Question 1

Looking at the Net Interest Margin indicates that the poor bank performance in the late 1980s

Accepted Answer

The answer of Looking at the Net Interest Margin indicates...

Question 2

Assume a bank has $200 million of assets with a duration of 2.5,and $190 million of liabilities with a duration of 1.05.If interest rates increase from 5 percent to 6 percent,the net worth of the bank falls by

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The answer of Assume a bank has $200 million of...

Question 3

All of the following are examples of off-balance sheet activities that generate fee income for banks except

Accepted Answer

Selling negotiable CDs is a type of on-balance sheet activity, as it involves the creation and sale of debt securities that are recorded on the bank's balance sheet. The other options, foreign exchange trades, guaranteeing debt securities, and back-up lines of credit are all examples of off-balance sheet activities that generate fee income for banks.

Question 4

Off-balance sheet activities involving guarantees of securities and back-up credit lines

Accepted Answer

Off-balance sheet activities involving guarantees of securities and back-up credit lines can increase the risk a bank faces. While these activities may not appear on a bank's balance sheet, they can still expose the bank to potential losses if the securities or loans guaranteed default. Additionally, these activities may involve the bank having to provide funding or liquidity in the event of a default, which can also increase its risk exposure.

Question 5

Which of the following is not an example of a backup line of credit?

Accepted Answer

Mortgages are not considered as backup lines of credit as they are typically an initial source of funding for a specific purpose, such as buying a property, rather than a standby source of funding in case of emergencies or unexpected expenses. Loan commitments, overdraft privileges, and standby letters of credit all serve as backup lines of credit that can be accessed when needed.

Question 6

A reason why rogue traders have bankrupt their banks is due to

Accepted Answer

Rogue traders have bankrupt their banks due to a failure to maintain proper internal controls. This means that there were not sufficient safeguards in place to prevent fraudulent or risky trading activities, allowing the rogue trader to take unauthorized risks and cause significant losses for the bank.

Question 7

Most of a bank's operating income results from

Accepted Answer

Interest on assets, such as loans and investments, typically accounts for the majority of a bank's operating income. Service charges and fees may also contribute, but to a lesser extent. Off-balance-sheet activities and standby lines of credit may generate revenue for the bank, but they do not typically account for the majority of operating income.

Question 8

When a bank suspects that a $1 million loan might prove to be bad debt that will have to be written off in the future the bank

Accepted Answer

When a bank suspects that a loan might not be repaid, it can set aside a portion of its earnings in its loan loss reserves account. This is because banks are required to maintain a certain level of reserves to cover potential losses on loans. By setting aside money in the loan loss reserves account, the bank can ensure that it has enough funds to cover any future losses without having to reduce its reported earnings or assets immediately.

Question 9

The quantity interest income minus interest expenses divided by assets is a measure of bank performance known as

Accepted Answer

Net interest margin measures the difference between the interest earned by a bank on its assets and the interest paid out to its lenders and depositors on its liabilities. It is a metric used to evaluate a bank's profitability and efficiency in managing its interest-earning assets.

Question 10

When banks involved in trading activities attempt to outguess markets,they are

Accepted Answer

When banks involved in trading activities attempt to outguess markets, they are speculating, which means making risky bets on the direction of markets with the hope of earning large profits. Forecasting involves predicting future trends, diversifying refers to spreading investments across different assets to reduce risk, and riskless arbitrage involves making profits by exploiting differences in prices of the same asset in different markets.

Question 11

One way for banks to reduce the principal-agent problems associated with trading activities is to

Accepted Answer

By setting limits on the total amount of a trader's transactions, the bank can decrease the risk of the trader taking excessive risks or engaging in unauthorized trading activities, which can lead to adverse consequences for the bank. This helps reduce the principal-agent problems associated with trading activities. Other options such as encouraging traders to take on more risk or reducing regulations on traders can lead to increased risk-taking behaviors and potentially worsen the principal-agent problem. Making sure that the person conducting and recording the trades is the same person can also help reduce the risk of fraudulent activity, but it may not directly address the principal-agent problem associated with excessive risk-taking.

Question 12

Assume a bank has $200 million of assets with a duration of 2.5,and $190 million of liabilities with a duration of 1.05.The duration gap for this bank is

Accepted Answer

Duration gap = (assets duration - liabilities duration)
Duration gap = (2.5 - 1.05)
Duration gap = 1.45 years

Therefore, the duration gap for this bank is 1.5 years. Option C is the correct answer.

Question 13

Traders working for banks are subject to the

Accepted Answer

Traders working for banks are subject to the principal-agent problem, which occurs when the goals of the trader (agent) do not align with the goals of the bank (principal). This can lead to moral hazard and adverse selection issues, where the trader may take on excessive risks or engage in unethical behavior to maximize their own interests at the expense of the bank.

Question 14

If interest rates increase from 9 percent to 10 percent,a bank with a duration gap of 2 years would experience a decrease in its net worth of

Accepted Answer

To calculate the impact on net worth, we can use the following formula:
Change in net worth = (duration gap x change in interest rates x net worth) / (1 + weighted average interest rate)
Here, duration gap = 2 years, change in interest rates = 1 percent (10% - 9%), and weighted average interest rate = (9% + 10%) / 2 = 9.5%
Let's assume the net worth of the bank is $100 million. Using the formula, we get:
Change in net worth = (2 x 1 x 100) / (1 + 0.095) = $17.46 million
As a percentage of assets, this works out to be 17.46%. Therefore, the bank would experience a decrease in its net worth of 1.8% of its assets (not liabilities), which is the closest option.

Question 15

The principal-agent problem that exists for bank trading activities can be reduced through

Accepted Answer

The principal-agent problem arises when the interests of the trading desk (agent) are not aligned with those of the bank (principal). By separating the trading activities from bookkeeping, the bank can more easily monitor the trading activities and ensure they are being conducted in the bank's best interest. This helps to mitigate the principal-agent problem. Internal controls are still necessary to ensure that the trading activities are conducted appropriately. Elimination of regulation or internal controls is not a viable solution as it would increase the risk of misconduct and further exacerbate the principal-agent problem.

Question 16

One of the problems in conducting a duration gap analysis is that the duration gap is calculated assuming that interest rates for all maturities are the same.That means that the yield curve is

Accepted Answer

A flat yield curve implies that interest rates for all maturities are the same, which is the assumption made in conducting a duration gap analysis. If the yield curve is not flat, the duration gap analysis may not accurately reflect the interest rate risk exposure of a financial institution.

Question 17

For banks,

Accepted Answer

Return on equity measures a bank's profitability based on its shareholder's investment, while return on assets measures how efficiently a bank uses its assets to generate profits. If a bank has a higher return on equity than return on assets, it means that the bank is leveraging its equity in order to make more profit, which is a desirable outcome for shareholders. Therefore, option C is the best choice.

Question 18

Banks develop statistical models to calculate their maximum loss over a given time period.This approach is known as the

Accepted Answer

The value-at-risk approach involves the use of statistical models to calculate the maximum amount of loss that can occur within a given time period. Stress-testing and trading-loss approaches are also used for measuring risk but are not specifically related to calculating maximum loss. The doomsday approach is not a recognized term in risk management.

Question 19

All of the following are operating expenses for a bank except

Accepted Answer

Service charges on deposit accounts are actually a source of revenue for a bank, not an operating expense. Choices B, C, and D are all common operating expenses for a bank.

Question 20

When banks calculate the losses the institution would incur if an unusual combination of bad events happened,the bank is using the ________ approach.

Accepted Answer

The stress-test approach is used to calculate the losses that a bank may incur in the event of an unusual combination of bad events. This is done by subjecting the bank's portfolio to various stress scenarios and analyzing the impact of each scenario on the bank's capital and liquidity position. Value-at-risk, trading-loss, and maximum value approaches are not specifically designed to calculate the impact of stress events on a bank's portfolio.

Quiz 10: Banking and the Management of Financial Institutions