Question 1

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

Accepted Answer

This is the formula for calculating the market value of capital.

Question 2

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.

Accepted Answer

If the value of equity is less than zero, it means the liabilities of the financial institution exceed its assets. In case of liquidation, the assets would need to be sold to pay off the liabilities and any remaining losses would be borne by the shareholders. Hence, they would suffer losses.

Question 3

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

Accepted Answer

The primary role of capital for an FI is to ensure safety and soundness, which includes meeting regulatory capital requirements, managing risk and providing a cushion against unexpected losses. While generating a return on equity is important, it is not the primary purpose of capital for an FI.

Question 4

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

Accepted Answer

The answer of The function of capital to serve as...

Question 5

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

Accepted Answer

When a substandard loan is identified, banks are required to take appropriate actions to mitigate the risk and improve the credit quality of the loan, such as restructuring or increasing collateral. Charging off a loan is a last resort and is only done when all other options have been exhausted.

Question 6

Market value of equity is more appropriate than book value of equity at reflecting changes in the credit risk and interest rate risk of an FI.

Accepted Answer

Market value of equity is based on the current market price of the FI's common stock, which takes into account market perceptions of changes in credit risk and interest rate risk. Book value of equity, on the other hand, is based on the historical cost of assets and liabilities, and may not reflect current market conditions. Therefore, market value of equity is a more appropriate indicator of changes in credit risk and interest rate risk.

Question 7

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

Accepted Answer

The answer of The book value of bonds and loans...

Question 8

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

Accepted Answer

Bank capital serves as a buffer against losses for uninsured depositors, bondholders, and creditors in case of insolvency and liquidation. It provides a cushion of protection for those who would otherwise be left with nothing if the bank were to fail.

Question 9

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

Accepted Answer

Capital provides a cushion for an FI to absorb losses and maintain solvency, making it the primary protection against insolvency and failure.

Question 10

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

Accepted Answer

Protecting FI insurance funds is the responsibility of the Federal Deposit Insurance Corporation (FDIC), not taxpayers. The FDIC is funded by insurance premiums paid by banks and savings institutions, not by taxpayers.

Question 11

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

Accepted Answer

The economic definition of the value of an FI's equity is the market value of assets minus the market value of liabilities, not book value of assets minus the market value of liabilities.

Question 12

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

Accepted Answer

Equity holders are the last to absorb losses, as liability holders (creditors) have senior claims on the assets of a company. Equity holders are considered residual claimants, meaning they only receive what is left after all liabilities have been paid.

Question 13

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

Accepted Answer

The book value of bank equity is calculated as the total value of the bank's assets minus the total value of its liabilities, not the present value of those quantities.

Question 14

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

Accepted Answer

The answer of Under Generally Accepted Accounting Principles,FIs have flexible...

Question 15

Except in cases of extreme credit risk shocks or interest rate risk shocks,the book value of equity is equal to the economic or market value of equity.

Accepted Answer

The book value of equity represents the value of the company's assets minus its liabilities, as reported on the balance sheet. It does not necessarily reflect the true market value of the company or its equity, which can be affected by factors such as future growth potential, market conditions, and investor sentiment. Therefore, in most cases, the book value of equity is not equal to the economic or market value of equity.

Question 16

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

Accepted Answer

This is because book value of equity only represents the historical accounting value of the company's assets and liabilities, while market value takes into account the current market conditions and perceptions of the company's future prospects. If the market believes that the company's assets are overvalued or that it is in financial trouble, it may drive down the stock price and leave the company insolvent even if its book value of equity is positive.

Question 17

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.

Accepted Answer

If the value of equity is negative, it means the liabilities of the FI are greater than its assets. In the event of liquidation, the assets may not be sufficient to pay off the debts, resulting in losses to depositors or creditors.

Question 18

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

Accepted Answer

Capital is one of the main sources of funding for real assets, including physical branches, technology, and equipment needed to provide financial services.

Question 19

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.

Accepted Answer

If an FI is closed by regulators before its economic net worth becomes zero, then the liability holders and the regulators guaranteeing the claims of liability holders are protected and would not stand to lose.

Question 20

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

Accepted Answer

The book value of equity is based on the company's accounting records and reflects historical costs of assets and liabilities. On the other hand, the market value of equity reflects the current market sentiment and expectations for the company's future performance. These two values can differ significantly, especially for companies with valuable intangible assets, growth potential, or market disruptions.

Quiz 20: Capital Adequacy