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Chapter5 Flashcards

1
Q

What is the purpose of financial statements?

A

-They reflect the particular services each financial firm chooses to offer and the overall size of each financial-service organization.
-They are a “road map” telling us where a financial firm has been in the past, where it is now, and, perhaps, where it is headed in the future.

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2
Q

Name the two main financial statements that managers, customers and the regulatory authorities rely upon.

A
  • Balance Sheet (Report of condition)
  • Income Statement (Report of Income)
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3
Q

What is the purpose of the balance sheet ?

A

It shows the amount and composition of funds sources (financial inputs) drawn upon to finance lending and investing activities and how much has been allocated to loans, securities, and other funds uses (financial outputs) at any given point in time.

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4
Q

What is the purpose of the Income Statement?

A

-It show how much it has cost to acquire funds and to generate revenues from the uses the financial firm has
made of those funds.
-The Report of Income also shows the revenues ( cash flow) generated by selling services to the public, including making loans and servicing customer deposits.
-Finally, the Report of Income shows net earnings after all costs are deducted from the sum of all revenues, some of which will be reinvested in the financial firm for future growth and some of which will flow to stockholders as dividends.

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5
Q

What is the basic balance sheet identity and why should it be valid for financial institutions?

A

ASSETS = LIABILITIES + EQUITY CAPITAL
( Because financial institutions are simply business firms selling a particular kind of product, just as would be true for nonfinancial
companies)

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6
Q

Name the 4 major types of assets in the balance sheet for banks and other depository institutions.

A

-Cash Assets (C), also known as Primary Reserves
-Security Holdings( S), secondary reserves
-Loans (L),
-Miscellaneous assets(MA)

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7
Q

Name the two two principal categories liabilities fall into.

A

-Deposits (D)
-Non-deposit borrowings(NDB).

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8
Q

What does the equity capital of banks represent?

A

Equity capital represents long-term funds the owners contribute (EC).

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9
Q

What is the balance sheet identity for depository institutions or Banks?

A

C + S + L + MA = D + NDB + EC

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10
Q

What are cash assets used for?

A

Cash assets ( C) are designed to meet the financial firm’s need for liquidity in order to meet deposit withdrawals, customer demands
for loans, and other unexpected or immediate cash needs.

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11
Q

What accounts are in Cash Assets?

A

Includes:
▫ Vault Cash
▫ Deposits with Other Banks (Correspondent Deposits)
▫ Cash Items in Process of Collection
▫ Reserve Account with the Federal Reserve (the required reserve by the central bank)

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12
Q

What is the Cash Assets account called?

A

Cash and Deposits Due from Bank

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13
Q

What are Security Holdings used for?

A

Used as a backup source of liquidity and include investments that provide a source of income.

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14
Q

Give the two types of security holdings

A
  • Investment Securities: The liquid portion
  • Investment Securities: The income generating portion
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15
Q

What accounts are included in Security holdings: The liquid portion?

A

-Short Term Government Securities
-Privately Issued Money Market Securities
-Interest Bearing Time Deposits
-Commercial Paper

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16
Q

What accounts are included in Security holdings: The income generating portion?

A
  • Bonds
    -Notes
    -securities held primarily for their expected rate of return
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17
Q

List examples of taxable securities.

A

-Government Bonds and notes
- Corporate bonds and notes
-Government Agency Securities

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18
Q

List examples of tax exempt securities.

A
  • Municipal bonds
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19
Q

How may investment securities be recorded?

A

Investment securities may be recorded on the books of a banking firm at their original
cost or at market value, whichever is lower.

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20
Q

What are trading Account Assets and what are they used for?

A

-Securities purchased to provide short-term profits from short-term price movements not included in “Securities” on the Report of Condition
-When the Bank Acts as a Securities Dealer

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21
Q

What are Federal Funds Sold and Reverse Repurchase Agreements and what are they used for?

A

-A type of loan account listed as a separate item on the Report of Condition is federal funds sold and reverse repurchase agreements.
-Includes temporary loans made to other depository institutions
-come from the reserves a bank has on deposit with the Federal Reserve Bank.
- Reverse Repurchase Agreements – Bank takes Temporary Title to Securities Owned by borrower

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22
Q

What are loans used for?

A

-To supply income
-By far the largest asset item , often account for half to almost three-quarters of the total value of all bank assets

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23
Q

List the types of loans.

A
  • Commercial and Industrial Loans( Loans to businesses)
  • Consumer Loans (Loans to Individuals)
  • Real Estate Loans(property based)
  • Financial Institution Loans( To other depository institutions)
  • Foreign Loans( To foreign governments and institutions)
  • Agriculture Production Loans( to farmers for livestock and crops )
  • Security Loans( To aid dealers in security trading activities)
  • Lease( bank buying equipment for customer use)
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24
Q

What are allowance for loan losses?

A

-A reserve for future loan losses built by depository institutions.
- A contra-asset (negative) account
-Represents an accumulated reserve against which loans declared to be noncollectable can be charged off
- Built up gradually over time by annual deductions from current income.

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25
What are provisions for loan losses?
Deductions that appear on the banking firm's income and expense statement (or Report of Income) as a noncash expense item, to build the allowance of loan losses account.
26
How is the ending balance of allowance for loan losses calculated?
Beginning ALL + Provision for Loan Loss (Income Statement) = Adjusted Allowance for Loan Losses -Actual Charge-Offs + Recoveries from Previous Charge-Offs = Ending Allowance for Loan Losses
27
Many financial firms divide the ALL account into two parts, name them.
- Specific reserves - General reserves
28
What are specific reserves and what are they used for?
▫ Set Aside to Cover a Particular Loan that represent above average risk ▫ Management may designate a Portion of ALL or ▫ Add More Reserves to ALL to cover specific reserves
29
What are general reserves and what are they used for?
-These are the remaining ALL,excluding specific reserves -Helps managers better understand their institutions need for protection against current or future loan defaults
30
Who determines reserves for loan losses?
Determined by Management But Influencedby Taxes and Government Regulation
31
How are loans to lesser developed countries handled?
Loans to Lesser Developed Countries Require Allocated Transfer Reserves
32
What are Miscellaneous Assets?
-Assets lacking physical substance but still generating income. -Usually dominated by fixed assets (plant and equipment) and investments in subsidiaries (if any).
33
What falls under miscellaneous assets and briefly explain them.
* Bank Premises and Fixed Assets- Net value of buildings and equipment * Other Real Estate Owned (OREO)- direct and indirect investment on real estate * Goodwill and Other Intangibles- when one firm acquires another and pays more than the market value of the acquired firm's net assets
34
Distinguish between deposits and Non Deposit borrowings.
Deposits are typically the main source of funding for banks, and comparable institutions with non-deposit borrowings carried out mainly to supplement deposits and provide the additional liquidity that cash assets and securities cannot provide.
35
What are deposits?
-The principal liability of any bank - Represents financial claims held by businesses, households, and governments against the banking firm.
36
What are the types of deposit accounts and briefly explain them.
* Non interest-Bearing Demand Deposits - regular checking accounts * Savings Deposits- bears lowest rate of interests * Now Accounts- Used to pay third parties * Money Market Deposit Accounts (MMDA) * Time Deposits - Usually carry a fixed maturity term
37
Why has borrowings from non deposit funds sources grown rapidly?
One reason borrowings from non-deposit funds sources have grown rapidly in recent years is that there are no reserve requirements or insurance fees on most of these funds, which lowers the cost of non-deposit funding.
38
List examples of non- deposit borrowings.
* Fed Funds Purchased (From central bank) * Securities Sold Under Agreement to Repurchase (Repurchase Agreements) * Acceptances Outstanding * Euro currency Borrowings * Subordinated Debt * Limited Life Preferred Stock * Other Liabilities
39
What is equity capital used for?
-Represents the owner's share of the business. -Supplies the long-term, relatively stable base of financial support upon which the financial firm will rely to grow and to cover any extraordinary losses it incurs
40
List the types of equity capital.
* Preferred Stock * Common Stock ▫ Common Stock Outstanding ▫ Capital Surplus ▫ Retained Earnings (Undivided Profits) ▫ Treasury Stock ▫ Contingency Reserve
41
What are Off-Balance-Sheet Items in Banking?
-The balance sheet, although a good place to start, does not tell the whole story about a financial firm - Financial firms offer their customers a number of fee-based services that normally do not show up on the balance sheet.
42
List and give a brief description of Off-Balance-Sheet Items.
* Unused Commitments- funds that have not yet been transferred from lender to borrower. * Standby Credit Agreements- firm receives a fee to guarantee repayment of a loan that a customer has received from another lender. * Derivative Contracts - financial institution has the potential to make a profit or incur a loss on an asset that it presently does not own. Include: ▫ Futures Contracts ▫ Options ▫ Swaps
43
What is the issue about Off-Balance-Sheet transactions?
They often expose a financial firm to considerable risk that conventional financial reports simply won't pick up.
44
How can one view the balance sheet identity?
By noting that liabilities and equity capital represent accumulated sources of funds, which provide the needed spending power to acquire assets. While assets represent the accumulated sources of funds which are made to generate income, pay interest and compensate employees.
45
Thus, the balance sheet identity can be pictured simply as:
Accumulated uses of funds(assets)=Accumulated sources of funds (liabilities and equity capital)
46
Why are cash assets referred to as primary reserves?
This means that these assets are the first line of defense against customer deposit withdrawals and the first source of funds to look to when a customer comes in with a loan request.
47
Why do banks strive to keep cash assets as low as possible?
Because cash balances earn little or no interest income.
48
What is the problem with book-value accounting?
-The book-value accounting method assumes all balance-sheet items will be held to maturity. -It does not reflect the impact on a balance sheet of changing interest rates and changing default risk, which affect both the value and cash flows associated with loans, security holdings, and debt.
49
What is the principal source of bank revenue?
Interest income generated by earning assets-mainly loans and investments.
50
What are the major expenses incurred by revenue?
- interest paid out to depositors - interest owed to non-deposit borrowings - the cost of equity capital - salaries and wages
51
What is the difference between all revenues and expenses?
Net Income (Net income = Total revenue items - Total expense items
52
What is the difference between all revenues and expenses?
Net Income (Net income = Total revenue items - Total expense items
53
How can financial firms increase their net earnings ?
(1) increase the net yield on each asset held; (2) redistribute earning assets toward those assets with higher yields; (3) increase the volume of services that provide fee income; (4) increase fees associated with various services; (5) shift funding sources toward less-costly borrowings; (6) find ways to reduce employee, overhead, loan-loss, and miscellaneous operating expenses; (7) reduce taxes owed through improved tax management practices.
54
What is interest income?
Interest earned from loans and security investments that accounts for the majority of revenues for most depository institutions and for many other lenders as well.
55
What are interest expenses?
The number one expense item for a depository institution normally , interest on deposits.
56
What is the net interest income?
-Total interest expenses are subtracted from total interest income to yield net interest income. - Often referred to as the interest margin, the gap between the interest income the financial firm receives on loans and securities and the interest cost of its borrowed funds. - It is usually a key determinant of profitability
57
What happens when the interest margin falls?
The stockholders of financial firms will usually see a decline in their bottom line-net after-tax earnings-and the dividends their stockholders receive on each share of stock held may decrease as well.
58
List items under net interest income.
* Interest and Fees on Loans * Taxable Securities Revenue * Tax-Exempt Securities Revenue * Other Interest Income * Deposit Interest Costs * Interest on Short-Term Debt * Interest on Long-Term Debt
59
What is non-interest Income?
-Sources of income other than interest revenues from loans and investments. -Net non-interest income= The difference between non-interest income and non- interest expenses
60
List items under non-interest income.
* Fees Earned from Fiduciary Activities( from trust services) * Service Charges on Deposit Accounts * Trading Account Gains and Fees * Additional Noninterest Income
61
List items under non-interest expense.
* Wages, Salaries, and Employee Benefits * Premises and Equipment Expense * Other Operating Expenses
62
List items under Fees Earned from Fiduciary Activities
* Fees for Managing Protecting a Customer’s Property * Fees for Record Keeping for Corporate Security Transactions and Dispensing Interest and Dividend Payments * Fees for Managing Corporate and Individual Pension and Retirement Plans
63
List items under Service Charges on Deposit Accounts.
* Checking Account Maintenance Fees * Checking Account Overdraft Fees * Fees for Writing Excessive Checks * Savings Account Overdraft Fees * Fees for Stopping Payment of Checks
64
What are Trading Account Gains and Fees?
Net gains and losses from trading cash instruments and off balance sheet derivative contracts that have been recognized during the accounting period.
65
List Additional Noninterest Income.
* Investment Banking, Advisory, Brokerage and Underwriting * Venture Capital Revenue * Net Servicing Fees * Net Securitization Income * Insurance Commission Fees and Income * Net Gains (Losses) on Sales of Loans * Net Gains (Losses) on ales of Real Estate * Net Gains (Losses) on the Sales of Other Assets
66
Give the format for Income statement
Net Interest Income -Provision for Loan Loss =NET INCOME AFTER PLL +/- Net Noninterest Income =Net Income Before Taxes Taxes Net Income -Dividends Undivided Profits

EKRP311 (4 decks)

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