Deck 13: The Business of Banking

Question 1

The payments system refers to

A)the means of clearing and settling transactions in the economy.
B)the means by which the government collects taxes.
C)the system that credit card companies use to collect their payments.
D)the type of medium of exchange used in the economy.

Answer 1

the means of clearing and settling transactions in the economy.

Question 2

Which of the following is a bank liability?

A)Reserves
B)Consumer loans
C)Nontransaction deposits
D)Securities

Answer 2

Nontransaction deposits

Question 3

In what country were the ten largest banks in the world located during the 1980s and early 1990s?

A)The United States
B)Japan
C)Germany
D)Canada

Answer 3

Japan

Question 4

Approximately how much in assets did U.S. banks hold in 2006?

A)$500 million
B)$6.5 billion
C)$8.3 trillion
D)$50.7 trillion

Question 5

On a bank's balance sheet, assets are

A)the uses of acquired funds.
B)the sources of acquired funds.
C)those items owed by the bank to depositors and others.
D)by definition equal to the bank's liabilities.

Question 6

Which of the following is a checkable deposit?

A)A NOW account
B)A money market deposit account
C)A certificate of deposit
D)A savings account

Question 7

What are the leading financial intermediaries in the United States and most developed countries?

A)Pension funds
B)Stock mutual funds
C)Banks
D)Credit unions

Question 8

On a bank's balance sheet, liabilities are

A)the uses of acquired assets.
B)the sources of acquired funds.
C)all those items of value owned by the bank.
D)by definition equal to the bank's assets.

Question 9

About what percentage of their financial wealth do households invest in banks?

A)5%
B)13%
C)20%
D)50%

Question 10

In the mid-1990s to 2000s Japanese banks were experiencing difficulties in which areas?

A)Real estate lending and poor management
B)Overly strict government regulation
C)High inflation
D)High taxes

Question 11

The interest rate on interbank loans is called the

A)discount rate.
B)federal funds rate.
C)repo rate.
D)prime rate.

Question 12

In banking, the spread refers to the difference between the

A)interest rate on long-term bonds and the interest rate on short-term bonds.
B)interest rate on car loans and the interest rate on home mortgages.
C)return earned from lending and the cost of the needed funds.
D)bid and asked prices on a bond.

Question 13

Unsecured loans between banks are called

A)federal funds.
B)repurchase agreements.
C)repos.
D)discount loans.

Question 14

A checkable deposit that pays no interest is known as a

A)demand deposit.
B)certificate of deposit.
C)NOW account.
D)time deposit.

Question 15

Which of the following is NOT a bank liability?

A)Checkable deposits
B)CDs
C)Mortgage loans
D)Borrowings from the Federal Reserve

Question 16

The difference between a demand deposit and a NOW account is that

A)checks may not be written against NOW account balances.
B)demand deposits pay no interest.
C)NOW accounts pay no interest.
D)checks may not be written against demand deposit balances.

Question 17

What is a super-NOW account?

A)A NOW account against which checks may not be written
B)A NOW account that pays no interest
C)A NOW account that pays high interest, but the funds in which may not be withdrawn for six months
D)A NOW account linked to a savings account

Question 18

Which of the following things do banks do with the funds they acquire from savers?

A)Invest in corporate stock
B)Invest in corporate bonds
C)Make loans to individuals
D)All of the above

Question 19

A balance sheet

A)is a statement showing an individual's or a firm's financial position at a particular point in time.
B)is a statement showing an individual's or a firm's income over a period of time.
C)is a statement listing the tax liabilities incurred by an individual or a firm.
D)can be constructed for any nonfinancial firm, but cannot be constructed for a financial firm.

Question 20

For a bank, net worth is equal to

A)the value of the capital originally invested in the bank by its owners.
B)the value of everything the bank owns.
C)the difference between the value of the bank's assets and the value of its liabilities.
D)the value of the buildings and other physical assets the bank owns.

Question 21

The interest rate on unsecured loans between banks is called the

A)discount rate.
B)repurchase rate.
C)T-bill rate.
D)federal funds rate.

Question 22

A key difference between small-denomination and large-denomination time deposits is that

A)small-denomination time deposits pay no interest.
B)large-denomination time deposits may be bought and sold on secondary markets.
C)large-denomination time deposits carry a significant penalty for early withdrawal.
D)small-denomination time deposits carry a significant penalty for early withdrawal.

Question 23

Which of the following helps explain why depositors sometimes put their funds in demand deposits rather than NOW accounts?

A)Demand deposits pay interest, whereas NOW accounts do not pay interest.
B)Businesses may not hold NOW accounts.
C)Checks may be written against demand deposits, but not against NOW accounts.
D)Demand deposits are more liquid than NOW accounts.

Question 24

All of the following are examples of borrowings by a bank EXCEPT

A)federal funds.
B)repurchase agreements.
C)discount loans.
D)commercial loans.

Question 25

A cash item in the process of collection is

A)a U.S. Treasury bill that has matured, but for which the bank has not yet received payment.
B)a car loan payment that is due but not yet received by the bank.
C)a check drawn against another bank, from whom the funds have not yet been collected.
D)currency that has been deposited in the bank, but not yet formally counted and entered into the bank's balance sheet.

Question 26

Securities that banks sell and agree to repurchase are known as

A)federal funds.
B)discount loans.
C)repurchase agreements.
D)NOW accounts.

Question 27

Which of the following would NOT be covered by federal deposit insurance?

A)A $50,000 demand deposit
B)A $50,000 NOW account
C)A $75,000 NOW account
D)A $200,000 certificate of deposit

Question 28

Required reserves are

A)a tax on bank intermediation.
B)zero on demand deposits.
C)zero on NOW accounts.
D)imposed on all deposits at commercial banks.

Question 29

The difference between a savings deposit and a time deposit is

A)time deposits pay no interest.
B)savings deposits pay no interest.
C)time deposits have specified maturities.
D)savings deposits have specified maturities.

Question 30

In what sense can a reserve requirement be said to be a tax on bank intermediation?

A)Banks must pay tax on any funds deposited in a reserve account at a rate equal to the applicable corporate income tax rate.
B)Banks must pay tax on any funds removed from a reserve account at a rate equal to the applicable corporate income tax rate.
C)Banks must pay taxes on the amount by which they fail to meet their reserve requirements.
D)Banks are unable to lend out all their deposits.

Question 31

Banks use repurchase agreements to

A)ensure that payments on consumer loans are made on time.
B)borrow funds from business firms or other banks.
C)guard against price fluctuations on long-term bonds.
D)ensure that they always have enough funds on hand to meet their federal tax liabilities.

Question 32

What is the current limit on balances that are covered by federal deposit insurance?

A)$10,000
B)$100,000
C)$500,000
D)$1,000,000

Question 33

Which of the following statements about checkable deposits is correct?

A)Checkable deposits are a larger fraction of banks' funds today than in 1960.
B)Checkable deposits are a smaller fraction of banks' funds today than in 1960.
C)All checkable deposits pay interest.
D)No checkable deposits pay interest.

Question 34

On a bank's balance sheet, "borrowings" are

A)loans to households.
B)loans to businesses.
C)nondeposit liabilities.
D)U.S. Treasury securities.

Question 35

Which of the following is NOT a nontransaction deposit?

A)A money market deposit account
B)A certificate of deposit
C)A savings account
D)A super-NOW account

Question 36

Loans by the Federal Reserve to banks are known as

A)repurchase agreements.
B)Federal funds.
C)discount loans.
D)cash items in the process of collection.

Question 37

Which of the following is a bank asset?

A)Checkable deposits
B)Savings deposits
C)Borrowings in the federal funds market
D)Cash items in the process of collection

Question 38

Federal funds are

A)the tax revenues of the Federal government.
B)loans by the Federal Reserve to banks.
C)loans by banks to the Federal Reserve.
D)unsecured loans between banks.

Question 39

Which of the following represented the largest liability on the balance sheet of U.S. commercial banks in 2006?

A)Checkable deposits
B)Loans
C)Nontransaction deposits
D)Borrowings

Question 40

Which of the following is NOT considered a cash item by banks?

A)U.S. Treasury bills
B)Deposits at other banks
C)Deposits at the Federal Reserve
D)Vault cash

Question 41

If you deposit $300 in your bank and the required reserve ratio is 10%, your bank will have

A)an increase in required reserves of $300.
B)an increase in required reserves of $270.
C)an increase in required reserves of $3000.
D)an increase in required reserves of $30 and an increase in excess reserves of $270.

Question 42

In which of the following assets are commercial banks in the United States NOT allowed to invest checkable deposits?

A)Home mortgages
B)Corporate bonds
C)Municipal bonds
D)U.S. Treasury bonds

Question 43

What percentage of bank assets were in loans in 2006?

A)2%
B)22%
C)37%
D)66%

Question 44

If you deposit a $50 check in the bank, before the check has cleared the change in your bank's balance sheet will be a

A)$50 increase in reserves and a $50 increase in checkable deposits.
B)$50 increase in cash items in the process of collection and a $50 increase in reserves.
C)$50 increase in cash items in the process of collection and a $50 increase in checkable deposits.
D)$50 increase in cash and a $50 increase in checkable deposits.

Question 45

Why are U.S. government securities referred to as a bank's secondary reserves?

A)Their current market value may count toward meeting a bank's legal reserve requirements.
B)They are very liquid.
C)Banks are legally required to hold a certain minimum amount of these securities.
D)They are the same thing as vault cash.

Question 46

If a bank decides that it must write off all or part of the value of a loan, what is the corresponding reduction in a liability entry that the bank makes?

A)Deposits are reduced by the amount of the loan write off.
B)Borrowings are reduced by the amount of the loan write off.
C)Net worth is reduced by the amount of the loan write off.
D)Cash items in the process of collection are reduced by the amount of the loan write off.

Question 47

If you have a checking account at First National Bank, the account is

A)an asset to both you and First National.
B)a liability to both you and First National.
C)an asset to First National and a liability to you.
D)an asset to you and a liability to First National.

Question 48

When a bank issues a checkable deposit and loans the funds out to a business, it has transformed

A)a financial asset for a saver into a liability for a borrower.
B)a financial liability for a saver into a financial asset for a borrower.
C)a short-term liability to a borrower into a long-term asset to a saver.
D)one liability into another liability.

Question 49

About what percentage of bank assets is made up of cash items in 2006?

A)3%
B)21%
C)37%
D)50%

Question 50

What is the largest category of bank assets?

A)Loans
B)Reserves
C)Securities
D)Cash items in the process of collection

Question 51

In 2006, net worth was about what percentage of total funds raised by banks?

A)2%
B)7%
C)10%
D)35%

Question 52

In managing its liabilities to deal with liquidity problems, banks trade off

A)credit risk against interest rate risk.
B)adverse selection against moral hazard.
C)the need for available funds to meet deposit outflows against the desire for greater operating income.
D)present tax liabilities against future tax liabilities.

Question 53

Which asset is sometimes referred to as a bank's secondary reserves?

A)Vault cash
B)U.S. government securities
C)Repurchase agreements
D)Federal funds

Question 54

What percentage of bank assets were in security holdings in 2006?

A)3%
B)13%
C)22%
D)37%

Question 55

A bank's equity capital is

A)the current market value of the bank's physical assets.
B)the historical or original value of the bank's physical assets.
C)the capital contributed by the bank's shareholders plus accumulated retained profits.
D)the sum of the value of the bank's assets plus the value of the bank's liabilities.

Question 56

Excess reserves equal

A)total reserves less required reserves.
B)required reserves less total reserves.
C)total reserves plus required reserves.
D)required reserves divided by total reserves.

Question 57

Banks make use of the federal funds market in part to

A)pay their tax liabilities.
B)manage liquidity risk.
C)deal with moral hazard.
D)deal with adverse selection.

Question 58

A bank's remaining value after it has met all its liabilities is known as a

A)bank's assets.
B)bank's liabilities.
C)bank's equity capital.
D)bank's income.

Question 59

With respect to the period of the last several decades, which of the following statements is true?

A)Bank net worth has been relatively stable, but the riskiness of bank assets has increased substantially.
B)Bank net worth has declined substantially, but the riskiness of bank assets has remained about the same.
C)Bank net worth has declined substantially and the riskiness of bank assets has increased substantially.
D)Bank net worth and the riskiness of bank assets have remained relatively stable.

Question 60

The threat that savers may withdraw their deposits

A)is not credible in the current banking situation.
B)helps to reduce the moral hazard problem in banking.
C)reduces interest rates banks charge on loans.
D)increases the volume of cash items in the process of collection.

Question 61

Which of the following is NOT a consideration when a bank decides the appropriate interest rate to charge on a loan?

A)The bank's cost of funds
B)The ratio of the bank's assets to its liabilities
C)The default risk on the loan
D)The rates of return on alternative investments available to the bank

Question 62

A loan officer uses a credit scoring system to

A)compare the interest rate on a loan to interest rates on other assets with comparable risk.
B)keep track of the fraction of a bank's assets tied up in loans to a single individual or business.
C)predict statistically whether an individual is likely to default on a loan.
D)match any particular loan with the deposits being used to fund it.

Question 63

Banks in the United States have been prohibited from investing deposits in significant equity holdings since the passage of the

A)Bank Reform Act of 1980.
B)Securities and Exchange Acts of 1933 and 1934.
C)National Banking Acts of 1863 and 1864.
D)Sherman Antitrust Act of 1890.

Question 64

Credit risk is the risk that

A)an insufficient number of borrowers will apply for loans or credit.
B)interest rates will rise after a loan has been granted.
C)interest rates will fall after a loan has been granted.
D)borrowers might default on their loans.

Question 65

A bank that expects interest rates to fall will

A)want the duration of its assets to be greater than the duration of its liabilitiesa positive duration gap.
B)want the duration of its assets to be less than the duration of its liabilitiesa positive duration gap.
C)want the duration of its assets to be greater than the duration of its liabilitiesa negative duration gap.
D)want the duration of its assets to be less than the duration of its liabilitiesa negative duration gap.

Question 66

When bank loan officers screen loan applicants to eliminate potentially bad risks, they are attempting to mitigate the problem of

A)adverse selection.
B)moral hazard.
C)interest rate risk.
D)illiquidity.

Question 67

Some economists have argued that the competitiveness of Germany and Japan has been improved by

A)the low interest rates in those economies.
B)the low tax rates in those economies.
C)the small government sectors in those countries.
D)the close relationship between banks and nonfinancial businesses in those countries.

Question 68

Which of the following statements is NOT true of credit cards?

A)The rate of return to banks from credit card lending is lower than for other bank assets.
B)Credit cards represent a preauthorized line of credit to borrowers.
C)The first credit cards to be widely accepted were nonbank travel and entertainment cards.
D)If bank cardholders don't pay the balance in full every month, they pay a finance charge on the unpaid balance.

Question 69

LIBOR measures

A)the duration of fixed-rate assets.
B)the vulnerability of a bank's net worth to interest rate risk.
C)rates that international banks charge on dollar-denominated loans.
D)the value of the dollar relative to the currencies of the major trading partners of the United States.

Question 70

Collateral is

A)the interest rate that banks charge high-quality borrowers.
B)assets pledged to the bank in the event the borrower defaults.
C)the difference between the value of a bank's assets and the value of a bank's liabilities.
D)required reserves minus excess reserves.

Question 71

Banks use "credit-risk analysis" to

A)determine the appropriate interest rate to charge borrowers.
B)determine whether to invest in the stock of a corporation.
C)determine the appropriate interest rate to pay depositors.
D)determine the likelihood of an audit by bank regulators.

Question 72

The use of floating-rate debt will not entirely eliminate a bank's exposure to interest rate risk because

A)the value of the bank's assets will still be affected more than the value of the bank's liabilities by changes in interest rates.
B)the value of the bank's liabilities will still be affected more than the value of the bank's assets by changes in interest rates.
C)a rise in interest rates might increase the default risk of borrowers.
D)Federal Reserve regulations limit the amount of floating-rate debt a bank may have.

Question 73

The duration of a bank's assets equals

A)the asset's market value divided by the market interest rate.
B)the market interest rate divided by the asset's market value.
C)the percentage change in the asset's market value divided by the percentage change in the market interest rate.
D)the percentage change in the market interest rate divided by the percentage change in the asset's market value.

Question 74

Banks experience interest rate risk

A)if adverse selection problems are particularly severe.
B)if moral hazard problems are particularly severe.
C)on any investment that has high information costs.
D)if changes in interest rates cause bank profits to fluctuate.

Question 75

The prime interest rate is the

A)interest rate on six-month U.S. Treasury bills.
B)discount rate.
C)Federal funds rate.
D)interest rate that banks charge high-quality borrowers.

Question 76

Banks use credit rationing rather than simply raising the interest rate charged borrowers with higher default risks because

A)of fear of adverse selection problems.
B)of interest rate ceilings in many states.
C)of fear of offending the loan applicants.
D)use of credit rationing is encouraged by the Federal Reserve.

Question 77

A bank's net worth will decline following an increase in interest rates if the value of its

A)fixed-rate assets is greater than the value of its fixed-rate liabilities.
B)fixed-rate assets is less than the value of its fixed-rate liabilities.
C)fixed-rate assets is greater than the value of its variable-rate assets.
D)fixed-rate liabilities is greater than the value of its variable-rate liabilities.

Question 78

Customers who have long-term relationships with banks

A)pose particular problems with respect to adverse selection.
B)pose particular problems with respect to moral hazard.
C)often obtain credit at a lower rate or with fewer restrictions.
D)are more likely to default or violate restrictive covenants.

Question 79

Why might the Community Reinvestment Act of 1977 backfire in its long-run effects on credit supply?

A)Its limits on credit card interest rates may lead to banks offering fewer credit cards.
B)Its requirements for local lending raise the cost of operating banks in urban areas and may lead to fewer banks entering these communities over time.
C)Its requirement that banks buy large amounts of local municipal bonds may lead to reckless spending by local governments.
D)Its requirement that banks make loans only for investment purposes may reduce the loans available for consumption purposes.

Question 80

A person takes out a car loan at a bank, but actually uses the money to play the lottery. This situation is an example of which problem banks face in lending?

A)Adverse selection
B)Moral hazard
C)Interest rate risk
D)Illiquidity