Exam 3

Question 1

Borrowers who default are more likely to seek loans than the borrowers who don’t default. This is an example of

Answer 1

adverse selection

Question 2

A legally enforced part of a loan contract that requires the borrower to act in a certain way or to use the borrowed funds for a particular purpose is known as

Answer 2

a covenant

Question 3

Savings and loan associates suffered losses in the late 1970s when

Answer 3

inflation rose, causing interest rates to rise

Question 4

The S&L crisis in the late 1970s and early 1980s was made much worse by

Answer 4

moral hazard, when regulators failed to close bankrupt S&Ls, which in turn caused a credit crunch

Question 5

A credit crunch occurs when

Answer 5

banks do not lend as they ordinarily would, but rather have much higher requirements for borrowers to qualify for loans than normal

Question 6

The market in which banks with excess reserves lend them to banks that desire additional reserves is known as the ______

Answer 6

federal funds market

Question 7

A bank’s spread equals

Answer 7

the average interest rate on the bank’s assets minus the average interest rate on its liabilities

Question 8

The decline in bank panics can be attributed to

Answer 8

the implementation of deposit insurance

Question 9

Which of the following is not a source of funds for commercial banks?

Answer 9

securities

Question 10

In the US today

Answer 10

most banks are state chartered

Question 11

A bank that does not want to hold a lot of excess reserves but is concerned about liquidity risk is likely to:

Answer 11

hold a lot in highly liquid securities

Question 12

If bank A sells some of its loans to bank B for cash, everything else equal:

Answer 12

Bank A’s total assets do not change, but Bank A is more liquid

Question 13

All else the same, if a bank’s liabilities are more sensitive to interest rate fluctuations than are its assets, then _____ in interest rates will _____ bank profits

Answer 13

an increase: reduce

Question 14

The S&L crisis can be analyzed as a principal agent problem. The agents in this case, the _____, did not have the same incentive to minimize cost to the economy as the principals, the _____

Answer 14

politicians/regulators: taxpayers

Question 15

The chartering process is especially designed to deal with the _____ problem, and regular bank examinations help to reduce the _____ problem

Answer 15

adverse selection: moral hazard

Question 16

A bank that makes most of its long-term loans at adjustable interest rates is:

Answer 16

increasing credit risk and reducing interest rate risk

Question 17

A bank’s assets tend to be long-term while its liabilities are short term. Therefore, when interest rates fall the value of the bank’s assets:

Answer 17

increases by more than the value of its liabilities increase

Question 18

Which of the following regulations has most likely contributed to the large numbers of small commercial banks in the US?

Answer 18

State unit banking laws

Question 19

The funds used to pay for FDIC insurance coverage come from

Answer 19

insurance premiums paid by banks

Question 20

In its role as a lender of last resort, the Federal Reserve lends to banks that are

Answer 20

solvent but illiquid

Question 21

The too big to fail policy

Answer 21

exacerbates moral hazard problems
puts small banks at a competitive disadvantage in attracting large deposits
treats large depositors of small banks inequitable when compared to depositors of large banks

Question 22

Over the last twenty years, the number of banks in the US has

Answer 22

steadily decreased

Question 23

considering the balance sheet for all commercial banks in the US, the largest category of liabilities is:

Answer 23

savings deposits and time deposits

Question 24

The US has a dual banking system, which means that a bank

Answer 24

may choose whether to be chartered by federal government authorities or by a state government

Question 25

In the CAMELS rating system, which is used to assess the health of the banks

Answer 25

Capital adequacy