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Test Bank Ngân hàng thương mại 2

Ngân hàng thương mại 1 (Đại học Tôn Đức Thắng)

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Chapter 1 - The Organization and Structure of Banking and the Financial Services Industry 2

Fill in the Blank Questions ....................................................................................................................... 2

True/False Questions ............................................................................................................................... 3

Multiple Choice Questions ....................................................................................................................... 6

Chapter 2 - The Financial Statements of Banks and Their Principal Competitors ...................... 15

Fill in the Blank Questions ...................................................................................................................... 15

True/False Questions .............................................................................................................................. 17

Multiple Choice Questions ...................................................................................................................... 19

Chapter 3 - Interest Rates Risk Management ...................................................................................... 41

Fill in the Blank Questions ...................................................................................................................... 41

True/False Questions ............................................................................................................................. 44

Multiple Choice Questions ..................................................................................................................... 48

Chapter 4 - Liquidity and Reserves Management: Strategies and Policies .................................. 68

Fill in the Blank Questions ..................................................................................................................... 68

True/False Questions .............................................................................................................................. 71

Multiple Choice Questions ..................................................................................................................... 74

Chapter 5 - The Management of Capital .............................................................................................. 89

Fill in the Blank Questions ..................................................................................................................... 89

True/False Questions .............................................................................................................................. 91

Multiple Choice Questions ..................................................................................................................... 93

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Chapter 1 - The Organization and Structure of Banking and

the Financial Services Industry

Fill in the Blank Questions

1. A(n) ___________________ is a machine located at the merchant's place of business which
allows depositors to use their debit card to pay for purchases directly.
Answer: POS
2. A(n) _____________ is a bank which offers its full range of services from several locations.
Answer: branch bank
3. A(n) _____________________ is a bank which offers its full range of services from only
one location.
Answer: unit bank
4. A(n)________________________ is a corporation chartered for the express purpose of
holding the stock of one or more banks.
Answer: Bank Holding Company
5. Managers who value fringe benefits, plush offices and ample travel budgets over the pursuit
of maximum returns for stockholders are exhibiting signs of __________________________.
Answer: Expense Preference Behavior
6. A(n) __________________ can invest in corporate stock as sell as loan money to help
finance the start of new ventures or support the expansion of existing businesses.
Answer: Merchant bank
7. A bank which operates exclusively over the internet is known as a ___________ bank.
Answer: Virtual

8. One new 21st century bank organizational structures is _____________________ . This is

a special type of holding company that may offer the broadest range of financial services.
Answer: Financial Holding Company (FHC)
9. The key problem in a large money center bank is . Managers
may be knowledgeable about banking practices but may be less informed about products and
services of subsidiary companies.

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Answer: span of control

10. The Gramm-Leach-Bliley Act moved the U.S. banking industry closer to
banking in which banks may provide securities, insurance, and other financial products.
Answer: universal
11. A bank that is not associated with a bank holding company is called a(n)
________ bank.
Answer: independent
12. is a view of how modern corporations operate which
analyzes the relationship between a firm’s owners and its managers.
Answer: Agency theory
13. Many experts believe that , the relationships that
exist between managers, the board of directors and stockholders, is more complicated in
financial institutions. Answer: Because of government regulations.
14. is the idea that there will be a lower cost of
production per unit as the firm gets larger.
Answer: Economies of scale
15. is the idea that there will be lower cost of
producing multiple services using the same organization and resources.
Answer: Economies of scope
16. Over the years, managers of banks and other financial institutions have evolved
different organizational forms to address changes in the industry. Indeed, these firms are
organized to carry out various roles in the most efficient way. This is referred to as
_________________________.
Answer: Organizational form follows function

True/False Questions
17. Bank size is not considered a significant factor in determining how banks are organized.

Answer: False

18. Nearly three quarters of all U.S. banks exceed $100 million in asset size apiece.

Answer: False

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19. Nearly all U.S. banks with federal or state charters have their deposits insured by the Federal
Deposit Insurance Corporation.

Answer: True

20. State-chartered banks in the United States represent about a quarter of all U.S.-chartered
banks, while national banks account for approximately three quarters of all U.S. chartered banks.

Answer: False

21. The majority of all U.S. banks are members of the Federal Reserve System.

Answer: False

22. A banking corporation chartered by either federal or state governments that operates only one
full-service office is called a unit bank.

Answer: True

23.Over half of all U.S. states today limit branching activity.

Answer: False

24. The average U.S. bank is larger in size (in terms of number of branch offices) than the average
Canadian bank.

Answer: False

25. Despite the rapid growth of automation in U.S. banking, there are more full-service branch
banking offices than automated teller machines across the whole U.S.

Answer: False

26. In the United States there are more one-bank holding companies than multi-bank holding
companies.

Answer: True

27. Bank holding companies hold more than 90 percent of the industry’s assets in the United
States.

Answer: True

28. Research evidence suggests that banks taken over by interstate banking organizations have
generally increased their market shares over their competitors within the same state and generally
are more profitable than their competitors.

Answer: False

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29. The concentration of bank deposits at the local level (that is in urban communities and rural
counties) has displayed only moderate changes in recent years.

Answer: True

30. There is evidence that branch banks charge higher fees for some banking services than do unit
banks.

Answer: True

31. Branch banks tend to offer a wider menu of services than unit banks.

Answer: False

32. Recent research suggests that branch banks tend to be more profitable than either unit or
holding company banks, while interstate banks tend to be the most profitable of all.

Answer: False

33. Less than 10 percent of the largest banks in the U.S. control almost 90 percent of the industry
assets.

Answer: True

34. Agency theory suggests that bank management will always pursue the goal of maximizing the
return of the bank's shareholders.

Answer: False

35. Recent research suggests that the relationship between bank size and the cost of production
per unit is roughly U shaped.

Answer: True

36. Bank holding companies that want to achieve the goal of risk reduction in earnings risk
through interstate banking can achieve the same level of risk reduction by entering any of the fifty
states.

Answer: False

37. Bank holding companies are allowed to own nonbank businesses as long as those businesses
offer services closely related to banking.

Answer: True

38. Banks tend to have a higher proportion of outside directors than a typical manufacturing firm.

Answer: True

39. Banks which operate entirely on the web are known as invisible banks.
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Answer: False

40. Banks acquired by holding companies are referred to as affiliated banks.

Answer: True

41. Bank organizational structure has become more complex in recent years.

Answer: True

42. There are only a very small number of unit banks in the U.S. today.

Answer: False

43. Traditional brick-and-mortar bank branch offices are on the decline in the U.S. today.

Answer: False

44. Community banks are usually smaller banks that are devoted principally to the markets for
smaller, locally based deposits and loans.

Answer: True

45. The question of whether financial firms operate as efficiently as possible requires researchers
to look into the issue of x-efficiency. The concept requires an assessment of the financial firm’s
operating costs in relation to its cost-efficient frontier.

Answer: True

Multiple Choice Questions

46. In banking, organizational form follows __________ because banks usually are organized in such
a way as to carry out the tasks and supply the services demanded of them. The term that correctly
fills in the blank in the sentence above is:
A) Bank size
B) Management's decision
C) Function
D) Regulation
E) Location
47. Which one of the following is charged with setting policy and overseeing a bank's performance?
A) Stockholders
B) Board of directors
C) Regulators

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D) Depositors
E) None of the above.
48. The largest banks possess some potential advantages over small and medium-size banks,
according to the textbook. What specific advantage of the largest banks over small and medium-
sized banks is not mentioned in the text?
A) Greater diversification geographically and by product line
B) Availability of financial capital at lower cost
C) Greater professional expertise to allocate capital to the most promising products and
services
D) Better positioned to take advantage of the opportunities afforded by interstate banking.
E) All of the above were mentioned in the text as advantages typically possessed by
the largest banks.
49. Before any financial services can be offered to anyone a bank in the United States must have a:
A) Certificate of deposit insurance
B) Charter of incorporation
C) List of established customers
D) New building constructed to be the bank's permanent home
E) None of the above.
50. In the United States there are close to __________ commercial banks in operation. Which number
shown below is closest to the actual total number of U.S. banks operating in the U.S.?
A) 20,500
B) 13,500
C) 11,500
D) 9,000
E) 7,500
51. One of the few states that has opted out of interstate banking is:
A) New York
B) Ohio
C) Texas
D) Montana
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E) None of the above

52. The concentration of U.S. bank deposits in the hands of the largest banks has _________ during
the most recent period,
A) Declined
B) Increased
C) Remained essentially unchanged
D) Exhibited large fluctuations in both directions
E) None of above.
53. Bank holding company organizations have several advantages over other types of banking
organizations. Among the advantages mentioned in this chapter is:
A) Greater ease of access to capital markets
B) Tax advantage
C) Product-line diversification
D) All of the above.
E) None of the above.
54. A company which owns the stock of three different banks is known as a(n):
A) Unit Bank
B) Interstate Bank
C) One Bank Holding Company
D) Multi Bank Holding Company
E) None of the above
55. Which of the following is considered an advantage of branch banking?
A) Increased availability and convenience of services
B) Decreased chance of failure
C) Reduced transaction costs
D) B and C above
E) All of the above
56. The types of nonbank businesses a bank holding company can own include which of the
following?
A) Retail Computer Store
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B) Security Brokerage Firm

C) Retail Grocery Store
D) Wholesale Electronic Distribution Company
E) All of the above
57. A bank which offers its full range of services from only one office is known as a:
A) Unit Bank
B) Branch Bank
C) Correspondent Bank
D) Bank Holding Company
E) None of the above
58. Why did so many states and the federal government finally enact interstate banking laws?
A) The need for new capital in order to revive struggling economies
B) The expansion of services by nonbank financial institutions
C) Competition from neighboring states that already liberalized their laws
D) Advances in technology which allowed banks to service customers in broader
geographic areas
E) All of the above are reasons for the passage of interstate banking laws
59. What is a bank holding company?
A) It is a bank that offers all of its services out of one office
B) It is a bank that offers all its services out of several offices
C) It is a corporation formed to hold the stock of one or more banks
D) It is a merchant bank
E) None of the above
60. Which of the following is a type of service a bank holding company is not allowed to own?
A) Merchant banking company
B) Savings and loan association
C) Retail electronics equipment sales company
D) Security brokerage firm
E) Insurance agency

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61. In the last decade, the number of banks has __________ and the number of branches has
_________.
A) Declined; Increased
B) Grown; Increased
C) Grown; Decreased
D) Declined; Decreased
E) Stabilized; Stabilized
62. Websites known as electronic branches offer all of the following except:
A) Internet banking services
B) ATMs
C) Point of sales terminals
D) Computer and phone services connecting customers
E) Traveler's checks

63. Relative to manufacturing firms, banks tend to have a (the) ___________ number of board
members.
A) Same
B) Larger
C) Smaller
D) Unknown
E) None of the above
64. The percentage of unit banks in the U.S. today is approximately:
A) 10%
B) 30%
C) 50%
D) 75%
E) 100%
65. The ‘typical’ community bank has:
A) $300 million in assets and is located in a smaller city in the Midwest.
B) $25 billion in assets and is located in a large city in the East
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C) $100 million in assets and is located in a large city the South

D) $10 billion in assets and is located in a small city in the West
E) None of the above
66. The ‘typical’ money center bank has:
A) $250 million in assets and is located in a smaller city in the Midwest
B) $25 billion in assets and is located in a large city in the East
C) $100 million in assets and is located in a large city in the South
D) $10 billion in assets and is located in a small city in the West
E) None of the above
67. The majority of banks today are:
A) Federally chartered
B) Uninsured
C) State Chartered
D) National Banks
E) All of the above
68. ‘Member’ banks are:
A) Members of the FDIC
B) National Banks
C) Unit Banks
D) Members of the Federal Reserve
E) All of the above
69. and banks tend to be larger and hold more of the public’s deposits.
A) National and Member
B) State and Nonmember
C) National and Uninsured
D) State and Insured
E) None of the above
70. Which of the following is a reason for the rapid growth in branch banks?
A) Exodus of population from cities to suburban areas
B) Bank convergence
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C) Business failures
D) Decreased costs of brick and mortar
E) All of the above
71. Under the Bank Holding Company Act control of a bank is assumed to exist only if:
A) The bank holding company acquires 100% of the bank’s stock
B) The bank holding company acquires 50% or more of the bank’s stock
C) The bank holding company acquires 25% or more the bank’s stock
D) The bank holding company acquires three banks
E) None of the above
72. When a bank holding company acquires a nonbank business it must be approved by:
A) The FDIC
B) The Comptroller of the Currency
C) The Federal Reserve
D) The President of the U.S.
E) All of the above
73. Many financial experts believe that the customers most likely to be damaged by decreased
competition include:
A) Large corporations in large cities
B) Households and business in smaller cities and towns
C) Households that earn more than a billion dollars a year
D) Students away at college
E) None of the above
74. According to Levonian and Rose in order to achieve some reduction in earnings risk, interstate
banks must expand into at least:
A) 2 states
B) 4 states
C) 6 states
D) 10 states
E) 25 states
75. The major competitors of banks have:
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A) Fewer but much larger service providers

B) Fewer but smaller service providers
C) More but smaller service providers
D) More but larger service providers
E) None of the above
76. Of the following countries in Europe, which has the largest number of banks?
A) Belgium
B) France
C) Germany
D) Great Britain
E) None of the above
77. Which country’s banks were owned by the state until the 1990’s?
A) Belgium
B) France
C) Germany
D) Italy
E) None of the above
78. When financial service providers offer a range of services including banking, insurance and
securities services it is known as:
A) Consolidation
B) Convergence
C) Economies of scale
D) E-Efficiencies
E) None of the above
79. The gradual evolution of markets and institutions such that geographic boundaries do not restrict
financial transactions is known as:
A) Deregulation
B) Integration
C) Re-regulation
D) Globalization
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E) Moral suasion
80. Banks with less than _______ in assets are generally called community banks.
A) More than $1 billion
B) Less than $1 billion
C) More than $5 million
D) Less than $1 trillion
E) More than $1 trillion
81. Nonbank financial firms that supply insurance coverage to customers borrowing money to
guarantee repayment of a loan are referred to as:
A) Merchant Bankers
B) Factoring Companies
C) Savings Associations
D) Investment Bankers
E) Credit Insurance Underwriters
82. A financial holding companies (FHC), defined as a special type of holding company that may
offer the broadest range of financial services such as securities and insurance activities, were
allowed under which act?
A) Riegle-Neal Interstate Banking and Branching Efficiency Act
B) The Competitive Equality in Banking Act
C) The Basel Agreement
D) The FDIC Improvement Act
E) The Gramm-Leach-Bliley Financial Services Modernization Act

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Chapter 2 - The Financial Statements of Banks and Their Principal

Competitors

Fill in the Blank Questions

1. Fed funds purchased is an example of ________________ along with Eurodollar borrowings.
Answer: nondeposit borrowings
2. The short term securities of the bank, including T-Bills and commercial paper, are often called
__________________________ because they are the second line of defense to meet demands for cash.
Answer: secondary reserves
3. __________________________ is a noncash expense on the bank's income statement which
allows the bank to account for future bad loans.
Answer: Provision for loan losses
4. _________ is the difference between interest income and interest expenses for a financial institution.
Answer: Net interest income
5. ________________________ are the primary long term liabilities of the bank. These liabilities
are paid only after deposits have been paid in the event of bankruptcy.
Answer: Subordinated notes and debentures
6. A(n)__________________________ is where the financial institution agrees to guarantee
repayment of a customer's loan received from a third party.
Answer: standby credit agreement
7. A(n)_________ is a short term collateralized loan. The collateral that is used generally consists
of T-Bills.
Answer: repurchase agreement
8. A(n)__________________________ is a deposit account which pays an interest rate
competitive with money market mutual funds and which generally has limited check writing ability.
Answer: money market deposit account
9. _____________________ is the sum of all outstanding IOU's owed to the bank in the form of
consumer, real estate, commercial and agriculture loans as well as other types of credit extensions.
Answer: gross loans
10. A financial institution often records the value of its assets and liabilities at _______________
which is the original or historical cost of the asset.
Answer: book value
11. The principal types of__________________________ include fee income, income from
fiduciary activities and services charges on deposits.
Answer: noninterest income
12. The__________________________ shows the amount of revenues received and expenses
incurred over a specific time period.
Answer: Report of Income (income statement)
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13. The__________ lists the assets, liabilities and equity capital held by the bank on a given date.
Answer: Report of Condition (balance sheet)
14. ______________ is labeled "Accounting for Derivative Instruments and Hedging Activities."
Answer: FASB 133
15. ________________ labeled “Accounting for Derivative Instruments and Hedging Activities”
and its recent amendments, FASB 138, are designed to make derivatives more publicly visible on
corporate financial statements.
Answer: FASB 133
16. Under _____________ banks must account for the expected loss of interest income on
nonperforming loans when calculating their loan-loss provision.
Answer: FASB 114
17. Temporarily buying and selling securities by a securities firm in a thinly traded market so as
to influence the price is known as _________________.
Answer: painting the tape
18. The activity of manipulating the financial statements to artificially enhance the banks financial
strength is known as ___________________.
Answer: window dressing or ‘creative accounting’
19. is direct and indirect investment in real estate. These are
properties obtained for compensations for nonperforming loans.
Answer: Other Real Estate Owned (OREO)
20. consists of interest income received on loans from customers
that has not yet been earned by the bank under accrual accounting methods.
Answer: Unearned discount income
21. can be held by individuals and nonprofit institutions, bear interest
and permit drafts from being written against the account to pay third parties.
Answer: Now accounts
22. In the worldwide banking system, represent transferable time
deposits in a variety of currencies and are often the principal source of short term borrows by
banks.
Answer: Eurocurrency Borrowings
23. One part of arises from fees charged for ATM and POS transactions.
Answer: Other Noninterest Income
24. Fees that arise from a financial firm’s trust activities, fees for managing a corporations’ interest
and dividend payments and fees for managing corporate or individual retirement plans are all
included in the category of fees arising from .
Answer: fiduciary activities
25. Checking account maintenance fees and overdraft fees are included in the noninterest income
account under .
Answer: service charges on deposit accounts
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True/False Questions
26. On a bank's income statement (Report of Income) deposit costs are financial inputs.
Answer: True
27. Loans and leases are financial outputs on a financial institution's balance sheet or Report of
Condition.
Answer: True
28. Nondeposit borrowings are a financial input on a bank's balance sheet or Report of Condition.
Answer: True
29. The cost of nondeposit borrowings is a financial input on a bank's income statement or Report
of Income.
Answer: True
30. Securities income is a financial output listed on a financial institution's Report of Condition.
Answer: False
31. Net loans on a bank's balance sheet are derived by deducting the allowance for loan losses and
unearned discounts from gross loans.
Answer: True
32.When a loan is classified as nonperforming any accrued interest recorded on the bank's books, but
not actually received, must be deducted from a bank's loan revenues.
Answer: True
33. In U.S. banking, securities gains are treated as ordinary income.
Answer: True
34. Most banks report securities gains as a component of their total noninterest income.
Answer: False
35. A bank displaying trading account securities on its balance sheet is serving as a security dealer
and plans to sell those securities before they reach maturity.
Answer: True
36. Bad loans normally do not affect a bank's current income.
Answer: True
37. The expensing of a worthless loan usually must occur in the year that loan become worthless.
Answer: True

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38. Recoveries on loans previously charged off are added to the Provision for Loan Losses (PLL)
account on a bank's income statement.
Answer: False
39. Loan-loss reserves set aside to cover a particular loan or loans expected to be a problem or
present the bank with above-average risk are known as specific reserves.
Answer: True
40. U.S. banks (especially those with $500 million or more in total assets) are required to file
financial statements audited by an independent public accountant with their principal federal
regulatory agency.
Answer: True
41. Off-balance-sheet items for a bank are fee generating transactions which are not recorded on
their balance sheet.
Answer: True
42. The experience method of accounting for future loan loss reserves allows a bank to deduct from
their income statement up to .6 percent of their eligible loans.
Answer: False
43. After the Tax Reform Act of 1986, large banks (>$500 million in assets) were required to use
the reserve method of accounting for future loan loss reserves.
Answer: False
44. The number one source of revenue for a bank based on dollar volume is loan income.
Answer: True
45. In looking at comparative balance sheets, it can be seen that large banks rely more heavily on
nondeposit borrowings while small banks rely more heavily on deposits.
Answer: True
46. The Pension Fund industry is now larger than the Mutual Fund industry.
Answer: False
47. Off-balance-sheet items for banks have declined in recent years.
Answer: False
48. Except for banks, Savings & Loans and Savings Banks hold the most deposits.
Answer: True
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49. "Painting the tape" refers to the practice whereby banks understate their nonperforming loans.
Answer: False
50.Financial statements issued by banks and nonblank financial service firms are looking
increasingly similar today.
Answer: True

Multiple Choice Questions

51. Bank assets fall into each of the following categories except:
A) Loans.
B) Investment securities.
C) Demand deposits.
D) Noninterest cash and due from banks.
E) Other assets.
52. Banks generate their largest portion of income from:
A) Loans.
B) Short-term investment.
C) Demand deposits.
D) Long-term investments.
E) Certificates of deposit.
53. Loans typically fall into each of the following categories except:
A) Real estate.
B) Consumer.
C) Commercial and Industrial (business).
D) Agricultural.
E) Municipal.
81. Which of the following adjustments are made to gross loans and leases to obtain net loans and
leases?
A) The loan and lease loss allowance is subtracted from gross loans
B) Unearned income is subtracted from gross interest received
C) Investment income is added to gross interest received
D) A and B.
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E) A. and C.
82. An example of a contra-asset account is:
A) The loan and lease loss allowance.
B) Unearned income.
C) Buildings and equipment.
D) Revenue bonds.
E) The provision for loan loss.
56. The noncash expense item on a bank's Report of Income designed to shelter a bank's current
earnings from taxes and to help prepare for bad loans is called:
A) Short-term debt interest
B) Noninterest expense
C) Provision for taxes
D) Provision for possible loan losses
E) None of the above.
57. A financial institution's bad-debt reserve, as reported on its balance sheet, is called:
A) Unearned income or discount
B) Allowance for possible loan losses
C) Intangible assets
D) Customer liability on acceptances
E) None of the above
58. When a bank serves as a security dealer for certain kinds of securities (mainly federal, state,
and local government obligations) the value of these securities is usually recorded in what
account on a bank's Report of Condition?
A) Investment Securities
B) Taxable and Tax-Exempt Securities
C) Trading Account Securities
D) Secondary Reserves
E) None of the above
59. The difference between noninterest income and noninterest expenses on a bank's Report of
Income is called:
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A) Net Profit Margin

B) Net Interest Income
C) Net Income After Provision for Possible Loan Losses
D) Income or Loss Before Income Taxes
E) Net Noninterest Income
60. The account that is built up by annual noncash expense deductions and is subtracted from
Gross Loans on the Report of Condition is:
A) Unearned income
B) Nonperforming loans
C) Allocated loan risk deductions
D) Allowance for possible loan losses
E) None of the above.
61. Nonperforming loans are credits on which any scheduled loan repayments and interest
payments are past due for more than:
A) 30 days
B) 60 days
C) 90 days
D) 180 days
E) None of the above.
62. One-time only transactions that often involve financial assets or real property pledged as
collateral behind a loan and upon which the bank has foreclosed affect a bank's account known
as:
A) Allowance for loan losses
B) Nonrecurring sales of assets
C) Asset gains or losses
D) Provision for loan and security losses
E) None of the above.
63. The use of fixed assets, rather than financial assets, in order to increase earnings flowing to a
bank's stockholders is known as:
A) Plant and equipment investment
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B) Financial leverage
C) Operating leverage
D) Nondeposit capital
E) None of the above.
64. Banks depend heavily upon borrowed funds supplied by customers with little owners' capital
invested. This means that banks make heavy use of:
A) Financial leverage
B) Capital restructuring
C) Operating Leverage
D) Margin borrowing
E) None of the above.
65. When a loan is considered uncollectible, the bank's accounting department will write (charge)
it off the books by reducing the ______ and the accounts. Which choice below
correctly fills in the blank in the preceding sentence?
A) PLL and Gross Loans
B) ALL and Net Loans
C) ALL and Gross Loans
D) PLL and Net Loans
E) None of the above.
66. The common banking practice of selling those investment securities that have appreciated in
order to reap a capital gain and holding onto those securities whose prices have declined is
known as:
A) Gains trading
B) Performance banking
C) Loss control trading
D) Selective portfolio management
E) None of the above.
67. Noninterest revenue sources for a bank are called:
A) Commitment fees on loans
B) Fee income
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C) Supplemental income
D) Noninterest margin
E) None of the above.
68. Large U.S. banks must use which of the methods listed below to determine their provision for
loan loss expense?
A) Experience method
B) Reserve method
C) Specific charge-off method
D) Historical cost method
E) None of the above.
69. A bank's temporary lending of excess reserves to other banks is labeled on the balance sheet
as:
A) Fed Funds Purchased
B) Fed Funds Sold
C) Money Market Deposits
D) Securities Purchased for Resale
E) None of the above
70. A bank sells shares of its common stock with a par value of $100 for $200 in the market.
Which two accounts on the bank's balance sheet are going to be affected?
A) Retained earnings and capital surplus accounts
B) Subordinated notes and debentures and commons stock outstanding accounts
C) Retained earnings and common stock outstanding accounts
D) Common stock outstanding and capital surplus accounts
E) Only the common stock outstanding account is affected
71. A type of letter of credit which is widely used in international trade is known as:
A) Banker's acceptance
B) Commercial paper
C) Repurchase agreement
D) Fed funds purchased
E) None of the above
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72. A bank which starts with ALL of $1.48 million at the beginning of the year, charges off
worthless loans of $.94 million during the year, recovers $.12 million on loans previously
charged off and charges current income for a $1.02 million provision for loan losses will have
an ALL at the end of the year of:
A) $.66 million
B) $3.32 million
C) $1.68 million
D) $1.28 million
E) The same amount as at the beginning of the year
73. A bank that has total interest income of $67 million and total noninterest income of $14
million. This bank has total interest expenses of $35 million and total noninterest expenses
(excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5.
What is this bank's net interest income?
A) $7
B) -$14
C) $18
D) $32
E) None of the above
74. A bank that has total interest income of $67 million and total noninterest income of $14
million. This bank has total interest expenses of $35 million and total noninterest expenses
(excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5.
What is this bank's net noninterest income?
A) $7
B) -$14
C) $18
D) $32
E) None of the above
75. A bank that has total interest income of $67 million and total noninterest income of $14
million. This bank has total interest expenses of $35 million and total noninterest expenses

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(excluding PLL) of $28 million. Its provision for loan losses is $6 million and its taxes are $5.
What is this bank's net income?
A) $7
B) -$14
C) $18
D) $32
E) None of the above
76. Which of the following financial statements shows the revenues and expense of a bank over a
set period of time?
A) The statement of stockholders equity
B) The funds-flow statement
C) The report of financial condition
D) The report of income
E) None of the above
77. Which of the following accounts is sometimes called the bank's primary reserves?
A) Cash and deposits due from bank
B) Investment securities
C) Trading account securities
D) Fed funds sold
E) None of the above
78. Which of the following assets is the largest asset item on the bank's balance sheet?
A) Securities
B) Cash
C) Loans
D) Bank Premises
E) None of the above
79. What financial service industry category is second to the banking industry in total assets held:
A) Mutual funds
B) Thrifts
C) Investment banks
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D) Insurance companies
E) Pension funds
80. FASB Rule 115 focuses primarily on bank:
A) Deposit sources
B) Investments in marketable securities
C) Derivatives trading
D) Loan-loss reserves
E) Federal funds
81. Which of the following most accurately describes the principal type(s) of bank noninterest
income:
A) Fees from fiduciary transactions
B) Fees from deposit transactions
C) Fees from securities transactions
D) Fees from additional noninterest income
E) All of the above
82. Fee income arising from fiduciary transactions include all of the following except:
A) Checking account maintenance fees
B) Fees for managing and protecting a customer’s property
C) Fees for recordkeeping for corporate security
D) Fees for dispersing interest and dividend payments for a corporation
E) Fees for managing corporate and individual retirement plans
83. You know the following information about the Miller State Bank:

Gross Loans $300

Miscellaneous Assets $50
Deposits $390
Total Equity $50
Common Stock Par $5
Non-Deposit Borrowings $60
Investment Securities $150
Net Premises $40
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Surplus $5
Allowance for Loan Losses $50
Deposits $390
Total Assets $500
Gross Premises $70
Given this information, what is this firm’s Net Loans?
A) $250
B) $350
C) $500
D) $50
E) $150
84. You know the following information about the Miller State Bank
Gross Loans $300
Miscellaneous Assets $50
Deposits $390
Total Equity $50
Common Stock Par $5
Non-Deposit Borrowings $60
Investment Securities $150
Net Premises $40
Surplus $5
Allowance for Loan Losses $50
Deposits $390
Total Assets $500
Gross Premises $70
Given this information, what is this firm’s Depreciation?

A) $250
B) $30

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C) $70
D) $40
E) $110
85. You know the following information about the Miller State Bank

Gross Loans $300

Miscellaneous Assets $50
Deposits $390
Total Equity $50
Common Stock Par $5
Non-Deposit Borrowings $60
Investment Securities $150
Net Premises $40
Surplus $5
Allowance for Loan Losses $50
Deposits $390
Total Assets $500
Gross Premises $70
Given this information, what is this firm’s Total Liabilities?

A) $390
B) $60
C) $450
D) $500
E) $50
86. You know the following information about the Miller State Bank
Gross Loans $300
Miscellaneous Assets $50
Deposits $390
Total Equity $50
Common Stock Par $5
Non-Deposit Borrowings $60
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Investment Securities $150

Net Premises $40
Surplus $5
Allowance for Loan Losses $50
Deposits $390
Total Assets $500
Gross Premises $70
Given this information, what is this firm’s Undivided Profits?
A) $50
B) $5
C) $10
D) $40
E) $450
87. You know the following information about the Miller State Bank
Gross Loans $300
Miscellaneous Assets $50
Deposits $390
Total Equity $50
Common Stock Par $5
Non-Deposit Borrowings $60
Investment Securities $150
Net Premises $40
Surplus $5
Allowance for Loan Losses $50
Deposits $390
Total Assets $500
Gross Premises $70
Given this information, what is this firm’s Total Liabilities Plus Equity?
A) $250

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B) $450
C) $150
D) $50
E) $500
88. You know the following information about the Davis National Bank
Total Interest Expenses ($500)
Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)
Provision for Loan Losses ($100)
Given this information, what is this firm’s Net Interest Income?
A) $300
B) $150
C) ($50)
D) $120
E) $80
89. You know the following information about the Davis National Bank
Total Interest Expenses ($500)
Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)
Provision for Loan Losses ($100)
Given this information, what is this firm’s Net Non Interest Income?

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A) $300
B) $150
C) ($50)
D) $120
E) $80
90. You know the following information about the Davis National Bank
Total Interest Expenses ($500)
Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)
Provision for Loan Losses ($100)
Given this information, what is this firm’s Pretax Net Operating Income (or Net Income before
Extraordinary Items)?

A) $300
B) $150
C) ($50)
D) $120
E) $80
91. You know the following information about the Davis National Bank

Total Interest Expenses ($500)

Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)
Provision for Loan Losses ($100)
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Given this information, what is this firm’s Net Income?

A) $300
B) $150
C) ($50)
D) $120
E) $80
92. You know the following information about the Davis National Bank
Total Interest Expenses ($500)
Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)
Provision for Loan Losses ($100)
Given this information, what is this firm’s Increase in Undivided Profits?

A) $300
B) $150
C) ($50)
D) $120
E) $80
93. You know the following information about the Davis National Bank

Total Interest Expenses ($500)

Total Non Interest Income $100
Securities Gains (Losses) $ 50
Income Taxes ($ 80)
Dividends to Stockholders ($ 40)
Total Interest Income $800
Total Non Interest Expenses ($150)

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Provision for Loan Losses ($100)

Given this information, what is this firm’s Total Revenues?
A) $800
B) $850
C) $150
D) $950
94. You know the following information about the Webb State Bank
Accumulated Depreciation $40
Net Loans $600
Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
Miscellaneous Assets $100
Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
Subordinated Debt $100
Investment Securities $160
Common Stock Par $20
Gross Loans $700
Given this information, what is this firm’s Allowance for Loan Losses?
A) $1300
B) $1000
C) $50
D) $200
E) $100
95. You know the following information about the Webb State Bank

Accumulated Depreciation $40

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Net Loans $600

Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
Miscellaneous Assets $100
Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
Subordinated Debt $100
Investment Securities $160
Common Stock Par $20
Gross Loans $700

Given this information, what is this firm’s Net Premises?

A) $130
B) $1000
C) $50
D) $200
E) $100
96. You know the following information about the Webb State Bank
Accumulated Depreciation $40
Net Loans $600
Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
Miscellaneous Assets $100
Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
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Subordinated Debt $100

Investment Securities $160
Common Stock Par $20
Gross Loans $700

Given this information, what is this firm’s Total Non Deposit Borrowings?
A) $1000
B) $300
C) $800
D) $200
E) $500
97. You know the following information about the Webb State Bank
Accumulated Depreciation $40
Net Loans $600
Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
Miscellaneous Assets $100
Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
Subordinated Debt $100
Investment Securities $160
Common Stock Par $20
Gross Loans $700
Given this information, what is this firm’s Total Liabilities?
A) $1000
B) $300
C) $800

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D) $200
E) $500
98. You know the following information about the Webb State Bank
Accumulated Depreciation $40
Net Loans $600
Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
Miscellaneous Assets $100
Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
Subordinated Debt $100
Investment Securities $160
Common Stock Par $20
Gross Loans $700

Given this information, what is this firm’s Total Equity?

A) $1000
B) $300
C) $800
D) $200
E) $500
99. You know the following information about the Webb State Bank

Accumulated Depreciation $40

Net Loans $600
Fed Funds Purchased and Repurchase Agreements $200
Cash and Due from Banks $50
Trading Account Securities $40
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Miscellaneous Assets $100

Deposits $500
Undivided Profits $140
Gross Premises $90
Surplus $40
Subordinated Debt $100
Investment Securities $160
Common Stock Par $20
Gross Loans $700
Given this information, what is this firm’s Total Assets?
A) $1000
B) $300
C) $800
D) $200
E) $500
100. You know the following information about the Taylor National Bank
Provision for Loan Losses ($100)
Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750
Given this information, what is this firm’s Net Interest Income?
A) $150
B) $210
C) $400
D) ($250)

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E) $750
101. You know the following information about the Taylor National Bank
Provision for Loan Losses ($100)
Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750

Given this information, what is this firm’s Net Non Interest Income?
A) $150
B) $210
C) $400
D) ($250)
E) $750
102. You know the following information about the Taylor National Bank
Provision for Loan Losses ($100)
Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750
Given this information, what is this firm’s Net Operating Income or Net Income Before Extraordinary
Income?
A) $150
B) $210

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C) $400
D) ($250)
E) $750
103. You know the following information about the Taylor National Bank

Provision for Loan Losses ($100)

Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750

Given this information, what is this firm’s Net Income?

A) $150
B) $210
C) $400
D) ($250)
E) $750
104. You know the following information about the Taylor National Bank
Provision for Loan Losses ($100)
Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750
Given this information, what is this firm’s Increase in Undivided Profits?
A) $150

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B) $210
C) $400
D) ($250)
E) $750
105. You know the following information about the Taylor National Bank
Provision for Loan Losses ($100)
Income Taxes ($140)
Non Interest Income $500
Dividends ($60)
Securities Gains (Losses) ($50)
Interest Income $1500
Non Interest Expense $750
Interest Expenses $750

Given this information, what is this firm’s Total Revenues?

A) $1500
B) $2000
C) $2050
D) $1950
E) $1450

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Chapter 3 - Interest Rates Risk Management

Fill in the Blank Questions

1. The ___________________ view of assets and liabilities held that the amount and
types of deposits was primarily determined by customers and hence the key decision a bank needed
to make was with the assets.
Answer: asset management
2. Recent decades have ushered in dramatic changes in banking. The goal of
__________________ was simply to gain control of the bank's sources of funds.
Answer: liability management
3. The__________________________ is the interest rate that equalizes the current
market price of a bond with the present value of the future cash flows.
Answer: yield to maturity (YTM)
4. The __________________ risk premium on a bond allows the investor to be
compensated for their projected loss in purchasing power from the increase in the prices of goods
and services in the future.
Answer: inflation
5. The __________________ shows the relationship between the time to maturity and
the yield to maturity of a bond. It is usually constructed using treasury securities since they are
assumed to have no default risk.
Answer: yield curve
6. The __________________ risk premium on a bond reflects the differences in the ease
and ability to sell the bond in the secondary market at a favorable price.
Answer: liquidity
7. __________________________ are those assets which mature or must be repriced
within the planning period.
Answer: Interest-sensitive assets
8. __________________________ is the difference between interest-sensitive assets and
interest-sensitive liabilities.
Answer: Dollar interest-sensitive gap
9. A(n)__________________________ means that the bank has more interest-sensitive
liabilities than interest-sensitive assets.
Answer: negative interest-sensitive gap (liability sensitive)
10. The bank's__________________________ takes into account the idea that the speed
(sensitivity) of interest rate changes will differ for different types of assets and liabilities.
Answer: weighted interest-sensitive gap
11. __________________________ is the coordinated management of both the bank's
assets and its liabilities.

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Answer: Funds management

12. __________________________ is the risk due to changes in market interest rates
which can adversely affect the bank's net interest margin, assets and equity.
Answer: Interest rate risk
13. The__________________________ is the rate of return on a financial instrument
using a 360 day year relative to the instrument's face value.
Answer: bank discount rate
14. The __________________________ component of interest rates is the risk premium
due to the probability that the borrower will miss some payments or will not repay the loan.
Answer: default risk premium
15. __________________ is the weighted average maturity for a stream of future cash
flows. It is a direct measure of price risk.
Answer: Duration
16. __________________________ is the difference between the dollar-weighted duration
of the asset portfolio and the dollar-weighted duration of the liability portfolio.
Answer: Duration gap
17. A(n)__________________________ duration gap means that for a parallel increase in
all interest rates the market value of net worth will tend to decline.
Answer: positive
18. A(n)__________________________ duration gap means that for a parallel increase
in all interest rates the market value of net worth will tend to increase.
Answer: negative
19. The __________________ refers to the periodic fluctuations in the scale of economic
activity.
Answer: business cycle
20. The__________________________ is equal to the duration of each individual type of
asset weighted by the dollar amount of each type of asset out of the total dollar amount of assets.
Answer: duration of the asset portfolio
21. The__________________________ is equal to the duration of each individual type of
liability weighted by the dollar amount of each type of asset out of the total dollar amount of assets.
Answer: duration of the liability portfolio
22. A bank is __________________ against changes in its net worth if its duration gap is
equal to zero.
Answer: immunized (insulated or protected)
23. The relationship between a change in an asset's price and an asset’s change in the yield
or interest rate is captured by __________________________.
Answer: convexity

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24. The change in a financial institution's __________________ is equal to difference in

the duration of the assets and liabilities times the change in the interest rate divided by the starting
interest rate times the dollar amount of the assets and liabilities.
Answer: net worth
25. When a bank has a positive duration gap a parallel increase in the interest rates on the
assets and liabilities of the bank will lead to a(n) __________________ in the bank's net worth.
Answer: decrease
26. When a bank has a negative duration gap a parallel decrease in the interest rates on
the assets and liabilities of the bank will lead to a(n)_________________________ in the bank's net
worth.
Answer: decrease
27. U.S. banks tend to do better when the yield curve is upward-sloping because they tend
to have ____________ maturity gap positions.
Answer: positive
28. One government-created giant mortgage banking firms which have subsequently been
privatized is the .
Answer: FNMA or Fannie Mae (or FHLMC or Freddie Mac)
29. One part of interest rate risk is . This part of interest rate
risk reflects that as interest rates rise, prices of securities tend to fall.
Answer: price risk
30. One part of interest rate risk is . This part of interest
rate risk reflects that as interest rates fall, any cash flows that are received before maturity are
invested at a lower interest rate.
Answer: reinvestment risk
31. When a borrower has the right to pay off a loan early which reduced the lender’s
expected rate of return it is called .
Answer: call risk
32. In recent decades, banks have aggressively sought to insulate their assets and liability
portfolios and profits from the ravages if interest rate changes. Many banks now conduct their
asset-liability management strategy with the help of an which
often meets daily.
Answer: asset-liability committee
33. is interest income from loans and investments less interest
expenses on deposits and borrowed funds divided by total earning assets.
Answer: Net interest margin (NIM)
34. are those liabilities that which mature or must be
repriced within the planning period.
Answer: Interest-sensitive liabilities

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35. Variable rate loans and securities are included as part of for
banks.
Answer: repriceable assets
36. Money market deposits are included as part of for banks.
Answer: repriceable liabilities
37. Interest sensitive assets less interest sensitive liabilities divided by total assets of the
bank is known as .
Answer: relative interest sensitive gap
38. Interest sensitive assets divided by interest sensitive liabilities is known as .
Answer: Interest sensitivity ratio
39. is a measure of interest rate exposure which is the total
difference in dollars between those assets and liabilities that can be repriced over a designated
time period.
Answer: Cumulative gap
40. is the phenomenon that interest rates attached to various
assets often change by different amounts and at different speeds than interest rates attached
to various liabilities,
Answer: basis risk
True/False Questions
41. Usually the principal goal of asset-liability management is to maximize or at least stabilize a
bank's margin or spread.
Answer: True
42. Asset management strategy in banking assumes that the amount and kinds of deposits and
other borrowed funds a bank attracts are determined largely by its management.
Answer: False
43. The ultimate goal of liability management is to gain control over a financial institution's
sources of funds.
Answer: True
44. If interest rates fall when a bank is in an asset-sensitive position its net interest margin will
rise.
Answer: False
45. A liability-sensitive bank will experience an increase in its net interest margin if interest rates
rise.
Answer: False

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46. Under the so-called liability management view in banking the key control lever banks possess
over the volume and mix of their liabilities is price.
Answer: True
47. Under the so-called funds management view bank management's control over assets must be
coordinated with its control over liabilities so that asset and liability management are internally
consistent.
Answer: True
48. Bankers cannot determine the level or trend of market interest rates; instead, they can only
react to the level and trend of rates.
Answer: True
49. Short-term interest rates tend to rise more slowly than long-term interest rates and to fall
more slowly when all interest rates in the market are headed down.
Answer: False
50. A financial institution is liability sensitive if its interest-sensitive liabilities are less than its
interest-sensitive assets.
Answer: False
51. If a bank's interest-sensitive assets and liabilities are equal than its interest revenues from
assets and funding costs from liabilities will change at the same rate.
Answer: True
52. Banks with a positive cumulative interest-sensitive gap will benefit if interest rates rise, but
lose income if interest rates decline.
Answer: True
53. Banks with a negative cumulative interest-sensitive gap will benefit if interest rates rise, but
lose income if interest rates decline.
Answer: False
54. For most banks interest rates paid on liabilities tend to move more slowly than interest rates
earned on assets.
Answer: False
55. Interest-sensitive gap techniques do not consider the impact of changing interest rates on
stockholders equity.
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Answer: True
56. Interest-sensitive gap, relative interest-sensitive gap and the interest-sensitivity ratio will
often reach different conclusions as to whether the bank is asset or liability sensitive.
Answer: False
57. The yield curve is constructed using corporate bonds with different default risks so the bank
can determine the risk/return tradeoff for default risk.
Answer: False
58. Financial securities that are the same in all other ways may have differences in interest rates
that reflect the differences in the ease of selling the security in the secondary market at a favorable
price.
Answer: True

59. Financial institutions face two major kinds of interest rate risk. These risks include price risk
and reinvestment risk.
Answer: True
60. Interest-sensitive gap and weighted interest-sensitive gap will always reach the same
conclusion as to whether a bank is asset sensitive or liability sensitive.
Answer: False
61. Weighted interest-sensitive gap is less accurate than interest-sensitive gap in determining the
affect of changes in interest rates on net interest margin.
Answer: False
62. A bank with a positive duration gap experiencing a rise in interest rates will experience an
increase in its net worth.
Answer: False
63. A bank with a negative duration gap experiencing a rise in interest rates will experience an
increase in its net worth.
Answer: True
64. Duration is a direct measure of the reinvestment risk of a bond.
Answer: False

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65. A bank with a positive duration gap experiencing a decrease in interest rates will experience
an increase in its net worth.
Answer: True
66. A bank with a negative duration gap experiencing a decrease in interest rates will experience
an increase in its net worth.
Answer: False
67. Duration is the weighted average maturity of a promised stream of future cash flows.
Answer: True
68. Duration is a direct measure of the price risk of a bond.
Answer: True
69. A bond with a greater duration will have a smaller price change in percentage terms when
interest rates change.
Answer: False
70. Long-term interest rates tend to change very little with the cycle of economic activity.
Answer: True
71. A bank with a duration gap of zero is immunized against changes in the value of net worth
due to changes in interest rates in the market.
Answer: True
72. Convexity is the idea that the rate of change of an asset's price varies with the level of interest
rates.
Answer: True
73. The change in the market price of an asset's price from a change in market interest rates is
roughly equal to the asset's duration times the change the interest rate divided by the original interest
rate.
Answer: True
74. U.S. banks tend to do better when the yield curve is upward-sloping.
Answer: True
75. Net interest margin tends to rise for U.S. banks when the yield curve is upward-sloping.
Answer: True
76. Financial institutions laden with home mortgages tend be immune to interest-rate risk.
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Answer: False
77. If a Financial Institution's net interest margin is immune to interest-rate risk then so is its net
worth.
Answer: False

Multiple Choice Questions

78. When is interest rate risk for a bank greatest?
A) When interest rates are volatile.
B) When interest rates are stable.
C) When inflation is high.
D) When inflation is low.
E) When loan defaults are high.
79. A bank’s IS GAP is defined as:
A) The dollar amount of rate-sensitive assets divided by the dollar amount of rate-sensitive
liabilities.
B) The dollar amount of earning assets divided by the dollar amount of total liabilities.
C) The dollar amount of rate-sensitive assets minus the dollar amount of rate-sensitive
liabilities.
D) The dollar amount of rate-sensitive liabilities minus the dollar amount of rate-sensitive
assets.
E) The dollar amount of earning assets times the average liability interest rate.
80. According to the textbook, the maturing of the liability management techniques, coupled
with more volatile interest rates, gave birth to the __________________ approach which
dominates banking today. The term that correctly fills in the blank in the preceding
sentence is:
A) Liability management
B) Asset management
C) Risk management
D) Funds management
E) None of the above.
81. The principal goal of interest-rate hedging strategy is to hold fixed a bank's:
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A) Net interest margin

B) Net income before taxes
C) Value of loans and securities
D) Noninterest spread
E) None of the above.
82. A bank is asset sensitive if its:
A) Loans and securities are affected by changes in interest rates.
B) Interest-sensitive assets exceed its interest-sensitive liabilities.
C) Interest-sensitive liabilities exceed its interest-sensitive assets.
D) Deposits and borrowings are affected by changes in interest rates.
E) None of the above.
83. The change in a bank's net income that occurs due to changes in interest rates equals the
overall change in market interest rates (in percentage points) times _____________. The
choice below that correctly fills in the blank in the preceding sentence is:
A) Volume of interest-sensitive assets
B) Price risk of the bank's assets
C) Price risk of the bank's liabilities
D) Size of the bank's cumulative gap
E) None of the above.
84. A bank with a negative interest-sensitive GAP:
A) Has a greater dollar volume of interest-sensitive liabilities than interest-sensitive
assets.
B) Will generate a higher interest margin if interest rates rise.
C) Will generate a higher interest margin if interest rates fall.
D) A and B.
E) A and C.
85. The net interest margin of a bank is influenced by:
A) Changes in the level of interest rates.
B) Changes in the volume of interest-bearing assets and interest-bearing liabilities.
C) Changes in the mix of assets and liabilities in the bank's portfolio.
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D) All of the above.

E) A and B only.
86. The discount rate that equalizes the current market value of a loan or security with the
expected stream of future income payments from that loan or security is known as the:
A) Bank discount rate
B) Yield to maturity
C) Annual percentage rate (APR)
D) Add-on interest rate
E) None of the above.
87. The interest-rate measure often quoted on short-term loans and money market securities
such as U.S. Treasury bills is the:
A) Bank discount rate
B) Yield to maturity
C) Annual percentage rate (APR)
D) Add-on interest rate
E) None of the above
88. A bank whose interest-sensitive assets total $350 million and its interest-sensitive liabilities
amount to $175 million has:
A) An asset-sensitive gap of 525 million
B) A liability-sensitive gap of $175 million
C) An asset-sensitive gap of $175 million
D) A liability-sensitive gap of $350 million
E) None of the above.
89. A bank has a 1-year $1,000,000 loan outstanding, payable in four equal quarterly
installments. What dollar amount of the loan would be considered rate sensitive in the 0
– 90 day bucket?
A) $0
B) $250,000
C) $500,000
D) $750,000
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E) $1,000,000
90. A bank has Federal funds totaling $25 million with an interest rate sensitivity weight of 1.0.
This bank also has loans of $105 million and investments of $65 million with interest rate
sensitivity weights of 1.40 and 1.15 respectively. This bank also has $135 million in interest-
bearing deposits with an interest rate sensitivity weight of .90 and other money market
borrowings of $75 million with an interest rate sensitivity weight of 1.0. What is the
weighted interest-sensitive gap for this bank?
A) $50.25
B) $-15
C) -$50.25
D) $34.25
E) None of the above
91. A bond has a face value of $1000 and five years to maturity. This bond has a coupon rate
of 13 percent and is selling in the market today for $902. Coupon payments are made
annually on this bond. What is the yield to maturity (YTM) for this bond?
A) 13%
B) 12.75%
C) 16%
D) 11.45%
E) Cannot be calculated from the information given
92. A treasury bill currently sells for $9,845, has a face value of $10,000 and has 46 days to
maturity. What is the bank discount rate on this security?
A) 12.49%
B) 12.13%
C) 12.30%
D) 2%
E) None of the above
93. The _______________ is determined by the demand and supply for loanable funds in the
market. The term that correctly fills in the blank in the preceding sentence is:
A) The yield to maturity
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B) The banker's discount rate

C) The holding period return
D) The risk-free real rate of interest
E) The market rate of interest on a risky loan
94. A bank with a positive interest-sensitive gap will have a decrease in net interest income
when interest rates in the market:
A) Rise
B) Fall
C) Stay the same
D) A bank with a positive interest-sensitive gap will never have a decrease in net interest
income
95. The fact that a consumer who purchases a particular basket of goods for $100 today has to
pay $105 next year for the same basket of goods is an example of which of the following
risks:
A) Inflation risk
B) Default risk
C) Liquidity risk
D) Price risk
E) Maturity risk
96. A bank has Federal Funds totaling $25 million with an interest rate sensitivity weight of 1.0.
This bank also has loans of $105 million and investments of $65 million with interest rate
sensitivity weights of 1.40 and 1.15 respectively. This bank also has $135 million in interest-
bearing deposits with an interest rate sensitivity weight of .90 and other money market
borrowings of $75 million with an interest rate sensitivity weight of 1.0. What is the dollar
interest-sensitive gap for this bank?
A) $50.25
B) $-15
C) -$50.25
D) $34.25
E) None of the above
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97. If a bank has a positive GAP, an increase in interest rates will cause interest income to
__________, interest expense to__________, and net interest income to __________.
A) Increase, increase, increase
B) Increase, decrease, increase
C) Increase, increase, decrease
D) Decrease, decrease, decrease
E) Decrease, increase, increase
98. If a bank has a negative GAP, a decrease in interest rates will cause interest income to
__________, interest expense to__________, and net interest income to __________.
A) Increase, increase, increase
B) Increase, decrease, increase
C) Increase, increase, decrease
D) Decrease, decrease, decrease
E) Decrease, decrease, increase
99. A treasury bill currently sells for $9,845, has a face value of $10,000 and has 46 days to
maturity. What is the yield to maturity on this security?
A) 12.49%
B) 12.13%
C) 12.30%
D) 2%
E) None of the above
100. The Third National Bank of Edmond reports a net interest margin of 5.83%. It has total
interest revenues of $275 million and total interest expenses of $210 million. What does
this bank's earnings assets have to be?
A) $4717 million
B) $3602 million
C) $1115 million
D) $3.790 million
E) None of the above

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101. The Third National Bank of Edmond reports a net interest margin of 5.83%. It has total
interest revenues of $275 million and total interest expenses of $210 million. This bank
has earnings assets of $1115. Suppose this bank's interest revenues rise by 8 percent and
its interest expenses and earnings assets rise by 10 percent next year. What is this bank's
new net interest margin?
A) 5.83%
B) 7.09%
C) 3.59%
D) 5.38%
E) 7.80%
102. Which of the following is part of funds management?
A) The goal of funds management is simply to gain control over the bank's funds sources.
B) Since the amount of deposits a bank holds is determined largely by its customers, the
focus of the bank should be on managing the assets of the bank.
C) Management of the bank's assets must be coordinated with management of the
bank's liabilities.
D) The spread between interest revenues and interest expenses is unimportant.
E) None of the above
103. If Fifth National Bank's asset duration exceeds its liability duration and interest rates rise,
this will tend to __________________ the market value of the bank's net worth.
A) Lower
B) Raise
C) Stabilize
D) Not affect
E) None of the above
104. If Main Street Bank has $100 million in commercial loans with an average duration of 0.40
years; $40 million in consumer loans with an average duration of 1.75 years; and $30
million in U.S. Treasury bonds with an average duration of 6 years, what is Main Street's
asset portfolio duration?
A) 0.4 years
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B) 1.7 years
C) 2.7 years
D) 4.1 years
E) None of the above
105. A bank has an average asset duration of 4.7 years and an average liability duration of 3.3
years. This bank has $750 million in total assets and $500 million in total liabilities. This
bank has:
A) A positive duration gap of 8.0 years.
B) A negative duration gap of 2.5 years.
C) A positive duration gap of 1.4 years.
D) A positive duration gap of 2.5 years.
E) None of the above.
106. A bank has an average asset duration of 1.15 years and an average liability duration of 2.70
years. This bank has $250 million in total assets and $225 million in total liabilities. This
bank has:
A) A negative duration gap of 1.55 years.
B) A positive duration gap of 1.28 years.
C) A negative duration gap of 3.85 years.
D) A negative duration gap of 1.28 years.
E) None of the above.
107. The duration of a bond is the weighted average maturity of the future cash flows expected
to be received on a bond. Which of the following is a true statement concerning duration?
A) The longer the time to maturity, the greater the duration
B) The higher the coupon rate, the higher the duration
C) The shorter the duration, the greater the price volatility
D) All of the above are true
E) None of the above are true
108. A bond has a duration of 7.5 years. Its current market price is $1125. Interest rates in the
market are 7% today. It has been forecasted that interest rates will rise to 9% over the
next couple of weeks. How will this bank's price change in percentage terms?
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A) This bond's price will rise by 2 percent.

B) This bond's price will fall by 2 percent.
C) This bond's price will fall by 14 .02 percent
D) This bond's price will rise by 14.02 percent
E) This bond's price will not change
109. A bank has an average asset duration of 5 years and an average liability duration of 3 years.
This bank has total assets of $500 million and total liabilities of $250 million. Currently,
market interest rates are 10 percent. If interest rates fall by 2 percent (to 8 percent), what
is this bank's change in net worth?
A) Net worth will decrease by $31.81 million
B) Net worth will increase by $31.81 million
C) Net worth will increase by $27.27 million
D) Net worth will decrease by $27.27 million
E) Net worth will not change at all
110. A bank has an average asset duration of 5 years and an average liability duration of 3 years.
This bank has total assets of $500 million and total liabilities of $250 million. Currently,
market interest rates are 10 percent. If interest rates fall by 2 percent (to 8 percent), what
is this bank's duration gap?
A) 2 years
B) –2 years
C) 3.5 years
D) –3.5 years
E) None of the above
111. A bank has an average asset duration of 5 years and an average liability duration of 9 years.
This bank has total assets of $1000 million and total liabilities of $850 million. Currently,
market interest rates are 5 percent. If interest rates rise by 2 percent (to 7 percent), what
is this bank's change in net worth?
A) Net worth will decrease by $50.47 million
B) Net worth will increase by $50.47 million
C) Net worth will decrease by $240.95 million
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D) Net worth will increase by $240.95 million

E) Net worth will not change at all
112. A bank has an average asset duration of 5 years and an average liability duration of 9 years.
This bank has total assets of $1000 million and total liabilities of $850 million. Currently,
market interest rates are 5 percent. If interest rates rise by 2 percent (to 7 percent), what
is this bank's duration gap?
A) –4 years
B) 4 years
C) 2.65 years
D) –2.65 years
E) 12.65 years
113. A bank has $100 million of investment grade bonds with a duration of 9.0 years. This bank
also has $500 million of commercial loans with a duration of 5.0 years. This bank has
$300 million of consumer loans with a duration of 2.0 years. This bank has deposits of
$600 million with a duration of 1.0 years and nondeposit borrowings of $100 million with
an average duration of .25 years. What is this bank's duration gap? These are all of the
assets and liabilities this bank has.
A) This bank has a duration gap of 14.75 years
B) This bank has a duration gap of 15.03 years
C) This bank has a duration gap of 3.55 years
D) This bank has a duration gap of 3.75 years
E) This bank has a duration gap of 5.15 years
114. Which of the following statements is true concerning a bank's duration gap?
A) If a bank has a positive duration gap and interest rates rise, the bank's net worth will
decline
B) A bank with a positive duration gap has a longer average duration for its assets than
for its liabilities
C) If a bank has a zero duration gap and interest rates rise, the bank's net worth will not
change

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D) If a bank has a negative duration gap and interest rates rise, the bank's net worth will
increase
E) All of the above are true statements
115. A bank has an average duration for its asset portfolio of 5.5 years. This bank has total
assets of $1000 million and total liabilities of $750 million. If this bank has a zero duration
gap, what must the duration of its liabilities portfolio be?
A) 7.33 years
B) 4.125 years
C) 7.5 years
D) 5.5 years
E) None of the above
116. A bond has a face value of $1000 and coupon payments of $80 annually. This bond matures
in three years and is selling for $1000 in the market. Market interest rates are 8%. What
is this bond's duration?
A) 3 years
B) 2.78 years
C) 1.95 years
D) 4.31 years
E) None of the above
117. A bond has a face value of $1000 and coupon payments of $120 annually. This bond matures
in three years and is selling in the market for $1160. Market interest rates are 6%. What
is this bond's duration?
A) 3 years
B) 5.71 years
C) 1.96 years
D) 2.71 years
E) None of the above
118. A bond is selling in the market for $950 and has a duration of 6 years. Market interest rates
are 9% and are expected to decrease to 7% in the near future. What will this bond's price
be after the change in market interest rates?
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A) $969
B) $931
C) $1055
D) $854
E) $950
119. A bond is selling in the market for $1100 and has a duration of 4.5 years. Market interest
rates are 5% and are expected to increase to 7% in the near future. What will this bond's
price be after the change in market interest rates?
A) $1006
B) $1194
C) $1122
D) $1078
E) $1100
120. Which of the following is a true statement?
A) The longer the time to maturity of a security the smaller the duration
B) The lower the coupon rate of a security the smaller the duration
C) For a given duration and change in interest rates, the change in the price of the
security will be larger for a lower starting level of interest rates
D) The duration of a security remains constant no matter the level of market interest rates
E) All of the above are true statements
121. The fact that the rate of change in an asset's price varies with the level of interest rates is
known as:
A) Duration
B) Convexity
C) Maturity
D) Yield
E) None of the above
122. U.S. banks tend to fare best when the yield curve is:
A) Flat
B) Downward-sloping
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C) Vertical
D) Upward-sloping
E) Kinked
123. Carolina National Bank knows that the interest rate on its loans change faster and by a
larger amount than the interest rate on its deposits. What type of risk is this an example
of?
A) Default risk
B) Inflation risk
C) Liquidity risk
D) Call risk
E) Basis risk
124. Havoc State Bank has a loan that it fears will not be repaid because the company is going
into bankruptcy. What type of risk would this be an example of?
A) Default risk
B) Inflation risk
C) Liquidity risk
D) Call risk
E) Basis risk
125. The Carter National Bank is worried because it knows that the municipal bonds it has in its
bond portfolio can be difficult to sell quickly. What type of risk would this be an example
of?
A) Default risk
B) Inflation risk
C) Liquidity risk
D) Call risk
E) Basis risk
126. The Jackson State Bank is worried because many of the loans it has made are home
mortgages which can be paid off early by the homeowner. What type of risk would this
be an example of?
A) Default risk
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B) Inflation risk
C) Liquidity risk
D) Call risk
E) Basis risk
127. A bank is liability sensitive if its:
A) Deposits and nondeposit borrowings are affected by changes in interest rates
B) Interest-sensitive assets exceed interest-sensitive liabilities
C) Interest-sensitive liabilities exceed its interest-sensitive assets
D) Loans and securities are affected by changes in interest rates
E) None of the above
128. Which of the following would be an example of a repriceable asset?
A) Money the bank has borrowed from the money market
B) Cash in the vault
C) Demand deposits that do not pay interest
D) Short term securities issued by the government about to mature owned by the
bank
E) All of the above are examples of repriceable assets
129. Which of the following would be an example of a repriceable liability?
A) Money the bank has borrowed from the money market
B) Cash in the vault
C) Demand deposits that do not pay an interest rate
D) Short term securities issued by the government about to mature owned by the bank
E) All of the above are examples of repriceable assets
130. Which of the following would be an example of a nonrepriceable asset?
A) Money the bank has borrowed from the money market
B) Cash in the vault
C) Demand deposits that do not pay an interest rate
D) Short term securities issued by the government about to mature owned by the bank
E) All of the above are examples of repriceable assets
131. Which of the following would be an example of a nonrepriceable liability?
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A) Money the bank has borrowed from the money market

B) Cash in the vault
C) Demand deposits that do not pay an interest rate
D) Short term securities issued by the government about to mature owned by the bank
E) All of the above are examples of repriceable assets
132. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. If interest rates do not change
in the next ninety days, what is this bank’s net interest margin?
A) 8%
B) 5%
C) 4%
D) 1.4%
E) Cannot tell from the information given
133. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. What is the dollar interest-
sensitive gap of this bank?
A) -$200
B) -$100
C) $200
D) $300
E) $600
134. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. If interest rates on both assets

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and liabilities rise by 2% in the next 90 days, what would this bank’s net interest margin
be?
A) 4%
B) 4.4%
C) 4.6%
D) 2.4%
E) 6%
135. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. If interest rates on both assets
and liabilities rise by 2% in the next 90 days, what should happen to this bank’s net interest
margin?
A) It should rise
B) It should fall
C) It should stay the same
D) Cannot be determined from the above information
136. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. If interest rates on both assets
and liabilities decrease by 2% in the next 90 days, what would this bank’s net interest
margin be?
A) 3.4%
B) 4%
C) .4%
D) 5.6%
E) 2%
137. The Tidewater State Bank has $1000 in total assets (all of which are earning assets), $700
of which will be repriced with in the next 90 days. This bank also has $800 in total
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liabilities, $400 of which will be repriced within the next 90 days. Currently, the bank is
earning 8% on its assets and is paying 5% on its liabilities. If interest rates on both assets
and liabilities decrease by 2%, what should happen to this bank’s net interest margin?
A) It should rise
B) It should fall
C) It should stay the same
D) Cannot be determined from the above information
138. The Arnold National Bank has a bond portfolio that consists of bonds with 5 years to
maturity and a 9% coupon rate. These bonds are selling in the market for $1126. Coupon
payments are made annually on this bond. What is the yield to maturity on these bonds?
A) 3%
B) 6%
C) 9%
D) 12%
139. The Arnold National Bank has a bond portfolio that consists of bonds with 5 years to maturity
and a 9% coupon rate. These bonds are selling in the market for $1126. Coupon payments
are made annually on this bond. What is duration of these bonds?
A) 3.77 years
B) 4.29 years
C) 5 years
D) 9 years
140. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
pays 4% on its liabilities. If interest rates do not change in the next 90 days, what is this
bank’s net interest margin?
A) .5%
B) .8%
C) 1.8%
D) 5.8%
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141. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
pays 4% on its liabilities. What is the dollar interest sensitive gap of this bank?
A) $400
B) -$1100
C) -$500
D) $1000
142. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
pays 4% on its liabilities. If interest rates on both assets and liabilities rise by 2% in the
next 90 days, what would be this bank’s net interest margin?
A) 4.2%
B) 5.3%
C) 5.8%
D) 6.2%
E) 7.8%
143. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
pays 4% on its liabilities. If interest rates on both assets and liabilities rise by 2% in the
next 90 days, what should happen to this bank’s net interest margin?
A) It should rise
B) It should fall
C) It should stay the same
D) Cannot be determined from the information given
144. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
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pays 4% on its liabilities. If interest rates on both assets and liabilities fall by 2% in the
next 90 days, what would be this bank’s net interest margin?
A) 3.8%
B) 5.4%
C) 5.8%
D) 6.3%
E) 7.8%
145. The Harris State Bank has $2000 in total assets (all of which are earning assets), $500 of
which will be repriced in the next 90 days. This bank also has $1600 in total liabilities,
$1000 of which will be repriced in 90 days. The bank currently earns 9% on its assets and
pays 4% on its liabilities. If interest rates on both assets and liabilities fall by 2% in the
next 90 days, what should happen to this bank’s net interest margin?
A) It should rise
B) It should fall
C) It should stay the same
D) Cannot be determined from the information given?
146. Maryellen Epplin notices that a particular T-Bill has a banker’s discount rate of 9% in the
Wall Street Journal. She knows that this T-Bill has 20 days to maturity and has a face
value of $10,000. What price is this T-Bill selling for in the market?
A) $9100
B) $10,000
C) $9950
D) $1900
147. Maryellen Epplin notices that a particular T-Bill has a banker’s discount rate of 9% in the
Wall Street Journal. She knows that this T-Bill has 20 days to maturity and has a face
value of $10,000. What is the yield to maturity on this T-Bill?
A) 9%
B) .5%
C) 4.5%
D) 9.17%
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148. The Raymond Burr National Bank has $1000 in assets with an average duration of 5 years.
This bank has $800 in liabilities with an average duration of 6.25 years. What is the
duration gap of this bank?
A) -1.25 years
B) 0 years
C) 1.25 years
D) -2.25 years
149. The Raymond Burr National Bank has $1000 in assets with an average duration of 5 years.
This bank has $800 in liabilities with an average duration of 6.25 years. Market interest
rates start at 6% and fall by 1%. What is the change in net worth of this bank?
A) $11.29
B) $-11.29
C) $0
D) -$22.22
E) $22.22
The interest rate on one year Treasury Bonds is 5%. The interest rate on five year TreasuryBonds is
7.5%. The interest rate on ten year Treasury Bonds is 10%. What is true about the yield curve?
A) It is upward sloping
B) It is downward sloping
C) It is a horizontal line
D) Cannot be determined from the information given

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Chapter 4
Liquidity and Reserves Management: Strategies and Policies

Fill in the Blank Questions

1. A(n) ________ is an asset which can be converted into cash easily, which has a relatively stable
price and is reversible so that the seller can recover their original investment with little risk of loss.
Answer: liquid asset
2. When a financial institution sells assets to manage liquidity it faces ____________. They lose
the future earnings on those assets, they face transaction costs on those sales and the assets most
easily sold often have the lowest return.
Answer: opportunity costs
3. _________________________ is when the financial institution borrows money in the money
market to meet their liquidity needs.
Answer: Purchased (borrowed) liquidity
4. The _____________________ is the total difference between its sources and uses of funds.
Answer: liquidity gap
5. _________________________ are the deposits and other borrowings of the bank which are
very interest sensitive or where the bank is sure they will be withdrawn during the current period.
Answer: "Hot money" liabilities
6. The _________________________ is the idea that management should make all good loans
and count on its ability to borrow funds if it does not have the liquidity to meet its cash needs.
Answer: customer relationship doctrine
7. _______________ are the assets the bank must by law hold behind its deposits. In the U.S.
only vault cash and deposits held with the Federal Reserves can be used to meet these requirements.
Answer: Legal reserves
8. A(n) _________________________ is the account the bank must have at the Federal Reserve
to cover any checks drawn against the bank.
Answer: clearing balance
9. A(n) _________________________ is a service developed by banks where the bank shifts
money out of accounts with reserve requirements and into savings accounts overnight.

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Answer: sweeps account

10. The _________________________ is a 14 day period stretching from a Thursday to a
Wednesday. This is the period in which the bank has to keep their average daily level of required
reserves for a particular computation period.
Answer: reserve maintenance period
11. _____________________ is the availability of cash in the amount needed at a reasonable cost.
Answer: Liquidity
12. The oldest approach to meeting liquidity needs which relies on the sale of liquid assets to meet
liquidity demands is called _________________________.
Answer: asset liquidity management
13. Under a ______ strategy some of the expected demands for liquidity are stored in assets, while
others are backstopped by arrangements for lines of credit from banks or other suppliers of funds.
Answer: balanced liquidity management
14. A(n) _________________________ is the person in the bank responsible for the bank's cash
position and meeting legal reserve requirements.
Answer: money position manager
15. The method used in the U.S. to determine a bank's legal reserve requirement in which the
period for holding legal reserves follows the period used to calculate the required amount of legal
reserves is called _________________________.
Answer: lagged reserve accounting
16. The fed funds rate is generally most volatile on bank __________ day.
Answer: settlement
17. Many depository institutions hold __________ balances (extra reserves) to help prevent
overdraft penalties.
Answer: precautionary
18. Not all _______ banks around the world have reserve requirements.
Answer: central
19. For several decades, the largest banks around the world have chosen which
calls for borrowing immediately spendable funds to cover all anticipated demands for liquidity.
Answer: liability management
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20. The approach to managing liquidity starts with two simple facts, liquidity rises as
deposits increase and loans decrease and liquidity falls when deposits fall and loans increase.
Answer: sources and uses of funds
21. In the approach to managing liquidity deposits and other sources
of funds are divided into categories and then liquidity managers must set aside liquid funds
according to some desired operating rule.
Answer: structure of funds
22. Many financial service institutions estimate their liquidity needs based upon experience and

industry averages. This approach to managing liquidity is called the approach.

Answer: liquidity indicator
23. Many analysts believe there is only one sound method for assessing a financial institution’s

liquidity needs. This method centers on .

Answer: discipline of the financial marketplace (signals from the marketplace)
24. The for deposits and other reservable liabilities and for vault cash holdings
is a two week period extending from Tuesday to a Monday two weeks later.
Answer: reserve computation period
25. If total legal reserves held are greater than required reserves the bank has .
Answer: excess reserves
26. If total legal reserves held are less than required reserves the bank has .
Answer: a reserve deficit
27. The is where a money position manager can cover a large reserve
deficit quickly. It is usually one of the cheapest places to borrow but is also frequently volatile.
Answer: federal funds market
28. One of the ratios used in the liquidity indicator approach to managing a financial institution’s

liquidity needs is . This ratio is cash and due from depository institutions
divided by total assets where a greater ratio indicates a stronger liquidity position.
Answer: cash position indicator

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True/False Questions
29. Liquid assets must have a reasonably stable price so that the market is deep enough to absorb the
sale without a significant loss of value.
Answer: True
30. Asset liquidity management (or asset conversion) involves storing liquidity in assets, such as
deposits and jumbo CDs.
Answer: False
31. Asset liquidity management (or asset conversion) involves storing liquidity in assets, such as cash
and marketable securities.
Answer: True
32. Liquid assets generally have a stable price but are not necessarily reversible.
Answer: False
33. Asset conversion is considered to be a costless approach to liquidity management.
Answer: False
34. One principle of sound bank liquidity management is to be sure to sell first those assets with the
least profit potential.
Answer: True
35. Borrowed liquidity (liability) management is less risky for a financial institution than is asset
conversion.
Answer: False
36. A financial institution's liquidity gap represents the difference between its sources and uses of
liquid funds.
Answer: True
37. A bank expects to lose its "hot money" liabilities, according to the textbook.
Answer: True
38. According to the customer relationship doctrine a bank should turn down any loan requests for
which it does not have enough deposits on hand but should help its borrowing customer obtain funds
from some other source (such as by issuing a letter of credit to backstop the customer's loan from
another lender).
Answer: False

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39. A U.S. bank can run up to a 5-percent deficit in its legal reserve requirement without incurring an
interest penalty from the Federal Reserve System.
Answer: False
40. Most liquidity problems in banking arise from inside a bank, not from its customers.
Answer: False
41. Holdings of liquid assets at U.S. banks have experienced a gradual decline in recent years.
Answer: True
42. The Federal Reserve has been lowering deposit reserve requirements in recent years.
Answer: True
43. The liquidity indicator, core deposits divided by total assets, is a measure of stored liquidity.
Answer: False
44. A bank's money position manager is responsible for insuring that the bank maintains an adequate
level of legal reserves.
Answer: True
45. If a bank in the United States runs a legal reserve deficit of more than 2 percent of its required
daily average legal reserve position it will be assessed an interest penalty equal to the Federal
Reserve's discount rate plus 5 percent.
Answer: False
46. If a bank receives more checks deposited to the accounts it holds than checks drawn against its
deposit accounts, the bank's legal reserves will tend to increase.
Answer: True
47. According to the textbook if a bank's liquidity deficit is expected to last for only a few hours, the
federal funds market or the central bank's discount window is normally the preferred source of funds.
Answer: True
48. Banks making heavy use of borrowed sources of liquidity must wrestle with the problem of
interest cost uncertainty, according to the textbook.
Answer: True
49. All central banks impose reserve requirements on the banks they regulate.
Answer: False

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50. The sources and uses of funds method of estimating a bank's liquidity requirements divides the
bank's liabilities into three types (hot money, vulnerable funds and stable funds) and estimates the
probability of each being withdrawn from the bank.
Answer: False
51. One of the problems with liquidity management for a bank is that rarely does the demand for
funds equal the supply of funds at a given time.
Answer: True
52. One of the problems with liquidity management for a bank is that there is a trade-off between
bank liquidity and profitability.
Answer: True
53. The liquidity problem for banks is made easier because most of their liabilities are not subject to
immediate repayment.
Answer: False
54. The liquidity problem for banks is made easier because depositors and borrowers are not sensitive
to changing interest rates.
Answer: False
55. The oldest approach to liquidity management is the asset liquidity management approach.
Answer: True
56. Some central banks around the world impose reserve requirements on bank loans.
Answer: True
57. Some central banks around the world impose reserve requirements on nondeposit liabilities.
Answer: True
58. Interest in bank and financial service liquidity management is a relatively new phenomenon which
arose following the 9/11 crisis.
Answer: False
59. Bank robberies have declined in recent years.
Answer: False
60. Discount window loans jumped dramatically the day following 9/11.
Answer: True

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61. A bank or financial service institution can meet reserve requirements by selling Treasury
securities in its portfolio.
Answer: True
62. All central banks around the world have some specified reserve requirement.
Answer: False
63. Core deposit ratio is used as one of the liquidity indicators for depository institutions and is
defined as the ratio of core deposits to total assets.
Answer: True
64. Loan commitments ratio measures the volume of promises a lender has made to its customers to
provide credit up to pre-specified amount over a given time period.
Answer: True

Multiple Choice Questions

65. A financial institution that has ready access to immediately spendable funds at reasonable

cost at precisely the time those funds are needed is:

A) Risk free
B) Liquid
C) Efficient
D) Profitable
E) None of the above
66. Which of the following is not a reason that banks to hold liquid assets?

A) To meet customer's needs for currency.

B) To meet capital requirements.
C) To meet required reserves.
D) To compensate for correspondent bank services.
E) To assist in the check clearing process.
67. The two most pressing demands for liquidity from a bank come from, first, customers

withdrawing their deposits and, second, from:

A) Credit requests from those customers the bank wishes to keep
B) Checks being cashed at local stores and directly from the bank
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C) Demands for wired funds from correspondent banks.

D) Legal reserve requirements set by the Federal Reserve Board.
E) None of the above.
68. A bank expects in the week about to begin $30 million in incoming deposits, $20 million in

deposit withdrawals, $15 million in revenues from the sale of nondeposit services, $25
million in customer loan repayments, $5 million in sales of bank assets, $45 million in
money market borrowings, $60 million in acceptable loan requests, $10 million in
repayments of bank borrowings, $5 million in cash outflows to cover other operating
expenses, and $10 million in dividend payments to its stockholders. This bank's net liquidity
position for the week is:
A) $30 million
B) $20 million
C) $10 million
D) $15 million
E) None of the above
69. There is a trade-off problem between liquidity and:

A) Risk exposure
B) Safety.
C) Profitability
D) Efficiency
E) None of the above

70. Financial institutions face significant liquidity problems because of:

A) Imbalances between the maturities of their assets and their principal liabilities.
B) Their high proportion of liabilities subject to immediate withdrawal.
C) Their sensitivity to changes in interest rates.
D) Both A and B
E) All of the above.
71. Sources of liquidity for banks include:

A) Deposit inflows
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B) Money market borrowings

C) Sales of marketable securities
D) Loan repayments
E) All of the above
72. Which of the following is not a source of liquidity for financial institutions?

A) Deposits
B) Money market borrowings
C) Sales of marketable securities
D) Dividend payments to stockholders
E) All of the above
73. Which of the following liquidity strategies is the most effective for banks today?

A) Asset Management
B) Liability Management
C) Balanced Liquidity Management
D) All of the above
E) A and B above
74. When a bank's sources of liquidity exceed it uses of liquidity, the bank will have a

_______________ liquidity gap.

A) Positive
B) Negative
C) Cyclical
D) Seasonal
E) None of the above
75. "Core deposits", "hot money", and "vulnerable money" are categories of funds under which

of the following methods of estimating a bank's liquidity needs?

A) Sources and Uses of Funds Approach
B) Structure of Funds Approach
C) Liquidity Indicator Approach
D) None of the above
E) A and C
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76. Factors that influence a bank's choice among the various sources of reserves include which

of the following?
A) Immediacy of the need
B) Duration of the need
C) Interest rate outlook
D) Regulations
E) All of the above
77. The risk that liquid funds will not be available in the volume needed by a bank is often

called:
A) Market risk
B) Price risk
C) Availability risk
D) Interest-rate risk
E) None of the above
78. A bank following an _________________________ liquidity management strategy must

take care that those assets with the least profit potential are sold first. The strategy that
correctly fills in the blank in the foregoing sentence is:
A) Asset conversion
B) Liability management
C) Availability
D) Funds source
E) None of the above
79. When some of a bank's expected demand for liquidity are stored in its assets, while other

unexpected cash needs are met from near-term borrowings this approach to liquidity
management is described by which of the terms listed below?
A) Liability management
B) Asset conversion
C) Borrowed liquidity management
D) Balanced liquidity management
E) None of the above
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80. The notion that bank management should strive to meet all good loans that walk in the door

in order to build lasting customer relationships is referred to as the:

A) Asset conversion liquidity strategy
B) Customer relationship doctrine
C) Loan accommodation doctrine
D) Balanced funds management doctrine
E) None of the above
81. A bank manager responsible for overseeing the institution’s legal reserve account is called:

A) Reserve manager
B) Money market manager
C) Money position manager
D) Legal counselor
E) None of the above
82. If a bank's management uses "the discipline of the financial marketplace" to gauge its

liquidity position one indicator of this market test of the adequacy of a bank's liquidity
position is:
A) The bank's return on equity capital
B) The volume of bank stock outstanding
C) The bank's return on assets
D) The size of risk premiums on CDs the bank issues
E) None of the above
83. Which of the following is an example of a use of funds for the bank?

A) A customer withdraws $1000 from their account

B) A borrower repays $1500 of a loan they have received
C) The bank issues a $1,000,000 CD
D) The bank sells $5,000,000 of T-Bills
E) None of the above are uses of funds
84. Which of the following is an example of a source of funds?

A) A customer withdraws $1000 from their account

B) A borrower repays $1500 of a loan they have received
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C) A bank increases its Fed funds sold by $1,000,000

D) The bank purchases $5,000,000 in T-Bills
E) None of the above are uses of funds
85. A bank currently has $150 million in "hot money" deposits against which they want to hold

an 80 percent reserve. This bank has $90 million in vulnerable deposits against which they
want to hold a 30 percent reserve and this bank has $45 million in stable deposits against
which they want to hold a 5 percent reserve. The legal reserves for this bank are 5 percent
of all deposits. What is this bank's liability liquidity reserve?
A) $149.25 million
B) $285 million
C) $141.7875 million
D) $216.60 million
E) None of the above
86. A bank maintains a clearing balance of $5,000,000 with the Federal Reserve. The Federal

funds rate is currently 6.5 percent. What credit will this bank earn over the reserve
maintenance period to offset any fees charged this bank by the Federal Reserve?
A) $325,000
B) $8,357,143
C) $194,444
D) $12,639
E) None of the above
87. A bank maintains a clearing balance of $1,000,000 with the Federal Reserve. The Federal

funds rate is currently 4.5 percent. What credit will this bank earn over the reserve
maintenance period to offset any fees charged this bank by the Federal Reserve?
A) $17,500
B) $1,750
C) $45,000
D) $12,500
E) None of the above

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88. A bank currently holds $105 million in transaction deposits subject to legal reserves but has

managed to enter into sweep account arrangements affecting $55 million of these accounts.
Given that the bank must hold 3 percent legal reserves up to $47.8 million of transaction
deposits and 10 percent legal reserves on any amount above that, how much has this bank
reduced its total legal reserves as a result of these sweep arrangements?
A) $5.500 million
B) $1.449 million
C) $7.119 million
D) $1.619 million
E) None of the above
89. A bank money manager estimates that the bank will experience a liquidity deficit of $400

million with a probability of 10 percent, a liquidity deficit of $900 million with a probability
of 20 percent, a liquidity surplus of $600 million with a probability of 30 percent and a
liquidity surplus of $1200 with a probability of 40 percent over the next month. What is
this bank's expected liquidity deficit or surplus over this next month?
A) $880 liquidity surplus
B) $440 liquidity deficit
C) $440 liquidity surplus
D) $880 liquidity deficit
E) None of the above
90. A bank expects in the week to come $55 million in incoming deposits, $75 million in

acceptable loan requests, $35 million in money market borrowings, $10 million in deposit
withdrawals and $30 million in loan repayments. This bank is expecting a:
A) Liquidity deficit
B) Liquidity surplus
C) Balanced liquidity position
D) None of the above
91. A financial institution has estimated that its growth rate in deposits over the last ten years

has averaged 6 percent per year. This is the _________________________ of estimating

future deposits.
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A) Trend component
B) Seasonal component
C) Cyclical component
D) Stationary component
E) None of the above
92. A financial institution has estimated that over the last ten years the deposit withdrawals

during Christmas time is about 25% higher than during any other time of the year. This is
the _________________________ of estimating future deposits.
A) Trend component
B) Seasonal component
C) Cyclical component
D) Stationary component
E) None of the above
93. Which of the following is a guideline for liquidity managers of banks?

A) The liquidity manager must keep track of the activities of all departments of the bank
B) The liquidity manager must know in advance (if possible) the plans of major creditors
and depositors
C) The liquidity manager should make sure the bank has clear priorities and objectives
for liquidity management
D) The liquidity manager must analyze the liquidity needs of the bank on a continuous
basis
E) All of the above are guidelines for liquidity managers
94. A manager that uses ratios such as cash and due from banks to total assets and U.S.

government securities to total assets to measure their liquidity position is using:

A) The sources and uses of funds approach
B) The structured funds approach
C) The liquidity indicator approach
D) Signals from the market place
E) None of the above

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95. A manager that examines the stock price behavior of the bank and the risk premium on the

bank CD's to measure their liquidity position is using:

A) The sources and uses of funds approach
B) The structured funds approach
C) The liquidity indicator approach
D) Signals from the marketplace
E) None of the above
96. A manager that looks at deposit increases and decreases and loan increases and decreases

among other things to measure their liquidity position is using:

A) The sources and uses of funds approach
B) The structured funds approach
C) The liquidity indicator approach
D) Signals from the marketplace
E) None of the above
97. Which of the following statements is correct?

A) The demands for liquidity and sources of liquidity for a bank are generally equal to
each other
B) Most liquidity problems in banking arise from outside the bank
C) The liquidity problems for a bank are made easier because most of their liabilities are
not subject to immediate repayment
D) Liquidity management is easy for a bank because a bank that is very liquid is also very
profitable.
E) All of the above statements are correct
98. The Fed funds market is most volatile on bank:

A) Computation day
B) Settlement day
C) Reserve day
D) Maintenance day
E) Holiday
99. The Fed funds rate usually hovers around the Feds:
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A) Target rate
B) Set rate
C) Quoted rate
D) Limit rate
E) Average rate
100. A bank or financial service institution can generally meet reserve requirements using
all of the following except:
A) Selling liquid investments
B) Borrowing in the fed funds market
C) Drawing on any excess correspondent balances
D) Borrowing in the repo market
E) Selling new shares
101. The Shirley State Bank has $90 in transaction deposits subject to legal reserves. This
bank must hold 3 percent legal reserves up to $43.9 of transaction deposits and 10 percent
legal reserves on any amount above this. What is this bank’s total legal reserves?
A) $2.700 million
B) $1.449 million
C) $5.924 million
D) $4.170 million
E) None of the above
102. John Camey, the money manager of the First State Bank, has estimated that the bank
has a 20 percent chance of a liquidity deficit of $700, a 30 percent chance of a liquidity deficit
of $200, a 30 percent chance of a liquidity surplus of $400 and a 20 percent chance of a
liquidity surplus of $900 over the next week. What is this bank’s expected liquidity deficit
or surplus over the next week?
A) $100 liquidity surplus
B) $100 liquidity deficit
C) $400 liquidity surplus
D) $500 liquidity surplus
E) $0 liquidity surplus
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103. A bank currently has $50 million in stable deposits against which they want to keep
10% reserves, $100 in vulnerable deposits against which they want to keep 40% reserves
and they have $50 million in “hot money’ deposits against which they want to keep 90%
reserves. The legal reserves for this bank are 10% of all deposits. What is this bank’s
liability liquidity reserve?
A) $90 million
B) $81 million
C) $70 million
D) $20 million
E) None of the above
104. The Hollingsworth National Bank maintains a clearing balance of $7,000,000 with the
Federal Reserve. The Federal Funds rate is currently 5.25 percent. What is the credit this
bank will earn over the maintenance period to offset any fees charged this bank by the
Federal Reserve?
A) $367,500
B) $1021
C) $14,292
D) $30,625
105. A bank must maintain an average daily balance at the Fed of $600. In the first 2 days
of the maintenance period, they maintain a balance of $450, the next three days they
maintain a balance of $700, the next two days they maintain a balance of $650, the next
three days they maintain a balance of $450 and the next three days they maintain a balance
of $650. What does their balance at the Fed have to be on the last day of the maintenance
period in order to have a zero cumulative reserve deficit?
A) $600
B) $400
C) $500
D) $800
106. A bank must maintain an average daily balance at the Fed of $700. On the first day of
the maintenance period they maintain a balance of $750, the next two days they maintain
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a balance of $725, the next three days they maintain a balance of $625, the next two days
they maintain a balance of $775, the next two days they maintain a balance of $700 and the
next two days they maintain a balance of $675. What does their balance have to be on the
last day of the maintenance period in order to have a cumulative reserve deficit?
A) $700
B) $650
C) $750
D) $325
107. David Ashby has just paid off the balance on his home mortgage with First American
Bank. What source of liquidity does this represent to the bank?
A) Incoming customer deposit
B) Revenues from the same of nondeposit services
C) Customer loan repayment
D) Sale of an asset
E) Borrowings from the money market
108. The Harmony Bank of the South has just increased its Federal Funds Purchased. What
source of liquidity does this represent to the bank?
A) Incoming customer deposit
B) Revenues from the same of nondeposit services
C) Customer loan repayment
D) Sale of an asset
E) Borrowings from the money market
109. The Peace Bank of Ohio has just received a $50 million credit at the local clearing house.
Which type of factor affecting legal reserves is this for the bank?
A) A controllable factor increasing legal reserves
B) A noncontrollable factor increasing legal reserves
C) A controllable factor decreasing legal reserves
D) A noncontrollable factor decreasing legal reserves
E) None of the above

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110. The Sasser State Bank has just sold $25 million in Treasury Bills. Which type

of factor affecting legal reserves is this for the bank?

A) A controllable factor increasing legal reserves
B) A noncontrollable factor increasing legal reserves
C) A controllable factor decreasing legal reserves
D) A noncontrollable factor decreasing legal reserves
E) None of the above
111. The Hora National Bank has just received notice that a large depositor with the bank
wants to close their account immediately. Which type of factor affecting legal reserves is
this for the bank?
A) A controllable factor increasing legal reserves
B) A noncontrollable factor increasing legal reserves
C) A controllable factor decreasing legal reserves
D) A noncontrollable factor decreasing legal reserves
E) None of the above
112. The Simpson State Bank of Stillwater has just sold Federal Funds to another bank in
their Federal Reserve district. Which type of factor affecting legal reserves is this for the
bank?
A) A controllable factor increasing legal reserves
B) A noncontrollable factor increasing legal reserves
C) A controllable factor decreasing legal reserves
D) A noncontrollable factor decreasing legal reserves
E) None of the above
113. The Burr Bank has just calculated the ratio of U.S. Government Securities to Total
Assets. Which liquidity indicator is this?
A) Cash position indicator
B) Liquid securities indicator
C) Net federal funds and repurchase agreement position
D) Capacity ratio
E) Hot money ratio
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114. The HTR Bank of Summerville has just calculated the ratios of money market (short
term) assets to volatile liabilities. Which liquidity indicator is this?
A) Cash position indicator
B) Liquid securities indicator
C) Net federal funds and repurchase agreement position
D) Capacity ratio
E) Hot money ratio
115. Which of the following is an option when a liquidity deficit arises and the bank wants
to borrow liquidity to cover the deficit?
A) Selling Treasury Bills
B) Reducing their correspondent deposits with another bank
C) Selling a municipal bond
D) Issuing a jumbo CD
E) All of the above
116. Which of the following is an option when a liquidity deficit arises and the bank wants
to use their stored liquidity in their assets to cover the deficit?
A) Borrowing in the Federal Funds market
B) Issuing a jumbo CD
C) Selling Treasury Bills
D) Increasing their correspondent deposits with another bank
E) All of the above
117. The Taylor Treadwell Bank has just calculated the ratio of net loans and leases to total
assets. Which liquidity indicator is this?
A) Cash position indicator
B) Liquid securities indicator
C) Net federal funds and repurchase agreement position
D) Capacity ratio
E) None of the above
118. The Taylor Treadwell Bank has just calculated the ratio of demand deposits to total
time deposits. Which liquidity indicator is this?
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A) Deposit composition ratio

B) Liquid securities indicator
C) Net federal funds and repurchase agreement position
D) Capacity ratio
E) None of the above

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Chapter 5 - The Management of Capital

Fill in the Blank Questions

1. The risk that has to do with banks trading in foreign currencies is called ___________.
Answer: exchange risk
2. The risk that has to do with fraud, embezzlement and bank robberies is called _______.
Answer: crime risk
3. __________ is measured by the par value of the shares of common equity outstanding.
Answer: Common stock
4. ______________ is the amount in excess of par value paid by the bank's shareholders.
Answer: Surplus
5. _________________________ are the net earnings of the bank which have been kept
by the bank rather than distributed as dividends to stockholders.
Answer: Undivided Profits (or retained earnings)
6. Core capital such as common stock, surplus, undivided profits, qualifying noncumulative
preferred stock, etc. is referred to as __________ capital as defined by the Basel agreement.
Answer: Tier 1
7. The international treaty involving the U.S. and 11 other leading industrialized countries
to impose common capital requirements on all banks is known as the _________________________.
Answer: Basel Agreement
8. Supplemental capital such as the allowance for loan losses, subordinated debt,
mandatory convertible debt, intermediate-term preferred stock, cumulative preferred perpetual stock
and equity notes is more commonly known as _________________________.
Answer: Tier 2 capital
9. When items on a bank's balance sheet are multiplied by the appropriate risk-weighting
factor they are often called _________________________.
Answer: risk-weighted assets
10. The fact that a bank may suffer deficiencies in quality control, inefficiencies in
producing and delivering of services, weather damage, aging or faulty computer systems, errors in
judgment by management and fluctuations in economy that could adversely affect the bank's
performance is known as _________________________ risk.
Answer: operational

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11. One defense against risk for the bank is to spread out a bank's credit accounts and
deposits among a wide variety of customers, including large and small accounts different industries,
etc. This defense is known as _________________________.
Answer: portfolio diversification
12. One defense against risk is for the bank to seek out customers located in different
communities or in different countries. This defense is known as _________________________.
Answer: geographic diversification
13. When all else fails, the ultimate defense against risk in banking is ____________.
Answer: owners' capital (net worth)
14. The largest component of capital among thrift institutions is _____________.
Answer: retained earnings
15. The largest component of capital among banks is ____________.
Answer: surplus
16. ____________ models attempt to measure price or market risk of a portfolio of assets
and attempt to determine the maximum loss they might sustain over a designated period of time.
Answer: Value at risk (VaR)
17. The latest revision to the Basel accord is known as __________ and will affect only
about 20 of the largest U.S. banks and a handful of leading foreign banks.
Answer: Basel II
18. ____________ models measure lender exposure to defaults or credit downgrades.
Answer: Credit Risk
19. Credit risk models will be ________ widely used when Basel II takes effect.
Answer: more
20. At the center of the debate of the Basel Agreement is the ,
headquartered in Basel Switzerland , which assists central banks in their transactions with
each other and serves as a forum for international financial issues.
Answer: Bank for International Settlements (BIS)
21. represents funds set aside for contingencies such as legal action against
the institution as well as providing a reserve for dividends expected to be paid but not yet
declared and a sinking fund to retire stock or debt in the future.
Answer: Equity reserves
22. are debt securities repayable from the sale of stock.
Answer: Equity commitment notes

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23. is a hybrid form of equity capital issued to investors through

a trust company, The funds raise are loaned to the financial firm. Dividends paid to
stockholders on this time of capital are tax deductible.
Answer: Trust preferred stock
24. is long-term debt capital whose claims legally follow claims
of depositors.
Answer: Subordinated notes and debentures
25. for banks include mortgage servicing rights and
purchased credit card relationships and can be counted as part of bank capital.
Answer: Identifiable intangible assets
True/False Questions
26. In the field of banking, capital refers principally to those funds contributed by a bank's owners.
Answer: True
27. According to the textbook capital and risk are intimately related to each other.
Answer: True
28. One fundamental purpose for regulating capital is to limit losses to the federal government arising
from deposit insurance claims.
Answer: True
29. Deposit insurance subsidized by government encourages banks to increase their ratios of capital
to deposits.
Answer: False
30. Tier 2 includes undivided profits.
Answer: False
31. Core capital includes the surplus account for stock.
Answer: True
32. Under the international capital (Basel) agreement Tier 2 capital must be raised to a minimum of
4 percent of risk-weighted assets.
Answer: False
33. Off-balance-sheet commitments of banks carry capital requirements under the international
(Basel) capital requirements.
Answer: True
34. Portfolio diversification refers to seeking out customers located in different communities or
countries, which presumably will experience different economic conditions.
Answer: False

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35. Geographic diversification refers to the spreading out credit accounts and deposits among a wide
variety of customers, including large and small business accounts, different industries, and
households with a variety of sources of income and collateral.
Answer: False
36. The last line of defense against bank failure is owner's capital, according to the textbook.
Answer: True
37. Under the FDIC Improvement Act of 1991 a U.S. bank possessing a leverage ratio greater than 4
percent would be considered well capitalized.
Answer: False
38. Under the FDIC Improvement Act of 1991 a bank whose leverage ratio drops to 2 percent or less
is considered to be critically undercapitalized
Answer: True
39. Recent research suggests that interest-rate contracts display considerably less risk exposure than
do foreign-currency contracts.
Answer: True
40. The Basel Agreement on capital as drafted in the 1980s failed to deal with market risk.
Answer: True
41. If a bank benefits when the value of a foreign currency rises, the bank is said to be in a short
position.
Answer: False
42. If a bank benefits when a foreign currency declines in value, then the bank is in a long position.
Answer: False
43. If the ratio of tangible equity capital to total assets is 2 percent or less it is subject to being placed
in conservatorship or receivership if its capital ratios are not increased within a prescribed period of
time even if its net worth is still positive.
Answer: True
44. According to recent research, bank stock prices usually drop within a week after a dividend cut
is announced.
Answer: True
45. Equity notes are considered to be part of Tier 1 capital.
Answer: False
46. The most important source of thrift capital in terms of dollar volume is common stock (par
value).
Answer: False
47. The daily rate at which robberies have occurred in the U.S. has continued to climb in the 1990s.
Answer: False

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48. One of the reasons to regulate the capital position of banks is to limit the risk of bank failures,
especially large bank failures.
Answer: True
49. Deposits with the Federal Reserve banks are considered to have moderate credit risk and are
therefore placed in the 50 percent risk weight category.
Answer: False
50. The largest component of capital among banks is retained earnings.
Answer: False
51. VaR models provide a single number which indicates the potential for losses on a portfolio of
assets.
Answer: True
52. VaR models are most successful in assessing potential risk when the assets are non-traded.
Answer: False
53. Credit risk models will probably not be needed when Basel II takes effect.
Answer: False
54. One of the key innovations which have been proposed in Basel II is to require banks to hold
capital against operational risk.
Answer: True
55. Basel II will require each bank to determine its own capital requirements based on its own
calculated risk exposure.
Answer: True
56. It is anticipated that Basel II may lower capital requirements for the largest banks.
Answer: True
57. The global financial crisis of 2007-2009 highlighted the importance of taking into consideration
a bank’s exposure to market risk that arise from changes in interest rates, security prices, and
currency.
Answer: True
58. Smaller banks rely more heavily on internally generated capital than larger banks.
Answer: True
59. A well-capitalized institution has a ratio of capital to risk-weighted assets of at least 10 percent
and faces no significant regulatory restrictions on its expansion.
Answer: True
60. Regulatory capital focus on the market value of equity.
Answer: False

Multiple Choice Questions

61. According to the textbook the role of capital is to:

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A) Provide a cushion against failure risk.

B) Provide funds needed to organize, open, and operate a bank.
C) Promote public confidence
D) Support growth and the development of new services
E) All of the above.
62. The textbook discusses several alternative defenses banks have against risk. These defenses

include:
A) Quality management
B) Portfolio diversification
C) Geographic diversification
D) Deposit insurance
E) All of the above.
63. Measured by dollar volume the largest category of capital at U.S. banks is:

A) Par value of common stock

B) Subordinated notes and debentures
C) Surplus
D) Undivided profits and capital reserves
E) None of the above.
64. The fundamental purposes of regulating bank capital cited in the textbook include which of

the following?
A) To limit the risk of bank failures.
B) To preserve public confidence in banks.
C) To limit losses to the federal government arising from insurance claims.
D) All of the above.
E) A and B only.
65. The Internal Capital Growth Rate for a bank is a function of which of the following factors?

A) Profit margin.
B) Asset utilization.
C) Equity multiplier.
D) Earnings retention ratio.
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E) All of the above.

66. Second National Bank is forecasting a return on equity of 15 percent for this year. The board

of directors wants to maintain its current policy of paying the bank's stockholders 40
percent of any net earnings the bank will earn. How fast can the bank's assets grow this
year without jeopardizing its ratio of capital to assets?
A) 15 percent.
B) 9 percent.
C) 8 percent.
D) 6 percent.
E) None of the above
67. Possible breakdowns in quality control, inefficiencies in producing and delivering financial

services, weather damage, aging or faulty computer systems and simple errors in judgment
by bank management illustrate what form of risk faced by banks?
A) Credit risk
B) Liquidity risk
C) Interest-rate risk
D) Operational risk
E) None of the above
68. The ratio of core capital to average assets is called the:

A) Supplemental Capital ratio

B) Leverage ratio
C) Long-term capital ratio
D) GAAP capital ratio
E) None of the above.
69. The risk that a customer the bank has entered into a contract with will fail to pay or to

perform, forcing the bank to find a replacement contract that may be less satisfactory is
what form of risk listed below?
A) Counterparty risk
B) Interest-rate risk
C) Operating risk
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D) Credit risk
E) Liquidity risk
Answer: A
70. If a bank benefits when a foreign currency declines in value, then the bank must be in a

__________ position. The term below that correctly fills in the blank in the preceding
sentence is:
A) Long
B) Short
C) Negative
D) Credit risk
71. In the United States a 'well capitalized' bank must have a ratio of capital to risk-weighted

assets of at least:
A) 6 percent
B) 8 percent
C) 10 percent.
D) 5 percent.
E) None of the above
72. In the United States a bank to be considered 'adequately capitalized' must have a ratio of

Tier 1 (or core) capital to risk-weighted assets of at least:

A) 8 percent
B) 6 percent
C) 10 percent
D) 4 percent
E) None of the above
73. A "well capitalized" bank in the United States must have a leverage ratio of at least:

A) 5 percent
B) 4 percent
C) 6 percent
D) 8 percent
E) None of the above
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74. A bank has $100 million in assets in the 0 percent risk weight category, $200 million in

assets in the 20 percent risk weight category, $500 million in assets in the 50 percent risk
weight category and $750 million in assets in the 100 percent risk weight category. This
bank has $57 million in core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to
risk-weighted assets?
A) 3.68 percent
B) 7.6 percent
C) 18.25 percent
D) 5.48 percent
E) None of the above
75. A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent , an equity

multiplier of 12 and a retention ratio of 60 percent. What is this bank's ICGR?

A) 6.6 percent
B) 3.96 percent
C) 7.2 percent
D) .33 percent
E) None of the above
76. Which of the following would be an example of Tier 1 capital?

A) Subordinated debt capital instruments with an original maturity of at least 5 years

B) Allowance for loan and lease losses
C) Minority interest in the equity accounts of consolidated subsidiaries
D) Intermediate term preferred stock
E) All of the above
77. Which of the following would be an example of Tier 2 capital?

A) Subordinated debt capital instruments with an original maturity of at least 5

years
B) Undivided profits
C) Minority interest in the equity accounts of consolidated subsidiaries
D) Qualifying noncumulative preferred stock
E) All of the above
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78. Which of the following would be an example of crime risk?

A) A bank manager that embezzles $1,000,000 from the bank

B) A bank that loses $500,000 from trading in foreign currencies
C) A $1,000,000 loan to a business on which no interest and principal has been collected
in 2 years
D) A bank manager predicts that interest rates will rise. However interest rates fall
causing the bank 's net income to fall by $250,000
E) All of the above are examples of crime risk
79. Which of the following assets fits into the 0 percent risk weight category?

A) Cash
B) Deposits at the Federal Reserve
C) Treasury Bills
D) GNMA mortgage-backed securities
E) All of the above fit into the 0 percent risk weight category
80. A bank that is 'well-capitalized':

A) Faces no significant regulatory restrictions

B) Cannot accept broker placed deposits without regulatory approval
C) Has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions
D) Will be placed into conservatorship or receivership if it its capital level is not increased
within a certain time limit.
E) None of the above
81. A bank that is 'critically undercapitalized':

A) Faces no significant regulatory restrictions

B) Cannot accept broker-placed deposits without regulatory approval
C) Has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions
D) Will be placed into conservatorship or receivership if it its capital level is not
increased within a certain time limit.
E) None of the above
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82. A bank that is adequately capitalized:

A) Faces no significant regulatory restrictions

B) Cannot accept broker-placed deposits without regulatory approval
C) Has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions
D) Will be placed into conservatorship or receivership if it its capital level is not increased
within a certain time limit.
E) None of the above
83. Which of the following is in the 100 percent risk-weight category?

A) Cash
B) General obligation municipal bonds
C) Residential mortgage loans
D) Credit card loans
E) None of the above
84. Which of the following is in the 50 percent risk-weight (moderate) category?

A) Cash
B) General Obligation Municipal Bonds
C) Residential Mortgage Loans
D) Credit Card Loans
E) None of the above
85. Which of the following is in the 20 percent risk-weight (low) category?

A) Cash
B) General obligation municipal bonds
C) Residential mortgage loans
D) Credit card loans
E) None of the above
86. A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity capital

to total assets ratio?

A) 7.00 percent
B) 14.29 percent
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C) 28.00 percent
D) 16 percent
E) None of the above
87. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million

in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50
percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight
category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What
is this bank's ratio of Tier 1 capital to risk assets?
A) 6.08 percent
B) 3.04 percent
C) 9.11 percent
D) 5.54 percent
E) None of the above
88. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million

in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50
percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight
category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What
is this bank's ratio of Tier 2 capital to risk assets?
A) 6.08 percent
B) 3.04 percent
C) 9.11 percent
D) 5.54 percent
E) None of the above
89. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million

in assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50
percent risk-weight category and has $1000 million in assets in the 100 percent risk-weight
category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What
is this bank's ratio of total capital to risk assets?
A) 6.08 percent
B) 3.04 percent
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C) 9.11 percent
D) 5.54 percent
E) None of the above
90. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent

and has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is
this bank's internal capital growth rate?
A) 28.35 percent
B) 2.36 percent
C) 11.34 percent
D) 4.8 percent
E) None of the above
91. The revised Basel I rules impose capital requirements for market risk on:

A) Only the largest banks

B) Only the smallest banks
C) Only moderate size banks
D) All banks
E) No banks
92. Bank debt which appears to be highly sensitive to the market perception of the bank's risk

is which of the following?

A) Deposits
B) Fed funds
C) Repos
D) Subordinated debt capital
E) Preferred stock
93. Bank operational risk includes:

A) Employee fraud
B) Account errors
C) Computer breakdowns
D) Natural disasters
E) All of the above
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94. The issue of correctly adding up all of the different types of bank risk exposure is known as:

A) Risk tallying
B) Summing risk
C) Risk aggregation
D) Risk accumulation
E) Risk totality
95. For a bank with deficient capital ratios, which of the following actions could be required by

regulators to increase the capital ratios, all else constant?

A) Cut the bank's dividend payment
B) Increase the bank's leverage
C) Reduce the bank’s holdings of cash
D) Increase the bank's growth rate by making additional commercial loans.
E) Reduce the bank's holdings of Treasury securities.
96. Basel II has a different set of rules for different bank size categories and the number of

categories is:
A) two
B) three
C) four
D) five
E) ten
97. Which of the following would be an example of exchange risk?

A) A bank manager embezzles $1,000,000 from the bank

B) A bank that loses $500,000 from trading in foreign currencies
C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2
years
D) A bank manager predicts interest rates will rise. However interest rates fall causing the
bank’s net income to fall by $250,000
E) All of the above are examples of exchange risk
98. Which of the following would be an example of credit risk?

A) A bank manager embezzles $1,000,000 from the bank

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B) A bank that loses $500,000 from trading in foreign currencies

C) A $1,000,000 loan to a business on which no interest or principal has been collected
in 2 years
D) A bank manager predicts interest rates will rise. However interest rates fall causing the
bank’s net income to fall by $250,000
E) All of the above are examples of credit risk
99. Which of the following would be an example of interest rate risk?

A) A bank manager embezzles $1,000,000 from the bank

B) A bank that loses $500,000 from trading in foreign currencies
C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2
years
D) A bank manager predicts interest rates will rise. However interest rates fall causing
the bank’s net income to fall by $250,000
E) All of the above are examples of interest rate risk?
100. Which of the following would be an example of operational risk?
A) A bank teller manages to steal $250,000 over a period of several months
B) An out of date computer system causes the bank to lose $750,000
C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors
D) A $500,000 loan the bank has made has been deemed uncollectable
E) None of the above are examples of operational risk
101. Which of the following would be an example of liquidity risk?
A) A bank teller manages to steal $250,000 over a period of several months
B) An out of date computer system causes the bank to lose $750,000
C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of
depositors
D) A $500,000 loan the bank has made has been deemed uncollectable
E) None of the above are examples of liquidity risk
102. Which of the following would not be an example of operational risk?
A) A bank on the coast of Louisiana is hit by a hurricane and is flooded for 6 weeks

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B) A bank employee acting as a derivatives trader is also the one who writes the reports on
profits and losses in derivatives trading at the end of each day
C) The banks older computer system breaks down causing a loss of service to customers for 2
weeks
D) A bank robber robs a teller at gun point and gets away before police can get to the
bank
E) All of the above are examples of operational risk
103. The Jennings Bank of Texas wants to protect itself from credit risk by making large loans to
corporate customers, by making residential mortgages to families, by making agriculture loans
to farmers and ranchers in the area, by making small business loans to business along main
street and by making automobile loans for the car dealership across the street from the bank.
What defense against risk is this bank making?
A) Portfolio diversification
B) Geographic diversification
C) Quality management
D) Increasing owners’ capital
E) All of the above
104. The Michelson Bank of Stetson wants to protect itself from risk. It decides to make loans in
Florida, Georgia, Texas and Oklahoma as well as invest in municipal bonds from California and
Oregon. What defense against risk is this bank making?
A) Portfolio diversification
B) Geographic diversification
C) Quality management
D) Increasing owners’ capital
E) All of the above
105. The Perdue Bank of Houston has just hired a new manager who has a reputation of anticipating
potential problems and acting quickly to prevent those problems so that the bank stays healthy
and profitable. What defense against risk is this bank making?
A) Portfolio diversification
B) Geographic diversification
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C) Quality management
D) Increasing owners’ capital
E) All of the above
106. The Norton Bank of Illinois has just issued trust preferred stock. What defense against risk is
this bank making?
A) Portfolio diversification
B) Geographic diversification
C) Quality management
D) Increasing owners’ capital
E) All of the above
107. What type of preferred stock has become popular among large banks in recent years, partly
because dividends paid are tax deductible for the issuing institution?
A) Cumulative preferred stock
B) Noncumulative preferred stock
C) Convertible preferred stock
D) Trust preferred stock
E) All of the above
108. Even if individual banks are good at forecasting risk using VAR models there may still be
problems because losses may occur at several banks at the same time due to the
interdependency of the financial system, magnifying each bank’s risk exposure and possibly
causing a major problem for regulators. The book calls this:
A) Systematic risk
B) Operational risk
C) Credit risk
D) Market risk
E) Liquidity risk
109. There are three pillars of Basel II. One of them wants to make market discipline a powerful
force compelling risky banks to lower their risk exposure. What does Basel II want to do to
make this happen?
A) Require minimum capital requirement based on the bank’s own evaluation of its risk
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B) Require greater public disclosure of each bank’s true financial condition

C) Expand the risks to be evaluated to include credit risk, market risk and operational risk
D) Require supervisory review of each bank’s risk evaluation procedures
E) All of the above
110. A bank has capital to risk weighted assets of 11.5%, Tier 1 capital to risk weighted assets of
7.2% and a leverage ratio of 5.8%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
D) Significantly undercapitalized
E) Critically undercapitalized
111. A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 5%
and a leverage ratio of 4.8%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
D) Significantly undercapitalized
E) Critically undercapitalized
112. A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 4.5%
and a leverage ratio of 3.7%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
D) Significantly undercapitalized
E) Critically undercapitalized
113. A bank has capital to risk weighted assets of 5.5%, Tier 1 capital to risk weighted assets of 2.8%
and a leverage ratio of 2.6%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
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D) Significantly undercapitalized
E) Critically undercapitalized
114. A bank has capital to risk weighted assets of 1.8%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
D) Significantly undercapitalized
E) Critically undercapitalized
115. Which of the following is not a weakness of Basel I risk-based capital standards?
A) They ignore interest rate risk
B) They ignore changes in value due to currency value changes
C) They ignore changes in value due to commodity price changes
D) They ignore credit risk
E) They ignore the market value
116. A bank has decided to retain more of their earnings, moving their retention ratio from 40% to
70%. What way of meeting their capital needs is the bank taking?
A) Changing their dividend policy
B) Issuing common stock
C) Issuing preferred stock
D) Issuing subordinated notes and debentures
E) Selling assets and leasing facilities
117. The First National Bank of Tucson has determined that the value of their property in Tucson
has tripled in the last three years. They decide that they would like to use this property to raise
funds and will rent space from the new owners of the building. What way of meeting their
capital needs is the bank taking?
A) Issuing common stock
B) Issuing preferred stock
C) Issuing subordinated notes and debentures
D) Selling assets and leasing facilities
E) Swapping stock for debt instruments
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118. The Second National Bank of Lincoln has decided that to raise funds it is going to issue new
common equity through a pre-emptive rights offering so that current owners will not have that
ownership diluted. What way of meeting their capital needs is the bank taking?
A) Issuing common stock
B) Issuing preferred stock
C) Issuing subordinated notes and debentures
D) Selling assets and leasing facilities
E) Swapping stock for debt instruments
119. The Third State Bank of Denton has decided to issue stock through a trust company and borrow
the funds from the trust company. This stock pays a fixed dividend and because of the way the
stock has been issued it is tax deductible. What way of meeting their capital needs in the bank
taking?
A) Issuing common stock
B) Issuing preferred stock
C) Issuing subordinated notes and debentures
D) Selling assets and leasing facilities
E) Swapping stock for debt instruments
120. The Northwest Bank of Charlotte has decided to issue new securities that have five years to
maturity that have claims to assets that follow the claims of depositors. What way of meeting
their capital needs is the bank taking?
A) Issuing common stock
B) Issuing preferred stock
C) Issuing subordinated notes and debentures
D) Selling assets and leasing facilities
E) Swapping stock for debt instruments
121. Why do regulators prefer higher capital requirements?
A) It justifies the existence of regulatory agencies
B) It better protects the deposit insurance fund
C) It enhances bank asset quality
D) It decreases bank profitability
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E) It increases bank leverage

122. Why do banks generally prefer lower capital requirements?
A) To minimize the impact shareholders have on management decisions
B) To increase the influence of bank regulators
C) To increase a bank’s return on equity
D) To increase depositor protection
E) To maximize operating leverage
123. A bank has issued $5,000,000 in long term debt and since that time interest rates have risen
so that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides
to issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way
of meeting their capital needs is the bank taking?
A) Issuing common stock
B) Issuing preferred stock
C) Issuing subordinated notes and debentures
D) Selling assets and leasing facilities
E) Swapping stock for debt instruments
124. Which of the following are the reasons for having the government set capital standards for
financial institutions as opposed to letting the private marketplace set those standards?
A) To preserve public confidence
B) To alleviate market imperfections arising from the mispriced effect of systemic failures
C) To limit losses to the federal government arising from deposit insurance claims
D) All of the above
E) None of the above
125. The following are the advantages of Basel II over Basel I except:
A) Uses “bifurcated” system that takes into consideration differences in risk exposures by bank
size
B) Provides for greater sensitivity to arbitrage and financial innovations
C) Applies the same minimum capital requirements to all banks
D) Broadens the types of risk considered
E) All of the above are the advantages of using Basel II
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