Chapter: Chapter 34: Banks
Multiple Choice
1. For financial institutions, which of the following is NOT true concerning trading income?
a) It has been on the decline over the past 30 years.
b) It is typically fairly volatile from year to year.
c) It can be derived from the trading of stocks and bonds.
d) It can be derived from the trading of swaps and other derivatives.
2. Which of the following is most often the largest source, in absolute value terms, of loan
losses for a bank?
a) Mortgage losses.
b) Credit card losses.
c) Bond default losses.
d) Business loan losses.
3. Given the following information, determine the net income (NI) of the bank. The loan and
deposit rates are 12 percent and 3 percent, respectively. The money rate is 2 percent, and it is
the benchmark of the profitability of loans and deposits. It is also the measure used to debit the
lack of earning ability of cash reserves at the Federal Reserve, and it is the opportunity cost of
equity capital. Other expenses are $40 million. The balance sheet information is in millions of
dollars.
a) $11.46
b) $14.82
c) $15.48
d) $16.14
4. Which of the following correctly ranks the sources of income for European banks over the
period 1988–2013?
a) Commission income > interest income > trading income.
b) Interest income > commission income > trading income.
c) Commission income > trading income > interest income.
d) Trading income > interest income > commission income.
5. Which of the following are included in other comprehensive income?
I. Hedging activities.
II. Foreign-currency translation items.
III. Unrealized losses on debt investments.
IV. Unrealized gains on equity investments.
a) I and II only.
b) I and IV only.
c) II, III, and IV only.
d) I, II, III, and IV.
6. Which of the following is NOT true concerning loan losses for a bank?
a) They are among the most important value drivers in retail banking.
b) Default losses are strongly correlated with overall economic growth.
c) They are among the most important value drivers in wholesale banking.
d) A bank’s historical additions to loan loss provisions are a poor indicator of future loan losses.
7. Which of the following best describes maturity mismatch and its role in bank operations?
a) It refers to banks selling old loans so they can take on new loans, which earns a capital gain.
b) It refers to banks lending for the long term and borrowing for the short term, which earns
positive net interest income.
c) It refers to the outdated accounting rules that most banks must operate under.
d) It refers to the inequality between accounting allowances for bad loans and the actual rate of
losses on those loans.
8. Which of the following will change the cost of equity?
I. Asset composition.
II. Liability composition.
III. The expected market return.
IV. The risk-free rate.
a) I and II only.
b) I, III, and IV only.
c) III and IV only.
d) I, II, III, and IV.
9. The best method for understanding how much value a bank is creating in its different
product lines is:
a) Free cash flow analysis.
b) Ratio analysis.
c) Economic spread analysis.
d) Net income analysis.
10. Up until the financial crisis of 2008, which of the following was the usual ordering of the
absolute values of the types of loan losses to banks?
a) Credit card losses > mortgage losses > business loan losses.
b) Mortgage losses > business loan losses > credit card losses.
c) Credit card losses > business loan losses > mortgage losses.
d) Mortgage losses > credit card losses > business loan losses.
11. Since the financial crisis ended in 2010, which of the following has been the usual ordering
of the absolute values of the types of loan losses to banks?
a) Credit card losses > mortgage losses > business loan losses.
b) Mortgage losses > business loan losses > credit card losses.
c) Credit card losses > business loan losses > mortgage losses.
d) Mortgage losses > credit card losses > business loan losses.
12. Most banks have a maturity mismatch as a result of using short-term deposits as funding to
back long-term loans and mortgages. In this case, the bank earns income from being on
different parts of the yield curve: typically, borrowing for the short term costs less than what
the bank can earn from long-term lending.
13. Economic spread analysis allows for understanding how much value a bank is creating in its
different product lines.
14. The tax penalty on equity is a minor cost to a bank, and to simplify results, it can usually be
left out of the valuation process.
15. Explain why analysts estimating the values of banks should not use the discounted cash flow
from operations method. What method should an analyst use?