Banking and Financial Institutions
Question Bank
Course Introduction
This course provides an in-depth exploration of the structure, functions, and operations of banking and financial institutions within the broader financial system. Students will examine the roles commercial banks, investment banks, credit unions, and other financial intermediaries play in channeling funds, facilitating payments, managing risk, and supporting economic growth. Key topics include regulatory frameworks, types of financial services, asset and liability management, risk assessment, and the impact of technological advancements on the industry. Case studies and real-world examples will help students understand contemporary challenges, such as financial crises, monetary policy implications, and the evolving landscape of digital banking.
Recommended Textbook
Financial Markets and Institutions 6th Edition by Anthony Saunders
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Chapter 1: Introduction
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Q1) The New York Stock Exchange (NYSE)is an example of a secondary market.
A)True
B)False
Answer: True
Q2) Discuss how secondary markets benefit funds issuers.
Answer: The secondary markets provide liquidity to investors after their initial purchase of the security. This liquidity encourages them to purchase the security at the initial offer. The current market price also reflects current prospects for the firm and the competitiveness of the issue relative to similar securities. Corporate treasurers follow their stocks' price closely because the stock price reflects how well their firm and the market are performing. The current security price also provides information about the cost of obtaining any additional funds.
Q3) Secondary markets are markets used by corporations to raise cash by issuing securities for a short time period.
A)True
B)False
Answer: False
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Chapter 2: Determinants of Interest Rates
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Q1) For any positive interest rate the present value of a given annuity will be less than the sum of the cash flows,and the future value of the same annuity will be greater than the sum of the cash flows.
A)True
B)False
Answer: True
Q2) The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.
A)True
B)False
Answer: True
Q3) Earning a 5 percent interest rate with annual compounding is better than earning a 4.95 percent interest rate with semiannual compounding.
A)True
B)False
Answer: False
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Chapter 3: Interest Rates and Security Valuation
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Q1) An investor is considering purchasing a Treasury bond with a 16-year maturity,a 6 percent coupon and a 7 percent required rate of return. The bond pays interest semiannually.
a. What is the bond's modified duration?
b. If annual promised yields decrease 30 basis points immediately after the purchase,what is the predicted price change in dollars based on the bond's duration?
Answer: a. The bond's price is $908.04 and the bond's modified duration is found as [(txCF<sub>t</sub>/(1.035))<sup>t</sup>]/($904.66 × 2)= 10.19 years duration; Modified duration = 10.19/1.035 = 9.85 years
b. With a decrease of 30 basis points in annual promised yields: Predicted D Bond Price = -9.85 × -.0030 = 2.95% or a $ price change of 0.0295 × $904.66 = $26.72
Q2) Any security that returns a greater percentage of the price sooner is less price-volatile.
A)True
B)False Answer: True
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Chapter
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Q1) What does the 2004 Check 21 law allow? Why was this law passed? Does it benefit the customer or banks? Explain.
Q2) A bank has $770 million in checkable deposits. The bank has $85 million in reserves. The bank's required reserves are _____________ and its excess reserves are _____________.
A)$85 million; $0
B)$770 million; $85 million
C)$89 million; $21 million
D)$685 million; $8.5 million
E)$77 million; $8 million
Q3) The Fed wishes to expand the money supply. What three things can it do? Which has the most predictable effects? Be specific.
Q4) Suppose that oil prices hit an all-time high of $200 a barrel,driving U.S. inflation up to 7 percent per year. At the same time,weak U.S. growth and increasing foreign competition has generated unacceptably high levels of unemployment in the United States. You are the chair of the Federal Reserve. What do you suggest?
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Chapter 5: Money Markets
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Q1) LIBOR is generally _______________ the Fed funds rate because foreign bank deposits are generally ________________ domestic bank deposits.
A)greater than; less risky than B)less than; riskier than C)the same as; of equal risk to D)greater than; riskier than E)less than; less risky than
Q2) Eurodollar CDs would include A)CDs denominated in euros.
B)dollar investments by European entities in the United States.
C)dollars deposited in Caribbean banks.
D)dollars deposited in Europe.
E)dollars deposited in Caribbean banks and dollars deposited in Europe.
Q3) The U.S. Treasury switched from a discriminating price auction to a single price auction because the latter lowered the average price paid by investors.
A)True B)False
Q4) How does a repo differ from a Fed funds transaction? How do their rates compare?
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Chapter 6: Bond Markets
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Q1) Revenue bonds are backed by the full revenue of the municipality.
A)True
B)False
Q2) The quoted ask yield on a 30-year $1,000 par T-bond with a 6.25 percent coupon and a price quote of 106: 16 is ___________ (use semiannual compounding).
A)2.94 percent
B)2.90 percent
C)5.79 percent
D)5.87 percent
E)4.95 percent
Q3) Treasury notes and bonds and municipal bonds are default risk free.
A)True
B)False
Q4) What ratings comprise investment-grade bonds and what ratings are used for junk bonds?
What are the primary differences between the two?
In particular,why are investment-grade bonds more marketable and why are junk bonds issued at all?
Q5) What is the difference between General Obligation and Revenue bonds?
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Chapter 7: Mortgage Markets
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Q1) Who are the major buyers of mortgages after they have been originated? What is the difference between selling with recourse or without recourse? Which is most common?
Q2) How does GNMA improve mortgage marketability?
Q3) If parents give their son $20,000 for a down payment,what is the most he can pay on a house with a 15-year mortgage if the interest rate is 5.50 percent?
Q4) If mortgage rates are 6.25 percent for a 30-year fixed-rate mortgage,how large can his mortgage be?
Q5) A homeowner can obtain a $250,000,30-year fixed-rate mortgage at a rate of 6.0 percent with zero points or at a rate of 5.5 percent with 2.25 points. If you will keep the mortgage for 30 years,what is the net present value of paying the points (to the nearest dollar)?
A)$9,475
B)$8,360
C)$7,564
D)$7,222
E)$6,578
Q6) Why do mortgage lenders prefer ARMs while many borrowers prefer fixed-rate mortgages,ceteris paribus.
Page 9
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Chapter 8: Stock Markets
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Q1) The NYSE recently merged with the London Stock Exchange to form the merged company NYSE Euronext.
A)True
B)False
Q2) Which of the following information is NOT usually found in a Wall Street Journal stock quote?
A)dividend yield
B)price-earnings ratio
C)closing price of the stock
D)stock rating
E)ticker symbol
Q3) A seasoned equity offering occurs when an issuer that already has equity publicly trading issues new shares to the public.
A)True
B)False
Q4) What are the major effects of the Sarbanes-Oxley Act (SO)of 2002 on the stock markets?
What else has the NYSE done to improve corporate governance?
Q5) What are the advantages and disadvantages of foreign investing? How does an ADR help overcome the disadvantages?
Page 10
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Chapter 9: Foreign Exchange Markets
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Q1) The ongoing accumulation of foreign currency reserves by foreign monetary authorities contributed to the dollar's drop in 2006.
A)True
B)False
Q2) If the United States has inflation of 3 percent and Europe has inflation of 5 percent,the value of the euro should increase,ceteris paribus.
A)True
B)False
Q3) During much of the 1800s,developed nations employed what came to be known as the Bretton Woods international monetary system to manage exchange rates.
A)True
B)False
Q4) If you can convert 150 Swiss francs to $90,the exchange rate is 1.67 francs per dollar. A)True
B)False
Q5) Explain how a drop in the value of the dollar could affect the U.S. import and export sectors.
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Chapter 10: Derivative Securities Markets
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Q1) FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public.
Q2) FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public.
Q3) When might an option on a futures contract be preferable to an option on the underlying instrument?
Q4) A contract that gives the holder the right to sell a security at a preset price only immediately before contract expiration is a(n)
A)American call option.
B)European call option.
C)American put option.
D)European put option.
E)knockout option.
Q5) If you think that interest rates are likely to rise substantially over the next several years,you might sell a T-bond futures contract or buy an interest rate cap to take advantage of your expectations.
A)True
B)False
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Chapter 11: Commercial Banks: Industry Overview
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Sample Questions
Q1) The provision of banking services to other banks,such as check clearing,foreign exchange trading,and so forth,is an example of
A)correspondent banking.
B)trust services.
C)off-balance-sheet assets.
D)economies of scope.
E)credit derivatives.
Q2) Business loans have dropped in importance since 1987 as measured by the proportion of these loans on the bank balance sheet.
A)True
B)False
Q3) About __________________ of federally insured banks are nationally chartered and about __________________ of federally insured banks are members of the Federal Reserve.
A)77 percent; 65 percent
B)65 percent; 77 percent
C)34 percent; 22 percent
D)20 percent; 34 percent
E)40 percent; 60 percent
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Chapter 12: Commercial Banks Financial Statements and Analysis
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Q1) Blue Ridge Bank has a PM of 12 percent,an interest income to total assets ratio of 6.00 percent,and a noninterest income to assets ratio of 1.50 percent. Blue Ridge also has $9 in assets per dollar in equity capital. Blue Ridge's ROE is
A)7.50 percent.
B)9.00 percent.
C)8.10 percent.
D)6.48 percent.
E)5.75 percent.
Q2) At the start of the quarter a bank has $55 million (gross)in its loan portfolio,and has $1 million in its allowance for loan loss account. During the quarter,loan audits indicate that an additional $300,000 of loans will not be paid as promised. These loans have not yet been written off as uncollectible,however. What are the starting and ending gross and net loan amounts and the provision for loan loss account,and what is the effect on the bank's quarterly earnings?
Q3) Loans to consumers and to individuals are jointly termed C&I loans on a bank's balance sheet.
A)True
B)False
Q4) What are the differences between purchased funds and core deposits?
Page 14
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Chapter 13: Regulation of Commercial Banks
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Q1) Banks are generally prohibited from making loans exceeding more than 15 percent of their own equity capital to any one company or borrower.
A)True
B)False
Q2) A bank that has an equity to asset ratio equal to 12 percent can normally lend no more than _________________ of its assets to any one borrower.
A)1.20 percent
B)1.50 percent
C)1.80 percent
D)12.00 percent
E)15.00 percent
Q3) Areas of commercial bank regulation designed to encourage banks to lend to socially important sectors such as housing and farming are termed ______________________ regulations.
A)safety and soundness
B)consumer protection
C)investor protection
D)credit allocation
E)monetary policy
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Chapter 14: Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies
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Q1) The QTL test requires that thrifts
A)limit the amount of mortgage-related assets on the balance sheet to improve diversification.
B)invest in a minimum percentage of government-backed securities to protect their mortgage loans.
C)lend no more than 80 percent of the value of a home to a borrower to ensure mortgage safety.
D)keep 35 percent of their assets in safe liquid investments to ensure adequate deposit liquidity.
E)invest at least 65 percent of their assets in mortgages or mortgage-related assets.
Q2) The American Bankers Association and others are seeking to limit growth of credit unions. What is the basis for the bankers' concern? What does the credit union industry argue?
What kind of limits on credit unions are the bankers seeking?
Q3) Why have postal savings institutions flourished in many foreign countries? What unique advantages do they have and what services do many offer?
Q4) What are the major disadvantages that credit unions face versus banks?
Q5) What are the major advantages that credit unions enjoy over banks?
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Chapter 15: Insurance Companies
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Q1) The primary regulator of insurance firms is the A)NAIC.
B)McCarran-Ferguson Commission.
C)FDIC.
D)state insurance regulator.
E)SEC.
Q2) Premiums received before the coverage period are termed
A)unearned premiums.
B)lagged premiums.
C)loss adjustment expenses.
D)loss reserves.
E)policyholder's surplus.
Q3) Hurricane damage in a given area is an example of a
for which it is difficult to predict loss exposure.
A)low-severity,low-frequency event
B)high-severity,high-frequency event
C)low-severity,high-frequency event
D)high-severity,low-frequency event
Q4) How do insurance guarantee funds differ from bank deposit insurance funds?
Q5) What three main sources of underwriter risk exist for insurers?
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Chapter 16: Securities Firms and Investment Banks
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Q1) Although an investor can write checks on a cash management account held with a broker,regulations prevent the use of ATMs or debit cards on these accounts.
A)True
B)False
Q2) What are soft dollar fees or commissions?
How can these lead to conflicts of interest for investment bankers?
Q3) The process of creating a secondary market for securities or contracts is termed brokerage.
A)True
B)False
Q4) The Securities Investor Protection Corporation protects investors against losses due to unfavorable market moves of up to $500,000.
A)True
B)False
Q5) Brokerage commission income and stock market valuations tend to move inversely in most years,including in 2010.
A)True
B)False
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Chapter 17: Investment Companies
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Q1) Hedge funds may be classified into three types based on their investment strategies and risk level. What are the three types and their broad risk levels?
Many different strategies exist in each type. List one example strategy in each type.
Q2) By type of fund,there are more ______________ funds than any other.
A)equity
B)bond
C)taxable money market
D)tax-exempt money market
E)hybrid
Q3) ETFs are a direct competitor to ___________.
A)hedge funds
B)money market mutual funds
C)REITS
D)index funds
E)market neutral funds
Q4) What is the purpose of index funds?
How does this differ from other equity mutual funds?
Why are index funds growing in popularity?
Q5) How do closed-end investment companies differ from open-end mutual funds?
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Chapter 18: Pension Funds
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Q1) The PBGC
I. insures participants of defined benefit plans if plan funds are insufficient to meet contractual pension obligations.
II. insures participants of defined contribution plans if investment returns are insufficient to meet expected pension obligations.
III. regulates day-to-day pension fund operations.
A)I only
B)II only
C)I and III only
D)II and III only
E)I,II,and III
Q2) The Pension Protection Act of 2006 requires companies to correct funding shortfalls in their defined benefit plans within A)one year.
B)three years.
C)five years.
D)ten years.
E)twenty years.
Q3) What are the main provisions of ERISA?
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Chapter 19: Types of Risks Incurred by Financial Institutions
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Q1) A U.S. bank has £900 million in loans it has made to corporate customers and it has £750 million in deposits when the exchange rate is £1 = $1.98. The bank will have a net foreign exchange loss on these accounts if the exchange rate moves to £1 = $1.95.
A)True
B)False
Q2) A bank that has made floating rate loans funded by longer maturity deposits is at risk from falling interest rates.
A)True
B)False
Q3) If a bank is exposed to refinancing risk,its profitability is reduced if interest rates __________________ and if it is exposed to reinvestment risk,its profitability is reduced if interest rates ________________.
A)rise; fall
B)rise; rise
C)fall; rise
D)fall; fall
E)rise; stay the same
Q4) How does foreign exchange risk arise for an FI?
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Chapter 20: Managing Credit Risk on the Balance Sheet
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Q1) A corporate loan applicant has had a growing cash account for the last three years,but cash flow from operations has been negative in every year. Would this concern you if you were the loan officer charged with approving the loan? If so,why?
If not,why not?
Q2) Explain what each ratio in the Altman credit model measures and explain why higher values of each of the variables predict lower default probability.
Q3) For most business loans,growing earnings are not a sufficient reason to grant a loan. Why?
Q4) A well-managed bank tries to keep the ratio of nonperforming loans to total loans at about 8 percent to 10 percent.
A)True
B)False
Q5) Gross debt service usually must be greater than 30 percent before a residential mortgage will be approved.
A)True
B)False
Q6) Explain how the Moody's Analytics Model predicts bankruptcy probability.
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Chapter 21: Managing Liquidity Risk on the Balance Sheet
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Q1) How does reliance on purchased liquidity rather than core deposits affect a bank?
I. Increases the risk of a liquidity crisis
II. Allows the bank to adjust to deposit drains without affecting bank size
III. Increases overall interest sensitivity of the bank's profits to interest rates
A)I only
B)II only
C)I and II only
D)II and III only
E)I,II,and III
Q2) The financing gap is defined as average core deposits minus average borrowed funds.
A)True
B)False
Q3) We rarely see bank runs since the advent of Federal Deposit Insurance,but runs on life insurers and mutual funds do occur even though claimants have pro rata claims in the event of default. Why do these runs still occur?
Q4) Why might a bank face abnormal deposit drains?
Q5) Explain how liquidity risk can lead to insolvency risk.
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Chapter 22: Managing Interest Rate Risk and Insolvency
Risk on the Balance Sheet
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Q1) For large interest rate declines,duration ___________ the increases in the bond's price,and for large interest rate increases,it ____________ the decline in the bond's price.
A)underpredicts; overpredicts
B)overpredicts; underpredicts
C)underpredicts; underpredicts
D)overpredicts; overpredicts
Q2) The repricing gap fails to consider how the value of fixed income accounts will change when rates change.
A)True
B)False
Q3) Explain how an FI's capital protects against credit risk and interest rate risk.
Q4) A thrift has an annual CGAP of -$25 million. A credit union has an annual CGAP of +$5 million. The thrift has total assets of $500 million and net income of $7.5 million,and the credit union has total assets of $40 million and net income of $0.7 million.
Q5) Convexity arises because a fixed income's price is a nonlinear function of interest rates.
A)True B)False
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Chapter 23: Managing Risk Off the Balance Sheet With
Derivative Securities
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Q1) Which of the following bond option positions increase in value when interest rates increase?
A)Long call; written put
B)Long put; written call
C)Long put; long call
D)Written put; written call
Q2) Gains and losses on a futures contract must be recognized daily.
A)True
B)False
Q3) The maximum gain (ignoring commissions and taxes)from buying an at-the-money bond put option is the bond price at time of option purchase less the put premium. The maximum loss is the put premium.
A)True
B)False
Q4) A spot contract is an immediate delivery versus payment contract.
A)True
B)False
Q5) Is it safer to hedge a contingent liability with options,futures,forwards,or swaps? Explain.
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Chapter 24: Managing Risk Off the Balance Sheet With Loan
Sales and Securitization
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Q1) An investor in a GNMA mortgage-backed security may be able to earn a return higher than the rate on a comparable maturity Treasury without taking on much,if any,default risk.
A)True
B)False
Q2) A bank originates $150,000,000 worth of 30-year single-family mortgages funded by demand deposits and the required amount of capital. Reserve requirements are 10 percent and the bank pays 32 basis points in deposit insurance premiums. The bank is earning a 6.25 percent coupon on the mortgages. The mortgages are priced at par and total monthly payments on the mortgages are $923,576. If the mortgages are securitized and deposits are reduced,how much will the bank save in the first year's reserve requirements and deposit insurance premiums in total?
A)$144,460,800
B)$160,512,000
C)$165,476,200
D)$178,332,500
E)$181,249,300
Q3) Why are MBBs the least used form of mortgage securitization?
Q4) Why has securitization progressed most rapidly for home mortgages?
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