Deck 7: Investment Management

Question 1

The investment policy of the bank should be to maximize rates of return.

Answer 1

False

Question 2

The investment policy should be written out as a guide to managers in allocating responsibilities, setting investment goals, and evaluating portfolio performance.

Answer 2

True

Question 3

When interest rates are low, differences in deposit and loan demands tend to cause a positive duration gap.

Answer 3

True

Question 4

If a bank has a positive duration gap, an increase in interest rates will tend to cause the equity value of the bank to increase.

Question 5

Pledging requirements are related to capital management rather than investment management.

Question 6

Both Treasury notes and bonds are coupon-bearing instruments.

Question 7

Ginnie Mae securities are a type of Treasury security.

Question 8

CMOs are ownership claims on conventional mortgages held by Freddie Mac and are issued as twenty-year securities.

Question 9

Revenue bonds are backed by the "full faith and credit" of the taxing government unit.

Question 10

GOs pay no federal income taxes on interest income.

Question 11

Banks and individuals are exposed to the same tax treatment for municipal securities holdings under the Tax Reform Act of 1986.

Question 12

Moody's/S&P's top five bond rating categories are considered to be investment grade, as opposed to junk bonds.

Question 13

Higher activity ratios reflect stronger short-term solvency.

Question 14

Moody's/S&P's regularly reports information on distressed sale values of assets of firms in the event those firms' debt issues go into default.

Question 15

During recessionary periods, the yield spread between low and high quality bonds tends to increase.

Question 16

When interest rates are high, and the expansionary phase of the economy is peaking out, this is an ideal time to purchase short-term securities, as opposed to long-term securities.

Question 17

The normal shape of the yield curve is upward sloping.

Question 18

The expectations theory of the yield curve says that the rate of return that investors earn can differ depending on the maturities of securities that investors hold.

Question 19

Empirical evidence has repeatedly shown that future implicit interest rates calculated from the equation representing the expectations theory of the yield curve tend to be upwardly biased estimates of actual future rates of interest.

Question 20

Bonds issued when interest rates are low tend to have higher levels of call risk than those issued when interest rates are high.

Question 21

The spaced-maturity approach to investment management is a passive approach.

Question 22

A "back-end loaded approach" can be used under the spaced-maturity investment strategy.

Question 23

A tax swap entails selling bonds with tax losses and buying bonds with tax gains.

Question 24

Investment securities are held by commercial banks to produce income in the forms of ___________ and ___________.

A) interest and dividends
B) dividends and capital gains
C) interest and capital gains
D) interest and tax credits

Question 25

Which of the following is NOT a factor that limits the performance of an investment portfolio and constrains maximization?

A) interest rates
B) regulatory requirements
C) lending demands
D) tax laws

Question 26

Investment securities are defined as those securities with:

A) high return per unit risk
B) interest rates above market rates
C) maturities greater than 1 year
D) a and c
E) a, b, and c

Question 27

The Glass Steagall Act prohibited banks from holding:

A) corporate bonds
B) corporate stocks
C) municipal securities
D) agency securities
E) none of the above

Question 28

Treasury notes and bonds:

A) are sold only at a discount
B) are coupon-bearing instruments
C) range in maturities from 1 to 5 years
D) b and c
E) a, b, and c

Question 29

Which of the following is NOT a federal agency that issues securities representing claims on mortgage pools?

A) VA
B) MRA
C) FNMA
D) GNMA

Question 30

Which of the following securities would tend to offer the highest yield?

A) Treasury bills
B) Treasury notes
C) agency securities
D) general obligation municipal bonds
E) revenue bonds

Question 31

The pretax equivalent rate of return on a 7% municipal bond when the tax rate is 30%, the average cost of funds is 6%, and 100% of interest is nondeductible is:

A) 10%
B) 8.2%
C) 9.0%
D) none of the above

Question 32

The benefit from the tax exemption of "munis" is maximized when:

A) net operating income is less than municipal interest earned
B) net income after taxes exceeds municipal interest earned
C) net operating income exceeds municipal interest earned
D) b and c
E) a, b, and c

Question 33

Which of the following comprises the largest proportion of investment in securities portfolios of commercial banks?

A) municipal securities
B) U.S. Treasury and agency securities
C) corporate securities
D) mortgage backed securities

Question 34

Investment grade bonds include bonds that are graded letters of:

A) AAA and AA
B) A and BBB
C) BB and B
D) a and b
E) a, b, and c

Question 35

The value of a $1,000 bond with an 8% yield-to-maturity and duration of 4 years would decline in value by how much if interest rates rose 2%?

A) $37
B) $74
C) $80
D) $100
E) none of the above

Question 36

You wish to forecast the 1-year bond rate 3 years from now. The 4-year spot rate is 10%, and the 3-year spot rate is 9%. Based on the expectations theory, the forecasted 1-year rate ₃r₄ is:

A) 10%
B) 11%
C) 13%
D) none of the above

Question 37

The expectations theory of the yield curve assumes that:

A) holding period is irrelevant
B) holding period is relevant
C) risk premiums exist for liquidity
D) supply and demand for securities is very important in long-term and short-term yields.

Question 38

When interest rates are relatively high, and the expansionary phase of the business cycle is peaking out, banks should take advantage of the yield curve by:

A) buying short-term securities
B) selling short-term securities
C) buying long-term securities
D) selling long-term securities

Question 39

According to the expectations theory of the yield curve, if the 2-year spot rate is 8% and the 1-year spot rate is 9%, the 1-year rate from now will be:

A) 10%
B) 9%
C) 8%
D) 7%
E) none of the above

Question 40

The higher rate that banks charge for loans with longer terms to maturity is the result of:

A) risk aversion
B) liquidity preference
C) a normally upward sloping yield curve
D) a and c
E) a, b, and c

Question 41

The long-term bond market is dominated by:

A) life insurance companies and pension funds
B) pension funds and commercial banks
C) commercial banks and the Fed
D) life insurance companies and the Fed

Question 42

The risk associated with NOT being able to sell bonds quickly without loss of principal is called:

A) credit risk
B) call risk
C) marketability risk
D) portfolio risk

Question 43

A corporate bond will most likely be called if it was issued when interest rates were _____________ and interest rates have since _____________.

A) high; fallen
B) high; risen
C) low; risen
D) low; fallen

Question 44

Benefits of diversification may be gained by buying securities that are __________ with the other assets in the bank's portfolio.

A) lower risk
B) higher risk
C) perfectly positively correlated
D) not perfectly positively correlated

Question 45

The passive portfolio management strategy in which available investment funds are spread equally over a specified number of periods is known as the:

A) split-maturity approach
B) spaced-maturity approach
C) barbell approach
D) spread-maturity approach
E) none of the above

Question 46

The split-maturity approach to securities management involves buying ___________amounts of short-term securities, ___________ amounts of intermediate-term securities, and ___________ amounts of long-term securities.

A) large; small; large
B) large; large; large
C) large; small; small
D) small; small; small

Question 47

Aggressive strategies for managing investment portfolios include:

A) bond swapping
B) playing the yield curve
C) split-maturity approach
D) a and b
E) a, b, and c

Question 48

Playing the yield curve will be successful if all of the following happen EXCEPT:

A) the yield curve stays at the same level
B) the yield curve is upward sloping
C) the expectations theory of the yield curve holds true
D) interest rates stay the same

Question 49

The most important consideration in succeeding in aggressive yield curve strategies is:

A) high liquidity
B) accurate market forecasting
C) taxes
D) risk aversion

Question 50

All of the following are types of bond swaps EXCEPT:

A) municipal swap
B) coupon swap
C) tax swap
D) spread swap

Question 51

If a bank's tax rate increases, it can reduce taxes by:

A) swapping municipals for corporate bonds
B) swapping corporate for municipal bonds
C) swapping long-term for short-term securities
D) swapping short-term for long-term securities

Question 52

The exchange of a low coupon bond for a high coupon bond, or vice versa, is called a:

A) spread swap
B) quality swap
C) trade-off swap
D) yield pickup swap

Question 53

The choice of aggressive or passive investment portfolio management strategies is related to all of the following EXCEPT:

A) need to conserve management resources
B) ability to implement the strategy
C) size of the bank
D) none of the above; they all influence portfolio management strategies

Question 54

Banks "cherry pick" securities in their investment portfolio to:

A) obtain tax losses on sales
B) obtain interest income
C) obtain capital gains
D) none of the above

Question 55

Securities that are "assets held for maturity" in a bank are valued on their balance sheet at:

A) book value
B) market value
C) regulatory value
D) none of the above

Question 56

Generally speaking, banks CANNOT deduct interest expenses on borrowed funds to purchase tax exempt securities, EXCEPT if:

A) the bank purchases less than $10 million in any one year.
B) the local government issues no more than $10 million of new issues in any one year.
C) the federal government approves the new issues of the local government, up to a limit of $10 million approved.
D) a or b

Question 57

Risk-based capital rules cause banks to favor:

A) GO municipal bonds
B) revenue bonds
C) all municipal bonds
D) no municipal bonds

Question 58

Default risk on bonds can be evaluated by using:

A) financial analysis
B) bond ratings
C) estimates of potential losses on bonds
D) a and b

Question 59

Bond ratings do NOT capture:

A) default risk
B) probability of missed interest payments
C) probability of missed principal payments
D) potential losses to bondholders

Question 60

Empirical evidence has shown that future implicit rates of interest are _____________ estimates of actual future rates of interest.

A) exact
B) downward biased
C) upward biased
D) none of the above; the two types of rates are totally unrelated to one another.

Question 61

High activity ratios reflect strong:

A) financial leverage
B) profitability
C) sales turnover
D) short-term solvency

Question 62

Inventory turnover is calculated as:

A) total assets/inventory
B) current liabilities/inventory
C) sales/inventory
D) none of the above

Question 63

Which of the following is NOT a passive investment strategy?

A) spaced-maturity
B) ladder
C) split-maturity
D) barbell
E) none of the above; they are all passive strategies