Deck 20: Capital Adequacy

Question 1

20-21 Book value accounting systems recognize the impact of credit risk problems sooner than interest rate risk problems.

Answer 1

True

Question 2

20-13 The book value of equity is seldom equal to the market value of equity.

Answer 2

True

Question 3

20-6 One function of capital is to provide funding for real assets,such as branches and technology,that are necessary to provide financial services.

Answer 3

True

Question 4

20-5 The book value of bank equity is the present value of assets minus the present value of liabilities.

Question 5

20-8 The economic definition of the value of an FI's equity is the book value of assets minus the market value of liabilities.

Question 6

20-7 The function of capital to serve as a source of funds is critical to regulators in setting risk-based deposit insurance premiums.

Question 7

20-12 The market value of capital is equal to market value of assets minus the market value of liabilities.

Question 8

20-1 Capital is the primary protection for an FI against the risk of insolvency and failure.

Question 9

20-19 Under Generally Accepted Accounting Principles,FIs have flexible rules in recognizing the amount and timing of loan losses.

Question 10

20-20 When a substandard loan is identified by a regulator,it is required that the loan immediately be charged off by the bank.

Question 11

20-9 Market value of equity is better than book value of equity at reflecting changes in the credit risk and interest rate risk of an FI.

Question 12

20-2 The primary role of capital for an FI is to assure the highest possible return on equity for its shareholders.

Question 13

20-3 Protecting FI insurance funds in the event of an FI failure is the responsibility of taxpayers.

Question 14

20-14 An FI may be insolvent in market value terms even if the book value of equity is positive.

Question 15

20-16 If an FI were closed by regulators before its economic net worth became zero,neither liability holders nor those regulators guaranteeing the claims of liability holders would stand to lose.

Question 16

20-15 Equity holders absorb credit losses on the asset portfolio because liability holders are senior claimants.

Question 17

20-10 If the value of equity is less than zero on a mark-to-market accounting basis,liquidation of the FI would result in losses to the shareholders.

Question 18

20-17 The book value of bonds and loans reflects the market value of those assets when they were placed on the books of an FI.

Question 19

20-4 One function of bank capital is to protect uninsured depositors,bondholders,and creditors in the event of insolvency and liquidation.

Question 20

20-11 If the value of equity is less than zero on a mark-to-market accounting basis,liquidation of the FI may result in losses to the depositors or creditors.

Question 21

20-41 Under Basel II,banks must hold a total capital to credit risk-adjusted assets equal to 8 percent to be adequately capitalized.

Question 22

20-35 The leverage ratio specified under FDICIA protects the depositors and the insurance fund from the effects of risk that may cause the market value of assets to be negative.

Question 23

20-38 Under Basel II,total capital is equal to Tier I capital plus Tier II capital.

Question 24

20-29 The SEC requires securities firms to follow capital rules that utilize market value accounting.

Question 25

20-24 A market to book ratio greater than one indicates that the book value of equity is overstated.

Question 26

20-26 Market value accounting often is said to be difficult to implement because of the amounts of nontraded assets.

Question 27

20-25 Market value accounting often is criticized because the error in market valuation of nontraded assets likely will be greater than the error using the original book valuation.

Question 28

20-22 It is likely that the discrepancy between book value of equity and market value of equity will increase as volatility in interest rates increases.

Question 29

20-28 The implementation of true market value accounting for FIs may have adverse effects on small business finance and economic growth because of the hesitancy of FIs to invest in long-term assets.

Question 30

20-32 The leverage ratio measures the amount of an FI's core capital relative to total assets.

Question 31

20-30 FDICIA required that banks and thrifts adopt the same capital requirements.

Question 32

20-40 Under Basel II,Tier I capital measures the market value of common equity plus the amount of perpetual preferred stock plus minority equity interest held by the bank in subsidiaries minus goodwill.

Question 33

20-39 Under Basel II,the credit risk and interest rate risk of assets on the balance sheet as well as off the balance sheet are differentiated.

Question 34

20-23 More frequent regulatory examinations and stricter regulator standards will cause greater discrepancies in book value of equity and the market value of equity.

Question 35

20-37 Basel I requires banks in the member countries of the Bank for International Settlements to utilize risk-based capital ratios.

Question 36

20-34 Under FDICIA,regulators are required to take prompt corrective action steps when a DI falls outside of Zone 1.

Question 37

20-36 The leverage ratio specified under FDICIA does not account for the risks of off-balance- sheet activities.

Question 38

20-27 Market value accounting is likely to increase the variability of earnings of an FI.

Question 39

20-31 The greater is the leverage ratio,the more highly leveraged is the bank.

Question 40

20-33 Under FDICIA,the ability for regulators to show forbearance is limited by a set of mandatory actions for each level of capital that an FI achieved as measured by the leverage ratio.

Question 41

20-53 The evaluation of credit risk of off-balance-sheet assets under Basel II requires that the notional amount of OBS items be converted to credit equivalent amounts of on-balance-sheet items.

Question 42

20-51 Similar to Basel I,Basel II will require banks to assign on-balance-sheet assets to one of four categories of credit risk exposure.

Question 43

20-50 As compared to Basel I,the standardized approach of Basel II is designed to produce capital ratios that are more in line with the actual economic risks that the DIs are facing.

Question 44

20-46 Basel II attempts to encourage market discipline by having banks disclose capital structure,risk exposures,and capital adequacy in a systematic manner.

Question 45

20-54 Under Basel II,OBS contingent guaranty contracts are assigned the same risk weights as on-balance-sheet principal items to determine their risk-adjusted asset values.

Question 46

20-56 Basel II guidelines for determining credit risk-adjusted on-balance-sheet assets relies more heavily on credit agency ratings than did Basel I.

Question 47

20-49 Under Basel II,the credit risk-adjusted value of the bank's on-balance-sheet assets can be found by adding the products of the risk weights for each asset times the market value of each asset.

Question 48

20-61 In evaluating the risk-adjusted asset value of foreign exchange forward contracts,the value of the current exposure can be either positive or zero.

Question 49

20-59 The risk-adjusted asset values of OBS market contracts or derivative instruments are determined in a manner similar to the risk-adjusted asset values of contingent guarantee claims.

Question 50

20-57 Counterparty credit risk is the risk that the other party of a contract will default on contract obligations.

Question 51

20-42 Under Basel II,regulatory minimum capital requirements for credit,market,and operational risks are covered in the first pillar of the regulation.

Question 52

20-44 Under Basel II,operational risk can be measured by four different approaches.

Question 53

20-52 Under the 2008-2009 TARP Capital Purchase Program,senior preferred shares of stock purchased by the U.S.Treasury are classified as Tier II Capital.

Question 54

20-55 In determining the risk-adjusted value of the on-balance-sheet credit equivalent amounts of the contingent guaranty contracts,the risk weights are determined by the credit rating of the underlying counterparty of the off-balance-sheet activity.

Question 55

20-48 The determination of risk-adjusted on-balance-sheet assets under Basel II requires the segregation of assets into five categories of credit risk exposure.

Question 56

20-58 Counterparty credit risk is more prevalent for exchange-traded derivatives than over-the-counter (OTC)contracts because the bank has more control of its OTC contracts.

Question 57

20-60 Determining risk-adjusted asset values for OBS market contracts requires multiplying the notional values by the appropriate risk weights.

Question 58

20-45 In addition to establishing minimum capital requirements,Basel II proposed procedures to ensure that sound internal process are used to assess capital adequacy and to set targets that are commensurate with the risk profile and environment.

Question 59

20-47 The use of risk-based capital measures under Basel I effectively mark-to-market the bank's on- and off-balance-sheet for the purpose of reflecting credit and market risk.

Question 60

20-43 Under Basel II,banks are allowed to use their internal estimates of borrower creditworthiness to assess credit risk subject to strict disclosure standards.

Question 61

20-63 Operational risk has increased to a point that the BIS will require DIs to account for it in the capital adequacy standards under Basel II.

Question 62

20-67 The risk-based capital ratio does account for loans made to companies with different credit ratings.

Question 63

20-71 In the life insurance model,morbidity risk differs from mortality risk by the circumstances surrounding the actual death event.

Question 64

20-77 Under market value accounting methods,FIs

A)must write down the value of their assets to fully reflect market values.
B)have a great deal of discretion in timing the write downs of problem loans.
C)must conform to regulatory write?down schedules.
D)have an incentive to fully reflect problem assets as they become known.
E)are required to invest in expensive computerized bookkeeping systems.

Question 65

20-65 The Standardized Approach in calculating capital to cover operational risk requires DIs to separate activities into business units from which a capital charge is determined based on the amount of operational risk in each unit.

Question 66

20-75 Regulatory-defined capital and required leverage ratios are based in whole or in part on

A)market value accounting concepts.
B)book value accounting concepts.
C)the net worth concept.
D)the economic meaning of capital.
E)None of the above.

Question 67

20-70 The risk-based capital model in the life insurance industry includes asset risk,business risk,insurance risk,and interest rate risk.

Question 68

20-64 The Basic Indicator Approach in calculating capital to cover operational risk requires banks to hold 12 percent of total assets in capital to cover operational risk exposure.

Question 69

20-62 A deficiency of the risk-based capital ratio is that it measures the ability of a bank to meet both the on- and off-balance-sheet credit risk,but not the interest rate or market risks.

Question 70

20-69 Broker-dealers make very few adjustments to the book value net worth to reach an approximate market value net worth.

Question 71

20-68 The capital requirements for broker-dealers include a net worth market value to assets ratio of at least 2 percent.

Question 72

20-72 In the life insurance model,the ratio of total surplus and capital to the risk-based capital calculation must be greater than or equal to 1.0 for the insurance company to be satisfactorily capitalized.

Question 73

20-76 Each of the following is a function of capital EXCEPT

A)funding the branch and other real investments to provide financial services.
B)protecting the insurance fund and the taxpayers.
C)assuring the highest possible return on equity for the shareholders.
D)protecting uninsured depositors in the event of insolvency and liquidation.
E)absorbing losses in a manner that allows the FI to continue as a going concern.

Question 74

20-79 Through August 2009,approximately which of the following indicates the amount of funds paid back to the U.S.Treasury as part of the TARP Capital Purchase Program?

A)$192 billion.
B)$120 billion.
C)$72 billion.
D)$26 billion.
E)$19 billion

Question 75

20-78 Losses in asset values due to adverse changes in interest rates are borne initially by the

A)equity holders of an FI.
B)liability holders of an FI.
C)regulatory authorities.
D)taxpayers.
E)insured depositors.

Question 76

20-74 The difference between the market value of assets and liabilities is the definition of the

A)accounting value of capital.
B)regulatory value of capital.
C)economic value of capital.
D)book value of net worth.
E)adjusted book value of net worth.

Question 77

20-66 The risk-based capital ratio fails to take into account the effects of diversification in the credit portfolio.

Question 78

20-81 What is the impact on economic capital of a 25 basis point decrease in interest rates if the FI is holding a 20-year,fixed-rate,11 percent annual coupon bond selling at a par value of $100,000?

A)A decrease of $250.
B)An increase of $250.
C)An increase of $2,024.
D)A decrease of $1,959.
E)No impact on capital since the book value is unchanged.

Question 79

20-73 In the property-casualty insurance model,risk-based capital is a function of six different risk categories.

Question 80

20-80 Through August 2009,approximately which of the following indicates the amount of dividends and assessments that the U.S.Treasury has received from entities participating in the TARP Capital Purchase Program?

A)$ 2.1 billion.
B)$ 1.2 billion.
C)$12.2 billion.
D)$16.0 billion.
E)$ 9.5 billion