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Indicate whether the statement is true or false.
1. Most loan sales enable the bank originating the loan to continue servicing the loan.
a. True
b. False
2. 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
3. The Sarbanes-Oxley Act has had little impact on the monitoring conducted by the board members of commercial banks.
a. True
b. False
4. 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
5. 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
6. Banks increase their risk by increasing their capital as a percentage of assets.
a. True
b. False
7. 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
8. 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
9. A bank can usually simultaneously maximize its return on assets and minimize credit risk.
a. True
b. False
10. A positive gap (or gap ratio of more than 1.00) suggests that rate-sensitive liabilities exceed rate-sensitive assets.
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b. False
11. The Financial Reform Act of 2010 provides that if a bank suffers large losses because it took excessive risk, the
Federal Reserve will appoint a new board of directors for the bank.
a. True
b. False
12. Banks tend to focus their loans in one industry so that they can specialize on that industry and reduce the credit risk of
their loan portfolio.
a. True
b. False
13. If the duration of all of a bank’s assets with a maturity of greater than one year is similar to that of its liabilities with a
maturity greater than one year, interest rate risk is nonexistent.
a. True
b. False
14. For most banks, the average duration of liabilities exceeds the average duration of assets, so the duration gap is
positive.
a. True
b. False
15. When determining the appropriate interest rate to charge on a loan, a bank uses the Federal Reserve’s primary credit
rate as a benchmark and adds a premium to this rate for less creditworthy customers.
a. True
b. False
16. Floating-rate loans completely eliminate interest rate risk.
a. True
b. False
Indicate the answer choice that best completes the statement or answers the question.
17. 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
18. 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. either a or b (depending on the size of the coupon payment)
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19. When a bank makes an international loan containing a clause that allows repayment in a foreign currency, the bank is
exposed to
a. loan settlement risk.
b. exchange rate risk.
c. global exchange risk.
d. currency transaction risk.
20. Which of the following statements is NOT correct?
a. Managers may be tempted to make decisions that are in their own best interests rather than shareholder interests.
b. Directors of a bank determine whether loan applications should be approved.
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
21. 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
22. Crazer Bank has a profit after taxes of $2 million, total assets of $100 million, and shareholders’ equity of $10 million.
Crazer’s return on equity (ROE) is ____ percent.
a. 18
b. 210
c. 15
d. 20
e. None of these are correct.
23. During a period of rising interest rates, 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.
24. 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; remain stable
25. 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.
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d. 5 percent.
26. 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 these are correct.
27. If a bank has a ____ duration gap, its average asset duration is probably ____ than its liability duration.
a. zero; smaller
b. positive; larger
c. negative; larger
d. None of these are correct.
28. Other things being equal, assets with ____ maturities and ____ frequent coupon payments have longer durations.
a. shorter; more
b. shorter; less
c. longer; more
d. longer; less
29. Banks can improve their liquidity position by restructuring their asset portfolio to contain fewer ____ and more ____.
a. excess reserves; Treasury bills
b. Treasury bonds; corporate bonds
c. loans; Treasury bills
d. None of these are correct.
30. In a sensitivity analysis using a bank’s stock return, an interest rate proxy, and market returns, a ____ coefficient for
the interest rate variable suggests that the bank’s performance is ____ affected by ____ interest rates.
a. positive; adversely; rising
b. positive; favorably; declining
c. negative; adversely; rising
d. negative; favorably; rising
31. 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. sale; increases AND purchase; reduces
32. 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 these are correct.
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33. 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 these are correct.
34. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain fewer ____ and
more ____.
a. Treasury bonds; commercial loans
b. Treasury bonds; excess reserves
c. consumer loans; Treasury bills
d. None of these are correct.
35. 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. decrease; sensitive AND increase; insensitive
e. None of these are correct.
36. 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. either b or c, depending on the maturities of the assets.
37. 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
38. Macon Bank has interest revenues of $5 million, interest expenses of $4 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.
39. A gap ratio of less than 1.00 suggests that
a. rate-sensitive assets exceed rate-sensitive liabilities.
b. an increase in interest rates would increase the bank’s net interest margin.
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c. rate-sensitive liabilities exceed rate-sensitive assets.
d. a decrease in interest rates would decrease the bank’s net interest margin.
e. an increase in interest rates would increase the bank’s net interest margin AND a decrease in interest rates would
decrease the bank’s net interest margin.
40. As the secondary market for loans has become active, banks can attempt 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
41. If a bank that relies heavily on short-term deposits for its funds replaces its investment in long-term Treasury
securities with more floating-rate commercial loans, it is likely that the bank’s exposure to
a. credit risk would decrease.
b. credit risk would increase.
c. interest rate risk would increase.
d. None of the above.
42. 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
43. 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
44. A bank has the following asset and liability portfolios. What is the gap?
Rate-sensitive
assets
Amount
(in millions)
Rate-sensitive
liabilities
Amount
(in millions)
Floating-rate
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loans
$4,000 NOW accounts $1,750
Floating-rate
mortgages
1,000
MMDAs
4,500
Short-term
Treasury securities
1,500
$6,500
Short-term CDs
1,000
$7,250
a. $750 million
b. −$750 million
c. 1.12
d. .896
e. None of these are correct.
45. If Bank A has a negative gap and Bank B has a positive gap, which of the following is true?
a. Bank A is favorably affected by rising interest rates.
b. Bank B is favorably affected by falling interest rates.
c. Bank A is adversely affected by falling interest rates.
d. None of these are correct.
46. Banks can reduce their credit risk by restructuring their asset portfolio to contain fewer ____ and more ____.
a. Treasury bonds; corporate bonds
b. Treasury bonds; municipal bonds
c. Treasury bonds; commercial loans
d. None of these are correct.
47. When measuring exposure to market risk, banks commonly use the ________.
a. value-at-risk method
b. operating leverage measure
c. matching maturity method
d. forward rate method
48. If a bank expects interest rates to consistently ____ over time, it will consider allocating most funds to rate-____
assets.
a. decrease; sensitive
b. decrease; insensitive
c. increase; insensitive
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49. The performance of a bank that continually concentrates on short-term deposits in euros and adjustable-rate dollar
loans with equal rate sensitivity is
a. unaffected if euro interest rates increase and U.S. rates decrease.
b. unaffected if U.S. interest rates increase and euro interest rates decrease.
c. adversely affected if euro interest rates increase and U.S. rates decrease.
d. adversely affected if U.S. interest rates increase and euro rates decrease.
e. unaffected if euro interest rates increase and U.S. rates decrease AND unaffected if U.S. interest rates increase
and euro interest rates decrease.
50. Other things being 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
51. 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.
52. 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
53. If a bank sells interest rate futures, it ____ the potential adverse effect of rising interest rates and ____ the potential
favorable effect of declining interest rates on its interest expenses.
a. reduces; reduces
b. increases; increases
c. reduces; increases
d. increases; reduces
54. Which of the following is a measure for banks to use to assess their exposure to interest rate risk?
a. capital ratio
b. leverage measure
c. duration
d. gap ratio
e. duration AND gap ratio
55. ____ is not a method used to assess interest rate risk.
a. Efficiency analysis
b. Gap analysis
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c. Duration analysis
d. Sensitivity analysis
56. If a bank desires 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
57. 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
58. Assume a U.S. bank accepts deposits in dollars and made some fixed-rate loans in British pounds. Which of the
following would reduce the bank’s profit margin?
a. The pound appreciates against the dollar.
b. The pound depreciates against the dollar.
c. British interest rates decrease.
d. British interest rates increase.
e. British interest rates decrease AND British interest rates increase.
59. 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 these are correct.
60. Banks can resolve a liquidity problem by
a. extending new loans.
b. selling assets.
c. buying back common stock.
d. increasing dividend payouts.
e. extending new loans AND selling assets.
61. Ringo Bank has a profit after taxes of $3 million, total assets of $300 million, and shareholders’ equity of $30 million.
Ringo’s return on equity (ROE) is ____ percent.
a. 1.0
b. 10.0
c. 3.0
d. None of these are correct.
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62. 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
63. 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 these are correct.
64. International diversification of loans can best reduce a bank’s overall credit risk if
a. the loans are made in countries in a single continent.
b. the loans are made in countries whose economic cycles do not move together over time.
c. the loans are made in countries in a single continent AND the loans are made in countries whose economic cycles
do not move together over time.
d. None of these are correct.
65. The measure of interest rate risk that uses the difference between rate-sensitive assets and rate-sensitive liabilities is
called the
a. gap.
b. duration measurement.
c. duration ratio.
d. gap ratio.
66. ____ is NOT a method used to assess interest rate risk.
a. Gap analysis
b. Ratio analysis
c. Duration analysis
d. Sensitivity analysis
e. All of these are methods of assessing interest rate risk.
67. 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
68. 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
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c. $1 million; increase
d. $1 million; decrease
e. None of these are correct.
69. A common method for banks to reduce their credit risk is to
a. specialize in loans to one or a few industries in which they have expertise in assessing creditworthiness.
b. specialize in loans to companies whose earnings patterns are quite similar over time.
c. specialize in loans to one or a few industries in which they have expertise in assessing creditworthiness AND
specialize in loans to companies whose earnings patterns are quite similar over time.
d. None of these are correct.
70. Banks would reduce their liquidity by restructuring their asset portfolio to contain fewer ____ and more ____.
a. Treasury securities; excess reserves
b. loans; Treasury securities
c. corporate bonds; Treasury securities
d. None of these are correct.
71. ____ 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
72. ROE is defined as
a.
b.
c.
d.
73. If interest rates ____, banks with ____ duration gaps will be ____ affected.
a. rise; positive; positively
b. rise; positive; adversely
c. decrease; positive; adversely
d. decrease; zero; positively
e. None of these are correct.
74. 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 is similar.
c. rate sensitivity of assets and liabilities is matched for each currency.
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d. currency mix of assets is similar to that of liabilities AND overall rate sensitivity of assets and liabilities is
similar.
75. 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
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Answer Key
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