51) Which of the following do banks hold as insurance against the high cost of deposit outflows?
A) Excess reserves
B) Secondary reserves
C) Bank equity capital
D) All of the above
E) Only A and B of the above
52) Which is the least costly way for a bank to handle deposit outflows?
A) Hold excess reserves.
B) Borrow from other banks.
C) Sell securities.
D) Call in loans.
53) The ________ the costs associated with deposit outflows are, the ________ excess reserves
banks will want to hold.
A) lower; more
B) higher; less
C) higher; more
D) none of the above, since deposit outflows cannot be anticipated
54) A bank can reduce its total amount of loans outstanding by
A) “calling in” loans; that is, by not renewing some loans when they come due.
B) selling loans to other banks.
C) selling loans to the Federal Reserve.
D) doing all of the above.
E) doing only A and B of the above.
55) Which of the following statements is an accurate description of modern liability
management?
A) Greater flexibility in liability management has allowed banks to increase the proportion of
their assets held in loans.
B) New financial instruments enable banks to acquire funds quickly.
C) The introduction of negotiable CDs have significantly reduced the percentage of funds that
banks borrow from one another to finance loans.
D) All of the above have occurred since 1960.
E) Only A and B of the above have occurred since 1960.
56) Banks fail when the value of bank ________ falls below the value of ________, causing the
bank to become insolvent.
A) reserves; required reserves
B) loans; secondary reserves
C) assets; liabilities
D) income; expenses
57) A bank fails when the value of its ________ falls below the value of ________, causing the
bank to become insolvent.
A) reserves; required reserves
B) loans; secondary reserves
C) securities; deposit liabilities
D) assets; liabilities
58) Bank failure is less likely to occur when a bank
A) holds less in U.S. government securities.
B) suffers large deposit outflows.
C) holds more excess reserves.
D) has less bank capital.
59) A bank failure is more likely to occur when
A) a bank holds less in U.S. government securities.
B) a bank suffers large deposit outflows.
C) a bank holds less equity capital.
D) all of the above occur.
E) only A and B of the above occur.
60) The largest source of bank income is
A) interest on loans.
B) interest on securities.
C) service charges on deposit accounts.
D) noninterest income.
61) The largest operating expense for a bank is
A) salaries and employee benefits.
B) interest paid on discount loans.
C) interest paid on federal funds borrowed from other banks.
D) interest paid on deposits.
62) On a bank’s income statement, the provision for loan losses is an ________ item and
represents the amount of ________ in the bank’s loan loss reserves.
A) income; decrease
B) income; increase
C) expense; decrease
D) expense; increase
63) On a bank’s income statement, the amount available to keep as retained earnings or pay to
the stockholders in dividends is the bank’s
A) net income.
B) net operating income.
C) net extraordinary items.
D) net interest margin.
64) Net profit after taxes per dollar of equity capital is a basic measure of bank profitability
called
A) return on assets.
B) return after taxes.
C) return on equity.
D) equity multiplier.
65) 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 after taxes.
66) The amount of assets per dollar of equity capital is called the
A) asset ratio.
B) equity ratio.
C) equity multiplier.
D) asset multiplier.
E) return on equity.
67) For a given return on assets, the lower the bank capital is,
A) the lower the return for the owners of the bank will be.
B) the higher the return for the owners of the bank will be.
C) the lower the credit risk for the owners of the bank will be.
D) both A and C of the above will happen.
68) 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, increasing the return on equity.
D) none of the above.
69) An argument that supports a regulated minimum capital requirement is that banks that hold
too little capital
A) are unprofitable.
B) impose costs on other banks because they are more likely to fail.
C) have an unfair competitive advantage over savings and loans.
D) includes all of the above.
70) Examples of off-balance-sheet activities include
A) loan sales.
B) foreign exchange market transactions.
C) trading in financial futures.
D) all of the above.
E) only A and B of the above.
71) Examples of off-balance-sheet activities include
A) loan sales.
B) extending loans to depositors.
C) borrowing from other banks.
D) all of the above.
72) The danger of banks engaging in activities such as trading in financial futures and interest-
rate swaps is that these activities allow banks to
A) increase profits.
B) decrease risks.
C) avoid bank regulations.
D) engage in speculation.
73) When a bank sells all or part of the cash stream from a specific loan,
A) it removes the loan from its balance sheet.
B) it usually does so at a loss.
C) it usually does so at a profit.
D) both A and B of the above occur.
E) both A and C of the above occur.
74) A bank
A) obtains funds by borrowing and by issuing liabilities.
B) makes profits by charging an interest rate on their asset holdings of securities and loans that is
lower than the interest and other expenses on their liabilities.
C) does both A and B of the above.
D) does neither A nor B of the above.
75) ________ were once the most common type of nontransaction deposit.
A) Checking accounts
B) Time deposits
C) Savings accounts
D) none of the above
76) Discount loans are also known as ________.
A) interest-free loans
B) advances
C) credits
D) market loans
77) Bank capital
A) is raised by selling new equity.
B) is a cushion against a drop in the value of its assets.
C) comes from retained earnings.
D) is all of the above.
78) Before the 1960s,
A) over half of the sources of bank funds were obtained through checkable deposits that by law
could not pay any interest.
B) banks mostly borrowed from other banks to meet their reserve needs.
C) both A and B occurred.
D) neither A nor B occurred.
79) With large banks beginning to explore ways in which the liabilities on their balance sheets
could provide them with reserves and liquidity, this led to
A) the expansion of overnight loan markets.
B) the development of negotiable CDs.
C) the ability of money center banks to acquire funds quickly.
D) all of the above occurring.
80) In the late 1960s,
A) money market banks no longer needed to depend on checkable deposits as the primary source
of bank funds.
B) banks aggressively set target goals for their asset growth.
C) the new management of liabilities created more flexibility.
D) all of the above.
81) In 2009 provisions for loan losses reached a new peak of ________ of total operating
expenses.
A) 60%
B) 50%
C) 33%
D) 13%
17.2 True/False
1) Since their introduction in 1961, negotiable CDs have become an important source of bank
funds.
2) Deposits that banks keep in accounts at the Federal Reserve less vault cash is called reserves.
3) When a bank receives additional deposits, it gains an equal amount of reserves; when it loses
deposits, it loses an equal amount of reserves.
4) To keep enough cash on hand to meet depositors’ demand for withdrawals, banks must engage
in liquidity management.
5) Required reserves are insurance against the costs associated with deposit outflows. The higher
the costs associated with deposit outflows, the more required reserves banks will want to hold.
6) A bank maintains bank capital to lessen the chance that it will become insolvent.
7) Given a bank’s return on assets, the higher the bank capital, the higher the return for the
owners of the bank.
8) Loan loss reserves are an asset on a bank’s balance sheet.
9) Off-balance-sheet activities consist of trading financial instruments and generating income
from fees and loan sales, all of which affect bank profits but are not visible on bank balance
sheets.
10) The value-at-risk method for estimating a bank’s risk exposure measures the losses a bank
could incur under a worst-case scenario.
11) The share of bank operating income earned from off-balance-sheet activities has increased
over the past two decades.
12) Since a bank’s assets exceed its equity capital, the return on assets always exceeds the return
on equity.
13) A loan commitment is an agreement to provide a loan up to a certain dollar amount if a
customer requests the loan during a specific time period.
14) Nontransaction deposits are the primary source of bank funds.
15) Owners cannot write checks on nontransaction deposits, but the interest rate paid on these
deposits are usually higher than those on checkable deposits.
1) What is the major focus of each of the following bank management concerns: asset
management, liability management, liquidity management, and capital adequacy management?
2) Explain the off-balance-sheet activities banks engage in, the risks they face from undertaking
these activities, and the controls they put in place to restrict bank employees from taking on too
much risk.
3) Discuss the recent trends in bank performance measures.
4) What are a bank’s major sources and uses of funds?
5) Distinguish between a bank’s reserves, required reserves, excess reserves, and secondary
reserves.
6) What costs do banks hope to avoid by holding excess reserves?
7) How did liability management change during the 1960s?
8) Explain how a capital crunch can lead to a credit crunch in our economy.