Chapter 19—Bank Management
1. Which of the following statements is incorrect?
a.
Managers may be tempted to make decisions that are in their own best interests rather than
shareholder interests.
b.
Directors are responsible for making most of the bank’s decisions regarding loans to
customers, which encourages a loan department to extend loans with a very high concern
for risk.
c.
To prevent agency problems, some banks provide stock as compensation to managers.
d.
The underlying goal behind the managerial policies of a bank is to maximize the wealth of
the bank’s shareholders.
2. When cash outflows temporarily exceed cash inflows, banks are most likely to experience
a.
higher dividend payments.
b.
illiquidity.
c.
a negative duration on its assets.
d.
an excess of capital.
3. Banks can resolve cash deficiencies by
a.
creating additional liabilities.
b.
selling assets.
c.
buying back common stock.
d.
increasing dividend payouts.
e.
A or B
4. As the secondary market for loans has become active, banks are more able to satisfy their liquidity
needs with a ____ proportion of loans while achieving ____ profitability.
a.
higher; higher
b.
lower; lower
c.
higher; lower
d.
lower; higher
5. Banks are more liquid as a result of securitization because it allows them to request repayment of the
loan principal from the borrower upon demand.
a. True
b. False
6. If a bank that relies heavily on short-term deposits expects interest rates to consistently decrease over
time, it would allocate most of its loans with ____ rates if it desires to maximize its expected returns. It
could reduce its exposure to interest rate risk by setting ____ rates on its loans.
a.
fixed; fixed
b.
variable; fixed
c.
variable; variable
d.
fixed; variable
7. During a period of rising interest rates, a bank’s net interest margin will likely ____ if its liabilities are
____ its assets.
a.
increase; more rate-sensitive than
b.
decrease; more rate-sensitive than
c.
increase; equally rate-sensitive as
d.
decrease; equally rate-sensitive as
8. If a bank expected interest rates to consistently ____ over time, it will consider allocating most funds
to rate-____ assets.
a.
decrease; sensitive
b.
decrease; insensitive
c.
increase; insensitive
d.
none of the above
9. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About
$300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are
rate-sensitive. Petri Bank’s net interest margin is ____ percent.
a.
4.0
b.
3.6
c.
6.7
d.
5.0
10. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About
$300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are
rate-sensitive. Petri Bank’s gap is $____.
a.
−300 million
b.
300 million
c.
−500 million
d.
500 million
11. Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About
$300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are
rate-sensitive. Petri Bank’s gap ratio is ____ percent.
a.
37.5
b.
50.0
c.
100.0
d.
40.0
12. The measure of interest rate risk that uses the difference between rate-sensitive assets and
rate-sensitive liabilities is called
a.
gap measurement.
b.
duration measurement.
c.
duration ratio.
d.
gap ratio.
13. A gap ratio of less than one suggests that
a.
rate-sensitive assets exceed rate-sensitive liabilities.
b.
an increase in interest rates would increase the bank’s net interest margin.
c.
rate-sensitive liabilities exceed rate-sensitive assets.
d.
a decrease in interest rates would decrease the bank’s net interest margin.
e.
B and D
14. Each bank may have its own classification system of interest rate sensitivity, because there is no
perfect measurement of the gap.
a. True
b. False
15. The duration of zero-coupon bonds will be ____ the duration of coupon bonds with the same maturity.
a.
lower than
b.
higher than
c.
the same as
d.
A or B, depending on the size of the coupon payment
16. In general, the duration of zero-coupon securities with short maturities is ____ than the duration of
zero-coupon securities with long maturities.
a.
higher than
b.
lower than
c.
equal to
d.
A or B, depending on the issuer of the securities
17. Other things equal, assets with shorter maturities have ____ durations. Assets that generate more
frequent coupon payments have ____ durations.
a.
shorter; longer
b.
shorter; shorter
c.
longer; shorter
d.
longer; longer
18. For most banks, the average duration of assets ____ the average duration of liabilities, so the duration
gap is ____.
a.
exceeds; zero
b.
exceeds; negative
c.
exceeds; positive
d.
is less than; negative
19. Other things being equal assets with ____ maturities and ____ frequent coupon payments have shorter
durations.
a.
shorter; more
b.
shorter; less
c.
longer; more
d.
longer; less
20. If a bank attempts to reduce exposure to interest rate risk by replacing long-term marketable securities
with more floating-rate commercial loans, it is likely that the bank’s
a.
default risk would decrease.
b.
default risk would increase.
c.
liquidity risk would increase.
d.
liquidity risk would decrease.
e.
B and C
21. Which of the following is not a likely method used by a bank to reduce interest rate risk?
a.
maturity matching
b.
using fixed-rate loans
c.
using interest rate futures contracts
d.
using interest rate caps
22. Floating-rate loans cannot completely eliminate interest rate risk; if the cost of funds is changing more
frequently than the rate on assets, the bank’s net interest margin is still affected by interest rate
fluctuations.
a. True
b. False
23. The ____ of interest rate futures ____ the potential adverse effect of rising interest rates on a bank’s
interest expenses.
a.
sale; increases
b.
sale; reduces
c.
purchase; reduces
d.
both A and C are correct
24. Which of the following financial institutions would be most willing to swap variable-rate payments for
fixed-rate payments in order to reduce exposure to interest rate risk?
a.
one whose assets and liabilities are equally interest-rate sensitive
b.
one whose assets are more interest-rate sensitive than its liabilities
c.
one whose liabilities are more interest-rate sensitive than its assets
d.
one whose gap ratio is equal to 1.0
25. Banks increase their risk by increasing their capital as a percentage of assets.
a. True
b. False
26. Banks generally ____ loans and ____ their purchases of low-risk securities when the economy is
weak.
a.
increase; increase
b.
reduce; reduce
c.
increase; reduce
d.
reduce; increase
27. Banks tend to focus their loans in one industry so that they can specialize on one industry and reduce
the credit risk of their loan portfolio.
a. True
b. False
28. Most loan sales enable the bank originating the loan to continue servicing the loan.
a. True
b. False
29. ROE is defined as
a.
.
b.
.
c.
.
d.
.
30. The greater the ____, the greater the amount of assets per dollar’s worth of equity.
a.
leverage measure
b.
ratio of equity to debt
c.
capital ratio
d.
proportion of loans to securities in the asset portfolio
31. A bank has a return on assets of 2 percent, $40 million in assets, and $4 million in equity. What is the
return on equity?
a.
10 percent
b.
.2 percent
c.
2 percent
d.
20 percent
e.
none of the above
32. A bank has the following asset and liability portfolios. What is the gap?
Rate-sensitive
Amount
Rate-sensitive
Amount
assets
(in millions)
liabilities
(in millions)
Floating-rate
loans
$4,000
NOW accounts
$1,750
Floating-rate
mortgages
1,000
MMDAs
4,500
Short-term
Treasury securities
1,500
Short-term CDs
1,000
$6,500
$7,250
a.
$750 million
b.
−$750 million
c.
1.12
d.
.896
e.
none of the above
33. A bank has the following asset and liability portfolios. What is the gap ratio?
Rate-sensitive
Amount
Rate-sensitive
Amount
assets
(in millions)
liabilities
(in millions)
Floating-rate
loans
$4,000
NOW accounts
$1,750
Floating-rate
mortgages
1,000
MMDAs
4,500
Short-term
Treasury securities
1,500
Short-term CDs
1,000
$6,500
$7,250
a.
$750 million
b.
−$750 million
c.
1.12
d.
.896
e.
none of the above
34. If Bank A has a negative gap and Bank B has a positive gap. Which of the following is true?
a.
Bank A is more favorably affected by rising interest rates.
b.
Bank B is more favorably affected by falling interest rates.
c.
Bank A is adversely affected by falling interest rates.
d.
none of the above
35. Which of the following is a measure for banks to assess their exposure to interest rate risk?
a.
capital ratio
b.
leverage measure
c.
duration measurement
d.
gap ratio
e.
C and D
36. If a bank sells interest rate futures, it ____ of rising interest rates and ____ of declining interest rates
on its interest expenses.
a.
reduces the potential adverse effect; reduces the potential favorable effect
b.
increases the potential adverse effect; increases the potential favorable effect
c.
decreases the potential adverse effect; increases the potential favorable effect
d.
increases the potential adverse effect; decreases the potential favorable effect
37. Which of the following loan portfolios are best diversified against default risk?
a.
consumer loans to farmers and commercial loans to farm equipment dealers in a local area
b.
commercial loans to the same industry
c.
commercial loans to various retail stores in the same city
d.
consumer and commercial loans to different industries in different cities
38. Banks can increase their liquidity position by restructuring their asset portfolio to contain less ____
and more ____.
a.
excess reserves; Treasury bills
b.
Treasury bonds; corporate bonds
c.
loans; Treasury bills
d.
none of the above
39. Banks would reduce their liquidity position by restructuring their asset portfolio to contain less ____
and more ____.
a.
Treasury securities; excess reserves
b.
loans; Treasury securities
c.
corporate bonds; Treasury securities
d.
none of the above
40. Banks can reduce their default risk by restructuring their asset portfolio to contain less ____ and more
____.
a.
Treasury bonds; corporate bonds
b.
Treasury bonds; municipal bonds
c.
Treasury bonds; commercial loans
d.
none of the above
41. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain less
____ and more ____.
a.
Treasury bonds; commercial loans
b.
Treasury bonds; excess reserves
c.
consumer loans; Treasury bills
d.
none of the above
42. If a bank desired to maximize its net interest margin, it would best achieve its goal by attempting to
obtain most of its funds through ____ and use most of its funds for ____ (assuming that all loans will
be repaid).
a.
traditional demand deposits; commercial loans
b.
traditional demand deposits; consumer loans
c.
NOW accounts; consumer loans
d.
NOW accounts; commercial loans
43. A bank that holds a greater percentage of traditional demand deposits and loans will likely incur ____
non-interest expenses and have a ____ net interest margin than other banks of the same size (assuming
that its loan losses are no higher than those at other banks).
a.
greater; higher
b.
greater; lower
c.
less; higher
d.
less; lower
44. A bank’s net interest margin is commonly defined as
a.
interest revenues minus interest expenses.
b.
(interest revenues minus interest expenses)/total assets.
c.
(interest revenues minus interest expenses)/total liabilities.
d.
(interest revenues minus interest expenses)/capital.
45. A common method for banks to reduce their default risk is to
a.
specialize in loans to just one or a few particular industries in which they have expertise in
assessing creditworthiness.
b.
specialize in loans of companies whose earnings patterns are quite similar over time.
c.
A and B
d.
none of the above
46. International diversification of loans can best reduce the bank’s overall default risk if
a.
the countries where loans are given are clustered together in a single continent.
b.
the countries where loans are given have economic cycles that do not move together over
time.
c.
A and B
d.
none of the above
47. A bank’s net interest margin will likely decline if it has a large amount of
a.
rate-sensitive assets and no rate-sensitive liabilities.
b.
rate-sensitive liabilities and no rate-sensitive assets.
c.
loans to technology firms.
d.
real estate loans.
48. Banks can reduce their required capital levels by
a.
increasing their loans.
b.
reducing their loans.
c.
increasing their dividends.
d.
obtaining more deposits.
49. Terp Bank obtains a relatively large portion of its funds from conventional demand deposits as it
creates many branches with many employees to attract demand deposits. Its interest expenses should
be relatively ____, while its noninterest expenses should be relatively ____.
a.
high; low
b.
low; high
c.
high; high
d.
low; low
e.
none of the above
50. Bank A has interest revenues of $4 million, interest expenses of $5 million, and assets totaling $20
million. Bank A’s net interest margin is
a.
$1 million.
b.
−$1 million.
c.
−5 percent.
d.
5 percent.
51. ____ is not a method used to assess interest rate risk.
a.
Efficiency analysis
b.
Gap analysis
c.
Duration analysis
d.
Regression analysis
52. Durango Bank has $2 million in rate-sensitive liabilities and $3 million in rate sensitive assets.
Durango’s gap is ____, and Durango is probably more concerned about a(n) ____ in interest rates.
a.
−$1 million; increase
b.
−$1 million; decrease
c.
$1 million; increase
d.
$1 million; decrease
e.
none of the above
53. Leskar Bank has $2 million in rate-sensitive liabilities and $3 million in rate sensitive assets. Leskar’s
gap ratio is ____.
a.
1.5
b.
0.67
c.
$1 million
d.
none of the above
54. ____ is (are) least likely to be used as a method of reducing interest rate risk.
a.
Maturity matching
b.
Using floating-rate loans
c.
Stock options
d.
Using interest rate swaps
e.
Using interest rate caps
55. Ringo Bank has a profit after taxes of $3.0 million, total assets of $300 million, and shareholder’s
equity of $30 million. Ringo’s return on equity (ROE) is ____ percent.
a.
1.0
b.
10.0
c.
3.0
d.
none of the above
56. For a commercial bank, when the average duration of assets exceeds the average duration of liabilities,
the duration gap is
a.
zero.
b.
positive.
c.
negative.
d.
B or C
57. Assume a bank accepts deposits on Australian dollars (A$) and makes some fixed-rate loans in British
pounds. Which of the following would reduce the bank’s profit margin?
a.
the A$ appreciates against the pound
b.
the A$ is stable against the pound
c.
the A$ depreciates against the pound
d.
the British interest rates increase
e.
C and D
58. The performance of a bank that continually concentrates in short-term deposits in euros and
adjustable-rate dollar loans with equal rate-sensitivity is
a.
unaffected if European interest rates increase and U.S. rates decrease.
b.
unaffected if U.S. interest rates increase and European interest rates decrease.
c.
adversely affected if European interest rates increase and U.S. rates decrease.
d.
adversely affected if U.S. interest rates increase and European rates decrease.
e.
A and B
59. If a bank has assets and liabilities in dollars and euros, its exposure to interest rate risk can best be
minimized if the
a.
currency mix of assets is similar to that of liabilities.
b.
overall rate-sensitivity of assets and liabilities are similar.
c.
rate sensitivity of assets and liabilities is matched for each currency.
d.
A and B
60. The risk of a loss due to closing out a transaction is referred to as ____ risk.
a.
credit
b.
settlement
c.
interest rate
d.
exchange rate
e.
none of the above
61. The Sarbanes-Oxley Act has had little impact on the monitoring conducted by the board members of
commercial banks.
a. True
b. False
62. Whether a bank has a temporary or a permanent need for funds, the decision should be to borrow in
the federal funds market.
a. True
b. False
63. A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed
rate-sensitive assets.
a. True
b. False
64. For most banks, the average duration of liabilities exceeds the average duration of assets, so the
duration gap is positive.
a. True
b. False
65. Floating-rate loans completely eliminate interest rate risk.
a. True
b. False
66. A bank can usually simultaneously maximize its return on assets and minimize credit risk.
a. True
b. False
67. If the currency mix of a bank’s assets is similar to that of its liabilities and the overall rate sensitivity of
its assets and liabilities is similar, interest rate risk is completely nonexistent.
a. True
b. False
68. Macon Bank has interest revenues of $4 million, interest expenses of $5 million, and assets totaling
$20 million. Macon Bank’s net interest margin is
a.
$1 million.
b.
−1 million.
c.
5 percent.
d.
−5 percent.
69. ____ is not a method used to assess interest rate risk.
a.
Gap analysis
b.
Ratio analysis
c.
Duration analysis
d.
Regression analysis
e.
All of the above are methods to assess interest rate risk.
70. ____ is (are) least likely to be used as a method of reducing interest rate risk.
a.
Maturity matching
b.
Floating-rate loans
c.
Stock options
d.
Interest rate swaps
e.
Interest rate caps
71. Crazer Bank has a profit after taxes of $2 million, total assets of $100 million, and shareholder’s equity
of $10 million. Crazer’s return on equity (ROE) is ____ percent.
a.
18
b.
210
c.
15
d.
20
e.
none of the above
72. Parsons Bank reported $3 million in interest revenues and $1 million in interest expenses. Parsons has
$20 million in assets and $8 million in liabilities. Parsons net interest margin is ____ percent.
a.
10
b.
−10
c.
35
d.
25
e.
none of the above
73. If a bank expects interest rates to consistently ____ over time, it will consider allocating most of its
funds to rate-____ assets.
a.
decrease; sensitive
b.
increase; insensitive
c.
increase; sensitive
d.
answers A and B are correct
e.
none of the above
74. During a period of ____ interest rates, a bank’s net interest margin will likely ____ if its liabilities are
more rate sensitive than its assets.
a.
decreasing; decrease
b.
increasing; increase
c.
decreasing; increase
d.
increasing; decrease
e.
answers C and D are correct
75. If interest rates ____, banks with ____ duration gaps will be ____ affected.
a.
rise; positive; positively
b.
rise; positive; adversely
c.
decrease; positive; adversely
d.
decrease; negative; positively
e.
none of the above
76. In a regression of a bank’s stock return on an interest rate proxy and market returns, a ____ coefficient
for the interest rate variable suggests that bank performance is ____ affected by ____ interest rates.
a.
positive; adversely; rising
b.
positive; favorably; declining
c.
negative; adversely; rising
d.
negative; favorably; rising
e.
none of the above
77. If a bank has a ____ duration gap, its average asset duration is probably ____ than its liability duration.
a.
negative; smaller
b.
positive; larger
c.
negative; larger
d.
none of the above
78. In an interest rate swap, a bank whose liabilities are ____ rate sensitive than its assets can swap
payments with a ____ interest rate in exchange for payments with a ____ interest rate.
a.
more; fixed; variable
b.
more; variable; fixed
c.
less; fixed; variable
d.
less; fixed; fixed
e.
none of the above
79. Because riskier assets offer ____ returns, a bank’s strategy to increase its return will typically entail
a(n) ____ in the overall credit risk of its asset portfolio.
a.
lower; increase
b.
lower; decrease
c.
higher; increase
d.
higher; decrease
e.
none of the above
80. The risk of a loss due to closing out a transaction is referred to as ____ risk.
a.
settlement
b.
credit
c.
interest rate
d.
exchange rate
e.
none of the above
81. An effective way to align bank managers’ interests with shareholders’ goal of higher returns is to
compensate the managers with fixed salaries without a bonus.
a. True
b. False
82. Which of the following is not a function of a bank’s board of directors?
a.
overseeing acquisitions
b.
determining a compensation system for the bank’s executives
c.
overseeing policies for changing the bank’s capital structure
d.
pursuing a proxy contest to change the bank’s dividend policy
83. As part of its liquidity management, a bank might:
a.
purchase interest rate swaps.
b.
issue commercial paper.
c.
purchase long-term Treasury securities.
d.
A and C
84. A(n) ____________ is an agreement for a fee to receive payments when the interest rate of a particular
security rises above a specified level by a specified date.
a.
interest rate cap
b.
interest rate futures contract
c.
interest rate swap
d.
maximum rate contract
85. Which of the following is a method that a bank can use to reduce its credit risk?
a.
diversifying its loans across industries
b.
focusing on credit card loans
c.
focusing on consumer loans
d.
selling its holdings of Treasury securities