Deck 12: The Effective Use of Capital

Question 1

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%.

Answer 1

A

Question 2

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.

Answer 2

B

Question 3

Use the following information for questions
$\begin{array}{l|r|l|lr}\text { Bank Assets }&&\text { Bank Liabilities }\\\hline\text { Cash and Treasury Securities } & \$ 2,500 & \text { Deposits } & \$ & 13,800 \\\hline \text { Repurchase Agreements } & \$ 1,000 & \text { Subordinated Debt } & \$ & 250\\\hline \text { Municipal Bonds } & \$ 1,500 & \text { Cumulative Preferred Stock } & \$ & 200 \\\hline \text { Single Family Home Mortgages } & \$ 2,700 & \text { Common Stock } & \$ & 100 \\\hline \text { Commercial Loans } & \$ 4,000 & \text { Common Stock Surplus } & \$ & 300\\\hline\text { Agricultural Loans } & \$ 1,500 & \text { Retained Earnings } & \$ & 350 \\\hline \text { Allowance for Loan Loss } & \$(350) & & &\\\hline \text { Bank Buildings } & \$ 2,000 \\\hline \text { Goodwill } & \$ 150 \\\hline \text { Total } & \$ 15,000&&\$15,000\\\end{array}$

-The tangible common equity (TCE) ratio for this bank is:

A) 4.00%
B) 4.04%
C) 5.00%
D) 5.05%
E) 5.39%

Answer 3

4.04%

Question 4

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 5

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 6

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

A) common stockholder's equity.
B) equity in subsidiaries.
C) goodwill.
D) allowance for loan and lease losses.
E) noncumulative perpetual preferred stock.

Question 7

Supplementary or Tier 2 capital does not include:

A) hybrid capital instruments
B) intermediate-term preferred stock
C) cumulative perpetual preferred stock
D) long-term preferred stock
E) noncumulative perpetual preferred stock

Question 8

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 9

Use the following information for questions
$\begin{array}{c|c|r|c}{\text { Bank Assets }} && \text { RIsk Welght } &\text { Rlsk-A dJusted Assets }\\\hline \text { Cash and Treasury Securities } & \$ 2,000 & 0 \%&\$-\\\hline \text { Repurchase Agreements } & \$ 1,000 & 20 \% &\$ 200 \\\hline \text { Munic ipal Bonds } & \$ 1,500 & 20 \% & \$ 300 \\\hline \text { Single Family Home Mortgages } & \$ 2,700 & 50 \% & \$ 1,350 \\\hline \text { CMOs } & \$ 2,500 & 50 \% & \$ 1,250 \\\hline \text { Commercial Loans } & \$ 1,500 & 100 \% & \$ 1,500 \\\hline \text { Agricultural Loans } & \$ 2,100 & 100 \% & \$ 2,100\\\hline \text { Allowance for Loan Loss } & \$(300) & 0 \% &\$-\\\hline \text { Bank Buildings } & \$ 2,000 & 100 \% &\$2,000\\\hline \text { Total } & \$ 15,000 &&\$8,700\end{array}$

-The minimum Tier 1 capital for this bank is:

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

Question 10

Use the following information for questions
$\begin{array}{c|c|r|c}{\text { Bank Assets }} && \text { RIsk Welght } &\text { Rlsk-A dJusted Assets }\\\hline \text { Cash and Treasury Securities } & \$ 2,000 & 0 \%&\$-\\\hline \text { Repurchase Agreements } & \$ 1,000 & 20 \% &\$ 200 \\\hline \text { Munic ipal Bonds } & \$ 1,500 & 20 \% & \$ 300 \\\hline \text { Single Family Home Mortgages } & \$ 2,700 & 50 \% & \$ 1,350 \\\hline \text { CMOs } & \$ 2,500 & 50 \% & \$ 1,250 \\\hline \text { Commercial Loans } & \$ 1,500 & 100 \% & \$ 1,500 \\\hline \text { Agricultural Loans } & \$ 2,100 & 100 \% & \$ 2,100\\\hline \text { Allowance for Loan Loss } & \$(300) & 0 \% &\$-\\\hline \text { Bank Buildings } & \$ 2,000 & 100 \% &\$2,000\\\hline \text { Total } & \$ 15,000 &&\$8,700\end{array}$

-The minimum total capital for this bank is:

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

Question 11

Which of the following was not part of the Basel 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 12

When the final Basel III rules are implemented in 2019, the minimum Tier 1 capital/risk-weighted assets percentage will be:

A) 4%
B) 6%
C) 8%
D) 8.5%
E) 10.5%

Question 13

Use the following information for questions
$\begin{array}{l|r|l|lr}\text { Bank Assets }&&\text { Bank Liabilities }\\\hline\text { Cash and Treasury Securities } & \$ 2,500 & \text { Deposits } & \$ & 13,800 \\\hline \text { Repurchase Agreements } & \$ 1,000 & \text { Subordinated Debt } & \$ & 250\\\hline \text { Municipal Bonds } & \$ 1,500 & \text { Cumulative Preferred Stock } & \$ & 200 \\\hline \text { Single Family Home Mortgages } & \$ 2,700 & \text { Common Stock } & \$ & 100 \\\hline \text { Commercial Loans } & \$ 4,000 & \text { Common Stock Surplus } & \$ & 300\\\hline\text { Agricultural Loans } & \$ 1,500 & \text { Retained Earnings } & \$ & 350 \\\hline \text { Allowance for Loan Loss } & \$(350) & & &\\\hline \text { Bank Buildings } & \$ 2,000 \\\hline \text { Goodwill } & \$ 150 \\\hline \text { Total } & \$ 15,000&&\$15,000\\\end{array}$

-How much Tier 1 capital does the bank have?

A) $100
B) $400
C) $450
D) $750
E) $950

Question 14

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 15

Prior to the Basel 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.

Question 16

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 17

Which of the following is not part of Tier 1 or core capital?

A) minority interests in equity capital of consolidated subsidiaries.
B) common stockholders equity
C) cumulative perpetual preferred stock.
D) noncumulative perpetual preferred stock.
E) All of the above are part of Tier 1 or core capital..

Question 18

Use the following information for questions
$\begin{array}{l|r|l|lr}\text { Bank Assets }&&\text { Bank Liabilities }\\\hline\text { Cash and Treasury Securities } & \$ 2,500 & \text { Deposits } & \$ & 13,800 \\\hline \text { Repurchase Agreements } & \$ 1,000 & \text { Subordinated Debt } & \$ & 250\\\hline \text { Municipal Bonds } & \$ 1,500 & \text { Cumulative Preferred Stock } & \$ & 200 \\\hline \text { Single Family Home Mortgages } & \$ 2,700 & \text { Common Stock } & \$ & 100 \\\hline \text { Commercial Loans } & \$ 4,000 & \text { Common Stock Surplus } & \$ & 300\\\hline\text { Agricultural Loans } & \$ 1,500 & \text { Retained Earnings } & \$ & 350 \\\hline \text { Allowance for Loan Loss } & \$(350) & & &\\\hline \text { Bank Buildings } & \$ 2,000 \\\hline \text { Goodwill } & \$ 150 \\\hline \text { Total } & \$ 15,000&&\$15,000\\\end{array}$

-How much Tier 2 capital does the bank have?

A) $200
B) $450
C) $550
D) $800
E) $1100

Question 19

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 20

Which of the following is included in regulatory capital but not accounting capital?

A) Capital reserve for contingencies
B) Preferred stock
C) Subordinated debt
D) Surplus
E) All of the above are included in both regulatory and accounting capital

Question 21

Which of the following is false regarding bank preferred stock?

A) Preferred stock investor claims are senior to those of common stockholders.
B) All preferred stock investors pay taxes on only 20% of dividends.
C) Most preferred stock issues are adjustable-rate perpetual stock.
D) Preferred stock has the same disadvantages as common stock.
E) None of the statements is false.

Question 22

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

Question 23

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 24

Decreasing capital increases risk by decreasing financial leverage.

Question 25

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) 0.2925%
B) 2.935%
C) 0.1075%
D) 1.075%
E) 1.367%

Question 26

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 27

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

Question 28

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 29

Regulatory capital ratios focus on the book value of equity.

Question 30

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 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%.
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 32

Banks can circumvent capital requirements by moving assets off the books.

Question 33

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 34

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 35

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 36

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 37

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 38

Which of the following is not a Category 1 (Risk Rate = 0%) balance sheet asset?

A) Currency in transit.
B) U.S. Treasury securities.
C) Cash items in the process of collection.
D) Claims unconditionally guaranteed by the U.S. government.
E) All of the above are Category 1 (Risk Rate = 0%) assets.

Question 39

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

Question 40

Approximately what percentage of commercial banks were currently considered well capitalized at the end of 2007?

A) 94%
B) 84%
C) 74%
D) 64%
E) 54%

Question 41

What constitutes Tier 2 capital varies substantially between countries.

Question 42

Discuss the rationale behind risk-based capital requirements.

Question 43

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

Question 44

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

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

Explain Tier 3 Capital Requirements for market risk under Basel I.

Question 49

Discuss the TARP Capital Purchase Program.