Question 1

A bank is considering adding life insurance underwriting to the services it offers.It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively.It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively.The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services.What is the expected standard deviation of the new combination of services?

Accepted Answer

To find the expected standard deviation of the new combination of services, we need to use the formula:

σ_comb = √[w_trad^2*σ_trad^2 + w_under^2*σ_under^2 + 2*w_trad*w_under*ρ*σ_trad*σ_under]

where

w_trad = 0.9 (weight of traditional services)
w_under = 0.1 (weight of underwriting services)
σ_trad = 0.06 (standard deviation of traditional services)
σ_under = 0.10 (standard deviation of underwriting services)
ρ = 0.10 (correlation between services)

Substituting these values, we get:

σ_comb = √[0.9^2*0.06^2 + 0.1^2*0.10^2 + 2*0.9*0.1*0.10*0.06*0.10]

σ_comb = 0.0559 or 5.59%

Therefore, the expected standard deviation of the new combination of services is 5.59%, which is closest to option C (5.59%).

Question 2

A bank is considering adding life insurance underwriting to the services it offers.It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively.It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively.The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services.If the bank is expecting that the overall risk of the bank will be reduced by adding the life insurance underwriting to the bank,what type of effect are they expecting?

Accepted Answer

The bank is expecting a product-line diversification effect by adding life insurance underwriting to its services. This is because the correlation between traditional services and the new underwriting services is only +0.10, indicating low correlation and therefore, diversification. By adding the new service, the bank can reduce its overall risk by spreading its business across different product lines, which can ultimately result in improved financial performance.

Question 3

A financial holding company may include all of the following services except:

Accepted Answer

Corporate liquidation is not typically a service offered by financial holding companies. The other options are commonly offered by financial holding companies.

Question 4

When a bank is expecting that the overall risk of FHC will be reduced when they combine investment banking services with the traditional banking services,what type of effect are they expecting?

Accepted Answer

The bank is expecting a Product-line diversification effect, which occurs when a bank combines different types of banking services, such as investment banking and traditional banking, to reduce overall risk by diversifying its product offerings.

Question 5

Among potential advantages of combining various financial services activities in one FHC,all of the following can be included except:

Accepted Answer

Combining various financial services activities in one FHC may increase earnings fluctuations due to increased exposure to different financial instruments and markets. All other options mentioned (A, B, C, and D) are potential advantages of combining financial services activities in one FHC.

Question 6

A bank would offer insurance services in addition to traditional banking services if it believed in the potential benefits of:

Accepted Answer

Offering insurance services would allow the bank to achieve economies of scope, which means the ability to leverage existing resources and infrastructure to offer a wider range of services. This would allow the bank to increase its revenue without significantly increasing its costs and help to diversify its business.

Question 7

If the correlation between revenues from traditional banking and nontraditional services offered by a bank rises,potential diversification benefits:

Accepted Answer

The correlation between traditional banking and nontraditional services offered by a bank rising indicates that the bank's revenue streams are becoming more interconnected. This, in turn, implies that diversification benefits will fall as the bank's earnings become more dependent on a single source of revenue.

Question 8

Which of the following trust agreements allows the bank trust officer to act on behalf of a living customer?

Accepted Answer

A revocable trust allows the bank trust officer to act on behalf of a living customer. This type of trust is also sometimes referred to as a living trust. In a revocable trust, the customer retains control over the assets and can make changes to the trust at any time during their lifetime. Because the trust is revocable, it can be dissolved if the customer so chooses.

Question 9

The prohibition against combining investment banking and commercial banking activity during the Depression-era,centered on possibly forcing customers seeking loans to buy securities that the IB was trying to sell and increasing the risk exposure of commercial banking firms.

Accepted Answer

The Glass-Steagall Act of 1933, which separated investment banking and commercial banking, aimed to prevent conflicts of interest that could arise when banks combined these activities. One concern was that commercial banks might be pressured by their investment banking arms to lend money to customers for the purpose of buying securities that the investment bank was trying to sell. This could potentially expose the commercial bank to higher levels of risk.

Question 10

Traditionally,the most profitable and best-known investment banking activity is providing client advice.

Accepted Answer

Traditionally, the most profitable and best-known investment banking activity is underwriting securities, such as stocks and bonds, for companies and governments.

Question 11

When a bank is expecting to be able to employ the same managers,employees,and physical resources to offer multiple products and generate costs savings they are expecting which of the following effects?

Accepted Answer

The bank is expecting to benefit from economies of scope, which occur when a firm is able to use the same resources and capabilities to produce and offer multiple products at a lower cost than if it produced each product separately. This is different from economies of scale, which occur when a firm reduces its costs by producing more of a single product. Geographic diversification and product-line diversification are not relevant to the scenario described.

Question 12

Investment bankers are financial advisors to individuals and act as brokers and dealers for those individuals.

Accepted Answer

Investment bankers are primarily financial advisors to corporations and governments, not individuals. They also serve as underwriters for securities issuances and facilitate mergers and acquisitions for clients.

Question 13

A bank is considering adding life insurance underwriting to the services it offers.It has estimated that the expected return and standard deviation of its traditional services are 12 percent and 6 percent respectively.It has also estimated that the expected return and standard deviation of its new underwriting services are 18 percent and 10 percent respectively.The correlation between these services has been estimated to be +0.10 and the bank estimates that 90 percent of its business will be from traditional services and 10 percent from the new underwriting services.What is the expected return of the new combination of services?

Accepted Answer

The expected return of the new combination of services is calculated as a weighted average of the expected returns of the traditional and new services: (0.90 * 12%) + (0.10 * 18%) = 12.60%.

Question 14

Which of the following trust agreements is used to back the issue of securities by a corporation?

Accepted Answer

An indenture trust is a trust agreement that is commonly used to back the issue of securities by a corporation. It outlines the terms and conditions of the securities being offered and specifies the rights of the investors. The trust serves as a form of security for the investors as it holds assets pledged by the corporation to back the securities issued.

Question 15

Which of the following trust agreements allows wealth to be passed free of gift and estate taxes?

Accepted Answer

Only an irrevocable trust allows wealth to be passed free of gift and estate taxes. Revocable trusts do not provide this benefit as the assets are still considered part of the settlor's estate for tax purposes. Charitable trusts can provide tax benefits, but it is not the same as passing wealth free of gift and estate taxes. Indenture trusts are used in finance and have no relation to estate planning.

Question 16

Trust department activities include all of the following except:

Accepted Answer

Trust departments typically do not engage in lending activities; their primary functions include safeguarding assets, generating earnings through investments, managing large deposits, and providing estate and trust services such as preparing wills.

Question 17

A 'Chinese wall' is supposed to prevent the transfer of insider information about clients between the investment banker's security underwriting division and the internal unit where proprietary trading of stocks and bonds takes place.

Accepted Answer

This is correct. A Chinese wall is a term used to describe the separation between investment banking and proprietary trading activities in order to prevent the misuse of insider information.

Question 18

Which of the following is an example of a nondeposit investment product of the bank?

Accepted Answer

A proprietary mutual fund is an example of a nondeposit investment product of the bank. The other options listed are deposit investment products.

Question 19

Customers purchasing nondeposit investment accounts sold by a bank operating in the United States must be told in writing that:

Accepted Answer

Customers must be informed in writing that investment accounts are not insured by the federal government, they are not guaranteed by the depository institution, and they could suffer a loss of principal. Therefore, all options are correct, and the best choice is D.

Question 20

A trust department's activities often center around establishing:

Accepted Answer

A trust department is responsible for managing a customer's assets and investments on their behalf. This requires the establishment of a fiduciary relationship, where the trust department acts in the best interests of the customer and is held to a high standard of care and loyalty. The other options - independent, partnership, and subservient - do not accurately describe the proper relationship between a trust department and its clients.

Quiz 14: Investment Banking, insurance, and Other Sources of Fee Income