Deck 12: The Deposit Contract, Deposit Insurance, and Shadow Banking

Question 1

Which of the following statements illustrate the desired effect of market discipline on banks?

A)A consumer, concerned with the activities of the bank, refuses to deposit funds with the bank and other depositors are unconcerned.
B)A group of consumers, concerned with the activities of the bank, refuses to deposit funds and attempt to influence the bank management to alter its activities.
C)A group of commercial or industrial borrowers, concerned with the activities of the bank, refuses to pay and borrow from the bank.
D)A group of consumers, concerned with the activities of the bank, deposits funds with the bank.
E)All of the above

Answer 1

B

Question 2

Low charter values can induce the banks to take on higher risk because

A)low charter values indicate a higher volatility of asset values.
B)low charter values imply a higher likelihood of insolvency and hence a lower bankruptcy cost.
C)low charter values imply a lower likelihood of insolvency and hence a higher bankruptcy cost.
D)low charter values indicate a relatively sound financial condition and hence allow the banks to take on more risk to increase profits.
E)all of the above

Answer 2

B

Question 3

From a macroeconomic standpoint, deposit insurance is desirable because

A)it preserves public confidence in the banking system.
B)it replaces deposits that would otherwise be lost.
C)it improves consumer welfare since the depositors need not monitor the bank anymore.
D)a and b only
E)all of the above

Answer 3

D

Question 4

The reasons) why we need deposit insurance despite the disciplining feature of the uninsured demand deposit contract is are)

A)the action of vigilant and informed depositors can be disruptive as they can discover the bank's project choice only with error.
B)there may be systemic elements in the banks' asset portfolios that may lead to a contagion effect among banks.
C)the banks' managers should be protected from making an incorrect project choice.
D)b and c only
E)a and b only

Question 5

The forces responsible for the banks' risk-taking behavior are

A)banking deregulation which leads to lower charter values.
B)the lax regulatory vigilance over the 1980s.
C)the availability of many derivative and speculative financial products.
D)a and b only
E)all of the above

Question 6

Which of the following factors is the result of the problems associated with the banking and thrift industries?

A)lax regulatory monitoring
B)low charter values due to deregulation
C)risk-insensitive deposit insurance pricing
D)excessive risk-taking behavior
E)all of the above

Question 7

Suppose that a demand deposit contract is not tradable and has a feature of a debt contract.Then,

A)acting in the best interests of the shareholders, the bank's managers have an incentive to engage in an asset-substitution scheme.
B)the moral hazard problem is aggravated by the fact the deposit is not tradable.
C)the bank has an incentive not to monitor the borrowers to whom it has extended loans.
D)all of the above
E)a and b only

Question 8

The reason why the deposit insurance has worked well for so long and its risk-taking incentive problems surfaced only recently is that

A)the banks were not aware of the risk-taking issue and have begun to understand it only recently.
B)the banks were less greedy in the early era of the institutionalization of the deposit insurance.
C)the banks' risk-taking propensity depends on the values of their charter and recent deregulation lowers the values of their charter.
D)the banks' risk-taking propensity increases over time.
E)none of the above

Question 9

A product-based instrument

A)entitles its buyer to purchase the bank service at a price below cost during a prespecified time period.
B)entitles its buyer to a financial claim as well as some non-monetary services.
C)is a contract that calls for an immediate delivery of a prespecified product and imposes a penalty if immediate delivery is not executed.
D)is a financial claim that pays its buyer a prespecified amount given the occurrence of certain events and nothing otherwise
E)none of the above

Question 10

Due to the sequential service constraint and the undefined maturity features, the bank

A)can costlessly raise money to satisfy withdrawals by informed depositors who may have detected a fraud.
B)can costlessly liquidate the loans to satisfy withdrawals by informed depositors who may have detected a fraud.
C)will be deterred from engaging in behaviors that give rise to moral hazard problems.
D)will be encouraged to undertake riskier projects to increase shareholders' wealth.
E)all of the above

Question 11

The reasons) why private arrangements like the Commercial Bank Clearinghouses CBCH) cannot eliminate banking panics is are)

A)the degree of diversification is limited by the size of the group of member banks.
B)the CBCH does not have enough funds to bail out failed banks.
C)there is no reason to completely believe the integrity of the arrangements.
D)a and b only
E)a and c only

Question 12

The moral hazard issues in financial firms differ from those in non-financial firms in the sense that

A)the moral hazard costs in non-financial firms are borne ex ante by the private lenders as well as the borrowers; while in financial firms, the costs are incurred ex post.
B)the moral hazard is priced among the contracting parties in non-financial firms in equilibrium; while in financial firms, the costs are borne by the taxpayers.
C)the moral hazard costs in a financial firms are borne ex post by the private lenders, resulting in a loss of value; while in financial corporations, the costs are borne ex ante, and therefore get priced in equilibrium.
D)the moral hazard costs in non-financial firms are borne ex post by the borrower; while in financial firms, the costs are incurred only to the extent that a project fails.
E)all of the above

Question 13

The debt contract feature of the demand deposit implies that

A)the bank faces a moral hazard problem in dealing with an insured depositor.
B)the bank faces an adverse selection problem in dealing with an uninsured depositor.
C)the bank faces a moral hazard problem in dealing with an uninsured borrower.
D)the uninsured depositor faces a moral hazard problem in dealing with the bank.
E)the uninsured depositor faces a moral hazard problem in dealing with the bank's borrowers.

Question 14

Which of the following factors is the cause of the banking and thrift industries problems?

A)excessive risk-taking by the depository institutions
B)fraud
C)excessive perquisites consumption
D)risk-insensitive deposit insurance pricing
E)all of the above

Question 15

If a demand deposit contract can be withdrawn anytime without penalty, it means that

A)a demand deposit is free of default risk
B)the depositor can sell the contract to the bank at par
C)the maturity is infinitesimal
D)all of the above
E)b and c only

Question 16

The sequential service constraint feature in a deposit contract implies that

A)the amount that the bank pays to a withdrawing depositor depends on what was promised by the bank and on his place in the queue of depositors wishing to withdraw.
B)the amount that the bank pays to a withdrawing depositor depends on what was promised by the bank and how long the queue of withdrawing depositors is.
C)the amount that the bank pays to a withdrawing depositor depends only on what the bank promised.
D)the amount that the bank pays to a withdrawing depositor depends only on how much money the bank has at the time.
E)None of the above

Question 17

A demand deposit contract does not have the following features:

A)it is a debt contract
B)it can be withdrawn at any time without penalty
C)it is traded in a secondary market
D)it is governed by a sequential service constraint
E)all of the above

Question 18

The widespread beliefs that deposit insurance causes a high degree of moral hazard problems in banks are due to

A)the risk-insensitive pricing structure.
B)the call option feature of the deposit insurance which gives the bank a protection from failure and hence increases its propensity to take risk.
C)the put option feature of the deposit insurance which gives the bank a protection from failure and hence increases its propensity to take risk.
D)a and b only
E)a and c only

Question 19

Which of the following factors is important in liability management?

A)credit risk
B)the debt maturity structure
C)diversified sources of funds
D)all of the above
E)b and c only

Question 20

Due to the option feature of the deposit insurance, a higher deposit insurance premium should be imposed on

A)banks that have high interest rate risk.
B)banks that have high capital to total assets ratio and low volatility of asset values.
C)banks that have low capital to total assets ratio and high volatility of asset values.
D)banks that have high liquidity risk.
E)banks that have low loan loss reserves.

Question 21

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Suppose that you are a type L depositor.You assume that all type L depositor will withdraw at t = 1.If you decide to withdraw at t = 1 and happens to be the 100th depositor in the queue, how much will you get?

A)$1.35
B)$1.12
C)$1.00
D)$0.68
E)$0

Question 22

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose you are a type A depositor, your expected payoff from not monitoring is

A)$1.10
B)$1.06
C)$1.044
D)$0.836
E)$0.73

Question 23

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Suppose you are a type L depositor.You assume that all other depositor will withdraw at t = 2.Should you withdraw at t = 1 or t = 2?

A)t = 2 since the payoff is $0.219 higher than withdrawal at t = 1.
B)t = 2 since the payoff is $0.186 higher than withdrawal at t = 1.
C)t = 2 since the payoff is $0.165 higher than withdrawal at t = 1.
D)t = 1 since the payoff is $0.133 higher than withdrawal at t = 2.
E)t = 1 since the payoff is $0.197 higher than withdrawal at t = 2.

Question 24

Use the following information for questions
Consider a bank with federally insured deposits maturing in one year.The bank's asset value changes monthly and you have the following data on asset value for the past three months.Assume that the probability distribution of asset value changes remains stationary over time.The bank's current deposit to asset value ratio is 0.90. $$\begin{array} { | l | l | } \hline \text { Month } & \text { Bank Asset Value } \\\hline 1 & \text { \$ } 105 \text { million } \\\hline 2 & \$ 101 \text { million } \\\hline 3 & \text { \$ 95 million } \\\hline\end{array}$$

-What A is the variance of the logarithmic change in the bank asset values?

A)0.000495
B)0.005945
C)0.006875
D)0.007115
E)0.007304

Question 25

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose you are a type A depositor.You don't monitor and behave like a type P depositor who wishes to withdraw at t = 1.Your expected payoff is

A)$1.10
B)$1.00
C)$0.93
D)$0.88
E)$0.77

Question 26

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
How many projects will have to be liquidated to satisfy t = 1 withdrawals?

A)125
B)95
C)79
D)56
E)44

Question 27

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-If type A depositors do not monitor and the project choice is error-prone, which project would the bank choose?

A)S since it makes the shareholders better off by $80 relative to R.
B)S since it makes the shareholders better off by $7.85 relative to R.
C)R since it makes the shareholders better off by $1.50 relative to S.
D)R since it makes the shareholders better off by $3.75 relative to S.
E)R since it makes the shareholders better off by $27.50 relative to S.

Question 28

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-If type A depositors do not monitor and the project choice is error-free, the expected payoff from choosing project R is

A)$350.00
B)$275.00
C)$223.75
D)$157.50
E)$155.50

Question 29

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Given the scenario in questions 36 and 37, your expected payoff from withdrawing at t=1 if you are a type L depositor is

A)$1.2
B)$1.1
C)$1.0
D)$0.9
E)$0.8

Question 30

Use the following information for questions
Consider a bank with federally insured deposits maturing in one year.The bank's asset value changes monthly and you have the following data on asset value for the past three months.Assume that the probability distribution of asset value changes remains stationary over time.The bank's current deposit to asset value ratio is 0.90. $$\begin{array} { | l | l | } \hline \text { Month } & \text { Bank Asset Value } \\\hline 1 & \text { \$ } 105 \text { million } \\\hline 2 & \$ 101 \text { million } \\\hline 3 & \text { \$ 95 million } \\\hline\end{array}$$

-What A is the cost of deposit insurance per dollar of insured deposits?

A)$0.0028
B)$0.0037
C)$0.0045
D)$0.0055
E)$0.0062

Question 31

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose you are a type A depositor.You don't monitor and behave like a liquidity- motivated type P depositor.If the other type A depositors don't withdraw, your expected payoff is

A)$0.68
B)$0.80
C)$0.93
D)$1.04
E)$1.10

Question 32

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Consider a case with no bank.Each individual invests in his own project.Each individual's expected utility will be

A)$2.202
B)$1.003
C)$0.934
D)$0.685
E)$0.556

Question 33

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose that all type A depositors monitor the bank.The expected payoff to the shareholders from choosing project S is

A)$157.50
B)$155.50
C)$124.00
D)$68.00
E)$31.00

Question 34

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Suppose you are a type L depositor.You assume that all type L depositor will withdraw at t = 1.How long will the queue of depositors have to be before you get nothing i.e., find a constant such that you get nothing if your number in the queue is greater than that constant)?

A)112
B)100
C)78
D)56
E)44

Question 35

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Given the scenario in questions 32 and 33, what is the expected utility of each depositor at t = 0?

A)$1.236
B)$1.042
C)$0.936
D)$0.914
E)$0.899

Question 36

Use the following information for questions
Suppose there are 125 risk averse individuals, each with a $1 to invest in a project at t = 0.The project will yield $1 if liquidated at t = 1 and $2.20 if liquidated at t = 2.At t = 0, no individual knows what his type will be at t = 1.If he turns out to be type D, his utility taction for consumption will be while if he turns out to be type L, his utility for consumption will be .It is known at t = 0 that 40% of the individuals will type D and 60% type L at t = 1.
Given the liquidation in question 32, how much can the bank promise to pay to the remaining depositors at t = 2?

A)$3.243
B)$2.024
C)$1.986
D)$1.650
E)$1.458

Question 37

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-If type A depositors do not monitor and the project choice is error-free, the expected payoff from choosing project S is

A)$430.00
B)$400.00
C)$357.85
D)$211.25
E)$155.00

Question 38

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Given that all type A depositors monitor the bank, the bank would choose project

A)R since it makes the shareholders better off by $31 relative to S.
B)R since it makes the shareholders better off by $68 relative to S.
C)R since it makes the shareholders better off by $88 relative to S.
D)S since it makes the shareholders better off by $57 relative to R.
E)S since it makes the shareholders better off by $93 relative to R.

Question 39

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose you are a type A depositor.You monitor the bank and discover that project S has been chosen.If you wait until t = 1, tour expected payoff at t = 1 is

A)$0
B)$0.86
C)$1.04
D)$1.06
E)$1.10

Question 40

Use the following information for questions
Consider a bank that receives a $1 deposit at t = 0 from each of 250 different depositors.It invests $50 in shareholders' equity in the bank and lends $280, keeping $20 as cash reserves.Out of the 250 depositors, there are 100 active depositors type A) who are capable of monitoring the bank's management; the remaining are passive type P who keep their money for transaction and safekeeping purposes.It costs $0.04 per period for a type A depositor to monitor the bank.The bank has two mutually exclusive projects or loans.Loan R pays $500 with probability 0.7 and zero with probability 0.3 at t = 1.Loan S pays $450 with probability 0.8 and $350 with probability 0.2 at t = 1.If the bank chooses one of these two loans, the probability that the bank will actually end up with that loan is 0.8.With probability 0.2, the bank will have inadvertently chosen the other loan.Monitoring allows the type A depositors to discover the bank's true project choice between t = 0 and t = 1, say at t = 1/2.If so desire, these depositors can force liquidation of the bank at t = 1/2 by withdrawing their deposits.Premature liquidation of the loans at t = 1/2 will yield $88.Under the terms of the deposit contract, the bank promises to pay a 10% interest conditional on the bank having the capacity to do so) if withdrawal occurs at t = 1, and no interest if withdrawal occurs before t = 1.The riskless discount rate is zero and all agents are risk-neutral.Although all type P depositors plan to withdraw at t = 1, each is subject to a random liquidity shock that may motivate them to withdraw at t = 1/2.The fraction of those type P depositors who want to withdraw is known in advance to be 25/150.Bank managers act in the best of the shareholders.

-Suppose you are a type A depositor.You monitor the bank and discover that project R has been chosen, your expected payoff from withdrawing at t = 1/2 is

A)$1.10
B)$1.04
C)$0.96
D)$0.86
E)$0.73

Question 41

Use the following information for questions
Consider a bank with federally insured deposits maturing in one year.The bank's asset value changes monthly and you have the following data on asset value for the past five months.Assume that the probability distribution of asset value changes remains stationary over time.The bank's current deposit to asset value ratio is 0.85. $$\begin{array} { | l | l | } \hline \text { Month } & \text { Bank Asset Value } \\\hline 1 & \$ 110 \text { million } \\\hline 2 & \$ 104 \text { million } \\\hline 3 & \$ 95 \text { million } \\\hline 4 & \$ 102 \text { million } \\\hline 5 & \text { \$ } 100 \text { million } \\\hline\end{array}$$

-What A is the variance of the logarithmic change in the bank asset value?

A)0.16854
B)0.08657
C)0.04533
D)0.03544
E)0.00295

Question 42

The similarity between shadow banking and traditional depository banking is that both involve _______________________________________________________.

Question 43

The funding process for shadow banking involves the following seven elements:

Question 44

Use the following information for questions
Consider a bank with federally insured deposits maturing in one year.The bank's asset value changes monthly and you have the following data on asset value for the past five months.Assume that the probability distribution of asset value changes remains stationary over time.The bank's current deposit to asset value ratio is 0.85. $$\begin{array} { | l | l | } \hline \text { Month } & \text { Bank Asset Value } \\\hline 1 & \$ 110 \text { million } \\\hline 2 & \$ 104 \text { million } \\\hline 3 & \$ 95 \text { million } \\\hline 4 & \$ 102 \text { million } \\\hline 5 & \text { \$ } 100 \text { million } \\\hline\end{array}$$

-What is the cost of deposit insurance per dollar of insured deposits?

A)$0.0224
B)$0.0354
C)$0.0623
D)$0.0707
E)$0.0818