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BANKING CHAPT 5&6 > CHAPTER 6 > Flashcards

CHAPTER 6 Flashcards

1
Q

THE ROLE OF ASYMMETRIC
INFORMATION IN LENDING (3)

A

o Asymmetric Information
o Adverse Selection
o Moral Hazard

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2
Q

The inequality of information between the bank and the borrower

A

Asymmetric Information

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3
Q

Means that the borrowers have more information about themselves than is available to the bank

A

Asymmetric Information

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4
Q

The average interest rate is too high for borrowers with low-risk investment projects and too low for borrowers with high-risk investment projects

True or False

A

True

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5
Q

Means that high-risk borrowers try to get loans from banks because they are willing to pay the average rate of interest, which is less than they would have to pay if their true condition were known to the bank

A

Adverse Selection

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6
Q

It also follows that low-risk creditworthy borrowers may be able to borrow directly from the money and capital markets at lower rates
than those offered by banks.

A

Adverse Selection

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7
Q

Is the base rate on corporate loans made by banks

A

Prime Rate

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8
Q

Is the risk that the borrower, who now has the loan, might use the funds to engage in higher risk activities in expectation of earning higher returns

A

Moral Hazard

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9
Q

Is most likely to occur when the lender is unable to monitor the borrower’s activities

A

Moral Hazard Problem

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10
Q

THE COMPETITIVE ENVIRONMENT (3)

A

o The Business in Lending
o Increasing Competition
o Changes in Technology

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11
Q

Changes in Technology (3)

A
  • Securitization of loans
  • Credit scoring
  • Electronic banking
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12
Q

Is the risk to earnings and capital that a borrower or counterparty may not meet the terms of the loan contract, resulting in losses to
the lender

A

Credit Risk

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13
Q

Applies to loans, derivatives, foreign exchange transactions, the investment portfolio, and other

A

Credit Risk

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14
Q

tells us that the expectation of high returns attracts competition, and the loan business is no exception

A

Economic Theory

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15
Q

are conditions in the loan contract that the borrower must meet

A

Loan Covenants

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16
Q

Is packaging and selling otherwise unmarketable loans to other financial institutions and investors

A

Securitization

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17
Q

means that loans that were formerly funded in local markets are now being funded in global capital markets

A

Growth of securitization

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18
Q

Today, the lending process can be divided into the following four (4) activities:

A
  1. Originating loans.
  2. Packaging loans for sale to others.
  3. Servicing loan portfolios.
  4. Investing in loan-backed credit instruments.
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19
Q

Syndication of any loan or loan commitment of at least $20 million that is shared by three or more unaffiliated federally supervised institutions, or a portion of which is sold to two or more unaffiliated federally supervised institutions

A

Shared National Credit (SNC)

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20
Q

From the borrower’s point of view, syndication provides more funds than may be available from
any single lender. From the lender’s point of view, syndication provides a means of diversifying some
of the risks of foreign lending

True or False

A

True

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21
Q

can enhance relations with foreign governments because it is a means of financing their domestic economic activity

A

Syndication

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22
Q

is the use of statistical models to determine the likelihood that a prospective borrower will default
on a loan

A

Credit Scoring

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23
Q

has the ultimate responsibility for all of the loans made by their bank

A

Board of directors

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24
Q

who has the authority to make loans. The lending limits relative to capital, deposits, or assets. The loan approval process

A

Loan Authority

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25
Q

the types of loans the bank wants to make, such as consumer loans, loans to start up businesses, loans to large businesses, farm loans, or international loans

A

Loan Portfolio

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26
Q

Reducing Credit Risk (7)

A
  1. Avoid making high-risk loans
  2. Collateral reduces the risk to the lender
  3. Diversify the loan portfolio
  4. Documentation
  5. Limit the amount of credit extended
  6. Monitor the behavior of the borrower
  7. Transfer risk to other parties
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27
Q

is considered a secondary source of repayment in the event of loan default.

A

Collateral

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28
Q

means making investments or loans to a variety of borrowers whose cash flows are not perfectly
positively correlated and avoiding undue concentration to a borrower or in a particular type of loan whose returns are related

A

Diversification

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29
Q

refers to all of the documents needed to legally enforce a loan contract and protect a bank’s interest

A

Documentation

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30
Q

Documents typically include: (5)

A
  • promissory notes,
  • guarantees
  • financial statements
  • UCC (Uniform Commercial Code) filings for collateral
  • notes about meetings with the customers
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31
Q

refers to the ability of the lender (the principal) to influence the behavior of the borrower (the agent).

A

Agency problems

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32
Q

SEVEN WAYS TO MAKE LOANS

A
  1. Banks Solicit loans
  2. Buying Loans
  3. Commitments
  4. Customers Request Loans
  5. Loan Brokers
  6. Overdrafts
  7. Refinancing
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33
Q

Banks buy parts of loans from other banks

A

Participations

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34
Q

is an agreement between a bank and a firm to lend funds under terms that are agreed on in writing

A

Loan commitment

35
Q

are individuals or firms who act as agents or brokers between the borrower and the lender

A

Loan brokers

36
Q

occurs when a customer writes a check on uncollected funds or when there are insufficient funds in the account to cover the withdrawal

A

Overdraft

37
Q

Overdrafts can be for less than one day when a check is written or funds transferred out by wire in the morning and the deposit to cover that check or wire transfer is not made until that afternoon

A

Daylight Overdraft

38
Q

Two (2) primary sources of repayment that lenders
consider when they make loans:

A
  1. from the borrowers’ cash flow (e.g., earnings)
  2. from the sale of the assets being financed (e.g., inventory)
39
Q

TYPES OF LOANS (4)

A
  • line of credit
  • revolving loans
  • term loans
  • bridge loans
40
Q

The total assets of a firm can be divided into two (2) categories

A
  • permanent assets
  • temporary assets
41
Q

include plant and equipment as well as that portion of working capital (cash, accounts receivable, and inventory) that will be sustained over time.

A

Permanent assets

42
Q

include that portion of working capital that fluctuates with periodic changes in sales and revenues

A

Temporary assets

43
Q

agreements which may or may not result in loans

A

Credit facilities

44
Q

is an agreement between a customer and the bank that the bank will entertain requests from that customer for a loan up to a predetermined amount

A

Line of credit

45
Q

is established when the bank gives a letter to the customer stating the dollar amount of the line, the time it is in effect (e.g., 1 year), and other conditions or provisions, such as the relationship the customer must maintain with the bank and the customer’s financial condition

A

Line of credit

46
Q

is the maximum amount that can be borrowed under the terms of the loan

A

Line of credit

47
Q

are similar to a line of credit because they, too, are used to finance borrowers’ temporary and seasonal working capital needs

A

Revolving loans

48
Q

commonly specify the minimum amount of the increments that may be borrowed

A

Revolving loans

49
Q

Another difference is that revolving loans usually have a maturity of two years or more, while lines of credit are usually for shorter periods.

True of False

A

True

50
Q

is usually a single loan for a stated period of time or a series of loans on specified dates

A

Term loan

51
Q

is used for a specific purpose, such as acquiring machinery, renovating a building, or refinancing debt

A

Term loan

52
Q

It should not be used to finance day-to-day operations

A

Term loan

53
Q

bridge a gap in a borrower’s financing until some specific event occurs

A

Bridge loans

54
Q

is a form of commercial lending where the assets of a company are used to secure the company’s obligation to the lender

A

Asset-based lending

55
Q

require a higher level of monitoring than other secured commercial loans

A

Asset-based loans

56
Q

is a contract that enables a user (the lessee) to secure the use of a tangible asset over a specified period of time by making payments to the owner (the lessor)

A

Lease

57
Q

are used to finance tangible assets such as cars, airliners, and ships

A

Lease

58
Q

Two types of leases:

A
  • operating leases
  • financial leases
59
Q

are short-term leases used to finance equipment such as computers, where the term of the lease is a fraction of the economic life of the asset

A

Operating leases

60
Q

are used in connection with financing long-term assets and have a term that is equal to the economic life of the asset

A

Financial leases

61
Q

refers to an asset pledged against the performance of an obligation

reduces the bank’s risk when it makes a loan

A

Collateral

62
Q

CHARACTERISTICS OF GOOD
COLLATERAL (5)

A
  • durability
  • identification
  • marketability
  • stability of value
  • standardization
63
Q

This refers to the ability of the asset to withstand wear or to its useful life.

Durable goods make better collateral than nondurables

A

Durability

64
Q

Certain types of assets are readily identifiable because they have definite characteristics or serial numbers that cannot be removed

A

Identification

65
Q

For collateral to be of value to the bank, the collateral must be marketable

A

Marketability

66
Q

TYPES OF COLLATERAL (6)

A
  • accounts receivable
  • nonrecourse
  • inventory
  • marketable securities
  • real property and equipment
  • guarantees
67
Q

There are three ways that accounts receivable can be used as collateral:

A
  • pledging
  • factoring
  • bankers’ acceptances
68
Q

A borrower can pledge accounts receivable with his or her bank

A

Pledging

69
Q

is the sale of accounts receivable to a factor, which is usually a bank or finance company

A

Factoring

70
Q

means that it cannot be returned to the firm that is selling the receivables

A

Nonrecourse

71
Q

usually arises from foreign trade

A

Bankers’ acceptance

72
Q

is widely used as collateral against commercial loans. The inventory may consist of raw materials or finished goods, such as automobiles. Other types of inventory may include natural resources, livestock, and crops.

A

Inventory

73
Q

including corporate stocks and bonds, certificates of deposit, and U.S. Treasury securities may be used as collateral for business loans

A

Marketable securities

74
Q

Real property refers to real estate that includes houses, office buildings, shopping centers, and
factories.
 Such property is widely used as collateral.
 equipment of various sorts may be used.
 Equipment includes trucks, forklifts, drill presses,
and robotics

A

Real property and equipment

75
Q

Bankers can improve their security by having a third party guarantee the payments

A

Guarantees

76
Q

THE LENDING PROCESS
Six C’s of credit:

A
  1. Character
  2. Capacity
  3. Capital
  4. Collateral
  5. Conditions
  6. Compliance
77
Q

 refers to a combination of qualities that distinguishes one person or a group from another
 refer to a borrower’s honesty, responsibility,
integrity, and consistency, on which we can determine willingness to repay loans

A

Character

78
Q

 This refers to success of the borrower’s business as reflected in its financial condition and ability to meet financial obligations via cash
flow and earnings
 the borrower’s success in running a business—cash flows

A

Capacity

79
Q

 represents the amount of equity capital a firm has that can be liquidated for payment if all other
means of collection of the debt fail
 (the financial condition of the borrower—net worth

A

Capital

80
Q

is equal to total assets less total liabilities

A

Equity capital

81
Q

 refers to assets that are pledged for security in a credit transaction
 pledged assets

A

Collateral

82
Q

compliance with laws and regulations

A

Compliance

83
Q

promises by the borrower to take or not take certain actions during the term of the loan

A

Covenants

BANKING CHAPT 5&6 (2 decks)

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