Final Exam (7-10, 13) Flashcards
Mortgage
loans to individuals or businesses to purchase homes, land, or other real property
securitization of a mortgage
occurs when securities are packaged and sold as assets backing a publicly traded or privately held debt instruments (i.e., mortgage-backed securities (MBSs))
how do mortgages differ from bonds and stocks
Mortgages are backed by a specific piece of real property
Primary mortgages have no set size or denomination
Primary mortgages generally involve a single investor
Comparatively little information exists on mortgage borrowers
Four basic types of mortgages are issued by financial institutions
home mortgages, multifamily dwelling mortgages, commercial mortgages, farm mortgages
home mortgages
Are used to purchase one- to four-family dwellings (called “single-family mortgages”)
multifamily dwelling mortgages
Are used to purchase apartment complexes, townhouses, and condominiums
commercial mortgages
Are used to finance the purchase of real estate for business purposes
farm mortgages
Are used to finance the purchase of farms
collateral
All mortgage loans are backed by a specific piece of property that serves as collateral to the mortgage loa
down payment
a portion of the purchase price of the property a financial institution requires the mortgage borrower to pay up front
private mortgage insurance (PMI)
generally required when the loan-to-value ratio is more than 80% (i.e., the borrower makes a down payment of less than 20%)
federally insured mortgages
Repayment is guaranteed by either the Federal Housing Administration (FHA) or the Veterans Administration (VA)
Low down payment and low mortgage rate
conventional mortgages
not federally insured
No popular in the secondary market is not privately insured and has a loan-to-debt ratio greater than 80%
amortized mortgage
when the fixed principal and interest payments fully pay off the mortgage by its maturity date
fixed-rate mortgages
lock in the borrower’s interest rate
required monthly payments are fixed over the life of the mortgage
lenders assume interest rate risk
balloon payment mortgages
require fixed monthly interest payments for a 3- to 5-year period,
Full payment of the mortgage principal (the balloon payment) is the due at the end of the period
adjustable-rate mortgages (ARMs)
tie the borrower’s interest rate to some market interest rate or interest rate index
required monthly payments can change over the life of the mortgage
yearly interest rate changes are often capped
borrowers assume interest rate risk
can increase default risk
discount points
are fees or payments made when a mortgage loan is issued
each point costs the borrower 1 percent of the principal value
the lender reduces the interest rate used to determine the payments on the mortgage in exchange for points paid
other mortgage fees
Application fee
Title search
Title insurance
Appraisal fee
Loan origination fee
Closing agent and review fees
Other fees (e.g., FHA loan guarantees and PMI)
mortgage refinancing
When a borrower takes out a new mortgage and uses the proceeds to pay off an existing mortgage
most often this when an existing mortgage has a higher interest rate than prevailing rates
Borrowers must balance the savings of a lower monthly payment with the costs (fees) of refinancing
An often-cited rule of thumb is that the new interest rate should be 2 percentage points less than this rate
mortgage amortization
The fixed monthly payment made by a mortgage borrower generally consists partly of repayment of the principal borrowed and partly of the interest on the outstanding (remaining) balance of the mortgage
During the early years of the mortgage, most of the fixed monthly payment represents interest on the outstanding principal and a small amount represents a payoff of the outstanding principal
amortization schedule
shows how the fixed monthly payments are split between principal and interest
jumbo mortgages
those that exceed the conventional mortgage conforming limits
Limits are set by the two government-sponsored enterprises, Fannie Mae and Freddie Mac, and are based on the maximum value of any individual mortgage they will purchase from a mortgage lender ($484,350 in 2019, with some exceptions)
subprime mortgages
mortgages to borrowers who have weakened credit histories
These borrowers may have weakened credit due to payment delinquencies and possibly more severe problems such as charge-offs, judgments, and bankruptcies
Alt-A mortgages
considered riskier than a prime mortgage and less risky than a subprime mortgage
Interest rates on these loans are usually between prime and subprime rates
option ARMs
adjustable rate mortgages that offer the borrower several monthly payment options
minimum payment option
Lowest of the four payment options and carries the most risk
The monthly payment is set for 12 months at an initial interest rate and changes annually after that
interest-only payment
Monthly payments must increase substantially after the initial interest-only period lapses
30-year fully amortizing payment
Borrower pays both principal and interest on the loan, based on a 30-year term
15-year fully amortizing payment
Based on a 15-year term
second mortgages
loans secured by a piece of real estate already used to secure a first mortgage
Should a default occur, the second mortgage holder is paid only after the first mortgage is paid off
home equity loans
borrow lump sum with their second mortgage
home equity line of credit (HELOC)
customers borrow on a line of credit secured with a second mortgage on their homes
reverse-annuity mortgages (RAMs)
Borrower receives regular monthly payments from a financial institution rather than making them
When it matures (or the borrower dies), the borrower (or the borrower’s estate) sells the property to retire the debt
They are attractive mainly to older homeowners who have accumulated substantial equity in their homes
correspondent banking
involves small banks making loans that are too big for them to hold on their balance sheets and selling parts of these loans to large banks with whom they have had a long-term deposit and lending correspondent relationship
loan syndication
Large banks often sell parts of their loans (i.e., participations) to smaller banks
when do mortgage sales occur
when an FI originates a mortgage and sells it to an outside buyer
how do FIs remove mortgages from their balance sheets
By pooling recently originated mortgages together and selling them in the secondary market
By securitizing mortgages (i.e., by issuing securities backed by newly originated mortgages)
Mortgage Backed Securities (MBS)
advantages of securitization
FIs can reduce their liquidity risk, interest rate risk, and credit risk
FIs generate fee income, which helps to offset the effects of regulatory constraints
what does the securitization of mortgages involve
the pooling of a group of mortgages with similar characteristics, the removal of these mortgages from the balance sheet, and the subsequent sale of interests in the mortgage pool to secondary market investors
mortgage-backed securities
allow mortgage issuers to separate the credit risk exposure from the lending process itself
major types of mortgage-backed securities
Pass-through security
Collateralized mortgage obligation (CMO)
Mortgage-backed bond
pass-through mortgage securities
“pass through” promised payments of principal and interest on pools of mortgages created by FIs to secondary market participants holding interests in the pools
collateralized mortgage obligations
mortgage-backed bonds with multiple bond holder classes, or tranches
Each bond holder class has a different guaranteed coupon
Mortgage prepayments retire only one tranche at a time, so all other trances are sequentially prepayment protected
mortgage-backed bonds
bonds collateralized by a pool of assets, also called asset-backed bonds
The relationship for these is one of collateralization rather than securitization; the cash flows on the mortgages backing the bond are not necessarily directly connected to interest and principal payments on them
corporate stock
serves as a source of financing for firms, in addition to debt financing or retained earnings financing
secondary stock markets
the most closely watched and reported of all financial security markets
stockholders
Have a right to share in the firm’s profits (through dividends) after the payment of interest to bond holders and taxes
Have a residual claim on the firm’s assets
Have limited liability
Have voting rights (e.g., to elect board of directors)
two types of corporate stock
Common stock
Preferred stock
common stock
the fundamental ownership claim in a public or private corporation, and many characteristics differentiate it from other types of securities:
Discretionary dividend payments
Residual claim status
Limited liability
Voting rights
dividends
discretionary, and are thus not guaranteed
Payment and size of them are determined by the board of directors of the issuing firm
They are taxed twice – once at the firm level and once at the personal level
May partially avoid this double taxation effect by holding stocks in growth firms that reinvest most of their earnings to finance growth rather than paying larger of these
who has the lowest priority claim in the event of bankruptcy (i.e., they have a residual claim)
common stockholders
senior claims
may be payments owed to creditors such as the firm’s employees, bond holders, the government (taxes), and preferred stockholders
limited liability
implies that common stockholder losses are limited to the amount of their original investment in the firm if the company’s asset value falls to less than the value of the debt it owes
how do common stockholders control the firm’s activities indirectly
by exercising their voting rights in the election of the board of directors
typical voting rights arrangement
assign one vote per share of common stock
dual-class firms
where two classes of common stock are outstanding, with different voting and/or dividend rights for each class
two methods of electing a board
Straight voting
Cumulative voting
straight voting
vote on the board of directors occurs one director at a time. Thus, the number of votes eligible for each director is the number of shares outstanding.
If you have 10 shares and 5 directors are up for election, you can vote 10 times for each seat
cumulative voting
all directors up for election are voted on at the same time. The number of votes assigned to each stockholder equals the number of shares held multiplied by the number of directors to be elected.
You can use all your 10 x 5 = 50 votes to a single director seat or divide it for multiple seats
proxy
voting ballot sent by a corporation to its stockholders
When returned to the issuing firm, it allows stockholders to vote by absentee ballot or authorizes representatives of the stockholders to vote on their behalf
By the 2010s, virtually all U.S. firms were putting these statements online and allowing votes to be cast via the Internet
preferred stock
a hybrid security that has characteristics of both bonds and common stock
Similar to common stock in that it represents an ownership interest in the issuing firm, but like a bond it pays a fixed periodic (dividend) payment
Dividends are generally fixed (paid quarterly)
These stockholders generally do not have voting rights in the firm, but most stock may be converted to common stock at any time the investor chooses
nonparticipating preferred stock
means the dividend is fixed regardless of any increase of decrease in the issuing firm’s profits
participating preferred stock
means actual dividends paid in any year may be greater than promised dividends
cumulative preferred stock
means that any missed dividend payments go into arrears and must be made up before any common stock dividends can be paid
noncumulative preferred stocks
do not go into arrears and are never paid
what is preferred stock
typically nonparticipating and cumulative
primary stock markets
markets in which corporations raise funds through new issues of stocks
Most transactions go through investment banks
how can an investment bank conduct a primary sale
using either a firm commitment or best efforts underwriting basis
firm commitment underwriting
the investment bank guarantees the corporation a price for the newly issued securities
best efforts underwriting
occurs when the underwriter does not guarantee a price to the issuer
syndicate
is a group of investment banks working in concert to sell and distribute a new issue
originating house
the lead banks in the syndicate
initial public offering (IPO)
the first public issue of a financial instrument by a firm
seasoned offering
the sale of additional securities by a firm whose securities are currently publicly traded
preemptive rights
give existing stockholders the ability to maintain their proportional ownership
red herring prospectus
a preliminary version of the prospectus that describes a new security issue
shelf registration
allows firms that plan to offer multiple issues of stock over a two-year period to submit one registration statement (i.e., master registration statement)
secondary stock markets
the markets in which stocks, once issued, are traded by investors
In these transactions, funds are exchanged, usually with the help of a securities broker or firm acting as an intermediary between the buyer and seller of the stock
Original issuer of the stock is not involved in this transfer of stocks or funds
two major U.S. stock markets
New York Stock Exchange Euronext (NYSE Euronext)
National Association of Securities Dealers Automated Quotation (NASDAQ) system
other stock exchanges in America
Philadelphia Stock Exchange (PHLX)
Boston Stock Exchange (BSE) - includes both the Boston Equities Exchange (BEX) and the Boston Options Exchange (BOX)
Chicago Stock Exchange (CHX)
Chicago Mercantile Exchange (CME) - world’s largest commodity derivatives exchange
Chicago Board Options Exchange (CBOE)
Chicago Board of Trade (CBOT)
International Securities Exchange (ISE) - includes both the ISE Options Exchange and the ISE Stock Exchange
Miami Stock Exchange (MS4X)
National Stock Exchange (NSX)
program trading
the simultaneous buying and selling of a portfolio of at least 15 different stocks valued at more than $1m, using computer programs to initiate the trades
Criticized for impact on stock market prices and increased volatility
High-frequency trading (HFT)
why were circuit breakers introduced by the NYSE
to account for increased volatility
circuit breakers
an imposed halt in trading that gives buyers and sellers time to assimilate incoming information
limit up limit down rules (LULD)
halts trading on individual stocks if the stock price moves outside the following price band
stock market index
the composite value of a group of secondary market-traded stocks
price-weighted index
Dow Jones Industrial Average (DJIA) is the most widely reported stock market index and includes the values of 30 large corporations selected by the editors of The Wall Street Journal
value-weighted indexes
NYSE Composite Index includes all NYSE-listed common stocks
S&P 500 Index consists of the stocks of the top 500 of the largest U.S. corporations listed on the NYSE and the NASDAQ
NASDAQ Composite Index consists of stocks traded through NASDAQ that are industrials, banks, and insurance companies
wilshire 5000 index
the broadest stock market index and possibly the most accurate reflection of the overall stock markets
Contains virtually every stock that meets three criteria:
Firm is headquartered in the U.S.
Stock is actively traded in a U.S.-based stock market
Stock has widely available price information (which rules out the smaller OTC stocks from inclusion)
Though the index started with 5,000 firms, because of firm delistings, privatizations, and acquisitions it currently includes just 3,687 stocks (as of Dec 31, 2021)
7,500 stock in 1998
Value-weighted index
risk
refers to the degree of uncertainty that an investment’s actual return will differ from expected return
total risk
Systematic Risk + Unsystematic Risk
= Market Risk + Firm-Specific Risk
= Undiversifiable Risk + Diversifiable Risk
systematic risk
market or diversifiable
unsystematic risk
diversifiable
diversification
results in a reduction of total risk of the portfolio due to imperfect correlation between individual securities in the portfolio
beta
The extent to which the variability of returns (risk) of a stock related to the risk of a broad-based market portfolio
Market portfolio (β ) is 1.0, i.e., the β of S&P 500 =1.
β >1: riskier than the market, aggressive stocks
β <1: less risky than the market, defensive stocks
security market line (SML)
depicts the offsetting returns demanded for increased increments of risk, the classic risk/return tradeoff.
enables one to conceptualize the risk of a stock as the sum of the risk-free rate plus the market risk premium adjusted for the relative risk of the stock (beta).
Also called Capital Assets Pricing Model (CAPM)
The investment policy of a mutual fund only permits the fund to invest in public equities traded in secondary markets. Would the fund be able to purchase:
Common stock of a company that trades on a large stock exchange?
Common stock of a public company that trades only through dealers?
A government bond?
A single stock futures contract?
Common stock sold for the first time by a properly registered public company?
Shares in a privately held bank with 10 billion of capital?
Yes, Yes, No, No, No, No
forex markets
a place in which currencies are traded against each other
Operates 24 hours a day, each business day
The largest financial market
Facilitates international trade and cash flows
In 2019, the daily turnover was USD 6.6 trillion, which was about 10 to 15 times larger than the daily turnover in global fixed-income markets and about 50 times larger than the global turnover in equity markets.
globalization
The world economy is increasingly transactional in nature
portfolio diversification
Important for even domestic investors
Roughly 30% of S&P 500 Index earnings are from abroad
foreign exchange rate
the price at which one currency (e.g., the U.S. dollar) can be exchanged for another currency (e.g., the Swiss franc) in the foreign exchange markets
These transactions expose U.S. corporations and investors to foreign exchange risk as the cash flows are converted into and out of U.S. dollars
currency depreciation (appreciation)
occurs when a country’s currency falls (rises) in value relative to other currencies
euro
European Union’s single currency
Started trading on January 1, 1999
The creation of it had its origins in the creation of the European Community (EC) a consolidation of three European communities in 1967:
European Coal and Steel Community, the European Economic Market, and the European Atomic Energy Community
dollar
remains the unparalleled medium of exchange because it is the world’s easiest currency to buy or sell
dollarization
the use of a foreign currency in parallel to, or instead of, the local currency
major advantage of dollarization
the promotion of fiscal discipline and thus greater financial stability and lower inflation
two types of FX rates and transactions
spot fx transactions and forward fx transactions
spot fx transactions
Involve the immediate exchange of currencies at the current (or spot) exchange rate
forward fx transactions
Is the exchange of currencies at a specified exchange rate (or forward exchange rate) at some specified date in the future
Example is an agreement today (at time 0) to exchange dollars for pounds at a given (forward) exchange rate in three months
Typically written for one-, three-, or six-month periods
fx rates listed in two ways
direct quote and indirect quote
direct quote
U.S. dollars received for one unit of the foreign currency exchanged (IN US$ or USD, also referred to as the direct quote)
0.98$/€ (11/3/2022
indirect quote
Foreign currency received for each U.S. dollar exchanged (PER US$, also referred to as the indirect quote)
1.02 €/$ (11/3/2022)
risk involved with a foreign fx transaction
is that the value of the foreign currency may change relative to the U.S. dollar over a holding period
FX risk is also introduced by adding foreign currency assets and liabilities to a firm’s balance sheet
main participants in the fx markets
FIs and commercial banks
sources of forex risk exposure
International differentials in real prices
Cross-country differences in the real rate of interest
Regulatory and government intervention
Restrictions on capital movements
Trade barriers
Tariffs
why do managers hedge
to manage their exposure to currency risks, not to eliminate it
While it reduces possible losses, it also reduces possible gains
how can an FI better control the scale of its fx exposure
On-balance-sheet hedging
Off-balance-sheet hedging
on balance sheet hedging
Involves making changes in the on-balance-sheet assets and liabilities to protect the FI’s profits from FX risk
By directly matching its foreign asset and liability book, an FI can lock in a positive return or profit spread whichever direction exchange rates change over the investment period
off balance sheet hedging
Involves no on-balance-sheet changes, but rather involves taking a position in forward or other derivative securities (such as futures, options, or sawps) to hedge FX risk
net exposure
the overall FX exposure in any given currency, measured by its net book or position exposure, where i = ith country’s currency:
positive net exposure
implies an FI is overall net long in a currency (i.e., the FI has purchased more foreign currency than it has sold)
negative net exposure
implies the FI is net short (i.e., the FI has sold more foreign currency than it has purchased) in a foreign currency
Banks’ net foreign exposure is equal to:
net foreign assets.
net FX bought.
net foreign assets + net FX bought.
assets − liabilities.
None of these choices are correct
net foreign assets + net FX bought
If a firm has more foreign currency assets than liabilities, and no other foreign currency transactions, it has:
positive net exposure.
negative net exposure.
a fully balanced position.
zero net exposure
positive net exposure
derivatives
financial securities that are based upon or derived from existing securities
derivative security
an agreement between two parties to exchange a standard quantity of an asset at a predetermined price at a specified date in the future
Payoff is linked to another, previously issued security
As the value of the underlying security to be exchanged changes, the value of the derivative security changes
Traders can experience large losses if the price of the underlying asset moves against them significantly
purpose of using derivatives
to manage the price risk inherent in transactions that call for future delivery and payment.
spot contract
an agreement to transact involving the immediate exchange of assets and funds
unique feature of a spot market
the immediate and simultaneous exchange of cash for securities, or what is often called delivery versus payment
why do spot transactions occur
because the buyer of the assets believes its value will increase in the immediate future (over the investor’s holding period)
If the value of the asset increases as expected, the investor can sell the asset at its higher price for a profit
forward contract
a non-standardized agreement to transact involving the future exchange of a set amount of assets at a set price
Market participants take a position in these because the future (spot) price or interest rate on an asset is uncertain
Buying/selling of a specified amount, price, and future delivery date of foreign currency.
Seller delivers at the specified date called the settlement date.
Buyer of this has the long position; seller of the forward contract has the short position
major forward market participants
Commercial banks, investment banks, and broker-dealers
futures contract
a standardized agreement to transact involving the future exchange of a set amount of assets for a price that is settled daily
Traded on an organized exchange
Very similar to a forward contract
One difference is that the default risk on these is significantly reduce by the futures exchange guaranteeing to indemnity counterparties against credit or default risk
Another difference relates to the contract’s price, which in this is marked to market daily
Unless a systematic financial market collapse threatens an exchange itself, these are essentially risk-free
futures trading
Chicago Board of Trade (CBOT) and the New York Mercantile Exchange (NYMEX), both of which are part of the CME Group
Financial futures market trading was introduced in 1972
clearinghouse
the unit that oversees trading on the exchange and guarantees all trades made by the exchange traders
two choices to liquidate futures contract position
Liquidate position before the futures contract expires
Hold the futures contract to expiration
delivery seldom made
buyer/seller offsets previous position before maturity
traders in futures and options markets
speculators, hedgers, or arbitrageurs
leveraged instruments
meaning traders post and maintain only a small portion of the value of their futures position in their accounts and borrow the rest from brokers
initial margin
a deposit required on futures trades to ensure that the terms of the contracts will be met
maintenance margin
is the margin a futures trader must maintain once a futures position is taken
Typically, 50% to 70% of the initial margin
if losses occur such that margin account funds fall below the maintenance margin, the customer is required to deposit additional funds in the margin account to increase the funds back to the initial margin level.
option
a contract that gives the holder the right, but not the obligation, to buy or sell the underlying asset at a specified price within a specified period of time
call option
gives the purchaser (or buyer) the right to buy an underlying security (e.g., a stock) at a prespecified price called the exercise or strike price (X)
In return, buyer of this option must pay the writer (or seller) an up-front fee known as a call premium (C)
put option
gives the option buyer the right to sell an underlying security (e.g., a stock) at a prespecified price to the writer of the put option
In return, the buyer of this option must pay the writer (or seller) the put premium (P)
american option
can be exercised at any time before (and on) the expiration date
european option
can be exercised only on the expiration date
three levels of institutional regulation for derivative securities
Regulators of derivatives specify “permissible activities” that institutions may engage in
Once permissible activities have been specified, institutions engaging in those activities are subjected to supervisory oversight
Regulators attempt to judge the overall integrity of each institution engaging in derivative activities by assessing the capital adequacy of the institutions and by enforcing regulations to ensure compliance with those capital requirements
swap
an agreement between two parties to exchange a series of cash flows based on some underlying instrument for a specific period of time at a specified interval
First developed in 1981 when IBM and the World Bank entered into a currency swap agreement
Allow better management of interest rates, foreign exchange, and credit risk
three types of swaps
Interest rate swap
Currency swap
Credit swap or Credit Default Swap (CDS)
interest rate swap
An exchange of fixed-interest payments for floating-interest payments by two counterparties
Plain vanilla swap
Largest segment of the swap market
Allows the swap parties to put in place long-term protection against interest rate risk
currency swap
A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities
involves an exchange of fixed-for-fixed interest rates cash flows between two currencies
credit swaps or credit default swaps (CDS)
provide the buyer with protection against default and other risks
Were developed to better allow FIs to hedge their credit risk
Allow FIs to transfer their credit risk (such as mortgages)
total return swap
involves swapping an obligation to pay interest at a specified fixed or floating rate for payments representing the total return on a loan of a specified amount
pure credit swaps
remove the “interest rate”-sensitive element of total return swaps, and are similar to buying credit insurance and/or a multi-period credit option
vital services of FIs
Information services
Liquidity services
Price-risk reduction services
types of regulation
Safety and soundness regulation
Monetary policy regulation
Credit allocation regulation
Consumer protection regulation
Investor protection regulation
Entry and chartering regulation
safety and soundness regulation
To protect depositors and borrowers against the risk of CB failure – for example, due to a lack of diversification in asset portfolios – regulators have developed layers of protective mechanisms that balance a CB’s profitability against its solvency, liquidity, and other types of risk
2010 wall street reform and protection act
Signed into law by President Obama in July 2010
Set forth reforms to meet five key objectives:
Promote robust supervision and regulation of financial firms
Establish comprehensive supervision of financial markets
Protect consumers and investors from financial abuse
Provide the government with the tools it needs to manage financial crises
Raise international regulatory standards and improve international cooperation
monetary policy regulation
Regulators commonly impose a minimum level of required cash reserves to be held against deposits
credit allocation regulation
Regulations support the CB’s lending to socially important sectors, such as housing and farming
qualified thrift lender test (QTL)
requires savings institutions to hold 65 percent of their assets in residential mortgage-related assets to retain a thrift charter
community reinvestment act (CRA) of 1977
Examinations for compliance have become increasingly rigorous
Since 1990, institutions have been required to disclose publicly their CRA ratings – which range from outstanding to substantial noncompliance
home mortgage disclosure act (HMDA) of 1975
Especially concerned about discrimination on the basis of age, race, sex, or income
Consumer financial protection bureau (CFPB)
Created as part of the financial services overhaul bill passed in 2010 to protect consumers from unfair, deceptive, and abusive practices
Example of CFPB oversight occurred in September 2016 when Wells Fargo Bank was ordered to pay $185 million in fines and penalties to settle “the widespread illegal practice of secretly opening unauthorized deposit and credit card accounts
four regulators of commercial banks
Federal Deposit Insurance Corporation (FDIC)
Office of the Comptroller of the Currency (OCC)
Federal Reserve (FR)
State bank regulators
facets of regulatory structure
Regulation of the overall operations
Regulation of product and geographic expansions
Provision and regulation of deposit insurance
Balance sheet regulations
commercial banking
involves deposit taking and lending
investment banking
involves underwriting, issuing, and distributing securities
glass steagull act of 1933
imposed a rigid separation between commercial and investment banks
financial services modernization act (FSMA)
repealed Glass-Steagall barriers between commercial banking and investment banking
dimensions of geographic expansion
Domestic
Within a state or region
International (participating in a foreign market)
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
Allowed U.S. and foreign banks to branch interstate by consolidating out-of-state bank subsidiaries into a branch network and/or by acquiring banks of individual branches of banks through acquisitions or merger
Result of this is that full interstate banking is a reality in the U.S.
Relaxation of the branching restrictions, along with recognition of the potential cost, revenue, and risk benefits from geographic expansions, are major reasons for the recent merger wave (and increased consolidation) in U.S. banking
federal deposit insurance corporation (FDIC)
Created in 1933 in the wake of the banking panics of 1930-1933 to maintain the stability of, and public confidence in, the U.S. financial system
The process of packaging and/or selling mortgages that are then used to back publicly traded debt securities is called:
collateralization
securitization
market capitalization
stock diversification
mortgage globalization
securitization
All else held constant, mortgage payments are ____________ on a 15-year fixed-rate mortgage than on a 30-year fixed-rate mortgage, and ____________ is paid on a 15-year mortgage than on a 30-year mortgage.
lower; less interest
lower; less principal
higher; less interest
higher; more principal
higher; more interest
higher; less interest
With a fixed-rate mortgage, the ____________ bears the interest rate risk and with an ARM the ______________ bears the interest rate risk
borrower; lender
borrower; borrower
lender; lender
lender; borrower
federal government ; pool organizer
lender; borrower
The schedule showing how monthly mortgage payments are split into principal and interest is called a(n):
securitization schedule
balloon payment schedule
graduated payment schedule
amortization schedule
growing equity schedule
amortization schedule
The preemptive right is designed to:
allow management to diffuse stock ownership of any voting power
allow managers to preempt a stock offering if they do not like the terms of the deal
allow existing shareholders the right to sell their existing shares before the new offer
allow existing shareholders to buy shares of the new offering if they desire
none of these choices are correct
allow existing shareholders to buy shares of the new offering if they desire
Which of the following information is not usually found in a Wall Street Journal stock quote?
dividend yield
price earnings ratio
closing price of the stokc
stock rating
ticker symbol
stock rating
in terms of volume of trading and market value of firms traded, the _____________ is the largest U.S. stock market. In terms of number of firms traded, the ___________ is the largest in the United States.
NYSE; NYSE
NASDAQ;NYSE
NYSE;AMEX
NYSE;NASDAQ
NASDAQ;AMEX
NYSE;NASDAQ
Which of the following indexes are value-weighted?
I. NYSE Composite
II. S&P 500
III. NASDAQ Composite
IV. Dow Jones Industrial Average
1, 2, 3 and 4
1 only
2 only
2, 3 and 4 only
1, 2 and 3 only
1, 2 and 3 only
Common stocks typically have which of the following that bonds do not have?
I. Voting rights
II. Fixed cash flows
III. Set maturity date
IV. Tax deductibility of cash flows to investors
1 only
1, 2 and 4 only
2, 3 and 4 only
4 only
1, 2, 3 and 4
1 only
With ____________ voting, all directors up for election are voted on by the shareholders at the same time in one general election
straight
participating
nonparticipating
proxy
cumulative
cumulative
If all preferred dividend payments that have been missed must be paid before any common stock dividend can be paid, the preferred stock is called _____________ preferred stock.
cumulative
participating
nonparticipating
voting
dual class
cumulative
Suppose that over the last 10 to 15 years significantly large numbers of investors have been able to earn abnormal returns from using the firm’s publicly-available financial information to forecast growth in earnings and dividends. This would be evidence that the markets are not:
I. weak form efficient.
II. semistrong form efficient.
III. strong form efficient
1 only
1 and 2 only
3 only
2 and 3 only
1, 2 and 3 only
1 and 2 only
According to the strong form of efficient market hypothesis:
private information is of no help
using past price and volume information one can earn abnormally high returns from stocks
using insider information one can earn abnormally high returns from stocks
financial statement analysis can be used to earn abnormally high returns from stocks
equity analysts are always correct in predicting the best stocks
private information is of no help
The preliminary version of a security offer that is circulated to potential buyers before SEC approval (registration) is obtained is called a:
final prospectus
shelf registration statement
due diligence draft
waiting period offer
‘
red herring prospectus
red herring prospectus
A U.S. investor has borrowed pounds, converted them to dollars, and invested the dollars in the United States to take advantage of interest rate differentials. To cover the currency risk, the investor should:
sell pounds forward
buy dollars forward
buy pounds forward
sell pounds spot
none of these choices are correct
buy pounds forward
A U.S. firm has £50 million in assets in Britain that they need to repatriate in six months. They could hedge the exchange rate risk by:
buy pounds forward
selling pounds forward
borrowing pounds
both selling pounds forward and borrowing pounds
both buying pounds forward and borrowing pounds
both selling pounds forward and borrowing pounds
If a firm has more foreign currency assets than liabilities, and no other foreign currency transactions, it has:
positive net exposure
negative net exposure
a fully balanced position
zero net exposure
positive net exposure
The levels of foreign currency assets and liabilities at banks have ___________ in recent years, and the level of foreign currency trading has ____________.
increased; increased
decreased; decreased
increased; decreased
decreased; increased
decreased; stayed the same
increased; increased
If interest rate parity holds and the annual German nominal interest rate is 3 percent and the U.S. annual nominal rate is 5 percent, and real interest rates are 2 percent in both countries, then inflation in Germany is about _______________ than in the United States
1 percent higher
2 percent higher
1 percent lower
4 percent lower
2 percent lower
2 percent lower
The largest center for trading in foreign exchange is:
New York
London
Tokyo
Hong Kong
Geneva
London
A negotiated OTC agreement to exchange currencies at a fixed date in the future but at an exchange rate specified today is a:
currency swap agreement.
forward foreign exchange transaction.
currency futures contract.
currency options contract.
spot foreign exchange transaction.
forward foreign exchange transaction.
Which of the following conditions may lead to a decline in the value of a country’s currency?
I. Low interest rates
II. High inflation
III. Large current account deficit
I only
I and II only
II and III only
II only
III only
II and III only
The large U.S. current account deficit implies that:
U.S. interest rates are too high.
the value of the dollar is too weak.
dollar foreign currency reserves at Asian central banks are too low.
the presidential administration desires to improve growth of overseas economies.
the United States must rely on foreigners to be willing to invest in the United States.
the United States must rely on foreigners to be willing to invest in the United States.
A current account deficit implies that:
more goods and services are exported than are imported.
more goods and services are imported than are exported.
there is excessive consumption of foreign financial assets.
the value of the dollar will rise.
the country is going bankrupt.
more goods and services are imported than are exported
The ________________ measures the net flows of imports and exports of goods, services, income payments, and unilateral transfers.
current account
capital account
change in official reserves
statistical discrepancy
basic balance account
current account
An increase in which of the following would increase the price of a call option on common stock, all else held constant?
I. Stock price
II. Stock price volatility
III. Interest rates
IV. Exercise price
II only
II and IV only
I, II, and III only
I, III, and IV only
I, II, III, and IV
I, II, and III only
Which of the following is true?
Forward contracts have no default risk.
Futures contracts require an initial margin requirement be paid.
Forward contracts are marked to market daily.
Forward contract buyers and sellers do not know who the counterparty is.
Futures contracts are only traded over the counter.
Futures contracts require an initial margin requirement be paid
A contract that gives the holder the right to sell a security at a preset price only immediately before contract expiration is a(n):
American call option.
European call option.
American put option.
European put option.
knockout option.
European put option
A speculator may write a put option on stock with an exercise price of $15 and earn a $3 premium only if he thought:
the stock price would stay above $12.
the stock volatility would increase.
the stock price would fall below $18.
the stock price would stay above $15.
the stock price would rise above $18 or fall below $12.
the stock price would stay above $12
In a bear market, which option positions make money?
I. Buying a call
II. Writing a call
III. Buying a put
IV. Writing a put
I and II
I and III
II and IV
II and III
I and IV
II and III
The higher the exercise price, the ________________ the value of a put and the _______________ the value of a call.
higher; higher
lower; lower
higher; lower
lower; higher
higher; lower
A stock has a spot price of $55. Its May options are about to expire. One of its puts is worth $5 and one of its calls is worth $10. The exercise price of the put must be ______________ and the exercise price of the call must be ________________.
$50; $45
$55; $55
$60; $45
$60; $50
One cannot tell from the information given.
$60; $45
A contract wherein the buyer agrees to pay a specified interest rate on a loan that will be originated at some future time is called a(n):
forward rate agreement.
futures loan.
option on a futures contract.
interest rate swap contract.
currency swap contract.
forward rate agreement
U.S. depository institutions may be subject to as many as ______________ separate regulators.
four
five
six
seven
eight
four
FDIC deposit insurance is generally limited to ________________ per depositor per bank.
$50,000
$100,000
$150,000
$200,000
$250,000
$250,000
Areas of commercial bank regulation dealing with preventing banks from discriminating unfairly in lending are termed ______________________ regulations.
safety and soundness
consumer protection
investor protection
credit allocation
monetary policy
consumer protection
Areas of commercial bank regulation designed to encourage banks to lend to socially important sectors such as housing and farming are termed ______________________ regulations.
safety and soundness
consumer protection
investor protection
credit allocation
monetary policy
credit allocation
Which act led to interstate banking in the United States?
Glass-Steagall Act
DIDMCA
McFadden Act
Riegle-Neal Act
Financial Services Modernization Act
Riegle-Neal Act
Recent regulation such as the Riegle-Neal Act of 1994 has removed some of the federal banking laws that formerly constrained profitable opportunities for commercial banks. The Riegle-Neal Act removes the major restrictions on banks’ abilities to _________________.
diversify geographically
diversify their product line
engage in securities underwriting
engage in insurance underwriting
engage in loan brokerage
diversify geographically
Tier I (core) capital includes at least some part of which of the following?
I. Common stockholders’ equity
II. Retained earnings
III. Subordinated debt
IV. Allowance for loan and lease losses
I only
I and II only
I and IV only
II and III only
I, II, III, and IV
I and II only
The _______________________ introduced the prompt corrective action policy that requires federal intervention when a bank’s capital falls below certain minimums.
Federal Deposit Insurance Corporation Improvement Act
Financial Services Modernization Act
USA Patriot Act
Foreign Bank Supervision Enhancement Act
Foreign Banking Activity Powers Enforcement Act
Federal Deposit Insurance Corporation Improvement Act
The layers of regulation imposed on banks to protect depositors against bank failure are termed credit allocation regulations.
True
False
False
The Investment Company Act of 1940 and the Securities Acts of 1933 and 1934 are examples of investor protection regulations
True
False
True
A securities subsidiary of a bank holding company that engages in investment banking is called a Riegle-Neal affiliate
True False
False
The Glass-Steagall Act came about due to concerns about excessive risk taking at banks and conflicts of interest between commercial and investment banking activities
True
False
True
The 1993 Basel Agreement explicitly incorporated the different credit risks of assets into capital adequacy measures.
True
False
True
Which act allowed the establishment of full-service financial institutions in the United States?
Riegle-Neal Act
Financial Services
Modernization Act
USA Patriot Act
Foreign Bank Supervision Enhancement Act
Foreign Banking Activity Powers Enforcement Act
Financial Services
Modernization Act
Major provisions of the Financial Services Modernization Act of 1999 include all of the following except:
allowing bank holding companies to open insurance underwriting affiliates and vice versa.
allowing bank holding companies to open or merge with investment banks.
creating one regulator to oversee all activities of financial service firms.
All of these choices are correct.
None of these options are correct.
creating one regulator to oversee all activities of financial service firms
