Deck 12: The Effective Use of Capital

Question 1

Prior to the Basle Agreement, capital requirements were established without regard to:

A)the bank's liquidity risk.
B)the bank's asset quality.
C)the size of the bank's assets.
D)the bank's operational risk.
E)the bank's interest rate risk.

Answer 1

C

Question 2

Prior to the Basle Agreement, secondary capital included which of the following?

A)The allowance for loan losses
B)Limited-life preferred stock
C)Long-term subordinated debt
D)All of the above
E)b.and c.

Answer 2

B

Question 3

Prior to the Basle Agreement, primary capital included all of the following except:

A)long-term subordinated debt.
B)common stock.
C)undivided profits.
D)perpetual preferred stock.
E)the allowance for loan losses.

Answer 3

A

Question 4

Use the following information for questions

What is the amount of risk-adjusted assets for the bank?

A)$7,700
B)$8,700
C)$9,700
D)$14,700
E)$15,700

Question 5

To be considered adequately capitalized, a bank's minimum Tier 1 capital, total capital, and leverage capital must be:

A)4%, 8%, and 3%, respectively.
B)8%, 5%, and 3%, respectively.
C)10%, 10%, and 10%, respectively.
D)6%, 10%, and 5%, respectively.
E)3%, 4%, and 8%, respectively.

Question 6

How does bank capital reduce bank risk?

A)It provides a cushion for firms to absorb losses.
B)It creates unlimited growth opportunities.
C)It limits access to the financial markets.
D)All of the above.
E)a.and b.

Question 7

Tier 2 capital consists of all of the following except:
a.30-year subordinated debt.
b.cumulative perpetual preferred stock.
c.mandatory convertible preferred stock.
d.preferred stock with a maturity of 7 years.
e.equity in subsidiaries.

Question 8

Under current capital requirements, Tier 1 Capital takes of all of the following into account except:

A)common stockholder's equity.
B)equity in subsidiaries.
C)goodwill.
D)mandatory convertible debt.
E)non-cumulative perpetual preferred stock.

Question 9

Under the current capital requirements, assets in Category 2, such as repurchase agreements, have an effective total capital-to-total-assets ratio of:

A)1.6%.
B)2.0%.
C)4.0%.
D)8.0%.
E)8.6%.

Question 10

A bank that does not meet the minimum levels for Tier 1 capital, total capital, and leverage capital ratios is classified as:

A)well-capitalized.
B)adequately capitalized.
C)undercapitalized.
D)significantly undercapitalized.
E)critically undercapitalized.

Question 11

The minimum Tier 1 capital for this bank is:

A)$348
B)$450
C)$509
D)$581
E)$696

Question 12

Under the current capital requirements, assets in Category 3, such as 1-4 family real estate loans, have an effective total capital-to-total-assets ratio of:

A)1.6%.
B)2.0%.
C)4.0%.
D)8.0%.
E)8.6%.

Question 13

Use the following information for questions

The minimum leverage capital for this bank is:

A)$348
B)$450
C)$509
D)$581
E)$696

Question 14

What is the total amount of the bank's regulatory capital?

A)$500
B)$700
C)$750
D)$1,000
E)$1,300

Question 15

Which of the following was not part of the Basle Agreement?

A)Bank's required capital was linked to its composition of assets.
B)Banks are required to operate with a minimum level of equity.
C)The ownership of equity by banks was prohibited.
D)Capital requirements across countries were standardized.
E)The minimum total capital requirements were set to 8% of risk-adjusted assets.

Question 16

Use the following information for questions

How much Tier 1 capital does the bank have?

A)$100
B)$450
C)$700
D)$750
E)$1000

Question 17

To be considered well-capitalized, a bank's minimum Tier 1 capital, total capital, and leverage capital must be:

A)4%, 8%, and 3%, respectively.
B)8%, 5%, and 3%, respectively.
C)10%, 10%, and 10%, respectively.
D)6%, 10%, and 5%, respectively.
E)3%, 4%, and 8%, respectively.

Question 18

Banks with greater capital can do all of the following except:

A)borrow at lower rates.
B)make larger loans.
C)expand faster through acquisitions.
D)expand faster through internal growth
E)Banks with greater capital can do all of the above.

Question 19

Community banks are typically considered those banks with assets:

A)over $100 billion.
B)between $50 billion and $99 billion.
C)between $10 billion and $49 billion.
D)between $1 billion and $9 billion.
E)under $1 billion.

Question 20

The minimum total capital for this bank is:

A)$348
B)$450
C)$509
D)$581
E)$696

Question 21

The Basel Committee defines operational risk as the risk of loss resulting from:

A)changes in interest rates.
B)changes in inflation.
C)inadequate internal processes.
D)excessive default risk.
E)inadequate capital.

Question 22

For a bank with deficient capital ratios, which of the following actions could be taken to increase the capital ratios, holding everything else the same?

A)Cut the bank's dividend payment.
B)Increase the bank's burden.
C)Repurchase the bank's common stock on the open market.
D)Increase the bank's growth rate by making additional commercial loans.
E)Reduce the bank's holdings of Treasury securities.

Question 23

Use the following information for questions
A bank currently just meets its total capital requirements of 8%.The bank currently has a dividend payout ratio of 35%.Assets are expected to grow at 5%.
If the bank expects its ROA to be .45%, what is the maximum dividend payout ratio to support the increase in assets?

A)11.1%
B)22.2%
C)33.3%
D)44.4%
E)89.9%

Question 24

In general, smaller banks have higher capital ratios than larger banks.

Question 25

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.
E)It increases bank leverage.

Question 26

Which of the following is true regarding subordinated debt?

A)Subordinated debt claims come before the claims of depositors.
B)Principal payments are not mandatory.
C)Transaction costs on issuing new debt are lower than when issuing new equity.
D)Interest payments on subordinated debt are tax-deductible.
E)New subordinated debt dilutes existing shareholder equity.

Question 27

Which of the following is a hybrid form of equity that effectively pays dividends that are tax deductible and is considered Tier 1 capital?

A)Common stock
B)Preferred stock
C)Trust preferred stock
D)Leases
E)Trust subordinated debt

Question 28

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.

Question 29

Approximately what percentage of commercial banks are currently considered well capitalized at the end of 2007?
a.97%
b.87%
c.77%
d.67%
e.57%

Question 30

Regulatory capital ratios focus on the book value of equity.

Question 31

Use the following information for questions
A bank currently just meets its total capital requirements of 8%.The bank currently has a dividend payout ratio of 35%.Assets are expected to grow at 5%.
What is the required ROA to support the growth in assets?

A)0.62%
B)0.65%
C)0.68%
D)0.72%
E)0.75%

Question 32

Decreasing capital increases risk by decreasing financial leverage.

Question 33

A significantly undercapitalized bank is one that does not meet the minimum levels for all three capital ratios.

Question 34

Which of the following is not a historical problem with deposit insurance?

A)Deposit insurance is a substitute for some functions of bank capital.
B)Some banks are considered Too-Big-To-Fail.
C)Historically, deposit insurance premium levels have been insufficient to cover potential payouts.
D)Historically, deposit insurance premiums were not assessed against all of a bank's insured liabilities.
E)All of the above are historical problems with deposit insurance.

Question 35

In general, bank capital ratios have increased over the last 100 years.

Question 36

How do capital requirements constrain bank growth?

A)By discouraging investments in Treasury securities.
B)By disallowing the ownership of mortgage loans.
C)By decreasing a bank's net interest margin.
D)By limiting the amount of new assets that a bank can acquire through debt financing.
E)By reducing a bank's CAMELS ratings.

Question 37

For banks that have insufficient capital, which of the following is not a typical operating strategy to achieve capital adequacy?

A)Limit asset growth
B)Shrink the bank
C)Increase the dollar amount of commercial loans outstanding
D)Shift more bank assets into lower risk categories.
E)Reprice assets to reflect greater equity support

Question 38

Which of the following is not a weakness of risk-based capital standards?

A)They ignore interest rate risk.
B)They ignore the value of deposit insurance.
C)They ignore changes in the market value of assets.
D)They ignore credit risk.
E)They ignore the value of a bank's charter.

Question 39

Use the following information for questions
A bank currently just meets its total capital requirements of 8%.The bank currently has a dividend payout ratio of 35%.Assets are expected to grow at 5%.
If the bank expects its ROA to be .45% and the bank does not wish to change its dividend payout ratio from 35%, how much new equity capital (as a percent of total assets) must the bank issue to support the growth in assets?

A)0.001075%
B)0.01075%
C)0.1075%
D)1.075%
E)10.75%

Question 40

Which of the following is not true regarding common stock?

A)Common stock has no maturity.
B)New issues of common stock may dilute existing shareholder equity.
C)Common stock is a permanent source of funds.
D)Dividends paid are not tax-deductible.
E)Dividends are considered a fixed charge that must be paid.

Question 41

Discuss the "three-pillars" in Basel II.

Question 42

Discuss the rationale behind risk-based capital requirements.

Question 43

What constitutes Tier 2 capital varies substantially between countries.

Question 44

Under the current risk-based capital requirements, banks must hold capital against standby letters of credit they have issued as guarantees.

Question 45

A bank that holds only U.S.Treasury securities is not required to hold any capital since all the assets are risk-less.

Question 46

Smaller banks rely more heavily on internally generated capital than larger banks.

Question 47

What are some of the weaknesses behind risk-based capital standards?

Question 48

An adequately capitalized bank may obtain brokered deposits without FDIC approval.

Question 49

What is "moral hazard" and what is its impact on deposit insurance?

Question 50

Why do smaller banks often have a more difficult time raising new capital compared to larger banks?