Deck 18: Liability and Liquidity Management

Question 1

A liquid asset can be converted to cash quickly, but will require a discount from market value.

Answer 1

False

Question 2

Under contemporaneous reserve accounting, there is a seven day reserve maintenance period.

Answer 2

False

Question 3

Holding small amounts of liquid assets could cause an FI to be unable to meet the claims of liability holders.

Answer 3

True

Question 4

The minimum average daily reserves required in a maintenance period is a percentage of the daily average demand deposits held by a bank during the computation period.

Question 5

By definition, all transaction accounts at U.S. FIs allow account holders to make unlimited withdrawals.

Question 6

Excessive illiquidity can result in an FI's inability to meet required payments on liability claims and, at the extreme, in insolvency.

Question 7

In most countries, regulators often set minimum liquid reserve requirements on FIs.

Question 8

One method of reducing the risk of a liquidity crisis for an FI to efficiently manage liquid asset positions.

Question 9

In most countries, assets used to satisfy the liquid assets ratio may include liquid government securities.

Question 10

A strategy to increase reservable deposits on a Friday and decrease reservable deposits on the following Monday is called the weekend game.

Question 11

The reserve computation period for determining required reserves covers the 14 days of a two-week period that runs from Monday to Monday.

Question 12

Regulators in the U.S. do not allow government securities to perform the role of a required reserve.

Question 13

One reason FIs such as depository institutions and life insurance companies are exposed to liquidity risk is the relatively illiquid nature of their liabilities.

Question 14

In the U.S., excess reserves held at the central bank pay interest to the DI.

Question 15

To reduce liquidity risk an FI can efficiently manage the liability structure of its portfolio.

Question 16

Managing a bank's reserve position requires knowing only the target reserve ratio and the period over which reserves must be maintained.

Question 17

In the U.S., banks can hold cash and government securities to meet reserve requirements.

Question 18

A strategy to lower deposits on Fridays can lower reserve requirements for a bank.

Question 19

In the U.S., cash reserves necessary to meet deposit reserve requirements typically include vault cash and cash deposits at the Federal Reserve Bank.

Question 20

The establishment of minimum required reserves by regulators is a method of extracting taxes from FIs.

Question 21

NOW accounts allow the explicit payment of interest.

Question 22

Demand deposits are a costless source of funds and have a high degree of withdrawal risk.

Question 23

Funding costs generally are positively related to the period of time the liability remains on the balance sheet.

Question 24

Federal Reserve primary credit loans available to DIs are generally at rates lower than the federal funds target rate.

Question 25

The penalty for undershooting the minimum reserve requirements may include explicit interest rate charges as well as implicit costs in the form of more frequent monitoring and examinations.

Question 26

The Fed discount window is an appropriate place to borrow reserve shortfalls because of its lower than market rates.

Question 27

Deposits with low withdrawal risk typically are the lowest cost deposits for a DI.

Question 28

The interbank funds market is a potential source for increasing reserves to meet required reserves.

Question 29

Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.

Question 30

The DI manager can change the pricing on NOW accounts by changing both implicit and explicit interest payments.

Question 31

Implicit interest involves the process of crediting the interest payment directly to a deposit account as opposed to sending an explicit interest check to the customer.

Question 32

One method of increasing reserves to meet a reserve target is to sell liquid assets.

Question 33

If the fees charged on demand deposit accounts do not cover the cost of providing demand deposit services, the bank receives a subsidy or implicit interest payment.

Question 34

One cost of demand deposits to DIs is the reserve requirement placed on the bank by the Federal Reserve.

Question 35

NOW accounts are potentially less prone to withdrawal risk than demand deposits.

Question 36

The contemporaneous reserve accounting system requires the maintenance period to occur simultaneously with the computation period.

Question 37

Up to six percent of excess reserves may be carried forward to the next reserve maintenance period.

Question 38

The DI can influence the withdrawal rates of NOW accounts through explicit interest payments, implicit interest payments, or minimum balance requirements.

Question 39

Excessive amounts of liquid asset holdings can penalize the earnings of a DI.

Question 40

Currently the reserve maintenance period begins 30 days after the end of the reserve computation period.

Question 41

Passbook savings accounts normally receive a lower interest rate than NOW accounts.

Question 42

Because the minimum amount of a negotiable wholesale CD is $100,000, holders of these CDs are fully covered by FDIC insurance.

Question 43

Because of the collateral feature, RPs typically have a higher interest rate than fed funds.

Question 44

In the U.S., a subsidiary bank can issue commercial paper to meet short-term liquidity needs, but the bank's parent holding company cannot.

Question 45

The negotiable instrument characteristic of large wholesale CDs effectively eliminates the adverse withdrawal risk for the bank.

Question 46

Fed funds are short-term uncollateralized loans with maturities that typically do not exceed one day.

Question 47

Passbook savings accounts are less liquid than demand deposit accounts.

Question 48

Federal funds are excess reserves held by the Federal Reserve Banks that are loaned to banks that have liquidity needs.

Question 49

Fed funds are subject to settlement risk, but have little or no early withdrawal risk.

Question 50

The interest rate paid on money market deposit accounts by U.S. DIs must directly reflect the rates earned on investments in commercial paper, bankers acceptances, repurchase agreement, and T-bills.

Question 51

Banks often convert on-balance-sheet bankers acceptances into off-balance-sheet letters of credit for the purpose of minimizing total assets and thus improving performance ratios such as ROA.

Question 52

Because MMDAs are in direct competition with MMMFs, the withdrawal rate is affected by the relative amount of explicit interest paid on these accounts.

Question 53

FIs participating in the fed funds market, either buying or selling, are usually able to do so without amount or maturity restrictions.

Question 54

Most large banks in the U.S. directly issue commercial paper to meet their liquidity needs.

Question 55

Short-term CDs often are priced competitively with T-bills of similar maturity.

Question 56

The advantage to a lender in a repurchase agreement transaction versus a fed funds sale is the collateral of government securities or other acceptable liquid assets provided by the borrowing FI.

Question 57

MMDAs are considered to be more liquid than demand deposits and NOW accounts.

Question 58

In the U.S., MMDAs typically are transaction accounts without limitations on the size or number of checks or transfers that can occur each month.

Question 59

Because of penalties imposed for early withdrawal, a CD depositor is unlikely to withdrawal the CD funds from the bank before maturity.

Question 60

Because retail CDs have fixed maturities, FI managers always should have perfect information regarding the scheduling of interest and principal payments.

Question 61

Reliance on purchased or borrowed funds will largely eliminate the liquidity risk faced by a bank.

Question 62

Required reserve ratios in the U.S. for demand deposits are

A)0 percent, 3 percent, and 10 percent.
B)10 percent on all deposits.
C)3 percent on all deposits.
D)0 percent on all deposits.
E)0 percent and 3 percent.

Question 63

Requiring minimum reserves to be held at the central bank is the equivalent of

A)buffer reserves.
B)a reserve requirement tax.
C)the target reserve ratio.
D)contagious effects of liquidity risk.
E)None of the above.

Question 64

Many states in the U.S. impose liquid asset ratios on insurance companies which may be met by

A)cash and excess reserves.
B)cash and municipal bonds from within the state of operation.
C)cash and government securities.
D)cash and policyholder reserves.
E)cash only.

Question 65

Recently banks have changed the liability structure towards instruments that have less withdrawal risk and higher explicit interest costs.

Question 66

For a DI in the U.S. with $200 in assets and $180 in deposits, a liquid assets ratio of 15 percent

A)would require $27.00 in cash and liquid government securities.
B)would require $27.00 in liquid government securities.
C)would require $30.00 in cash and liquid government securities.
D)would require $30.00 in liquid government securities.
E)None of the above.

Question 67

Managing the reserve position of a U.S. bank requires knowing

A)the target reserve ratio.
B)the time period over which average deposits are calculated.
C)the time period over which average reserves must be maintained.
D)the asset and liability methods that may be used to meet required reserves.
E)All of the above.

Question 68

Which of the following observations is NOT true of a liquid asset?

A)It can be turned into cash quickly.
B)Conversion to cash entails low transaction costs.
C)Conversion to cash happens with little or no loss in principal value.
D)It is traded in an active market.
E)Large transactions may move its market price substantially.

Question 69

Buffer reserves at DIs are

A)reserves in excess of the minimum required reserves.
B)government securities that do not qualify as required reserves, but that can be converted to cash quickly.
C)the portion of reserves that are calculated at a rate of ten percent of deposits.
D)non-government securities and loans that must be converted into cash.
E)the portion of life insurance company assets that require minimum reserves.

Question 70

Property-casualty insurance companies typically have greater liquidity risk than life insurance companies.

Question 71

Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?

A)These assets carry a reserve requirement tax.
B)These assets offer low returns.
C)These assets offer higher returns that reflect their risk.
D)Inflation increases the purchasing power value of these assets.
E)All of the above.

Question 72

Which of the following is an outcome of a decrease in the reserve requirement ratio?

A)DIs must hold more reserves against the transaction accounts on their balance sheets.
B)DIs are able to lend a smaller percentage of their deposits.
C)Decreased credit availability in the economy.
D)A multiple contraction in deposits and a decrease in the money supply.
E)A multiplier effect on the supply of DI deposits and thus, the money supply.

Question 73

The increased securitization of bank loans has reduced the liquidity of bank assets.

Question 74

Although they are subject to reserve requirements, many DIs have begun to issue medium-term notes because they are a stable source of funds.

Question 75

For reserve calculation purposes, the period that begins on a Tuesday and ends on a Monday 14 days later is known as

A)the reserve maintenance period.
B)the reserve allocation period.
C)the reserve computation period.
D)the contemporaneous accounting period.
E)None of the above.

Question 76

Because investment banks typically buy and sell securities on a regular basis; they have no need for a liability management plan.

Question 77

The concept of constrained optimization facing an FI manager involving the minimum amount of liquid reserve assets required by regulators may

A)penalize the FI if the minimum amount is less than the amount warranted by the actual withdrawal risk.
B)benefit the FI if the minimum amount is more than is warranted by actual withdrawal risk.
C)lead to increased withdrawals by depositors that do not meet the minimum requirement.
D)assist the FI manager by providing an optimal target amount of reserves that will exactly match withdrawal expectations.
E)None of the above.

Question 78

Property-casualty insurance companies can reduce their exposure to liquidity risk by diversifying coverage across different types of disasters.

Question 79

Which of the following is considered to be the most liquid asset?

A)T-notes.
B)T-bills.
C)Cash.
D)T-bonds.
E)Wholesale CDs.

Question 80

Which of the following is an outcome of an increase in the reserve requirement ratio?

A)DIs may hold fewer reserves against their transaction accounts.
B)DIs are able to lend out a greater percentage of their deposits.
C)Increased credit availability in the economy.
D)DIs are only able to lend a smaller percentage of their deposits than before.
E)A multiplier effect on the supply of DI deposits and thus the money supply.