Banking and Financial Intermediation
Textbook Exam Questions
Course Introduction
This course explores the fundamental role of banks and other financial intermediaries in the economy, focusing on how these institutions facilitate the flow of funds between savers and borrowers. Topics include the functions and operations of commercial banks, risk management, regulatory frameworks, and the process of financial intermediation. The course also examines issues such as asymmetric information, the impact of technology on banking services, and recent trends in the financial industry. Students will gain an understanding of the crucial part financial intermediaries play in promoting economic growth and stability.
Recommended Textbook
Financial Markets and Institutions 8th Edition by Frederic Mishkin
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Page 2
Chapter 1: Why Study Financial Markets and Institutions?
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Sample Questions
Q1) Why should consumers be concerned with movements in foreign exchange rates?
Answer: Consumers should understand the movements in foreign exchange rates affect their profits and lives. The consumers deal cross country for some dealings in transactions.
The imports and exports are affected by foreign exchange rates and the inflation rate of an economy is also impacted by fluctuation in currencies. Exchange rates affect expenditure patterns as well as budgets which in turn affect the cost of living for consumers.
It is also more prominent for consumers to understand from a global perspective that movements in foreign exchange rates affect how they they will deal economically with other countries in various transactions.
The buying of goods by the consumer which are cheaper due to currency exchange rate and subsequent selling in the own country where the product price in cheaper to gain from the transaction or vice versa that will result in loss from the transaction.
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3
Chapter 2: Overview of the Financial System
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Sample Questions
Q1) Which of the following is not a regulator of part of the U.S.financial system?
A) National Credit Union Administration
B) Securities and Exchange Commission
C) Federal Reserve System
D) Federal Deposit Insurance Corporation
E) All of the above are regulators.
Answer: E
Q2) Which of the following can be described as involving indirect finance?
A) A corporation takes out loans from a bank.
B) People buy shares in a mutual fund.
C) A corporation buys commercial paper in a secondary market.
D) All of the above.
E) Only A and B of the above.
Answer: E
Q3) The purpose of diversification is to
A) reduce the volatility of a portfolio's return.
B) raise the volatility of a portfolio's return.
C) reduce the average return on a portfolio.
D) raise the average return on a portfolio.
Answer: A
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Chapter 3: What Do Interest Rates Mean and What Is Their
Role in Valuation?
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Sample Questions
Q1) An ex post real interest rate is adjusted for ________ changes in the price level.
A) actual
B) expected
C) nominal
D) real
Answer: A
Q2) Reinvestment risk is the risk that
A) a bond's value may fall in the future.
B) a bond's future coupon payments may have to be invested at a rate lower than the bond's yield to maturity.
C) an investor's holding period will be short and equal in length to the maturity of the bonds he or she holds.
D) a bond's issuer may fail to make the future coupon payments and the investor will have no cash to reinvest.
Answer: B
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Page 5
Chapter 4: Why Do Interest Rates Change?
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Sample Questions
Q1) A person who is risk averse prefers to hold assets that are more,not less,risky.
A)True
B)False
Q2) Holding everything else constant,an increase in wealth lowers the quantity demanded of an asset.
A)True
B)False
Q3) Holding everything else constant,a decrease in the money supply causes
A) interest rates to decline initially.
B) interest rates to increase initially.
C) bond prices to increase initially.
D) both A and C of the above.
E) both B and C of the above.
Q4) Factors that cause the demand curve for bonds to shift to the left include
A) a decrease in the inflation rate.
B) an increase in the volatility of stock prices.
C) an increase in the liquidity of stocks.
D) all of the above.
E) only A and B of the above.
Q5) What is the difference between systematic and nonsystematic risk?
Page 6
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Chapter 5: How Do Risk and Term Structure Affect Interest
Rates?
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Sample Questions
Q1) If the expected path of one-year interest rates over the next five years is 2 percent,4 percent,1 percent,4 percent,and 3 percent,then the pure expectations theory predicts that the bond with the lowest interest rate today is the one with a maturity of A) one year.
B) two years.
C) three years.
D) four years.
Q2) How would a severe recession affect the risk premium on corporate bonds?
Q3) ________ are investment advisory firms that rate the quality of corporate and municipal bonds in terms of probability of default.
A) Financial institutions
B) Credit-rating agencies
C) Securities companies
D) none of the above
Q4) According to the expectations theory,the interest rate on a long-term bond is the average of the short-term interest rates expected over the life of the long-term bond.
A)True
B)False
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Chapter 6: Are Financial Markets Efficient?
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Sample Questions
Q1) Sometimes one observes that the price of a company's stock falls after the announcement of favorable earnings.This phenomenon is
A) clearly inconsistent with the efficient market hypothesis.
B) consistent with the efficient market hypothesis if the earnings were not as high as anticipated.
C) consistent with the efficient market hypothesis if the earnings were not as low as anticipated.
D) the result of none of the above.
Q2) The efficient market hypothesis applies to
A) both the stock market and the foreign exchange market.
B) the stock market but not the foreign exchange market.
C) the foreign exchange market but not the stock market.
D) neither the stock market nor the foreign exchange market.
Q3) What is a rational bubble?
Q4) The evidence suggests technical analysts are not superior stock pickers. A)True B)False
Q5) What is the optimal investment strategy according to the efficient market hypothesis? Why?
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Chapter 7: Why Do Financial Institutions Exist?
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Sample Questions
Q1) When an accounting firm conducts on independent audit,the accounting firms certify that
A) the firm is adhering to standard accounting principles and disclosing accurate information about sales, assets, and earnings.
B) the firm is adhering to federal regulations with regard to product safety, hiring practices, and environmental regulations.
C) the firm's management is qualified to conduct the firm's business in the best interest of share holders.
D) All of the above are correct answers.
Q2) Debt contracts
A) are agreements by the borrowers to pay the lenders fixed dollar amounts at periodic intervals.
B) have an advantage over equity contracts in that they have a lower cost of state verification.
C) are used much more frequently to raise capital than equity contracts.
D) all of the above.
E) only A and B of the above.
Q3) Distinguish between adverse selection and moral hazard.
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Chapter 8: Why Do Financial Crises Occur and
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Sample Questions
Q1) During a bank panic,many banks fail in a very short time period.
A)True
B)False
Q2) In Europe,Greece was the first nation to face a debt crisis.
A)True
B)False
Q3) Why was the shadow banking system important during the 2007-2009 U.S.financial crisis?
Q4) Describe how the European debt crisis evolved.
Q5) In an advanced economy,a financial crisis can begin in several ways,including A) mismanagement of financial liberalization or innovation.
B) asset pricing booms and busts.
C) an increase in uncertainty caused by failure of financial institutions.
D) all of the above.
Q6) When asset prices fall following a boom,
A) moral hazard may increase in companies that have lost net worth in the bust.
B) financial institutions may see the assets on their balance sheets deteriorate, leading to deleveraging.
C) both A and B are correct.
D) none of the above are correct.
Page 10
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Chapter 9: Central Banks and the Federal Reserve System
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Q1) The unusual structure of the Federal Reserve System is best explained by Americans' fear of centralized power.
A)True
B)False
Q2) Currently,there are ________ countries that are members of the European Monetary Union.
A) 10
B) 17
C) 15
D) 20
Q3) The Board of Governors sets reserve requirements.
A)True
B)False
Q4) What are the arguments for and against an independent Fed?
Q5) Rapid money supply growth and uncontrollable inflation were among the factors which motivated the creation of the Federal Reserve System.
A)True
B)False
Q6) In recent years,has Fed policymaking become more or less transparent? Why?
Page 11
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Chapter 10: Conduct of Monetary Policy: Tools, Goals, Strategy, and Tactics
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Sample Questions
Q1) A discount loan by the Fed to a bank causes a(n)________ in reserves in the banking system and a(n)________ in the monetary base.
A) increase; decrease
B) decrease; decrease
C) decrease; increase
D) increase; increase
Q2) Although the goals of high employment and economic growth are closely related,policies can be specifically aimed at encouraging economic growth by A) encouraging firms to invest.
B) encouraging people to save.
C) both A and B of the above.
D) neither A nor B of the above.
Q3) The Federal Reserve will engage in a matched sale-purchase transaction when it wants to ________ reserves ________ in the banking system.
A) increase; permanently
B) increase; temporarily
C) decrease; temporarily
D) decrease; permanently
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Chapter 11: The Money Markets
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Sample Questions
Q1) Interest rates on banker's acceptances are low because the risk of default is very low.
A)True
B)False
Q2) Which of the following statements are true of Treasury bills?
A) The market for Treasury bills is extremely deep and liquid.
B) Occasionally, investors find that earnings on T-bills do not compensate them for changes in purchasing power due to inflation.
C) By volume, most Treasury bills are sold to individuals who submit noncompetitive bids.
D) All of the above are true.
E) Only A and B of the above are true.
Q3) The Treasury accepts noncompetitive bids in ascending order of yield until the accepted bids reach the offering amount.
A)True
B)False
Q4) Explain why the money markets are referred to as wholesale markets.
Q5) Explain how and why repurchase agreements would be used.
Q6) Explain how the Federal Reserve can influence the federal funds interest rate.
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Chapter 12: The Bond Market
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Sample Questions
Q1) Most of the time,the interest rate on Treasury notes and bonds is ________ that on money market securities because of ________ risk.
A) above; interest-rate
B) above; default
C) below; interest-rate
D) below; default
Q2) What is a bond indenture?
Q3) What is the difference between a general obligation bond and a revenue bond?
Q4) The Commodity Futures Modernization Act (2000)removed derivative securities,such as credit default swaps,from regulatory oversight.
A)True
B)False
Q5) (I)Capital market securities fall into two categories: bonds and stocks.
(II)Long-term bonds include government bonds and long-term notes,municipal bonds,and corporate bonds.
A) (I) is true, (II) false.
B) (I) is false, (II) true.
C) Both are true.
D) Both are false.
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Chapter 13: The Stock Market
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Sample Questions
Q1) All stocks pay dividends,as that is the only way an investor can profit from holding stock.
A)True
B)False
Q2) What are American Depository Receipts (ADRs)?
Q3) Which of the following is not an objective of the Securities and Exchange Commission?
A) Maintain integrity of the securities markets
B) Advise investors about which particular stocks are good buys
C) Require firms to provide specific information to investors
D) Regulate major participants in securities markets
Q4) What are the advantages and disadvantages of Electronic Communications Networks (ECNs)for trading stocks?
Q5) Holding other things constant,a stock's value will be highest if its most recent dividend is
A) $2.00.
B) $5.00.
C) $0.50.
D) $1.00.
Q6) How do corporate stocks differ from bonds?
Page 15
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Chapter 14: The Mortgage Markets
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Sample Questions
Q1) Why may Fannie Mae and Freddie Mac pose a threat to the health of the financial system?
Q2) During the early years of an amortizing mortgage loan,the lender applies
A) most of the monthly payment to the outstanding principal balance.
B) all of the monthly payment to the outstanding principal balance.
C) most of the monthly payment to interest on the loan.
D) all of the monthly payment to interest on the loan.
E) the monthly payment equally to interest on the loan and the outstanding principal balance.
Q3) Distinct elements of a mortgage loan include
A) origination.
B) investment.
C) servicing.
D) all of the above.
E) only B and C of the above.
Q4) A FICO score below 660 is considered good while a score above 720 is likely to cause problems in obtaining a loan.
A)True
B)False
Q5) What are points? What is their purpose?
Page 16
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Chapter 15: The Foreign Exchange Market
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Sample Questions
Q1) The more modern asset market approach to exchange rate determination
A) emphasizes the role of import and export demand.
B) emphasizes stocks of assets.
C) emphasizes both of the above.
D) emphasizes neither of the above.
Q2) If the dollar appreciates from 0.8 euros per dollar to 1.2 euros per dollar,the euro depreciates from ________ dollars to ________ dollars per euro.
A) 1.25; 0.83
B) 0.83; 1.25
C) 0.67; 1.50
D) 1.50; 0.67
Q3) A fall in the expected future exchange rate shifts the expected return schedule for ________ deposits to the ________ and causes the domestic currency to depreciate.
A) domestic; right
B) domestic; left
C) foreign; right
D) foreign; left
Q4) What are some of the long-run determinants of the exchange rate?
Q5) Explain the theory of purchasing power parity.
Page 17
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Chapter 16: The International Financial System
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Sample Questions
Q1) The difference between merchandise exports and imports is called the current account balance.
A)True
B)False
Q2) A current account ________ indicates that the United States is ________ its claims on foreign wealth.
A) surplus; increasing B) surplus; decreasing C) deficit; increasing D) balance; decreasing
Q3) A foreign exchange intervention with an offsetting open market operation that leaves the monetary base unchanged is called
A) an unsterilized foreign exchange intervention.
B) a sterilized foreign exchange intervention.
C) an exchange rate feedback rule.
D) a money-neutral foreign exchange intervention.
Q4) What is the policy trilemma as it relates to capital mobility,fixed/floating exchange rates,and monetary policy?
Q5) Describe the pros and cons for controls on capital inflows and outflows.
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Chapter 17: Banking and the Management of Financial Institutions
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Sample Questions
Q1) In general,banks make profits by selling ________ liabilities and buying ________ assets.
A) long-term; shorter-term
B) short-term; longer-term
C) illiquid; liquid
D) risky; risk-free
Q2) Since a bank's assets exceed its equity capital,the return on assets always exceeds the return on equity.
A)True
B)False
Q3) In 2009 provisions for loan losses reached a new peak of ________ of total operating expenses.
A) 60%
B) 50%
C) 33%
D) 13%
Q4) Explain how a capital crunch can lead to a credit crunch in our economy.
Q5) How did liability management change during the 1960s?
Page 19
Q6) Distinguish between a bank's reserves,required reserves,excess reserves,and secondary reserves.
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Page 20
Chapter 18: Financial Regulation
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Sample Questions
Q1) Describe the CAMELS rating system used by bank examiners.
Q2) The Dodd-Frank legislation of 2010 finally resolved the status of GSEs such as Freddie Mac.
A)True
B)False
Q3) The result of the too-big-to-fail policy is that ________ banks will take on ________ risks,making bank failures more likely.
A) small; fewer
B) small; greater
C) large; fewer
D) large; greater
Q4) During the boom years of the 1920s,bank failures were quite
A) uncommon, averaging less than 30 per year.
B) uncommon, averaging less than 100 per year.
C) common, averaging about 600 per year.
D) common, averaging about 2,000 per year.
Q5) Discuss the role of mark-to-market accounting during the global financial crisis.Did it help or hurt credit markets and bank lending?
Q6) Why did the United States experience a banking crisis in the 1980s?
Page 21
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Chapter 19: Banking Industry: Structure and Competition
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Sample Questions
Q1) Large fluctuations in interest rates lead to
A) substantial capital gains and losses to owners of securities.
B) greater uncertainty about returns on investments.
C) greater interest-rate risk.
D) all of the above.
Q2) Bank failures and mergers have caused the number of commercial banks in the U.S.to decline from around ________ in the 1970s to below ________ today.
A) 25,000; 10,000
B) 15,000; 8,000
C) 25,000; 20,000
D) 15,000; 5,000
Q3) Which of the following is an example of a financial innovation introduced to avoid regulations?
A) Securitization
B) Junk bond
C) Debit card
D) Sweep account
Q4) Explain what happened to the large,free-standing investment banks as a result of the Global Financial Crisis.
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Chapter 20: The Mutual Fund Industry
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Sample Questions
Q1) Most mutual funds are structured in two ways.The most common structure is a(n)________ fund,from which shares can be redeemed at any time at a price that is tied to the asset value of the fund.A(n)________ fund has a fixed number of nonredeemable shares that are traded in the over-the-counter market.
A) closed-end; open-end
B) open-end; closed-end
C) no-load; closed-end
D) no-load; load
E) load; no-load
Q2) The increase in the number of defined contribution pension funds has slowed the growth of mutual funds.
A)True
B)False
Q3) Capital appreciation funds select stocks of ________ and tend to be ________ risky than total return funds.
A) large, established companies that pay dividends regularly; more B) large, established companies that pay dividends regularly; less C) companies expected to grow rapidly; more D) companies expected to grow rapidly; less
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Page 23
Chapter 21: Insurance Companies and Pension Funds
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Sample Questions
Q1) In the future,do the authors expect pension funds to continue to grow in popularity?
Q2) Between 1995 and 2009,the amount of credit default swaps (CDSs)exploded,along with the marketing of securitized mortgages.By their peak in 2008,there were about ________ of CDSs outstanding.
A) $62 million
B) $62 billion
C) $6.2 trillion
D) $62 trillion
Q3) Insurance companies' attempts to minimize adverse selection and moral hazard explain which of the following insurance practices?
A) Risk-assessment screening
B) Risk-based premiums
C) Restrictive provisions
D) All of the above
E) Only A and B of the above
Q4) Why must insurance companies screen applicants so carefully?
Q5) Distinguish between different types of life insurance.
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Chapter 22: Investment Banks, Security Brokers and
Dealers, and Venture Capital Firms
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Q1) Which of the following is not a step in the process by which an investment bank assists in the sale of a company or corporate division?
A) Preparation of a confidential memorandum
B) Negotiation of a letter of intent
C) Preparation of a definitive agreement
D) Forming a syndicate of purchasers
Q2) The first true venture capital firm was ________,established in 1946 by MIT president Karl Compton and local business leaders.
A) American Research & Development (ARD)
B) Charles River Development
C) Redsocks Capital
D) the MIT Fund
Q3) Which of the following is the second phase in the life cycle of a venture capital deal?
A) A limited partnership is formed and funds are raised.
B) Funds are invested in start-up companies.
C) The venture firm exits the investment.
D) The venture firm seeks approval from the S.E.C.
Q4) Discuss the difference between full-service and discount brokers.
Page 25
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Chapter 23: Risk Management in Financial Institutions
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Sample Questions
Q1) Banks' attempts to solve adverse selection and moral hazard problems help explain loan management principles such as
A) screening and monitoring of loan applicants.
B) collateral and compensating balances.
C) credit rationing.
D) all of the above.
E) only A and B of the above.
Q2) If a bank has more rate-sensitive assets than rate-sensitive liabilities,then a(n)________ in interest rates will ________ bank profits.
A) increase; increase B) increase; reduce C) decline; increase
D) decline; not affect
Q3) Income gap analysis and duration gap analysis are basically the same thing,so hedging against one gap automatically hedges against the other.
A)True
B)False
Q4) What is gap analysis and why is it important to a bank?
Q5) What is duration gap analysis and why is it important to a bank?
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Chapter 24: Hedging with Financial Derivatives
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Sample Questions
Q1) A put option gives the owner the ________ to ________ the underlying security.
A) right; sell
B) obligation; sell
C) right; buy
D) obligation; buy
Q2) The most widely traded stock index future is on the
A) Dow Jones 1000 index.
B) S&P 500 index.
C) NASDAQ index.
D) Dow Jones 30 index.
Q3) If a portfolio manager believes stock prices will fall and knows that a block of funds will be received in the future,then he should
A) sell stock index futures short.
B) buy stock index futures long.
C) stay out of the futures market.
D) borrow and buy securities now.
Q4) To reduce foreign exchange risk from selling goods to a foreign country,futures contracts should be sold.
A)True
B)False
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Chapter 25: Financial Crises In Emerging Market Economies
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Q1) In an emerging market economy,a currency crisis can be triggered by two things: a deterioration of bank balance sheets and severe fiscal imbalances.
A)True
B)False
Q2) During a bank panic,many banks fail in a very short time period.
A)True
B)False
Q3) The experience with financial crises in emerging market economies suggests a number of government policies that can help make financial crises in emerging market countries less likely,including
A) beefing up prudential regulation and supervision of banks.
B) better bank risk disclosure.
C) limiting the currency mismatch.
D) all of the above.
E) only B and C of the above.
Q4) What is the problem with government safety nets,such as deposit insurance,during the formative stages of a financial crisis?
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Chapter 26: Savings Associations and Credit Unions
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Sample Questions
Q1) Credit unions are characterized by
A) mutual ownership.
B) common bond membership.
C) nonprofit, tax-exempt status.
D) all of the above.
E) none of the above.
Q2) The policy of regulatory forbearance
A) meant delaying the closing of "zombie S&Ls" as their losses mounted during the 1980s.
B) benefited "zombie S&Ls" at the expense of healthy S&Ls, as healthy institutions lost deposits to insolvent institutions.
C) contributed to declining profitability in the S&L industry and an increase in the number of "zombie S&Ls."
D) did all of the above.
E) did only A and B of the above.
Q3) Why did the Competitive Equality in Banking Act of 1987 fail to solve the problems in the thrift industry?
Q4) Explain the advantages and disadvantages between mutual savings banks and savings and loans.
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Chapter 27: Finance Companies
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Sample Questions
Q1) Although finance companies are largely unregulated,they do face some regulations aimed primarily at
A) protecting unsophisticated customers.
B) the government deposit insurance.
C) large corporate customers.
D) protecting the finance companies from failure.
Q2) A sales finance company differs from a captive finance company primarily in regulations and other restrictions.
A)True
B)False
Q3) What is default risk?
A) A problem that arises when a firm runs short of cash.
B) The risk of asset prices rising too high.
C) The chance that the borrower will fail to repay a loan.
D) The risk associated with longer-term contracts.
Q4) A balloon loan requires periodic payments of principle and interest.
A)True
B)False
Q5) What are the various types of finance companies?
Q6) Describe the process of factoring? When and why is it used?
Page 30
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