Deck 12: Capital Management

Question 1

Bank capital does NOT include reserves set aside to meet anticipated operating losses.

Answer 1

False

Question 2

Bank equity includes surplus and undivided profits on the balance sheet.

Answer 2

True

Question 3

Normally, the market value of equity exceeds the book value of equity for commercial banks.

Answer 3

True

Question 4

Market value accounting would make the value of equity more closely approximate the book value of equity.

Question 5

Large banks tend to use more long-term debt than small banks.

Question 6

Subordinated notes and debentures issued by banks are higher in priority of claims in the event of bank failure than deposit accounts.

Question 7

Losses on defaulted loans that were anticipated decrease the current earnings of the bank.

Question 8

The provision for loan losses account can be found on a bank's balance sheet.

Question 9

Today, banks with assets more than $500 million can only expense actual loan losses from pre-tax income.

Question 10

For failed banks, long-term debt serves the role of absorbing unexpected operating losses.

Question 11

Capital requirements do NOT reduce the moral-hazard problem of deposit insurance.

Question 12

Because deposit insurance may create incentives for a bank to take excessive risks at the expense of the insuring agency, there is a moral-hazard problem.

Question 13

Regulatory forebearance means that regulators bear the losses of failed banks.

Question 14

Capital requirements balance safety and soundness considerations against the efficiency and competitiveness of the banking system.

Question 15

Historical evidence on bank failures in the U.S. has proven that small banks are more risky than large banks and, therefore, should have higher capital requirements than large banks.

Question 16

Uniform capital requirements in the early 1980s tended to motivate banks to increase their off-balance-sheet activities.

Question 17

The Basle Agreement was between the U.S, England, and Japan -- no other countries signed the agreement.

Question 18

Retained earnings are part of Tier 2 capital under Basel I capital rules.

Question 19

To calculate risk-adjusted assets under Basel I capital requirements, home loans get a weight of 100%.

Question 20

Under the Basel I capital rules, banks with abnormal risk levels must maintain capital in excess of the minimum requirements.

Question 21

The new capital rules take into account credit risk and interest rate risk.

Question 22

In a depositor payoff of a failed bank by the FDIC, the failed bank is merged with a healthy bank.

Question 23

Under the new variable-rate deposit insurance scheme, undercapitalized banks can face various restrictions on their activities.

Question 24

A Deposit Insurance National Bank (DINB) can be used by the FDIC to take over the operations of a distressed bank until the bank is either closed or acquired by another bank.

Question 25

The variability of earnings per share decreases due to increasing tax deductions on interest payments as debt is increased by a bank.

Question 26

Tax gains on debt interest deductions from taxes increase as debt is increased by a bank, and these gains are offset by increasing regulatory costs as debt increases and equity decreases in the capital structure of a bank.

Question 27

The agency cost problem arises when a regulatory agency increases its scrutiny of a bank, thereby raising the bank's operating costs and capital requirements.

Question 28

By increasing the dividend paid to stockholders, the duration on a bank's stock is increased.

Question 29

Banks anticipating a takeover by another bank may repurchase some outstanding equity to decrease this takeover threat.

Question 30

The internal capital generation rate (ICR) indicates the rate at which equity can be expanded and still maintain its asset ratio.

Question 31

Market risk capital requirements concern the valuation of real estate assets.

Question 32

The weighting or scaling factor for VAR estimates in market risk capital requirements is normally 3.

Question 33

Market risk capital requirements require the calculation of market-risk equivalent assets.

Question 34

When bank earnings declined in the 1980's, bankers decreased capital ratios in order to:

A) boost equity rates of return.
B) increase the banks' safety and soundness.
C) avoid issuing stocks at depressed prices induced by poor earnings.
D) keep in line with the regulatory standard.
E) a and b

Question 35

Bank capital does NOT include which of the following?

A) equity
B) long-term debt
C) commercial paper
D) capital reserves

Question 36

The amount of paid-in capital in excess of par value realized by the bank upon the initial sale of stock is called:

A) retained earnings
B) book value of shares
C) surplus
D) market value of shares

Question 37

Banks' long-term debt is subordinated to which of the following items?

A) common stock
B) depositor claims
C) preferred stock
D) market value of shares

Question 38

Which of the following factors causes the issuance of long-term debt to be more costly for small banks than large banks?

A) higher unit transaction costs
B) poor liquidity of small issues
C) higher rate of return demanded by investors
D) all of the above

Question 39

The provision for loan losses, for accounting purposes, is classified as a (an):

A) equity
B) expense
C) liability
D) revenue
E) none of the above

Question 40

In what section of the balance sheet are the loan-loss reserves carried?

A) assets
B) liability
C) equity
D) they do not appear on the balance sheet.

Question 41

In what section of the balance sheet is the provision for loan losses included?

A) long-term assets
B) short-term assets
C) long-term liabilities
D) none of the above

Question 42

Long-term debt can absorb bank losses:

A) at any time
B) if net income is negative
C) if permitted by regulators
D) if the bank fails

Question 43

Record bank failures in the 1980s and early 1990s were due to:

A) interest rate risk
B) high and volatile interest rates
C) local and regional economic declines
D) deregulation
E) all of the above

Question 44

Federal deposit insurance at fixed premiums led to a serious ___________ problem.

A) moral dilemma
B) moral hazard
C) moral shortfall
D) moral debt

Question 45

From a regulator's viewpoint, greater variability of bank earnings means:

A) the bank is insolvent.
B) the bank requires more capital.
C) the bank requires less capital.
D) the shareholders will demand a higher rate of return.

Question 46

Regulatory forbearance caused losses to increase with respect to failed depository institutions in the 1980s. An example of regulatory forbearance is:

A) low, fixed deposit insurance premiums
B) low, uniform capital requirements
C) not closing insolvent institutions
D) all of the above

Question 47

The capital adequacy decision is a trade-off between the safety and soundness and the _____________ of the banking system.

A) efficiency
B) competitiveness
C) a and b
D) none of the above

Question 48

The Form for Analyzing Bank Capital (FABC) was used by the _________ in the 1950s.

A) OCC
B) Federal Reserve Board
C) FDIC
D) all of the above

Question 49

In 1981 federal bank regulators moved to a uniform bank capital requirement that focused
On:

A) equity capital
B) debt capital
C) loan-loss reserves
D) primary capital

Question 50

When undercapitalized banks raised new capital in response to a uniform capital requirement in 1981, what other action(s) did they take which tended to offset the advantage of added capital?

A) increased off-balance sheet activities.
B) reduced service prices.
C) made riskier loans.
D) a and b
E) a and c

Question 51

Historical evidence in banking has indicated that:

A) there is a positive relationship between failure risk and asset size.
B) there is no clear-cut relationship between bank capital and failure risk.
C) since the Great Depression, undercapitalization has been most responsible for bank failures
D) only in times of economic expansion was failure risk related to asset size.

Question 52

Under the current risk-based capital requirement, total capital as a percent of risk-adjusted assets must be at least:

A) 4 percent
B) 6 percent
C) 8 percent
D) 10 percent

Question 53

Tier 1 capital does NOT include which of the following?

A) common stock
B) perpetual preferred stock
C) surplus
D) loan-loss reserves

Question 54

When a distressed bank situation arises, which of the following is most closely associated with the FDIC's method of disposition wherein the bank is merged with a healthy bank?

A) depositor payoff
B) purchase and assumption
C) reorganization
D) provision of financial aid

Question 55

Increased use of debt, holding all else the same, causes the variability of EPS to:

A) increase.
B) decrease.
C) stay the same.

Question 56

What is the explanation for the fact that many bank depositors are NOT concerned about the
Financial leverage of the bank and do not require a higher rate of interest as bank risk increases?

A) Bank risk does not depend on leverage.
B) The depositors are insured by FDIC.
C) There is an interest rate ceiling on deposits.
D) Depositors are not concerned about risk because they assume that regulators monitor bank risk.

Question 57

From the viewpoint of bank shareholders, what is(are) the advantage(s) of using debt to finance assets?

A) using debt reduces bank financial risk
B) interest on debt is tax deductible
C) using debt prevents the dilution of ownership
D) a and b
E) b and c

Question 58

Under what condition(s) would equity financing be more preferred than debt financing from the viewpoint of bank shareholders?

A) when inflation is expected to decrease in the future
B) when the level of interest rate is relatively high
C) when the marginal tax rate of the bank is very low
D) b and c
E) a, b, and c

Question 59

Total capital equals:

A) Tier 1 capital
B) Tier 2 capital
C) Tier 3 capital
D) a and b

Question 60

Which of the following factor(s) can affect banks' debt-equity mix decision from the viewpoint of shareholders?

A) dividend policy
B) ownership control
C) financial risk
D) all of the above

Question 61

Which of the following statements is true about transaction costs in issuing debt securities when comparing banks and nonfinancial corporations?

A) the costs of issuing debt are nominally higher for banks
B) the costs of issuing debt are normally higher for nonfinancial corporations
C) the costs of issuing equity are normally lower for bankers
D) none of the above

Question 62

The rate at which a bank can internally expand assets and still maintain its capital ratio is known as the:

A) capitalization rate
B) internal capitalization rate
C) internal capital generalization rate
D) internal generalization rate
E) internal rate of expansion

Question 63

Which of the following statements is NOT true about the trends in bank equity capital?

A) Since 1984 equity capital ratios in the banking industry as a whole have gradually declined.
B) When the growth rate of equity capital increases, the growth rate of total assets will decrease.
C) As asset size decreases, equity capital ratios rise.
D) Equity capital for most banks exceeds the new risk-based capital requirements.

Question 64

Loan-loss reserves are counted in:

A) Tier 1 capital
B) Tier 2 capital
C) Tier 3 capital
D) a and b

Question 65

Under Basel I, the risk weight for commercial loans under the new risk-based capital requirements is:

A) 0.20
B) 0.50
C) 0.75
D) 1.00

Question 66

Risk-based capital requirements employ:

A) risk-adjusted capital ratios
B) a minimum total capital ratio
C) a maximum loan-loss reserves ratio
D) a and b
E) a, b, and c

Question 67

Under Basel I, risk-based capital requirements do NOT consider:

A) credit risk
B) interest rate risk
C) liquidity risk
D) b and c
E) a, b, and c

Question 68

Under risk-based capital requirements, off-balance sheet items must be converted to:

A) credit equivalent amounts
B) on-balance sheet amounts
C) risk-adjusted amounts
D) forward amounts

Question 69

A standby letter of credit is an example of a(an):

A) on-balance sheet item
B) depreciable item
C) tax-free item
D) off-balance sheet item

Question 70

Shareholders co-insure against bank losses by:

A) merging the failed bank with a solvent bank
B) holding equity in the bank
C) purchasing the bank's notes and debentures
D) paying deposit insurance premiums

Question 71

Regulatory costs of compliance cause bank values to:

A) increase
B) decrease
C) not change

Question 72

Agency costs in banking arise due to conflicts of interest between:

A) shareholders and depositors
B) managers and depositors
C) shareholders and managers
D) depositors and regulators

Question 73

Which of the following risks are employed in market risk capital requirements?

A) general market risk
B) credit risk
C) specific risk
D) a and c
E) a, b, and c

Question 74

VAR is calibrated to a ___________ standard.

A) 30-day, 90^th precentile
B) 30-day, 50^th percentile
C) 10-day, 99^th percentile
D) none of the above

Question 75

To calculate market-risk equivalent assets, it is necessary to multiple the risk estimates by:

A) a scaling factor
B) the capital ratio
C) risk-adjusted assets
D) none of the above

Question 76

A problem with Basel I risk-based capital standards is that they do NOT consider:

A) price risk of securities
B) specific risks of securities
C) differences in default probabilities of business loans
D) all of the above

Question 77

New capital rules under Basel I and II:

A) incorporate off-balance sheet activities
B) do not penalize banks for holding low-risk, liquid assets
C) increase the consistency of rules applied to large banks around the world
D) all of the above

Question 78

Because new capital rules generally have lower weights on securities than loans,
There is the possibility that:

A) bank credit could be curtailed
B) savings are not being channeled to their best uses in the banking system
C) allocational efficiency is diminished in the banking system
D) all of the above

Question 79

Under Basel II, the internal ratings based (IRB) approach to measuring credit risk using the advanced method will be implemented at:

A) the 10 largest banks
B) the smallest banks
C) foreign banks in the U.S.
D) the highest risk banks

Question 80

Under Basel II, which of the following is NOT one of the three pillars:

A) minimum capital requirements
B) supervisory review process
C) market discipline
D) deposit insurance protection