Chapter 2: An Overview of the Financial System

Question 1

What is a bank failure?

Answer 1

tangible equity/assets < 2%

Question 2

what is tangible equity?

Answer 2

money put up to start bank

Question 3

what makes up tangible equity?

Answer 3

tier 1 capital + cumulative perpetual preferred stock - intangible assets

Question 4

what makes up tier 1 capital?

Answer 4

equity + retained earnings

Question 5

equity

Answer 5

money from common stockholders

Question 6

retained earnings

Answer 6

kept earnings not given out as dividends

Question 7

what makes up assets?

Answer 7

investments, loans, and fixed assets

Question 8

what is an asset on a bank balance sheet?

Answer 8

something you own

Question 9

what is a liability/capital on a bank balance sheet?

Answer 9

what a bank owes

Question 10

what makes up liabilities and capital?

Answer 10

deposits, borrowings, total capital (tier 2, tier1)

Question 11

what does the bank invest in?

Answer 11

treasury bonds, corporate bonds, mortgage backed securities

Question 12

what makes up the loans banks give out?

Answer 12

commercial, auto, home, student, credit card

Question 13

what makes up a bank’s fixed assets?

Answer 13

land, building, equipment

Question 14

what makes up a bank’s deposits?

Answer 14

checking accounts, savings, money market deposits, CDs

Question 15

House hold nudge constraint

Answer 15

income = consumption + tax + savings

Question 16

What are the 10 characteristics of failed banks?

Answer 16

1. pursued aggressive growth strategies
2. chartered for less than 10 years
3. rapid growth of commercial real estate loan portfolio
4. had out of territory CRE loans
5. large credit losses on CRE loans
6. used nontraditional funding sources
7. exhibit weak underwriting standards
8. exhibit weak credit administration practices
9. did not maintain enough for loan loss allowance account
10. located in fast growing housing market areas

Question 17

underwriting

Answer 17

approve or denying loans

Question 18

asymmetric information

Answer 18

one party does not know enough about the other party to make accurate decisions

Question 19

adverse selection

Answer 19

people who apply loans for that will likely default on them (before transaction)

Question 20

moral hazard problem

Answer 20

not making sure borrower isn’t taking excessive risk

Question 21

maturity

Answer 21

of years until debt instrument’s expiration

Question 22

short term maturity

Answer 22

less than a year

Question 23

intermediate maturity

Answer 23

between 1 and 10 years

Question 24

long term maturity

Answer 24

ten years or longer

Question 25

primary market

Answer 25

financial market that sells new issues of a security to initial buyers by the or government agency borrowing the funds

Question 26

secondary market

Answer 26

financial market in which securities that have been previously issues are resold

Question 27

two ways secondary markets are organized

Answer 27

1. exchanges
2. over the counter market

Question 28

exchanges

Answer 28

where buyers and sellers meet to conduct trade

Question 29

over the counter market

Answer 29

dealers at different locations who have an inventory of securities stand ready to buy and sell securities to anyone who comes and is willing to accept their prices

Question 30

money market

Answer 30

short term debt instruments are sold

Question 31

capital market

Answer 31

longer term debt and equity instruments are traded

Question 32

money market instruments

Answer 32

short-term debt securities issued by governments, financial institutions, and corporations; least risky

Question 33

federal funds rate

Answer 33

interest rate on federal funds

Question 34

default

Answer 34

when people don’t pay backs their loans

Question 35

commercial paper

Answer 35

short term debt instruments issued by large banks and well known corporations

Question 36

repurchase agreements (repos)

Answer 36

effectively short term loans for which treasury bills serve as collateral

Question 37

federal funds

Answer 37

interbank loans

Question 38

capital market instruments

Answer 38

debt and equity instruments with maturities of greater than one year

Question 39

US government securities

Answer 39

long-term debt instruments issued by the US treasury to finance the deficits of the federal government

Question 40

economies of scale

Answer 40

as transaction costs decreases, the size of transactions increase

Question 41

risk sharing

Answer 41

assets with risk characteristics that people are comfortable with

Question 42

economies of scope

Answer 42

a saving gained by producing multiple goods as the cost of producing each individual thing decreases

Question 43

allowance for loan loss

Answer 43

an estimate of uncollectible amounts used to reduce the book value of loans and leases to the amount that a bank expects to collect (money for defaults)

Question 44

provision for loan loss

Answer 44

an income statement expense set aside as an allowance for uncollected loans and loan payments

Question 45

3 major goals of banking

Answer 45

1. safe and sound (capital ratio)
2. competitiveness (asset growth rate)
3. economic viability (ROA)

Question 46

Who were bailed out by the Federal Housing Finance Administration during the financial crisis of 2008?

Answer 46

Fannie Mae