11) The difference between the interest a bank earns on loans and securities and the interest paid
on deposits and debt divided by the total value of its assets is called
A) interest spread.
B) net interest margin.
C) return on assets.
D) return on equity.
12) The ratio of a bank’s after-tax profit to its assets is known as
A) net interest margin.
B) return on equity.
C) return on capital.
D) spread.
13) The ratio of a bank’s after-tax profit to bank capital is known as
A) net interest margin.
B) return on equity.
C) return on capital.
D) spread.
14) The ratio of bank capital to bank assets is known as the bank’s
A) leverage ratio.
B) net interest margin.
C) return on equity.
D) return on capital.
15) If a bank has a leverage ratio of 0.1 and a return on capital of 2%, what is its return on
equity?
A) 0.2%
B) 2.1%
C) 5%
D) 20%
16) Moral hazard can contribute to high bank leverage in all of the following ways EXCEPT
A) having high capital requirements.
B) bank managers are compensated in part on providing shareholders with high returns on
equity.
C) high bank leverage provides shareholders with a potential for a higher return on equity.
D) federal deposit insurance has reduced the incentive of depositors to monitor the behavior of
bank managers.
17) If a bank’s ratio of assets to capital is 25 and it’s return on assets is -5%, what is its return on
equity?
A) -0.2%
B) -5%
C) -30%
D) -125%
18) In order to reduce the likelihood of excessive leverage in the banking system, governments
have traditionally
A) imposed capital requirements on commercial banks.
B) imposed capital requirement on investment banks.
C) imposed capital requirements on both commercial and investment banks.
D) imposed asset requirements on all banks.
19) Why do banks make use of loan loss reserves?
20) Suppose a bank has $10 million in capital, $100 million in assets, and after-tax profit of $2
million? what is its return on assets? What is its return on equity?
21) Suppose a bank has assets of $500 million and capital of $100 million. Its return on assets is
-3%. What is its leverage ratio? What is its return on equity?
22) How does moral hazard contribute to high bank leverage?
23) Suppose First National Bank has $200 million of assets and $20 million of equity capital. If
First National has a 2% return on assets (ROA), what is its return on equity (ROE)? Suppose
First National’s equity capital declines to $10 million, while its assets and ROA are unchanged.
What is First National’s ROE now?
10.3 Managing Bank Risk
1) In managing its liabilities to deal with liquidity problems, banks trade off
A) credit risk against interest rate risk.
B) adverse selection against moral hazard.
C) the need for available funds to meet deposit outflows against the desire for greater profit.
D) present tax liabilities against future tax liabilities.
2) Banks make use of the federal funds market in part to
A) pay their tax liabilities.
B) manage liquidity risk.
C) deal with moral hazard.
D) deal with adverse selection.
3) Credit risk is the risk that
A) an insufficient number of borrowers will apply for loans or credit.
B) interest rates will rise after a loan has been granted.
C) interest rates will fall after a loan has been granted.
D) borrowers might default on their loans.
4) Banks use “credit-risk analysis” to
A) determine the appropriate interest rate to charge borrowers.
B) determine whether to invest in the stock of a corporation.
C) determine the appropriate interest rate to pay depositors.
D) determine the likelihood of an audit by bank regulators.
5) A person takes out a car loan at a bank, but actually uses the money to play the lottery. This
situation is an example of which problem banks face in lending?
A) adverse selection
B) moral hazard
C) interest rate risk
D) illiquidity
6) When bank loan officers screen loan applicants to eliminate potentially bad risks, they are
attempting to mitigate the problem of
A) adverse selection.
B) moral hazard.
C) interest rate risk.
D) illiquidity.
7) A loan officer uses a credit scoring system to
A) compare the interest rate on a loan to interest rates on other assets with comparable risk.
B) keep track of the fraction of a bank’s assets tied up in loans to a single individual or business.
C) predict statistically whether an individual is likely to default on a loan.
D) match any particular loan with the deposits being used to fund it.
8) The prime interest rate is the
A) interest rate on six-month U.S. Treasury bills.
B) discount rate.
C) Federal funds rate.
D) interest rate that banks charge high-quality borrowers.
9) Collateral is
A) the interest rate that banks charge high-quality borrowers.
B) assets pledged to the bank in the event the borrower defaults.
C) the difference between the value of a bank’s assets and the value of a bank’s liabilities.
D) required reserves minus excess reserves.
10) Banks use credit rationing rather than simply raising the interest rate charged borrowers with
higher default risks because
A) of fear of adverse selection problems.
B) of interest rate ceilings in many states.
C) of fear of offending the loan applicants.
D) use of credit rationing is encouraged by the Federal Reserve.
11) Customers who have long-term relationships with banks
A) pose particular problems with respect to adverse selection.
B) pose particular problems with respect to moral hazard.
C) often obtain credit at a lower rate or with fewer restrictions.
D) are more likely to default or violate restrictive covenants.
12) Banks experience interest rate risk
A) if adverse selection problems are particularly severe.
B) if moral hazard problems are particularly severe.
C) on any investment that has high information costs.
D) if changes in interest rates cause bank profits to fluctuate.
13) Banks are exposed to interest rate risk primarily because
A) interest rates are very difficult to forecast.
B) the maturities of banks’ assets and liabilities differ.
C) borrowers from banks are prone to default.
D) depositors are always searching for a slightly higher interest rate.
14) Bank capital will decline following an increase in interest rates if the value of its
A) fixed-rate assets is greater than the value of its fixed-rate liabilities.
B) fixed-rate assets is less than the value of its fixed-rate liabilities.
C) fixed-rate assets is greater than the value of its variable-rate assets.
D) fixed-rate liabilities is greater than the value of its variable-rate liabilities.
15) A bank that expects interest rates to fall will
A) want the duration of its assets to be greater than the duration of its liabilities a positive
duration gap.
B) want the duration of its assets to be less than the duration of its liabilities a positive duration
gap.
C) want the duration of its assets to be greater than the duration of its liabilities a negative
duration gap.
D) want the duration of its assets to be less than the duration of its liabilities a negative duration
gap.
16) How does the use of adjustable-rate mortgages affect interest-rate risk?
A) It reduces the interest-rate risk of lenders.
B) It reduces the interest-rte risk of borrowers.
C) It reduces the interest-rate risk of both lenders and borrowers.
D) It increases the interest-rate risk of both lenders and borrowers.
17) Since most banks have positive gaps and negative duration gaps, an increase in market
interest rates will
A) increase bank profits and increase bank capital.
B) increase bank profits and decrease bank capital.
C) decrease bank profits and increase bank capital.
D) decrease bank profits and decrease bank capital.
18) The sensitivity of bank capital to market interest rates is measured by
A) gap analysis.
B) duration analysis.
C) leverage ratio.
D) capital analysis.
19) Given that most banks have positive gap and negative durations, banks prefer
A) lower market interest rates.
B) higher market interest rates.
C) higher market fixed rates but lower market floating rates.
D) either higher or lower market interest rates since interest rates have little effect on bank
profits.
20) What steps can a bank take to deal with a significant outflow of deposits?
21) How do banks manage credit risk?
10.4 Trends in the U.S. Commercial Bank Industry
1) Banks in the United States have been prohibited from investing deposits in significant equity
holdings since the passage of the
A) Bank Reform Act of 1980.
B) Securities and Exchange Acts of 1933 and 1934.
C) National Banking Acts of 1863 and 1864.
D) Sherman Antitrust Act of 1890.
2) As of 2009, about how many banks were there in the United States?
A) 57
B) 2000
C) 6800
D) 14,000
3) By 2009, what share of U.S. assets were held by the 10 largest banks in the United States?
A) 10%
B) 29%
C) 45%
D) 68%
4) Which of the following is NOT an example of off-balance-sheet lending?
A) a swap
B) a standby letter of credit
C) a loan commitment
D) a loan sale
5) What is the primary reason for the differences between the U.S. banking system and those in
other major industrial countries?
A) Economies of scale are greater in banking in the United States than in banking in other
countries.
B) legislation that led to the development of state and national banks.
C) the Federal Reserve System.
D) the National Bank.
6) The United States has a dual banking system in the sense that
A) the public may deposit money in either commercial banks or savings-and-loan associations.
B) banks offer both demand deposits and time deposits to savers.
C) banks are chartered by the federal government and by state governments.
D) banks both take in deposits and make loans.
7) Standby letters of credit
A) are a form of swaps.
B) are a promise by a bank to lend the borrower funds to pay off its maturing commercial paper.
C) are a promise by a large depositor to provide additional funds to a bank should the bank face
an unexpectedly large deposit outflow.
D) represent the unused balance on a bank credit card.
8) Securitization refers to
A) changing the mix in a financial portfolio away from stocks and toward bonds.
B) selling directly to investors loans or securities that were formerly held by financial
intermediaries.
C) banks insisting that collateral be supplied on previously unsecured loans.
D) reducing the exposure of a bank’s portfolio to interest rate risk.
9) What are federally chartered banks called?
A) federal banks
B) Federal Reserve banks
C) national banks
D) central banks
10) National banks are supervised by the
A) Office of the Comptroller of the Currency.
B) Office of Bank Supervision.
C) Securities and Exchange Commission.
D) Office of Management and the Budget.
11) Congress introduced deposit insurance in response to
A) the savings-and-loan crisis of the 1980s.
B) the banking crisis of the 1930s.
C) the demise of the Second Bank of the United States in 1836.
D) the demise of the First Bank of the United States in 1811.
12) A bank run involves
A) a failure by a bank to get the maximum return on its investments.
B) large numbers of depositors withdrawing their deposits within a short period of time.
C) a bank being forced out of business.
D) fraud on the part of a bank’s managers.
13) The Federal Reserve System was created in response to
A) the stock market crash of 1929.
B) the ending of the Civil War.
C) the banking panic of 1907.
D) difficulties of the free-banking era.
14) The Federal Reserve System was created in
A) 1836.
B) 1863.
C) 1913.
D) 1945.
15) The FDIC was created in
A) 1863.
B) 1913.
C) 1934.
D) 1991.
16) The McFadden Act of 1927
A) separated commercial banking from investment banking.
B) put a tax on the issuance of bank notes by state banks.
C) prohibited national banks from operating branches outside their home states.
D) established the Federal Reserve System.
17) During a banking panic, a lender of last resort will
A) purchase banks which are having difficulty but appear sound.
B) make loans to solvent but temporality illiquid banks.
C) make loans to insolvent but liquid banks.
D) make loans to any banks which request them.
18) In the current U.S. economy, who plays the role of lender of last resort?
A) The Securities and Exchange Commission
B) The Federal Deposit Insurance Corporation
C) The Federal Reserve System
D) The Social Security Administration
19) Currently, the FDIC insures deposits up to a limit of
A) $1000.
B) $100,000.
C) $250,000.
D) $1,000,000.
20) If you have $2 million in a CD at a commercial bank that is a member of the FDIC, how
much of your funds are uninsured?
A) $0
B) $1 million
C) $1.75 million
D) $2 million
21) Where do the FDIC’s funds come from?
A) Congress appropriates money for the FDIC, just as it does for other federal agencies.
B) The FDIC earns income through the insurance premiums paid by insured banks and from
investment earnings.
C) The FDIC sells bonds in the financial markets.
D) The FDIC relies on voluntary contributions from the banking community.
22) States that restrict banks to having a single branch are said to require
A) mono banking.
B) nonbank banking.
C) unit banking.
D) semi-banking.
23) Geographic restrictions on banks
A) reduce their ability to take advantage of economies of scale.
B) raise the costs of their providing risk-sharing, liquidity, and information services.
C) reduce their exposure to credit risk.
D) reduce the amount of local lending they undertake.
24) Which group had the most difficult time receiving credit from banks during the credit crunch
of the late 2000s?
A) corporations
B) federal government
C) state and local government
D) small businesses
25) All of the following are reasons that small businesses had difficulty receiving credit in the
late 2000s EXCEPT
A) declining commercial real estate value resulted in a decline in he value of their collateral.
B) many banks feared adverse selection and moral hazard and thus tightened lending standards.
C) banks reduce business credit card limits.
D) banks tried to reduce their reserves making lending more difficult.
26) In 2010, the Treasury estimated that the bank portion of TARP would
A) earn a profit
B) cost $60 billion
C) cost $180 billion
D) cost $700 billion