysis. B) the maturity bucket approach to gap analysis. C) the segmented maturity approach to gap analysis. D) the segmented maturity approach to interest-exposure analysis.

Q: Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap times the change in the interest rate is called A) basic duration analysis. B) basic gap analysis. C) interest-exposure analysis. D) gap-exposure analysis.

Q: If the First National Bank has a gap equal to a negative $30 million, then a 5 percentage point increase in interest rates will cause profits to A) increase by $15 million. B) increase by $1.5 million. C) decline by $15 million. D) decline by $1.5 million.

Q: The difference of rate-sensitive liabilities and rate-sensitive assets is known as the A) duration. B) interest-sensitivity index. C) rate-risk index. D) gap.

Q: If a bank has $50 million in rate-sensitive assets and $20 million in rate-sensitive 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.

Q: If a bank's liabilities are more sensitive to interest rate movements than are its assets, then A) an increase in interest rates will reduce bank profits. B) a decrease in interest rates will reduce bank profits. C) interest rates changes will not impact bank profits. D) an increase in interest rates will increase bank profits.

Q: If a bank has ________ rate-sensitive assets than liabilities, a ________ in interest rates will reduce bank profits, while a ________ in interest rates will raise bank profits. A) more; rise; decline B) more; decline; rise C) fewer; decline; decline D) fewer; rise; rise

Q: If a bank has ________ rate-sensitive assets than liabilities, then ________ in interest rates will increase bank profits. A) more; a decline B) more; an increase C) fewer; an increase D) fewer; a surge

Q: 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. A) an increase; increase B) an increase; reduce C) a decline; reduce D) a decline; not affect

Q: Risk that is related to the uncertainty about interest rate movements is called A) default risk. B) interest-rate risk. C) the problem of moral hazard. D) security risk.

Q: How can specializing in lending help to reduce the adverse selection problem in lending?

Q: Credit risk management tools include A) deductibles. B) collateral. C) interest rate swaps. D) duration analysis.

Q: When banks offer borrowers smaller loans than they have requested, banks are said to A) shave credit. B) rediscount the loan. C) raze credit. D) ration credit.

Q: When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in A) coercive bargaining. B) strategic holding out. C) credit rationing. D) collusive behavior.

Q: Of the following methods that banks might use to reduce moral hazard problems, the one not legally permitted in the United States is the A) requirement that firms keep compensating balances at the banks from which they obtain their loans. B) requirement that firms place on their board of directors an officer from the bank. C) inclusion of restrictive covenants in loan contracts. D) requirement that individuals provide detailed credit histories to bank loan officers.

Q: A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be prevented, will require borrowers to A) place a bank officer on their board of directors. B) place a corporate officer on the bank's board of directors. C) keep compensating balances in a checking account at the bank. D) purchase the bank's CDs.

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

Q: Property promised to the lender as compensation if the borrower defaults is called A) collateral. B) deductibles. C) restrictive covenants. D) contingencies.

Q: A bank's commitment to provide a firm with loans up to pre-specified limit at an interest rate that is tied to a market interest rate is called A) an adjustable gap loan. B) an adjustable portfolio loan. C) loan commitment. D) pre-credit loan line.

Q: Unanticipated moral hazard contingencies can be reduced by A) screening. B) long-term customer relationships. C) specialization in lending. D) credit rationing.

Q: Long-term customer relationships ________ the cost of information collection and make it easier to ________ credit risks. A) reduce; screen B) increase; screen C) reduce; increase D) increase; increase

Q: To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also A) monitor and enforce them. B) be willing to rewrite the contract if the borrower cannot comply with the restrictions. C) trust the borrower to do the right thing. D) be prepared to extend the deadline when the borrower needs more time to comply.

Q: Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called A) proscription bonds. B) restrictive covenants. C) due-on-sale clauses. D) liens.

Q: 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

Q: In one sense ________ appears surprising since it means that the bank is not ________ its portfolio of loans and thus is exposing itself to more risk. A) specialization in lending; diversifying B) specialization in lending; rationing C) credit rationing; diversifying D) screening; rationing

Q: In order to reduce the ________ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones. A) moral hazard B) adverse selection C) moral suasion D) adverse lending

Q: Because borrowers, once they have a loan, are more likely to invest in high-risk investment projects, banks face the A) adverse selection problem. B) lemon problem. C) adverse credit risk problem. D) moral hazard problem.

Q: If borrowers with the most risky investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, banks are said to face the problem of A) adverse credit risk. B) adverse selection. C) moral hazard. D) lemon lenders.

Q: Banks face the problem of ________ in loan markets because bad credit risks are the ones most likely to seek bank loans. A) adverse selection B) moral hazard C) moral suasion D) intentional fraud

Q: Your bank has the following balance sheet: Assets Liabilities Reserves $ 50 million Checkable deposits $200 million Securities 50 million Loans 150 million Bank capital 50 million If the required reserve ratio is 10%, what actions should the bank manager take if there is an unexpected deposit outflow of $50 million?

Q: If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to A) buy back bank stock. B) pay higher dividends. C) shrink the size of the bank. D) sell securities the bank owns and put the funds into the reserve account.

Q: Which of the following would not be a way to increase the return on equity? A) Buy back bank stock B) Pay higher dividends C) Acquire new funds by selling negotiable CDs and increase assets with them D) Sell more bank stock

Q: 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.

Q: Banks hold capital because A) they are required to by regulatory authorities. B) higher capital increases the returns to the owners. C) it increases the likelihood of bankruptcy. D) higher capital increases the return on equity.

Q: In the absence of regulation, banks would probably hold A) too much capital, reducing the efficiency of the payments system. B) too much capital, reducing the profitability of banks. C) too little capital. D) too much capital, making it more difficult to obtain loans.

Q: What two key factors trigger speculative attacks leading to currency cries in emerging market countries?

Q: At the time of the South Korean financial crisis, the merchant banks were A) almost virtually unregulated. B) subject to heavy government regulation. C) engaged in long-term lending to the corporate sector. D) restricted to long-term foreign borrowing.

Q: At the time of the South Korean financial crisis, the government allowed many chaebol owned finance companies to convert to merchant banks. Finance companies ________ allowed to borrow abroad and merchant banks ________. A) were not; could borrow abroad B) were not; could not borrow abroad C) were; could borrow abroad D) were; could not borrow abroad

Q: The chaebols encouraged the Korean government to open up Korean financial markets to foreign capital. The Korean government responded by A) allowing unlimited short-term foreign borrowing but maintained quantity restrictions on long-term foreign borrowing by financial institutions. B) allowing unlimited short-term and long-term foreign borrowing by financial institutions. C) maintaining quantity restrictions on short-term foreign borrowing but allowing unlimited long-term foreign borrowing by financial institutions. D) not allowing any foreign borrowing by financial institutions.

Q: Before the South Korean financial crisis, sales by the top five chaebols (family-owned conglomerates) were A) nearly 50% of GDP. B) about 10% of GDP. C) almost 90% of GDP. D) nearly 25% of GDP.

Q: The economic hardship resulting from a financial crises is severe, however, there are also social consequences such as A) increased crime. B) difficulty getting a loan. C) currency devaluations. D) loss of output.

Q: A feature of debt markets in emerging-market countries is that debt contracts are typically A) very short term. B) long term. C) intermediate term. D) perpetual.

Q: Argentina's financial crisis was due to A) poor supervision of the banking system. B) a lending boom prior to the crisis. C) fiscal imbalances. D) lack of expertise in screening and monitoring borrowers at banking institutions.

Q: Factors that led to worsening conditions in Mexico's 1994-1995 financial markets, but did not lead to worsening financial market conditions in East Asia in 1997-1998 include A) rise in interest rates abroad. B) bankers' lack of expertise in screening and monitoring borrowers. C) deterioration of banks' balance sheets because of increasing loan losses. D) stock market decline.

Q: Factors that led to worsening financial market conditions in East Asia in 1997-1998 include A) weak supervision by bank regulators. B) a rise in interest rates abroad. C) unanticipated increases in the price level. D) increased uncertainty from political shocks.

Q: Factors that led to worsening conditions in Mexico's 1994-1995 financial markets include A) failure of the Mexican oil monopoly. B) the ratification of the North American Free Trade Agreement. C) increased uncertainty from political shocks. D) decline in interest rates.

Q: The key factor leading to the financial crises in Mexico and the East Asian countries was A) a deterioration in banks' balance sheets because of increasing loan losses. B) severe fiscal imbalances. C) a sharp increase in the stock market. D) a sharp decline in interest rates.

Q: A sharp depreciation of the domestic currency after a currency crisis leads to A) higher inflation. B) lower import prices. C) lower interest rates. D) decrease in the value of foreign currency-denominated liabilities.

Q: In emerging market countries, many firms have debt denominated in foreign currency like the dollar or yen. A depreciation of the domestic currency A) results in increases in the firm's indebtedness in domestic currency terms, even though the value of their assets remains unchanged. B) results in an increase in the value of the firm's assets. C) means that the firm does not owe as much on their foreign debt. D) strengthens their balance sheet in terms of the domestic currency.

Q: Severe fiscal imbalances can directly trigger a currency crisis since A) investors fear that the government may not be able to pay back the debt and so begin to sell domestic currency. B) the government may stop printing money. C) the government may have to cut back on spending. D) the currency must surely increase in value.

Q: The two key factors that trigger speculative attacks on emerging market currencies are A) deterioration in bank balance sheets and severe fiscal imbalances. B) deterioration in bank balance sheets and low interest rates abroad. C) low interest rates abroad and severe fiscal imbalances. D) low interest rates abroad and rising asset prices.

Q: Factors likely to cause a financial crisis in emerging market countries include A) severe fiscal imbalances. B) decreases in foreign interest rates. C) a foreign exchange crisis. D) too strong oversight of the financial industry.

Q: The mismanagement of financial liberalization in emerging market countries can be understood as a severe A) principal/agent problem. B) asymmetric information problem. C) lemons problem. D) free-rider problem.

Q: All of the following might create problems from financial liberalization in emerging countries except A) ineffective screening of borrowers. B) limits on risk-taking. C) lax government supervision of banks. D) lenders failure to monitor borrowers.

Q: In emerging market countries, the deterioration in bank's balance sheets has more ________ effects on lending and economic activity than in advanced countries. A) negative B) positive C) affirming D) advancing

Q: Financial crises generally develop along two basic paths: A) mismanagement of financial liberalization/globalization and severe fiscal imbalances. B) stock market declines and severe fiscal imbalances. C) mismanagement of financial liberalization/globalization and stock market declines. D) stock market declines and unanticipated declines in the value of the domestic currency.

Q: Typically, the economy recovers fairly quickly from a recession. Why did this not happen in the United States during the Great Depression?

Q: Which investment bank filed for bankruptcy on September 15, 2008 making it the largest bankruptcy filing in U.S. history? A) Lehman Brothers B) Merrill Lynch C) Bear Stearns D) Goldman Sachs

Q: Although the subprime mortgage market problem began in the United States, the first indication of the seriousness of the crisis began in A) Europe. B) Australia. C) China. D) South America.

Q: As "haircuts" increased during 2007-2009, financial institutions found that to borrow the same loan amount now required ________ collateral. A) less B) no C) more D) default-free

Q: If a borrower takes out a $200 million loan in a repo agreement and is asked to post $220 million of mortgage-backed securities as collateral, the "haircut" is A) 5%. B) 10%. C) 20%. D) 50%.

Q: When housing prices began to decline after their peak in 2006, many subprime borrowers found that their mortgages were "underwater." This meant that A) the value of the house fell below the amount of the mortgage. B) the basement flooded since they could not afford to fix the leaky plumbing. C) the roof leaked during a rainstorm. D) the amount that they owed on their mortgage was less than the value of their house.

Q: The growth of the subprime mortgage market led to A) increased demand for houses and helped fuel the boom in housing prices. B) a decline in the housing industry because of higher default risk. C) a decrease in home ownership as investors chose other assets over housing. D) decreased demand for houses as the less credit-worthy borrowers could not obtain residential mortgages.

Q: 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 mortgage 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.

Q: Mortgage brokers often did not make a strong effort to evaluate whether the borrower could pay off the loan. This created a A) severe adverse selection problem. B) decline in mortgage applications. C) call to deregulate the industry. D) decrease in the demand for houses.

Q: The originate-to-distribute business model has a serious ________ problem since the mortgage broker has little incentive to make sure that the mortgagee is a good credit risk. A) principal-agent B) debt deflation C) democratization of credit D) collateralized debt

Q: A ________ pays out cash flows from subprime mortgage-backed securities in different tranches, with the highest-rated tranch paying out first, while lower ones paid out less if there were losses on the mortgage-backed securities. A) Collateralized debt obligation (CDO) B) Adjustable-rate mortgage C) Negotiable CD D) Discount bond

Q: ________ is a process of bundling together smaller loans (like mortgages) into standard debt securities. A) Securitization B) Origination C) Debt deflation D) Distribution

Q: The economy recovers quickly from most recessions, but the increase in adverse selection and moral hazard problems in the credit markets caused by ________ led to the severe economic contraction known as The Great Depression. A) debt deflation B) illiquidity C) an improvement in banks' balance sheets D) increases in bond prices

Q: A possible sequence for the three stages of a financial crisis in an advanced economy 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

Q: A substantial decrease in the aggregate price level that reduces firms' net worth may stall a recovery from a recession. This process is called A) debt deflation. B) moral hazard. C) insolvency. D) illiquidity.

Q: Debt deflation occurs when A) an economic downturn causes the price level to fall and a deterioration in firms' net worth because of the increased burden of indebtedness. B) rising interest rates worsen adverse selection and moral hazard problems. C) lenders reduce their lending due to declining stock prices (equity deflation) that lowers the value of collateral. D) corporations pay back their loans before the scheduled maturity date.

Q: In a bank panic, the source of contagion is the A) free-rider problem. B) too-big-to-fail problem. C) transactions cost problem. D) asymmetric information problem.

Q: If uncertainty about banks' health causes depositors to begin to withdraw their funds from banks, the country experiences a(n) A) banking crisis. B) financial recovery. C) reduction of the adverse selection and moral hazard problems. D) increase in information available to investors.

Q: Most U.S. financial crises have started during periods of ________ either after the start of a recession or a stock market crash. A) high uncertainty B) low interest rates C) low asset prices D) high financial regulation

Q: A credit boom can lead to a(n) ________ such as we saw in the tech stock market in the late 1990s. A) asset-price bubble B) liability war C) decline in lending D) decrease in moral hazard

Q: When financial intermediaries deleverage, firms cannot fund investment opportunities resulting in A) a contraction of economic activity. B) an economic boom. C) an increased opportunity for growth. D) a call for government regulation.