Question 1

The use of the option pricing model to determine the actuarially fair premium is difficult to apply in practice because the asset values and risks are difficult to determine.

Accepted Answer

The option pricing model requires accurate estimations of asset values and risks, which can be challenging to determine in practice. Therefore, it can be difficult to apply this model in real-world scenarios.

Question 2

The initial risk-based deposit insurance program implemented on January 1,1993 was based on capital adequacy and supervisory judgments involving asset quality,loan underwriting standards and other operating risks.

Accepted Answer

The statement accurately describes the initial risk-based deposit insurance program implemented on January 1, 1993.

Question 3

More than 90 percent of all insured DIs did not pay deposit insurance premiums in the late 1990s and early 2000s.

Accepted Answer

According to the FDIC, more than 90 percent of all insured DIs did not pay deposit insurance premiums during the period between 1996 and 2006.

Question 4

Requiring higher capital ratios often is proposed as method to reduce the incentive to take excessive risk because the moral-hazard risk-taking incentives are thought to decrease as the amount of net worth increases.

Accepted Answer

Requiring higher capital ratios is often seen as a way to reduce the moral-hazard risk-taking incentives by increasing the net worth of a bank, thereby reducing their incentive to take excessive risk.

Question 5

The policy of capital forbearance practiced by the FSLIC in the late 1980s allowed many commercial banks to remain open even in the face of continuing losses and insolvency.

Accepted Answer

The policy of capital forbearance was practiced by the Federal Savings and Loan Insurance Corporation (FSLIC) primarily on savings and loan institutions (S&Ls), not commercial banks, allowing them to remain open despite insolvency.

Question 6

One of the overall objectives in using subordinated debt in addition to common stock for a DI's capital base is to improve market discipline of a DI's risk structure.

Accepted Answer

Subordinated debt provides a layer of protection for depositors and other creditors, which incentivizes them to monitor the DI's risk-taking behavior more closely. This, in turn, helps to promote market discipline and reduce the likelihood of excessive risk-taking by the bank.

Question 7

The use of the option pricing model to determine the actuarially fair premium for deposit insurance indicates that the cost of the insurance should rely on both the asset size and level of leverage of the DI.

Accepted Answer

The answer of The use of the option pricing model...

Question 8

The cost of insolvency of an FI to the FDIC is offset in part by the deposit insurance premiums paid by the bank.

Accepted Answer

The cost of insolvency of an FI is partially covered by the deposit insurance premiums paid by the bank to the FDIC. This is intended to minimize the burden on taxpayers and ensure that the financial system remains stable. However, the FDIC may still incur losses if the cost of resolving a failed bank exceeds the amount of funds available in the insurance fund. In such cases, the FDIC may need to borrow from the Treasury or seek other sources of funding.

Question 9

The Financial Institutions Reform,Recovery,and Enforcement Act (FIRREA)required the FDIC to establish risk-based premiums for deposit insurance coverage at banks.

Accepted Answer

The answer of The Financial Institutions Reform,Recovery,and Enforcement Act (FIRREA)required...

Question 10

The improved financial health of the FDIC during the 1990s resulted in a considerable reduction in deposit insurance premiums.

Accepted Answer

The improved financial health of the FDIC during the 1990s did result in a considerable reduction in deposit insurance premiums.

Question 11

The regulatory practice of excessive capital forbearance is a method of reducing the short-run and long-run costs to deposit insurance funds.

Accepted Answer

The regulatory practice of excessive capital forbearance may increase the short-run profits of banks, but it can also increase the long-run costs to deposit insurance funds as it reduces the amount of capital available to absorb losses.

Question 12

The use of subordinated debt as a replacement for common stock has been proposed as a method of increasing stockholder discipline.

Accepted Answer

The answer of The use of subordinated debt as a...

Question 13

Currently in the U.S. ,deposit insurance premiums increase with the amount of risk of the institution.

Accepted Answer

Deposit insurance premiums are determined based on the risk level of the financial institution. Higher risk institutions will pay higher premiums to insure their deposits.

Question 14

Pricing deposit insurance premiums to reflect increases in risk-taking by financial institutions is one method to reduce incentives to take risks.

Accepted Answer

Pricing deposit insurance premiums to reflect increases in risk-taking by financial institutions can make it more expensive for them to take risks, which can discourage such behavior.

Question 15

The ability of the FDIC to place a bank into receivership even though the book value of capital remains positive is an attempt to institute increased stockholder discipline.

Accepted Answer

The FDIC's ability to place a bank into receivership even though the book value of capital remains positive is intended to increase stockholder discipline. This is because it forces stockholders to take responsibility for the bank's performance and make changes to prevent insolvency.

Question 16

The Designated Reserve Ratio is a rule that stipulates that highly-rated DIs would not pay deposit insurance premiums if this ratio was above 0.25 percent.

Accepted Answer

The Designated Reserve Ratio (DRR) is a target set by the FDIC for the Deposit Insurance Fund (DIF), not a rule about premium payments by highly-rated depository institutions (DIs) based on the ratio being above 0.25 percent. Premiums are determined by a variety of factors, not just the DRR.

Question 17

Because deposit insurance premiums were not priced in an actuarially fair manner during the period from 1933-1980s,instability was created in the credit and monetary system.

Accepted Answer

The answer of Because deposit insurance premiums were not priced...

Question 18

The prompt corrective action program of the FDIC Improvement Act allows a bank or thrift to be placed into receivership when the book value of capital to assets falls below 2 percent.

Accepted Answer

The FDIC Improvement Act requires a bank or thrift to be placed into receivership when the book value of capital to assets falls below 2 percent as part of its prompt corrective action program.

Question 19

The provision of deposit insurance is similar to the FDIC selling a call option on the assets of a bank allowing the FDIC to exercise the option and seize the bank's assets if the bank becomes insolvent.

Accepted Answer

Deposit insurance, provided by the FDIC, is more akin to the FDIC offering protection to depositors against the loss of their deposits if a bank fails, rather than the FDIC having an option to seize a bank's assets. The primary purpose is to maintain public confidence in the banking system, not to give the FDIC an option to acquire assets.

Question 20

Risk-based capital supports risk-based deposit insurance premiums by increasing the cost risk taking for DI stockholders.

Accepted Answer

Risk-based capital requirements require banks to hold more capital for riskier assets, which increases the cost of risk-taking for DI stockholders. This, in turn, supports the use of risk-based deposit insurance premiums, where banks that take on more risk pay higher insurance premiums.

Quiz 19: Deposit Insurance and Other Liability Guarantees