Exam 2

Question 1

During a so-called “flight to safety” the yield on US treasuries tend to ____ well the price of US treasuries tends to ____

Answer 1

decrease, increase

Question 2

A company has issued a one-year coupon bond with a face value of $10,000. Suppose that there is a 25% probability that the company will default on the bond, in that case, the bond is worth $1,000. What price should the bond sell for today?

Answer 2

$7,750

Question 3

In general, a bank makes its profits by gathering ____ and issuing ____

A. Short-term assets, long-term assets
B. Short-term assets, long-term liabilities
C. Short-term liabilities, long-term liabilities
D. Short-term liabilities, long-term assets

Answer 3

D. Short-term liabilities, long-term assets

Question 4

Which of the following statements is true?

A. Leverage increases expected return and increases risk
B. Leverage increases expected return but has no effect on risk
C. Leverage decreases expected return and increases risk
D. Leverage has no effect on expected return but increases risk

Answer 4

a. Leverage increases expected return and increases risk

Question 5

Which of the following will increase the npv of a project?

A. An increase in the discount rate
B. A decrease in the amount of initial cash investment
C. A decrease in the final period cash flow
D. Both b and c will increase and npv
E. All would decrease npv

Answer 5

b. A decrease in the amount of initial cash investment

Question 6

The Federal Reserve’s open market operations influence interest rates that banks charge each other for overnight loans by changing ____ on the banking system’s balance sheet

A. Amount of assets 
B. Amount of labilities 
C. Amount of capital 
D. Composition of assets 
E. Composition of liabilities

Answer 6

D. Composition of assets

Question 7

If a bond is upgraded, we expect the yield to ____ and the assets of a bank that owned the bond to ____.

A. Rise, fall
B. Fall, rise
C. Rise, rise
D. Fall, fall

Answer 7

B. Fall, rise

Question 8

If a bond is downgraded, we expect its risk premium to ____ and the assets of a bank that owned the bond to ____

A. Rise, rise
B. Fall, fall
C. Rise, fall
D. Fall, rise

Answer 8

C. Rise, fall

Question 9

The probability of a bond defaulting has decreased. In general,

A. The risk premium will increase 
B. The price will increase 
C. The yield will increase 
D. The old will decrease 
E. Both B and D are correct

Answer 9

e. Both B and D are correct

Question 10

A debt covenant is designed to limit risk taking by borrowers, this is an attempt to solve

A. A moral hazard problem
B. An adverse selection problem
C. A principal-agent problem
D. An access to Capital problem

Answer 10

a. A moral hazard problem

Question 11

Reserves are a ____ to the bank

A. Liability 
B. Asset 
C. Equity 
D. Revenue 
E. None of the above

Answer 11

B. Asset

Question 12

A bank lends existing cash as a mortgage, this mortgage is a ____ to the bank

A. An increase in assets 
B. An increase in equity 
C. A decrease in liability 
D. A decrease in assets 
E. None of the above

Answer 12

e. None of the above

composition in assets

Question 13

If a bank’s assets increase while its capital stays the same, then

A. Its liabilities must increase 
B. It's leverage must increase 
C. Its leverage must decrease 
D. Both A and B are correct
E. Both A and C are correct

Answer 13

D. Both A and B are correct

Question 14

If a bank shifts its assets from a 30-year treasury bond to a 30-year mortgage, it’s

A. Liquidity risk has increased 
B. Credit risk has decreased 
C. Liquidity risk has decreased 
D. Interest rate risk has increased 
E. Both A and D are correct

Answer 14

a. Liquidity risk has increased

Question 15

A bank has a lot of long-term bonds held in assets, as interest rates rise, this will tend to ____ the bank’s blank.

A. Increase, assets 
B. Reduce, liabilities 
C. Increased, capital 
D. Increased, liabilities 
E. None of the above

Answer 15

e. None of the above

decrease, assets

Question 16

When the Federal Reserve buys bonds from a bank, the Fed’s assets ____ and its liabilities ____

A. Increase, increase
B. Decrease, decrease
C. Increase, decrease
D. Decrease, increase

Answer 16

a. Increase, increase

Question 17

A bank run is an extreme example of

A. Foreign exchange risk 
B. Trading risk 
C. Default risk 
D. Liquidity risk 
E. Interest rate

Answer 17

D. Liquidity risk

Question 18

In general, a bank would prefer to attract deposits in the form of ____ because these deposits help to minimize ____.

A. Demand deposits, liquidity risk
B. Large certificates of deposit, liquidity risk
C. Checking accounts, credit risk
D. Savings accounts, default risk

Answer 18

B. Large certificates of deposit, liquidity risk

Question 19

When the Federal Reserve provides a loan to a bank, the bank’s assets ____ and its liabilities ____, while its capital ____.

A. Increase, increase, increase 
B. Increase, stays the same, increase 
C. Decrease, stays the same, decrease 
D. Increase, increase, stays the same 
E. Stay the same, increase, stay the same

Answer 19

D. Increase, increase, stay the same

Question 20

If a bank has $90 million in assets and capital of $10 million, its debt to equity ratio is

a. 5
b. 6
C. 9
D. 10
e. None of the above

Answer 20

e. None of the above

8

Question 21

Liquidity risk is a potential problem for banks because

A. A bank funds itself with short-term assets
B. A Bank funds itself with short-term liabilities
C. A Bank funds itself with long-term assets
D. A Bank funds itself with long-term liabilities

Answer 21

B. A Bank funds itself with short-term liabilities

Question 22

In general, banks would like to ____ leverage and increase ____ because this tends to increase profits.

A. Increase, capital 
B. Decrease, capital 
C. Increase, liabilities 
D. Decrease, assets 
E. None of the above

Answer 22

C. Increase, liabilities

Question 23

Too-big-to-fail banks are a ____ problem because the banks have an incentive to ____ the riskiness of their activities

A. Adverse selection, increase
B. Asymmetric information, decrease
C. moral hazard, increase
D. Moral hazard, decrease

Answer 23

C. Moral hazard, increase

Question 24

The Glass-Steagall act of 1938 required commercial banks to

A. Sell off their investment banking operations
B. Eliminate the FDIC
C. Required Federal Charter Banks to meet their branding restrictions of the states
D. Required all states Banks to get Federal charters

Answer 24

a. Required commercial Banks to sell off their Investment Banking operations

Question 25

The Gramm-Leach-Bliley Act
A. Repealed the Riegle-Neal Interstate Banking and Branching Efficiency Act.
B. Repealed the Glass-Steagall Act prohibition of merging between commercial banks and insurance or security firms
C. Repealed the McFadden acts restriction on Bank branching
D. Reinforced the Glass-Steagall Act limitation on Commercial banking’s ability to merge with insurance or security firms by increasing the penalties for doing so

Answer 25

B. Repealed the Glass-Steagall Act prohibition of mergers between commercial banks and insurance or security firms

Question 26

The principal-agent problem is a

A. Potential problem due to adverse selection
B. When stockholders are not acting in the best interest of managers
C. A potential problem due to moral hazard
D. Due to managers not being able to monitor stockholder behavior
E. Both B and C

Answer 26

c. A potential problem do to moral hazard

Question 27

A bank has profits of $1,000 with a capital base of $1,000 and a debt to equity ratio of 5. The bank has a ROA of ____.

A. 10% 
B. 15% 
C. 20% 
D. 25% 
E. None of the above

Answer 27

e. None of the above 16.67%