Deck 19: Liability and Liquidity Management

Question 1

A strategy to increase reservable deposits on a Friday and decrease reservable deposits on the following Monday is called the weekend game.

Answer 1

False

Question 2

A liquid asset can be converted to cash quickly, but will require a discount from market value.

Answer 2

False

Question 3

One reason FIs such as depository institutions and life insurance companies are exposed to liquidity risk is the relatively illiquid nature of their liabilities.

Answer 3

False

Question 4

To reduce liquidity risk an FI can efficiently manage the liability structure of its portfolio.

Question 5

In the U.S., cash reserves necessary to meet deposit reserve requirements typically include vault cash and cash deposits at the Federal Reserve Bank.

Question 6

In the U.S., excess reserves held at the central bank pay interest to the DI.

Question 7

Excessive illiquidity can result in an FI's inability to meet required payments on liability claims and, at the extreme, in insolvency.

Question 8

Managing a bank's reserve position requires knowing only the target reserve ratio and the period over which reserves must be maintained.

Question 9

The reserve computation period for determining required reserves covers the 14 days of a two-week period that runs from Monday to Monday.

Question 10

In most countries, regulators often set minimum liquid reserve requirements on FIs.

Question 11

Regulators in the U.S.do not allow government securities to perform the role of a required reserve.

Question 12

The establishment of minimum required reserves by regulators is a method of extracting taxes from FIs.

Question 13

The minimum average daily reserves required in a maintenance period is a percentage of the daily average demand deposits held by a bank during the computation period.

Question 14

In most countries, assets used to satisfy the liquid assets ratio may include liquid government securities.

Question 15

By definition, all transaction accounts at U.S.FIs allow account holders to make unlimited withdrawals.

Question 16

Holding small amounts of liquid assets could cause an FI to be unable to meet the claims of liability holders.

Question 17

One method of reducing the risk of a liquidity crisis for an FI to efficiently manage liquid asset positions.

Question 18

In the U.S., banks can hold cash and government securities to meet reserve requirements.

Question 19

A strategy to lower deposits on Fridays can lower reserve requirements for a bank.

Question 20

Under contemporaneous reserve accounting, there is a seven day reserve maintenance period.

Question 21

Implicit interest involves the process of crediting the interest payment directly to a deposit account as opposed to sending an explicit interest check to the customer.

Question 22

The interbank funds market is a potential source for increasing reserves to meet required reserves.

Question 23

One method of increasing reserves to meet a reserve target is to sell liquid assets.

Question 24

The DI can influence the withdrawal rates of NOW accounts through explicit interest payments, implicit interest payments, or minimum balance requirements.

Question 25

Currently the reserve maintenance period begins 30 days after the end of the reserve computation period.

Question 26

The Fed discount window is an appropriate place to borrow reserve shortfalls because of its lower than market rates.

Question 27

NOW accounts are potentially less prone to withdrawal risk than demand deposits.

Question 28

NOW accounts allow the explicit payment of interest.

Question 29

If the fees charged on demand deposit accounts do not cover the cost of providing demand deposit services, the bank receives a subsidy or implicit interest payment.

Question 30

The DI manager can change the pricing on NOW accounts by changing both implicit and explicit interest payments.

Question 31

The contemporaneous reserve accounting system requires the maintenance period to occur simultaneously with the computation period.

Question 32

Excessive amounts of liquid asset holdings can penalize the earnings of a DI.

Question 33

Funding costs generally are positively related to the period of time the liability remains on the balance sheet.

Question 34

Up to six percent of excess reserves may be carried forward to the next reserve maintenance period.

Question 35

Federal Reserve primary credit loans available to DIs are generally at rates lower than the federal funds target rate.

Question 36

One cost of demand deposits to DIs is the reserve requirement placed on the bank by the Federal Reserve.

Question 37

The penalty for undershooting the minimum reserve requirements may include explicit interest rate charges as well as implicit costs in the form of more frequent monitoring and examinations.

Question 38

Demand deposits are a costless source of funds and have a high degree of withdrawal risk.

Question 39

Deposits with low withdrawal risk typically are the lowest cost deposits for a DI.

Question 40

Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.

Question 41

MMDAs are considered to be more liquid than demand deposits and NOW accounts.

Question 42

The interest rate paid on money market deposit accounts by U.S.DIs must directly reflect the rates earned on investments in commercial paper, bankers acceptances, repurchase agreement, and T-bills.

Question 43

Retail CDs are time deposits with a face value below $100,000.

Question 44

Because retail CDs have fixed maturities, FI managers always should have perfect information regarding the scheduling of interest and principal payments.

Question 45

Because of the collateral feature, RPs typically have a higher interest rate than fed funds.

Question 46

Because of penalties imposed for early withdrawal, a CD depositor is unlikely to withdrawal the CD funds from the bank before maturity.

Question 47

The advantage to a lender in a repurchase agreement transaction versus a fed funds sale is the collateral of government securities or other acceptable liquid assets provided by the borrowing FI.

Question 48

Because the minimum amount of a negotiable wholesale CD is $100,000, holders of these CDs are fully covered by FDIC insurance.

Question 49

An instrument whose ownership can be transferred in the secondary market is referred to as a negotiable instrument.

Question 50

In the U.S., a subsidiary bank can issue commercial paper to meet short-term liquidity needs, but the bank's parent holding company cannot.

Question 51

Short-term CDs often are priced competitively with T-bills of similar maturity.

Question 52

Fed funds are subject to settlement risk, but have little or no early withdrawal risk.

Question 53

Fed funds are short-term uncollateralized loans with maturities that typically do not exceed one day.

Question 54

Because MMDAs are in direct competition with MMMFs, the withdrawal rate is affected by the relative amount of explicit interest paid on these accounts.

Question 55

Federal funds are excess reserves held by the Federal Reserve Banks that are loaned to banks that have liquidity needs.

Question 56

FIs participating in the fed funds market, either buying or selling, are usually able to do so without amount or maturity restrictions.

Question 57

Passbook savings accounts are less liquid than demand deposit accounts.

Question 58

In the U.S., MMDAs typically are transaction accounts without limitations on the size or number of checks or transfers that can occur each month.

Question 59

The negotiable instrument characteristic of large wholesale CDs effectively eliminates the adverse withdrawal risk for the bank.

Question 60

Passbook savings accounts normally receive a lower interest rate than NOW accounts.

Question 61

Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?

A)These assets carry a reserve requirement tax.
B)These assets offer low returns.
C)These assets offer higher returns that reflect their risk.
D)Inflation increases the purchasing power value of these assets.
E)All of the options.

Question 62

Property-casualty insurance companies can reduce their exposure to liquidity risk by diversifying coverage across different types of disasters.

Question 63

Property-casualty insurance companies typically have greater liquidity risk than life insurance companies.

Question 64

Banks often convert on-balance-sheet banker's acceptances into off-balance-sheet letters of credit for the purpose of minimizing total assets and thus improving performance ratios such as ROA.

Question 65

Most large banks in the U.S.directly issue commercial paper to meet their liquidity needs.

Question 66

Which of the following is considered to be the most liquid asset?

A)T-notes.
B)T-bills.
C)Cash.
D)T-bonds.
E)Wholesale CDs.

Question 67

Which of the following observations is NOT true of a liquid asset?

A)It can be turned into cash quickly.
B)Conversion to cash entails low transaction costs.
C)Conversion to cash happens with little or no loss in principal value.
D)It is traded in an active market.
E)Large transactions may move its market price substantially.

Question 68

An accounting system in which the reserve computation and reserve maintenance periods do not overlap is called?

A)the reserve maintenance period
B)a lagged reserve accounting system
C)a contemporaneous reserve accounting system
D)undershooting.
E)None of the above.

Question 69

Recently banks have changed the liability structure towards instruments that have less withdrawal risk and higher explicit interest costs.

Question 70

The nonreserve assets that can be quickly turned into cash is referred to as the reserve requirement ratio.

Question 71

Which of the following is an outcome of an increase in the reserve requirement ratio?

A)DIs may hold fewer reserves against their transaction accounts.
B)DIs are able to lend out a greater percentage of their deposits.
C)Increased credit availability in the economy.
D)DIs are only able to lend a smaller percentage of their deposits than before.
E)A multiplier effect on the supply of DI deposits and thus the money supply.

Question 72

Requiring minimum reserves to be held at the central bank is the equivalent of

A)buffer reserves.
B)a reserve requirement tax.
C)the target reserve ratio.
D)contagious effects of liquidity risk.
E)None of the options.

Question 73

Reliance on purchased or borrowed funds will largely eliminate the liquidity risk faced by a bank.

Question 74

Which of the following is an outcome of a decrease in the reserve requirement ratio?

A)DIs must hold more reserves against the transaction accounts on their balance sheets.
B)DIs are able to lend a smaller percentage of their deposits.
C)Decreased credit availability in the economy.
D)A multiple contraction in deposits and a decrease in the money supply.
E)A multiplier effect on the supply of DI deposits and thus, the money supply.

Question 75

The concept of constrained optimization facing an FI manager involving the minimum amount of liquid reserve assets required by regulators may

A)penalize the FI if the minimum amount is less than the amount warranted by the actual withdrawal risk.
B)benefit the FI if the minimum amount is more than is warranted by actual withdrawal risk.
C)lead to increased withdrawals by depositors that do not meet the minimum requirement.
D)assist the FI manager by providing an optimal target amount of reserves that will exactly match withdrawal expectations.
E)None of the options.

Question 76

Although they are subject to reserve requirements, many DIs have begun to issue medium-term notes because they are a stable source of funds.

Question 77

The increased securitization of bank loans has reduced the liquidity of bank assets.

Question 78

Because investment banks typically buy and sell securities on a regular basis; they have no need for a liability management plan.

Question 79

The cost of holding reserves that pay no or little interest at the central bank is referred to as the requirement tax.

Question 80

A sweep account is a strategy that Dis offer customers where a high reserve ratio demand deposits are automatically transferred out of customer's accounts on Friday into higher-interest-bearing savings accounts.