Econ 330 Chapter 10-15

At the height of the global financial crisis in October 2008, the US Treasury forced nine of the largest US banks to accept capital injections in exchange for nonvoting ownership stock, even though some of the banks did not need to capital and did not want to participate. What could be the rationale for doing this?

By forcing all banks to accept capital injections, it would help prevent bank runs on the weakest banks

If casualty insurance companies provided fire insurance without any restrictions, what kind of moral hazard problem might result?

Customers would take less preventive care in avoiding fire risk with this type of insurance

How could higher deposit insurance premiums for banks with riskier assets benefits the economy?

Risk-based premium would help mitigate the moral hazard problem; however, it is difficult to monitor the degree of risk in bank assets because often only the bank making the loans knows how risky they are.

Why has the trend in bank supervision moved away from a focus on capital requirements to a focus on risk management?

Since capital requirements do not effectively indicate whether banks are taking on too much risk, risk management allows supervisors to focus more on risk-taking procedures and thus may prevent insolvency in the future

Which agency has regulatory responsibility when a bank operates in many different countries?

It is not always clear

Agreements such as _______ are attempts to standardize international banking regulations

the Basel Accord

During the boom years of the 1920s, bank failures were quite

common, averaging about 600 per year

The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is

that the FDIC guarantees al deposits when it uses the "purchase and assumption" method

When bad drivers line up to purchase collision insurance, automobile insurers are subject to the

adverse selection problem

In may 1991, the FDIC announced that it would sell the government’s final 26% stake in Continental Illinois, ending government ownership of the banks that it had rescued in 1984. The FDIC took control of the bank, rather than liquidate it, because it believed that Continental Illinois

was too big to fail

Federal deposit insurance covers deposits up to $250000 but as part of a doctrine called "too-big-to-fail" the FDIC sometimes ends up covering all deposits to avoid disrupting the financial system. When the FDIC does this, it uses the

"purchase and assumption" method

Regulators attempt to reduce the riskiness of banks asset portfolios by

limiting the amount of loans in particular categories or toe individual borrowers

A bank failure is less likely to occur when

a bank has more bank capital

The leverage ratio is the ratio of a bank’s

capital divided by its total assets

The Basel Accord, an international agreement, requires banks to hold capital based on

risk-weighted assets

The practice of keeping high-risk assets on a bank’s books while removing low-risk assets with the same capital requirements is known as

regulatory arbitrage

The chartering process is especially designed to deal with the _____ problem, and regular bank examinations help to reduce the ____ problem

adverse selection; moral hazard

Regulations designed to provide information to the marketplace so that investors can make informed decisions are called

disclosure requirements

With ____, firms value assets on their balance sheet at what they would sell for in the market

mark-to-market accounting

Regulations that reduced competition between banks included

branching restrictions

Moral hazard and adverse selection problem increased in the 1980’s:

as part of the financial innovation in the 1970s and early 1980s that produced new financial instruments and markets, thereby widening the scope for risk taking

The Depository Institutions Deregulation and Monetary Control Act of 1980:

led to the creation of NOW accounts nationwide

In order to halt the decline in the number of savings and loans and mutual savings bank, the Garn-St. Germain Act of 1982 allowed:

money market deposit accounts (MMDAs)

A main provision of the Competitive Equality in Banking Act (CEBA) of 1987 included:

directing the Federal Home Loan Bank Board to continue to pursue regulatory forbearance

Which of the following does not explain the poor performance of thrift regulators in 1980s?

The determination of Congress to protect taxpayers from the unsound banking practices of managers at many of the nation’s savings and loans

The FSLIC and the Federal Home Loan Bank Board were abolished by the:

Financial Institutions Reform, Recovery, and Enforcement Act of 1989

Why did many economists criticize the FIRREA legislation?

It did little to deal with the underlying adverse selection and moral hazard problems created by deposit insurance

In May 1991, the FDIC announced that it would sell the government’s stake in the Continental Illinois, a bank that it had rescued in 1984. Why did the FDIC initially take control of Continental Illinois, rather than liquidate it?

The FDIC believed that Continental Illinois was too big to fail

The Federal Deposit Insurance Corporation Improvement Act of 1991:

increased the FDIC’s ability to borrow from the Treasury to deal with failed banks

In the ten year period 1981-1990, 1202 commercial banks were closed, with a peak of 206 failures in 1989. This rate of failures was approximately ___ times greater than that in the period from 1934 to 1980

ten

During the 1960s, 1970s, and early 980s, traditional bank profitability declined because of

financial innovation that increased competition from new financial institutions

The Depository Institutions Deregulation and Monetary Control Act of 1980

increased deposit insurance from$40000 to $100000

The Argentine banking crisis of 2001 resulted from banks in that nation being required to

purchase large amounts of government debt

What does the cross-sectional evidence from banking crises in several countries indicate?

Deregulation and poor regulatory supervision raise moral hazard incentives

Why were consumer protection provisions included the Dodd-Frank bill, a bill designed to strengthen the financial system?

Consumer protection will avert future financial problems in the housing market

Why is it important for the US government to have resolution authority?

Resolution authority allows the government to quickly takeover a failing firm

What are the five areas included in the Dodd-Frank Act of 2010

Consumer protection, resolution authority, systemic risk regulation, Volcker rule, and derivatives

In order to ensure that borrowers have an ability to repay residential mortgages, the new consumer protection legislation requires lenders to do all of the following except

verify that the borrower can read and understand a loan contract

The new Consumer Financial Protection Bureau is an independent agency but is funded and housed within

the Federal Reserve

Firms that are designated as systemically important financial institutions (SIFIs) are subject to all of the following additional Federal Reserve regulations except

interest rate ceilings on time deposits

The Volcker Rule addresses the off-balance-sheet problem involving

trading risks

The inaccurate ratings provided by credit-rating agencies

meant that investors did not have the information they needed to make informed choices about their investments

Rank the following bank assets from most liquid (1) to least liquid (4)

Reserves 1 Securities 2 Commercial loans 3 Physical capital 4

A bank finds that its ROE is too low because it has too much bank capital. Which of the following with not raise its ROE

The bank can sell part of its holdings of securities and hold more excess reserves

Which of the following in not an asset on a bank’s balance sheet?

Checkable deposits

Large-denomination CDs are _____, so that like a bond, they have a _____ degree of liquidity and can be sold in secondary markets

negotiable; greater

Which of the following statements are true?

A bank’s balance sheet shows that total assets equal total liabilities plus equity captial

Which of the following are reported as liabilities on a bank’s balance sheet?

Checkable deposits

The share of checkable deposits in total bank liabilities has

shrunk over time

In recent years the interest paid on checkable and time deposits has accounted for around ____ of total banking operating expenses, while the costs involved in servicing accounts have been approximately ____ of operating expenses

25 percent; 50 percent

Which of the following statements are true?

Checkable deposits are payable on demand

Which of the following are transaction deposits?

Negotiable order of withdraw accounts

Because ____ are less liquid for the depositor than ____, they earn higher interest rates

passbook saving; checkable deposits

Banks acquire the funds that they use to purchase income-earning assets from such sources as

savings accounts

Bank loans from the Federal Reserve are called ____ and represent a ____ of funds

discount loans; source

Bank capital is listed on the ____ side of the bank’s balance sheet because it represents a ___ of funds

liability; source

Which of the following are reported as assets on a bank’s balance sheet?

Reserves

The largest percentage of bank’s holdings of securities consist of

Treasury and government agency securities

Which of the following bank assets is the most liquid?

Reserves

Secondary reserves include

short-term Treasury securities

Banks generate profits by earning higher returns on their ____ than they pay in interest on ____

loans; deposits

Banks can profits by selling ____ with attractive combinations of liquidity, risk, and return, and using the proceeds to buy _____ with a different set of characteristics

liabilities; assets

When a new depositor opens a checking account at the First National Bank, the bank’s assets ____ and its liabilities ____

increase; increase

When Jane Brown writes a $100 check to her nephew, and he cashes the check, Ms. Brown’s bank ____ assets of $100 and ____ of $100

loses; loses

Holding all else constant, when a bank receives the funds for a deposited check,

cash items in the process of collection fall by the amount of the check

When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to hold any excess reserves but makes loans instead, then, in the bank’s final balance sheet,

the liabilities of the bank increase by $1000000

If the bank you own has no excess reserves and a sound customer comes in asking for a loan, should you automatically turn the consumer down, explaining that you don’t have any excess reserves to lend? Why or why not? What options are available for you to provide the funds you customer needs?

No. There are several ways that reserves can be acquired. For example, the bank can borrow at the discount window or in the federal funds market, or it can acquire funds by issuing negotiable CDs

If a bank doubles the amount of its capital and ROA stays constant, what will happen to ROE?

Given the ROA, if bank capital doubles, the ROE will fall by half

Which of the following is a main responsibility of the bank manager?

Maintaining reserves at a level to minimize the cost to the bank of deposit outlfows

Which of the following are primary concerns of the bank manager?

Maintaining sufficient reserves to minimize the cost to the bank of deposit outlfows

If a bank has $100000 of checkable deposits, a required reserve ratio of 20 percent, and its holds $40000 in reserves, then they maximum deposit outflow it can sustain without altering its balance sheet is

$25000

If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will result in equal reductions in

deposits and reserves

Bankers’ concerns regarding the optimal mix of excess reserves, and secondary reserves, borrowing from the Fed, and borrowings from other banks to deal with deposit outflows is an example of

liquidity management

If, after a deposit outflow, a bank needs an additional $3 million to meet tis reserve requirements, the bank can

sell $3 million of securities

____ may antagonize customers and thus can be a very costly way of acquiring funds to meet to unexpected deposit outflow

Calling in loans

If a bank needs to acquire funds quickly to meet an unexpected deposit outflow, the bank could

borrow from another bank in the federal funds market

Banks that suffered significant losses in the 1980s made the mistake of

failing to diversify their loans portfolio

As the costs associated with deposit outflows ____, the banks willingness to hold excess reserves will ____.

increase; increase

Which of the following has not resulted from more acitvie liability management on the part of banks?

Increased bank holdings of cash items

A bank is insolvent

its liabilities exceed its assets

Net profit after taxes per dollar of assets is a basic measure of bank profitability called

return on assets

The amount of assets per dollar of equity capital is called the

equity multiplier

In the absence of regulation, banks would probably hold

too little capital

"Because diversification is desirable strategy for avoiding risk, it never makes sense for a bank to specialize in making specific types of loans." Is this statement true of false? Explain your answer

False. A bank may have developed expertise in screening and monitoring a particular type of loan, thus improving its ability to handle problems of adverse selection and moral hazard

If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment projects, banks are said to face the problem of:

adverse selection

In order to reduce the ____ problem in loan markets, banks often insist on collateral from potential borrowers

moral hazard

Banks face the problem of ____ in loan markets because bad credit risks are the ones most likely to seek bank loans

adverse selection

In order to reduce the ____ problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones

adverse selection

From the standpoint of ____, specialization in lending is surprising but makes perfect sense when one considers the ____ problem

diversification; adverse selection

Provisions in loan contracts that prohibit borrowers from engaging in specified risky activities are called

restrictive covenants

A bank’s commitment to provide a firm with loans up to pre-specified limit at an interest rate that is tied to a market interest rate is called

loan commitment

Collateral requirements lessen the consequences of ____ because the collateral reduces the lender’s losses in the case of a loan default and it reduces ____ because the borrower has more to lose from a default

adverse selection; moral hazard

When a lender refuses to make a loan, although borrowers are willing to pay the stated interest rate or even a higher rate, the bank is said to engage in

credit rationing

If you are a banker and expect interest rates to rise in the future, would you want to make short-term or long-term loans

You would want to make short-term loans so you can reinvest the funds at higher interest rates after their maturity

Risk that is related to the uncertainty about future interest-rate movements is called:

interest-rate risk

Risk that is related to to the uncertainty about interest rate movements is valled

interest-rate risk

All else that same, if a bank’s liabilities are more sensitive to interest rate fluctuations than are its assets, then ____ in interest rates will ____ bank profits

an increase; reduce

If a bank’s liabilities are more sensitive to interest rate movements than are its assets, then

an increase in interest rates will reduce bank profits

The difference of rate-sensitive liabilities and rate-sensitive assets is known as the

gap

If the First National Bank has a gap equal to negative $30 million, then a 5 percentage point increase in interest rates will cause profits to

decline by $1.5 million

Measuring the sensitivity of bank profits to changes in interest rate by multiplying the gap times the change in interest rate is called

basic gap analysis

Because of an expected rise in interest rates in the future, a banker will likely

buy short-term rather than long-term bonds

Bruce the Bank Manager can reduce interest rate risk by ____ the duration of the bank’s assets to increase their rate sensitivity or, alternatively, ____ the duration of the bank’s liabilities

shortening; lengthening

Which of the following may not be used as a backup line of credit

Mortgages

Examples of off-balance-sheet activities include

selling loan portfolios

Examples of off-balance-sheet activities include

loan sales

Banks earn profits from off-balance sheet loan sales

by selling existing loan for more than the original loan amount

Which of the following is not an example of a backup line of credit?

mortgages

A reason why rogue traders have bankrupt their banks is due to

a failure to maintain proper internal controls

The principal-agent problem that exists for bank trading activities can be reduced trhough

creation of internal controls that separate trading activities from bookkeeping

Which of the following are not reported as assets on a bank’s balance sheet?

Checkable deposits

Which of the following statements is false?

Checkable deposits are the primary source of bank funds

The volume of checkable deposits relative to total bank liabilities has:

declined over time

When you deposit a $50 bill in the Security Pacific Nation Bank,

its assets increase by $50

Conditions that likely contributed to a credit crunch during the global financial crisis include

capital shortfalls caused in part by falling real estate prices

Why do equity holders care more about ROE than about ROA?

ROE measures how much equity holders are earning, while ROA measures how efficiently the bank is being run

Transformation of assets can be accomplished by

borrowing short and lending long

Net profit taxes per dollar of equity capital is a basic measure of bank profitability called

return on equity

Which of the following would a bank not hold as insurance against the highest cost of deposit outflow-bank failure

mortgages

When the $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserved instead, then, in the bank’s final balance sheet

the assets at the bank increase by $1 million

Because of their ____ liquidity, ____ US government securities are called secondary reserves

high; short-term

A bank with excess reserves can economize on these reserves by:

lending reserves in the federal funds market

A bank failure occurs whenever

a bank cannot satisfy its obligations to pay its depositors and have enough reserves to meet its reserve requirements

Bank capital is equal to ____ minus ____

total assets; total liabilities

A bank with insufficient reserves can increase its reserves by

calling loans

In general, banks make profits by selling ______ liabilities and buying _____ assets

short-term; longer-term

Why might a bank be willing to borrow funds from other banks at a higher rate rather than borrow from the Fed?

Borrowing from the Fed might invite greater supervisory scrutiny from the central bank

Banks hold excess and secondary reserves to

provide for deposit outflows

If a bank has $200,000 of checkable deposits, a required reserve ratio of 20% percent, and it holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its balance sheet is

$50000

Which of the following is not an income-producing asset on a bank’s balance sheet?

Bank reserves

A $5 million deposit outflow from a bank has the immediate effect of

reducing deposits and reserves by $5 million

Why has the development of overnight loan markets made it more likely that banks will hold fewer excess reserves?

The presence of overnight loan markets reduces the cost associated with deposit outflows

Because ____ are less liquid for the depositor than ____, they earn higher interest rates

time deposits; passbook savings

Which of the following statements is false?

Bank capital is recorded as an asset on the bank balance sheet

If a banker expects interest rates to fall in the future, her best strategy for the present is

to increase the duration of the bank’s assets

Why is being nosy a desirable trait for a banker?

All of the above are correct

Measuring the sensitivity of bank profits to changes in interest rates by calculating the product of the gap and the change in the interest rate is called

basic gap analysis

One way for banks to reduce the principal-agent problems associated with trading activities is to

set limits on the total amount of a traders’ transactions

Unanticipated moral hazard contingencies can be reduced by

long-term customer relationships

Measuring the sensitivity of bank profits to changes in interest rates by multiplying the gap for several maturity subintervals times the change in the interest rate is called

the maturity bucket approach to gap analysis

Off-balance sheet activities involving guarantees os securities and back-up credit lines

increase the risk a bank faces

Assets of value promised to the lender as compensation if the borrower defaults are called:

collateral

To reduce moral hazard problems, banks include restrictive covenants in loan contracts. In order for these restrictive covenants to be effective, banks must also

monitor and enforce them

When investors are involved in trading activities in an attempt to outguess markets, investors are

speculating

The principal-agent problem that exists for bank trading activities can be reduced by:

the physical separation of trading activities from bookkeeping acitivities

If a bank has ____ rate-sensitive assets than liabilities, then ____ in interest rates will increase bank profits

more; an increase

A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be prevented, will require borrowers to

keep compensating balances in a checking account at the bank

"Bank managers should always seek the highest return possible on their assets." Is this statement true, false, or uncertain?

False. A bank must also consider an asset’s risk and liquidity when deciding which assets to hold

When banks offer borrowers smaller loans than they have requested, banks are said to

ration credit

Provisions in loan contracts designed to mitigate the moral hazard problem are called

restrictive covenants

Banks develop statistical models to calculate their maximum loss over a given time period. This approach is known as the

Value-at-risk approach

If a bank has $50 million in rate-sensitive assets and $20 million in rate-sensitive liabilities then

a decrease in interest rates will reduce bank profits

Why has noninterest income been growing as a source of bank operating income?

Banks can increase profits by engaging in noninterest income, or off-balance-sheet activities

If borrowers with the most risky investment projects seek bank loans in higher proportion to those borrowers with the safest investment projects, bank are said to face the problem of

adverse selection

All of the following are examples of off-balance sheet activities that generate fee income for banks except

selling negotiable CDs

Why was the United States one of the last major industrialized countries to have a central bank?

Agricultural and other US interests were suspicious of centralized power and opposed the creation of a central bank

Which of the following is not a motivation for the original Glass-Steagall Act in 1933?

The need to further consolidate the banking industry and securities industry

Federally chartered banks are supervised by

the Office of the Comptroller of the Currency

The ____ established the Office of the Comptroller of Currency

National Bank Act of 1863

The modern commercial banking system began in America when the

Bank of North America was chartered in Philadelphia in 1782

Because of the abuses by state bank and the clear need for a central bank to help federal government raise funds during the War of 1812, Congress created the

Second Bank of the United States in 1816

The Second Bank of the United States was denied a new charter by

President Andrew Jackson

The belief that bank failures were regularly caused by fraud or the lack of sufficient bank capital explains, in part, the passage of

the National Bank Act of 1863

Although the National Bank Act of 1863 was designed to eliminate state-chartered banks by imposing a prohibitive tax on banknotes, these banks have been able to stay in business by

acquiring funds through deposits

Today the United States has a dual banking system in which bank supervised by the ____ and by the ____ operate side by side

federal government; states

The Federal Reserve Act required all ____ bank to become members of the Federal Reserve System, while ____ banks could choose to become members of the system

national; state

Probably the most significant factor explaining the drastic drop in the number of bank failures since the Great Depression has been

the creation of the FDIC

The legislation that separated investment banking from commercial banking until its repeal in 1999 is known as the

Glass-Steagall Act

State banks that are not members of the Federal Reserve System are most likely to be examined by

FDIC

How does the emergence of interest-rate risk help explain financial innovation

It increases the demand for financial products and services that could reduce that risk

If inflation had not risen in the 1960s and 1970s, the banking industry might be healthier today. Is this statement true, false, or uncertain?

True. Higher inflation helped raise interest rates, which caused the disintermediation process to occur and helped create money market mutual funds

How do sweep accounts and money market mutual funds allow bank to avoid reserve requirements?

Although they function as interest-earning deposits, these accounts are not legally deposits and so are not subject to reserve requirements

Why have banks been losing cost advantages in acquiring funds in recent years?

The increased cost of funds from higher interest rates and the abolishment of Regulation Q

Why have banks been losing income advantages on their assets in recent years?

Both A and C are correct

Which of the following is likely a result of increased interest-rate volatitilty

An increase in demand for financial services and products

Financial instruments with returns tied to previously issued securities are called

financial derivatives

The most significant change in the economic environment that changed the demand for financial products in recent years has been

the dramatic increase in the volatility of interest rates

In the 1950s the interest rate on three-month Treasury bills fluctuated between 1 percent and 3.5 percent; in the 1980s it fluctuated between _____ percent and ____ percent

5; 15

Uncertainty about interest-rate movements and returns is called

interest-rate risk

Adjustable rate mortgages

benefit homeowners when interest rates are falling

The agreement to provide a standardized commodity to a buyer on a specific date at a specific future price is

a futures contract

An instrument developed to help investors and institutions hedge interest-rate risk is

a financial derivative

Both ____ and ____ were financial innovations that occurred because of interest rate volatility

adjustable-rate mortgages; financial derivatives

The most important source of the changes in supply conditions that stimulate financial innovation has been the

improvement in computer and telecommunications technology

Credit cards date back to

prior to the second World War

The declining cost of computer technology has made _____ a reality

virtual banking

so-called fallen angels differ from just bonds in that

junk bonds refer to newly issued bonds with low credit ratings, whereas fallen angels refer to previously issued bonds that have had their credit ratings fall below Baa

One factor contributing to the rapid growth of the commercial paper market since 1970 is

improved information technology making it easier to screen credit risks

____ is creating a marketable capital market instrument by bundling a portfolio of mortgage or auto loans

securitization

According to Edward Kane, because the banking industry is one of the most ____ industries in America, it is an industry in which ____ is especially likely to occur

regulated; loophole mining

Prior to 2008, bank managers looked on reserve requirements

as a tax on deposits

The process in which people take their funds out of the banking system seeking higher yielding securities is called

disintermediation

In September 2008, the Reserve Primary Fund, a money market mutual fund, found itself in the situation know as "breaking the buck." This means that

they could no longer afford to redeem shares at the par value of $1

Sweep accounts which were created to avoid reserve requirements became possible because of a change in

technology

Since 1974, commercial banks importance as a source of funds for nonfinancial borrowers

has shrunk dramatically, from around 40 percent of total credit advanced to around 25 percent by 2011

One factor contributing to the decline in cost advantages that bank once had is the

decline in the importance of checkable deposits from over 60 percent of banks’ liabilities to 2 percent today

"The commercial banking industry in Canada is less competitive than the commercial banking industry in the United States because in Canada only a few large banks dominate the industry, while the United States there are around 6500 commercial banks/" Is this statement true or False?

False. The reason for the large number of US banks is anticompetitive regulations such as branching restrictions

The McFadden Act of 1927

prohibited banks from branching across state lines

As a result of strict banking regulations, the United States has:

many more smaller banks when compared to other industrialized countries

A financial innovation the developed as result of banks avoidance of bank branching restrictions was ____

bank holding companies

ATMs were developed because of breakthroughs in technology and as a

means of avoiding restrictive branching regulations

Bank holding companies that rival money center banks in size but are not located in money center cities are known as

superregional banks

The primary reason for the recent reduction in the number of banks is

mergers and acquisitions

The business term for economies of scope is

synergies

The legislation that overturned to prohibition on interstate banking is

the Riegle-Neal Act

Critics of nationwide banking fear

an elimination of community banks

What has been the likely effect of the Gramm-Leach-Bliley Act of financial consolidation?

The legislation further stimulated financial consolidation of the banking industry. Thus, more financial mergers are likely to occur, which will increase both the size and complexity of financial institutions in the future

What is the major difference between banking systems in the United States and Japan

American banks are not allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks can

The Glass-Steagall Act, which was repealed in 1999, prohibited commercial banks from

engaging in underwriting and dealing corporate securities

The legislation overturning the Glass-Steagall Act is

the Gramm-Leach-Bliley Act

In a _____ banking system, commercial banks provide a full range of banking, securities, and insurance services, all within a single legal entity

universal

Why is there a higher percentage of bank with less than $25 million of assets among commercial banks than among savings and loans in mutual savings banks?

Because restrictions on branching are stricter for commercial banks that for savings and loans, smaller commercial banks have greater protection from competition and are more likely to survive than small savings and loans.

Unlike commercial banks, savings and loans, and mutual savings banks, credit unions did not have restrictions on locating branches in other states. Why, then, are credit unions typically smaller than the other depository institutions?

Credit unions are small because members usually share a common employer or have ties to a particular organization

Unlike banks, ____ have been allowed to branch statewide since 1980

federally-chartered S&Ls

____ are the only depository institutions that are tax-exempt

Credit unions

Which of the following factors does not explain the rapid growth in international banking

increased regulation of the US banking industry

Which of the following is not an incentive created by regulatory agencies to encourage international banking?

Direct federal subsidies

Why is there only one US bank among the ten largest banks in the world?

US banks are more heavily regulated than foreign banks, thus limiting the number of mergers in the United States. With fewer mergers and bank consolidation, US banks are less dominant in world markets

Deposits in European banks denominated in dollars for the purpose of international transactions are known as:

Eurodollars

An advantage to American banks operating foreign branches in that Eurodollar deposits in offshore branches are:

not subject to reserve requirements

Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by foreign banks has been

eroded

What country is given credit for the birth of the Eurodollar barket

The Soviet Union

Reason for holding Eurodollars include

the fact that dollars are widely used to conduct international transactions

US banks have most of their branches in

Latin America, the Far East, the Caribbean, and Canada

____ of foreign bank operates in the US but cannot accept deposits from domestic residents

An agency office

Currency in circulation that cannot be redeemed for gold is called

fiat money

The bank panic of 1907 led to the passage of the

Federal Reserve Act of 1913

Which of the following is a requirement of the Federal Deposit Insurance Corporation?

Member banks of the Federal Reserve System are required to purchase FDIC insurance for their depositors

A major controversy involving the banking industry in its early years was

wether the federal government or the states should charter banks

Currency circulated by bank that could be redeemed for gold was called ____

banknotes

Prior to 1863, all commercial banks in the United States

were chartered by the banking commission of the state in which they operated

The regulatory system that has evolved in the United States whereby banks are regulated at the state level, the national level, or both, is known as

dual banking system

The Federal Reserve Act of 1913 required that

national banks join the Federal Reserve System

With the creation of the Federal Deposit Insurance Corporation,

member banks of the Federal Reserve System were required to purchase FDIC insurance for their depositors, while non-member commercial banks could chose to buy deposit insurance

The Glass-Steagall Act, before its repeal in 1999, prohibited commercial bank from

engaging in underwriting and dealing of corporate securities

Why is loophole mining so prevalent in the banking industry in the United States

Banks engage in loophole mining in order to avoid regulatory constraints that restrict their ability to earn profits

____ is the process of researching and developing new instruments to address the needs of investors and institutions in a rapidly changing financial climate

Financial engineering

Uncertainty about future interest rate volatility and returns is known as:

interest risk-rate

Agreements to provide a standardized commodity to a buyer at a specific price on a specific date are:

futures contracts

When depositors withdraw funds from commercial banks to seek other more attractive assets, deposit losses in the banking system may restrict the amount of funds that banks can lend. Which of the following identifies this process?

Disintermediation

____ is the process of researching and developing profitable new products and services by financial institutions

Financial engineering

Risk interest-rate risk

increased the demand for financial innovation

Financial instruments whose payoffs are linked to previously issued securities are called____

financial derivities

Automated teller machines

cost less than human tellers, so banks may encourage their use by charging less for using ATMs

In 1977, he pioneered the concept of selling new public issues of junk bonds for companies that had not yet achieved investment grade status

Michael Milken

The development of money market mutual funds contributed to the growth of ____ since the money market mutual funds need to hold liquid, high-quality, short-term assets

the commercial paper market

Prior to 2008, the bank’s cost of holding reserves equaled

the interest earned on loans time the amount of reserves

Prior to 1980, the Fed set an interest rate ____, a maximum limit on the interest rate could be paid on time deposits

ceiling

In this type of arrangement, any balance above a certain amount in a corporation’s checking account at the end of the business day are "removed" and invested in over night securities that pay the corporation interest. This innovation is referred to as a

sweep account

Disintermediation resulted from

interest rate ceilings combined with inflation-driven increases in interest rates

The most important developments that have reduced banks cost advantages in the past thirty years include

the competition from money market mutual funds

Which of the following is not a reason for the dramatic increase the number of bank holding companies?

Bank holding companies can monopolize the market for banking services in a given region

As a result of strict banking regulations, the US has:

many more smaller banks when compared to other industrialized countries

The large number of banks in the US is an indication of

lack of competition within the banking industry

The ability to use one common resource to provide different products and services is

economies of scope

Which of the following repealed the prohibition on interstate banking?

Riegle-Neal Act

Experts predict that future trends in the US banking industry will lead to:

several thousand banks

Although it has a population about half that of the US, Japan has

fewer than 100 commercial banks

One of the concerns of increased bank consolidation is the reduction in community banks which could result in

less lending to small businesses

Which of the following repealed the Glass-Steagall Act?

Gramm-Leach-Bliley Act

Commercial banks that provide a full range of banking, securities, and insurance services, all within a single legal entity, are part of:

a universal banking system

Under the Gramm-Leach-Bliley Act states retain regulatory authority over ____

insurance activities

Under the Gramm-Leach-Bliley Act the oversight of the securities activities of bank holding companies belong to

the SEC

Which of the following is responsible for the supervision of savings and loan associations

Federal Home Loan Banking System

Thrift institutions include

mutual savings banks

What is a primary characteristic of credit unions?

Credit Unions are organized around a group of individuals that belong to a common institution

The FHLBS gives loans to S&Ls and thus performs a function similar to the ____ for commercial banks

Federal Reserve

Mutual savings banks are owned by ____

depositors

How could the approval of international banking facilities (IBFs) by the Fed in 1981 have reduced employment in the banking industry in Europe?

IBFs encourage American and foreign banks to do more banking business in the United States, thus shifting employment from Europe to the United States

If the bank at which you keep your checking account is owned by foreigners, should you worry that your deposits are less safe that if the bank were owned by Americans?

No, because the foreign bank is subject to the same regulations as the American-owned bank

Why might American businesses want to hold Eurodollars?

Many commerical transactions and internation contracts are denominated in dollars

Since the passage of the International Banking Act of 1978, the competitive advantage enjoyed by foreign banks has been:

eroded

The spectacular growth in international banking can be explained by

the rapid growth in international trade

Eurodollars are

dollar-dominated deposits held in banks outside the US

An advantage to American banks from operating foreign branches is that Eurodollars deposits in offshore branches are

not subject to reserve requirements

If a foreign bank operates a subsidiary bank in the US, the subsidiary bank in the US, the subsidiary bank is

subject to the same regulations as a US owned bank

Foreign banks may engage in banking activities in US by opening all of the following except

a McFadden Corporation

As financial intermediaries, banks:

accept deposits and make loans

The players in the money supply process include all of the following except:

the Treasury

Loans that the Fed makes to bank appear on the balance sheet as part of its _____, and deposits made by banks appear on the Fed’s balance sheet as part of its ____

assets; liabilities

Two primary assets of the Federal Reserve System are:

government securities and loans to commercial banks

A bank has required reserve ratio to 10%. If the bank has deposits of $100000 and is holding $12000 in reserves:

the bank is holding $2000 in excess reserves

In the balance sheet above, the excess reserve ratio of ABC bank is ____ and its excess reserves are ____

0.011; $10

The interest rate charged to bank that borrow funds from the Fed is known as the:

discount rate

If a bank depositor withdraws $1000 of currency from an account, what happens to reserves, checkable deposits, and the monetary base? Assume that the required reserve ratio on checkable deposits is 10% and banks do not hold any excess reserves

Reserves fall by $1000, checkable deposits fall by $10000, and the monetary base remains unchanged

What happens to checkable deposits in the banking system when the Fed lends an additional $1 million to the First National Bank, assuming that the required reserve ratio on checkable deposits is 10%, banks do not hold any excess reserves, and the public’s holding of currency do not change?

Checkable deposits rise by $10 million

If the required reserve ratio on checkable deposits increased to 20%, how much multiple deposit creation will take place when reserves are increased by $100? Assume that bank do not hold any excess reserves and the public’s holding of currency do not change

$500

Predict what will happen to the money supply if there is a sharp rise in the currency ratio

The money supply falls

Why might the procyclical behavior of interest rates (rising during business cycle expansions and falling during recessions) lead to procyclical movements in the money supply?

Both A & C are correct

If the economy starts to boom and loan demand picks up, what do you predict will happen to the money supply?

The money supply will increase

The money multiplier declined significantly during the period 1930-1933 and also during the recent financial crisis of 2008-2010. Yet the M1 money supply decreased by 25% in the Depressing period by increased by more than 20% during the recent financial crisis. What explains the difference in outcomes?

There was a significant increase in the monetary base during the recent financial crisis.

Both ____ and ____ are Federal Reserve assets

securities; loans to financial institutions

The monetary liabilities of Federal Reserve include

currency in circulation and reserves

The sum of the Fed’s monetary liabilities and the US Treasury’s monetary liabilities is called

the monetary base

The monetary base consists of

currency in circulation and reserves

Total reserves minus bank deposits with the Fed equals

valut cash

Total reserves are the sum of ____ and ____

excess reserves; required reserves

Excess reserves are equal to

vault cash plus deposits with Federal Reserve banks minus required reserves

Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and one million dollars in required reserves. Given this information, we can say First National Bank faces a required reserve ratio of ____ percent

ten

Suppose that from a new checkable deposit, First National Bank holds two million dollars in vault cash, eight million dollars on deposit with the Federal Reserve, and nine million dollars in required reserves. Given this information, we can say First National Bank faces a required reserve ratio of ____ percent

ten

Suppose that from a new checkable deposit, First National Bank holds eight million dollars on deposit with the Federal Reserve, one million dollars in required reserves, and faces a required reserve ratio of ten percent. Given this information, we can say First National Bank has ____ million dollars in vault cash

two

The primary reason for the creation of the Federal Reserve System was:

to reduce or eliminate future bank panics

The many regional Federal Reserve banks resulted from a compromise between parties favoring:

a private central bank and those favoring a government institution

Why was the Federal Reserve System set up with twelve regional Federal Reserve banks rather than one central bank, as in other countries?

The writers of the Federal Reserve Act wanted to ensure the Fed’s power was not centralized in a single location

Should the Federal Reserve redraw its district boundaries, similar to how congressional districts are periodically realigned?

Uncertain. This would required Congress to rewrite the Federal Reserve Act, which could create opportunities for political interests to interfere with the monetary policy

Which of the following is not part of the checks and balances of the Federal Reserve System?

The requirement that all depository institutions keep deposits at the Fed

Which of the following entities in the Federal Reserve System controls the discount rate?

The Board of Governors

Which of the following entities in the Federal Reserve System sets reserve requirements?

The Board of Governors

Which of the following entities in the Federal Reserve System directs open market operations?

the FOMC

In what ways can the regional Federal Reserve Banks influence the conduct of monetary policy?

All of the above are correct

Why is the New York Federal Reserve always a voting member on the FOMC?

All of the above are correct

Despite the important role that the Board of Governors has in setting monetary policy, seats to serve on the Board of Governors can sometimes be empty for several years. How could this happen?

Since members of the Board of Governors are appointed by the president and confirmed by the Senate, these seats may remain vacant due to the arduous and lengthy political approval process that candidates must endure

Although neither ____ nor the ____ is officially set by the Federal Open Market Committee, decisions concerning these policy tools are effectively made by the committee

reserve requirements; discount rate

Which of the following statements regarding Federal Reserve independence is incorrect?

the fourteen-year nonrenewable terms for governors effectively insulate the Board of Governors from political pressure

How does the Federal Reserve have a high degree of instrument independence?

The Federal Reserve can choose any method it wants in order to achieve a given set of policy objectives

The Fed is the most independent of all US government agencies. What is the main difference between it and other government agencies that explains the Fed’s greater independence?

The Fed’s source of revenue is free from the appropriations process

What is the primary tool of Congress uses to exercise some control over the Fed?

The threat that Congress will acquire greater control over the Fed’s finances and budget

"The independence of the Fed leaves it completely unaccountable for its actions." Why is this statement not true?

All the above are correct

Eliminating the Fed’s independence might lead to a more pronounced political business cycle because a politically exposed Fed would be more concerned with

short-run objectives and thus be more likely to engage in expansionary policies designed to lower unemployment and interest rates before an election

Critics of the Fed independence argue that

it is undemocratic to have monetary policy controlled by an elite group responsible to no one

The theory of bureaucratic behavior suggests that the objective of a bureaucracy is to maximize:

its own welfare

The theory of bureaucratic behavior when applied to the Fed helps to explain why the Fed

is so secretive about the conduct of future monetary policy

Which is more independent, the Federal Reserve of the European Central Bank? Why?

The European Central Bank – Its charter cannot be changed the legislation, making it more independent than the Federal Reserve

The European Central Bank (ECB) has complete control over monetary policy in eleven euro countries and has a charter that cannot be changed by legislation. In comparison to the Federal Reserve System, the ECB is

more independent

The ECSB is similar to the Federal Reserve system in that:

it is structured such that the central banks for each country have a similar role to that of the Federal Reserve banks

Which of the following statements about central bank structure and independency is true?

In recent years, there has been a remarkable trent toward increasing independence

While legislation enacted in 1998 granted the Bank of Japan new powers and greater autonomy, its critics contend that:

its independence is limited by the Ministry of Finance’s veto power over part of the Bank’s budget

Graph question

negatively related; countries with low ratings have generally produced higher inflation

The Federal Reserve Bank of ____ plays a special role in the Federal Reserve System because it houses the open market desk

New York

The president from which Federal Reserve Bank always has a vote in the Federal Open Market Committee?

New York

An important function of the regional Federal Reserve Bank is

clearing checks

Prior to 1980, member banks left the Federal Reserve System due to

the high cost of required reserves

Banks subject to reserve requirements set by the Federal Reserve System include

all banks whether or not they are members of the Federal Reserves System

The Depository Institutions Deregulation and Monetary Control Act of 1980:

established uniform reserves requirements for all banks

There are ____ members of the Board of Governors of the Federal Reserve System

7

What is the primary tool that congress uses to exercise some control over the Fed?

The threat that Congress will acquire greater control over the Fed’s finances and budget

The Board of Governors of the Federal Reserve System:

All of the above are correct

The primary reason for the creation of the Federal Reserve System was

to reduce or eliminate future bank panics

A dilemma challenging the existing structure of the ECB has been brought on by:

the possibility to expanding the membership in the Eurosystem

In England, the Chancellor of the Exchequer (the equivalent of the US Secretary of Treasury) sets the goal of monetary policy, a target for inflation. Thus, when compared to the Fed, the Bank of England has:

less goal independence

Critics of Fed independence argue that

it is undemocratic to have monetary policy controlled by an elite group responsible to no one

If Jane Brow closes her account at the First National Bank and uses the money instead to open a money market mutual fund account, what happens to M1? Why?

M1 does not change because the funds that go to the money market mutual fund are first deposited into the mutual fund’s bank

The money multiplier when people hold currency and when banks hold excess reserves is ____ the simple multiplier

smaller than

Under 100% reserve banking, the money multiplier will be

1

If a bank decides that it wants to hold $1 million of excess reserves, what effect will this have on checkable deposits in the banking system? Assume that the required reserve ratio on checkable deposits is 10% and the public’s holdings of currency do nto change

Checkable deposits decline by $10 million

The interest rate charged to banks that borrow funds from the Fed is known as the:

discount rate

The M2 money multiplier increases in value when the:

A and B are correct

Two primary assets of the Federal Reserves System are:

government securities and loans to commercial banks

The monetary base is affected by

all of the above are correct

"The federal funds rate can sometimes be above the discount rate" Is this statement true, false, or uncertain?

True. Banks may prefer to pay a higher market rate than to borrow directly from the Fed and incur the perceived stigma

Another graph question

the federal funds rate would increase to i^2/ff The federal funds rate would stay at i^1/ff

The federal funds interest rate is determined by the

equilibrium of supply and demand in the market for reserves

An open market purchase would shift the supply curve to the ____ and cause the federal funds rate to ____

right, fall

The graph to the right shows a fall in the vertical section of the supply curve of reserves. The fall in the supply curve is caused by

a decreased in the discount rate

What would happen to the federal funds rate if it were initially at i^1/ff and households started transferring money from savings to checking, leading to an increase in the amount of checkable deposts

The federal funds rate would increase to i^2/ff

During the holiday season when the public’s holdings of currency increase, what defensive open market operations typically occur

a defensive open market purchase

If the Treasury has just paid a large bill to defense contractors and as a result its deposits with the Fed fall, what defensive open market operations will the manager of the open market desk undertake?

A defensive open market sale

"The only way that the Fed can affect the level of borrowed reserves is by adjusting the discount rate." Is this statement true, false, or uncertain? Explain your answer

False. The Fed can also limit the amount of discount loans that an individual bank can have

Why is paying interest on reserves an important tool for the Federal Reserve to manage crises?

it allows the Fed to increase its lending as much as it wants without reducing the federal funds rate

Why are repurchase agreements used to conduct most short-term monetary policy operations, rather than simply buying and selling securities outright?

Only A and B are correct

____ are intended to change the level of reserves and the monetary base

Dynamic open market operations

____ are intended to offset movements in other factors that affect reserves and the monetary base

Defensive open market operations

Because most open market operations are typically repurchase agreements, it is likely that the volume of defensive open market operations is ____ the volume of dynamic open market operations

greater than

Following the global financial crisis in 2008, assets on the Federal Reserve’s balance sheet increased dramatically, from approximately $800 billion at the end of 2007 to $3 trillion in 2011

Reverse repos serve as a temporary open market sale in which the Federal Reserve temporarily sells assets to reduce its balance sheet, thus decreasing the money supply and raising short-term interest rates

"Discount loans are no longer needed because the presence of the FDIC eliminates the possibility of bank panics" Why is this statement false?

The Fed uses discounting to keep bank failures from spreading

You often read in the newspaper that the Fed has just lowered the discount rate. Does this signal that the Fed is moving to a more expansionary monetary policy? Why or why not?

No. The Fed usually lowers the discount rate when market rates fall regardless of the direction of monetary policy

Open market sales shrink the _____, thereby decreasing the _____

monetary base and reserves; money supply

The Fed’s most commonly used means of changing the money supply is

open market operations

Open market operations as a monetary policy tool have the advantage that

All of the above are correct

Crazy graph

equal to the distance between B and C

The Fed’s lender-of-last-resort function

creates a moral hazard problem

Graph question

All of the above are correct

What is the disadvantage of quantitative easing as an alternative to conventional monetary policy when short-term interest rates are at the zero lower-bound?

Quantitative easing may not actually have the effect of increasing economic activitivy

zero lower bound problem

occurs because people can always earn more from holding bonds than holding cash

Credit easing refers to

altering the composition of the Fed’s balance sheet in order to improve the functioning of particular segments of the credit markets

The European System of Central Banks uses similar monetary policy tools to that of the Federal Reserve. These tools involve

All of the above

Everything else held constant, in the market for reserves, when the federal funds rate is 3%, lowering the discount rate from 5% to 4%

has no effect on the federal funds rate

Everything else held constant, in the market for reserves, when the supply for federal funds intersects the reserve demand curve along the horizontal section of the demand curve, lowering the interest rate paid on excess reserves

lowers the federal funds rate

Everything else held constant, in the market for reserves, when the supply for federal funds intersects the reserve demand curve on the downward sloping section, decreasing the interest rate paid on excess reserves

has no effect on the federal funds rate

Everything else held constant, in the market for reserves, increases in the discount rate affect the federal funds rate

when the funds rate equals the discount rate

In the market for reserves, if the federal funds rate is betewen the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ____ the demand for reserves, _____ the federal funds rate, everything else held constant

increases; raising

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement ____ the demand for reserves, raising the federal funds interest rate, everything else held constant

rises; increases

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves , an increase in the reserve requirement ____ the demand of reserves and causes the federal funds interest rate to ____ everything else held constant

increases; rise

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, a ____ in the reserve requirement ____ the demand for reserves, lowering the federal funds interest rate, everything else held constant

decline; decreases