Q&A Hero

Q: During the 1960s, 1970s, and early 1980s, traditional bank profitability declined because of A. financial innovation that increased competition from new financial institutions. B. a decrease in interest rates to fight the inflation problem. C. a decrease in deposit insurance. D. increased regulation that prohibited banks from making risky real estate loans.

Q: Moral hazard and adverse selection problems increased in prominence in the 1980s A. as deregulation required savings and loans and mutual savings banks to be more cautious. B. following a burst of financial innovation in the 1970s and early 1980s that produced new financial instruments and markets, thereby widening the scope for risk taking. C. following a decrease in federal deposit insurance from $100,000 to $40,000. D. as interest rates were sharply decreased to bring down inflation.

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: In the ten year period 1981-1990, 1202 commercial banks were closed, with a peak of 206 failures in 1989. This rate of failures was approximately ________ times greater than that in the period from 1934 to 1980. A. two B. three C. five D. ten

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: The Basel Committee ruled that regulators in other countries can ________ the operations of a foreign bank if they believe that it lacks effective oversight. A. restrict B. encourage C. renegotiate D. enhance

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: 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 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 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: 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: 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: 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 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: 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: 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: 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: 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: 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 other creditors. B. a bank suffers a large deposit outflow. C. a bank has to call in a large volume of loans. D. a bank refuses to make new loans.

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: Modern liability management has resulted in A. increased sales of negotiable CDs 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: Foreign banks generally pay higher deposit rates than U.S. banks.

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: 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: Foreign banks generally operate with higher capital ratios than U.S. banks.

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: 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: A forward market exchange in foreign currencies is an agreement to exchange: a. currencies in the future at an unspecified time at an exchange rate determined at the time the contract is agreed to. b. currencies in the future at a specified time at an unknown exchange rate. c. currencies in the future at an unspecified time at an unknown exchange rate. d. a product for a foreign currency in the future at a specified time. e. currencies in the future at a specified time at an exchange rate determined at the time the contract is signed.

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: 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: Covered interest rate arbitrage is possible when: a. both currencies are appreciating. b. the actual inflation rates are identical in both countries. c. the difference in the interest rates in two countries exactly equals the spot-to-forward exchange rate differential. d. the difference in interest rates in two countries is out of line with the spot-to-forward exchange rate differential. e. none of the above

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: If the spot rate is 1.67CAN$/US$ and the 1-month forward rate is 1.70CAN$/US$: a. the Canadian dollar is selling at a premium. b. the Canadian dollar is selling at a discount. c. the U.S. dollar is selling at a discount. d. the U.S. dollar is selling at par. e. none of the above

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 London based firm has a subsidiary located in New York. The subsidiary has $1,000 in assets, $750 in liabilities and $250 in equity. The current spot rate is $1.60/£.If the spot rate changes to $1.50/£, what will be the firm's gain or loss?a. $10.42 gainb. £10.42 gainc. $10.42 lossd. £10.42 losse. cannot be determined

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: A London based firm has a subsidiary located in New York. The subsidiary has $1,000 in assets, $750 in liabilities and $250 in equity. The current spot rate is $1.60/£.What is the U.S. firm's net exposure?a. $250b. £250c. £1,000d. $1,200e. $1,600

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: An example of the ________ problem would be if Brian borrowed money from Sean in order to purchase a used car and instead took a trip to Atlantic City using those funds. A. moral hazard B. adverse selection C. costly state verification D. agency

Q: All of the following are basic sources of cash flows except: a. liquidating assets. b. cash flows from operations. c. issuing new equity. d. liquidating liabilities. e. issuing new debt.

Q: A bank's net balance sheet exposure to changes in the value of Euros is measured as:a. the amount of assets denominated in U.S. dollars minus the amount of liabilities denominated in Euros.b. the amount of assets denominated in Euros minus the amount of liabilities denominated in U.S. dollars.c. the amount of liabilities denominated in Euros minus the amount of liabilities denominated in U.S. dollars.d. the amount of assets denominated in Euros minus the amount of assets denominated in U.S. dollars.e. the amount of assets denominated in Euros minus the amount of liabilities denominated in Euros.

Q: The problem faced by the lender that the borrower may take on additional risk after receiving the loan is called A. adverse selection. B. moral hazard. C. transactions costs. D) diversification.

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: Term loans are generally repaid with funds from: a. investing cash flows. b. issuing new debt. c. reductions in inventory and receivables. d. cash flows from operations. e. redeeming marketable securities.

Q: Non-performing international loans do not completely reflect potential losses because: a. foreign governments have never defaulted on their debts. b. banks often loan borrowers funds to make payments on existing loans. c. U.S. banks can easily recover the funds in foreign courts. d. the U.S. government has strongly discouraged U.S. banks from making international loans. e. all of the above

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: If bad credit risks are the ones who most actively seek loans then financial intermediaries face the problem of A. moral hazard. B. adverse selection. C. free-riding. D. costly state verification.

Q: Short-term working capital loans are generally repaid with funds from: a. investing cash flows. b. issuing new debt. c. reductions in inventory and receivables. d. issuing new equity e. redeeming marketable securities.

Q: The risk that a foreign government will suspend debt service payments is known as: a. LC risk. b. foreign exchange risk. c. euro risk. d. sovereign risk. e. country risk.

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: The presence of ________ in financial markets leads to adverse selection and moral hazard problems that interfere with the efficient functioning of financial markets. A. noncollateralized risk B. free-riding C. asymmetric information D. costly state verification

Q: Which of the following is not one of the essential issues in evaluating commercial loan requests? a. The structure of the borrower's board of directors. b. The character of the borrower. c. The use of the loan proceeds. d. The source of repayment for the loan. e. The amount the customer needs to borrow.

Q: Put the following steps of the creation of a banker's acceptance in order. I. Shipping documents delivered II. Letter of credit is issued III. Bankers' acceptance presented at maturity IV. Goods are shipped a. I, IV, II, III b. II, IV, III, I c. II, IV, I, III d. I, IV, III, II e. I, II, III, IV

Q: A borrower who takes out a loan usually has better information about the potential returns and risk of the investment projects he plans to undertake than does the lender. This inequality of information is called A. moral hazard. B. asymmetric information. C. noncollateralized risk. D. adverse selection.

Q: All of the following would be generally be considered acceptable commercial loan purposes except: a. seasonal cash needs. b. paying off other bank debts. c. purchasing new equipment. d. acquiring another firm. e. expanding plant capacity.

Q: How does a mutual fund lower transactions costs through economies of scale?

Q: Firms may need cash for all of the following except: a. operating purposes. b. pay taxes. c. pay employee salaries. d. pay overdue suppliers. e. liquidate fixed assets.

Q: Financial intermediaries' low transaction costs allow them to provide ________ services that make it easier for customers to conduct transactions. A. liquidity B. conduction C. transcendental D. equitable

Q: All leveraged buyouts (LBOs) are labeled highly leveraged transactions.

Q: One purpose of regulation of financial markets is to A. limit the profits of financial institutions. B. increase competition among financial institutions. C. promote the provision of information to shareholders, depositors and the public. D. guarantee that the maximum rates of interest are paid on deposits.

Q: Financial intermediaries develop ________ in things such as computer technology which allows them to lower transactions costs. A. expertise B. diversification C. regulations D. equity

Q: Loans that are seasonal in nature should be self-liquidating.

Q: Which of the following is a non-discretionary factor that will increase a bank's daily reserves held at the Federal Reserve? a. Federal funds sold. b. Receiving a discount window loan c. Remittances charged d. Security sales e. Deposits from the U.S. Treasury

Q: Regulation of the financial system A. occurs only in the United States. B. protects the jobs of employees of financial institutions. C. protects the wealth of owners of financial institutions. D. ensures the stability of the financial system.

Q: Which of the following is NOT a benefit to an individual purchasing a mutual fund? A. reduced risk B. lower transactions costs C. free-riding D. diversification

Q: National banks can directly take equity positions in real estate projects.