Function, Purpose and Regulation of Financial Institutions

Question 1

Commercial Banks

Answer 1

Commercial banks offer a variety of financial services, including checking and savings accounts, credit cards, safety deposit boxes, financial consulting, and all types of lending services. Examples of commercial banks include Bank of America, Capital One, and Wells Fargo.

Question 2

Savings & Loan Institutions

Answer 2

A Savings and Loan Association (S&L), or thrift association, is similar to a bank. They borrow money from depositors and lend this money out primarily in the form of home mortgages.

Question 3

Two types of S&L Ownership Structures

Answer 3

Mutual

Corporate

Question 4

Mutual S&L

Answer 4

In a mutual S&L, depositors are the owners. They receive dividends rather than interest on savings.

Question 5

Corporate S&L

Answer 5

Within a corporate S&L, depositors receive interest rather than dividends, just like in a commercial bank. This is a technical difference, with dividends from mutual S&Ls treated as if they were really interest payments.

Question 6

Savings Bank

Answer 6

A savings bank is a close cousin of a savings and loan association, especially a mutual S&L, and is generally found in the northeastern United States.

Question 7

Credit Unions

Answer 7

Credit unions are another type of depositor-owned financial institution. They are “not-for-profit cooperatives” made up of members with some type of common bond.

Question 8

FDIC Insurance

Answer 8

If your account is with a federally insured institution, it is insured for up to $250,000 per account of the same registration and same institution.

Question 9

FDIC Insured Ownership Categories

Answer 9

Single Accounts

Certain Retirement Accounts

Joint Accounts

Revocable Trust Accounts

Irrevocable Trust Accounts

Employee Benefit Plan Accounts

Each of these ownership categories receives up to $250,000 of FIDC insurance.

Question 10

Three General Categories of Brokers

Answer 10

Full-Service brokers

Discount brokers

Deep Discount brokers

Question 11

Full Service Brokers

Answer 11

Full-Service brokers take buy and sell orders, extend margin credit to customers, hold the clients’ securities in safekeeping, and collect cash dividends. Most importantly, they also provide free investment research and perform “hand-holding” services.

Question 12

Discount Brokers

Answer 12

Discount brokers simply take orders from their clients - they furnish little or no investment advice. If the discounters provide any investment research, it will likely be in the form of published reports from Moody’s or Standard & Poor’s. Like most brokers, the discounters extend margin credit, hold clients’ securities in safekeeping, and accumulate the client’s cash dividends and interest income.

Question 13

Deep Discount Brokers

Answer 13

Deep Discount brokers, also known as electronic brokers, take buy and sell orders over the Internet. Most provide no hand-holding. The investor/client might not even speak with a human as a self-service transaction is executed. Some electronic brokers provide printed investment research. If so, it might be free or there may be a modest charge.

Question 14

Three Types of Margin Calls

Answer 14

Regulation T Call

Maintenance Margin

Minimum Equity Call

Question 15

Regulation T Call

Answer 15

Regulation T Call: Occurs when the intital margin amout is below the minimum established in Reg T (50%)

Question 16

Maintenance Margin

Answer 16

Maintenance Margin: Required when the value of an account drops below the specificed maintenance level at the brokerage firm that holds the margin account.

Question 17

Minimum Equity Call

Answer 17

Minimum Equity Call: There is a required minimum balance to establish and maintain a margin account. When the current account value falls below the required minimum, a minimum equity call is issued. Generally this amount is $2,000, but “pattern day traders” are required to maintain a minimum of $25,000.

Question 18

Securities Investors Protection Corporation

Answer 18

The Securities Investors Protection Corporation (SIPC) is similar to the FDIC. It provides coverage for customers of its member broker-dealers up to $500,000. Of the $500,000, no more than $250,000 can be for cash losses. Customers who own both a cash account and a margin account will have a combined account under SIPC coverage. Spouses who have joint accounts will have separate coverage. SIPC coverage is for individual customers only and does not apply to institutional clients.

Question 19

Federal Law Governing Insurance

Answer 19

The governing federal insurance law is the McCarran-Ferguson Act of 1945 (Public Law 15). This turns the regulation of the insurance industry over to the states. States regulate the industry through their three branches of government. An insurance commissioner conducts the administration of state laws and applies insurance laws to specific cases. COBRA and HIPPA are federal regulations that affect the continuation of health care coverage.

Question 20

Two Types of Pension Plans

Answer 20

Defined Contribution

Defined Benefit

Question 21

Defined Contribution

Answer 21

In a defined contribution plan, each employee has an account into which the employer, and usually the employee, make regular contributions. The employee defines how much is put into the plan. At retirement, the employee receives a benefit whose size depends on the accumulated value of the funds in the retirement account.

Question 22

Defined Benefit

Answer 22

In a defined benefit plan, the employee’s pension benefit is determined by a formula that takes into account years of service to the employer. In most cases, it also includes salary or wages. The amount the employee receives is defined for him or her. The most common formulas used to determine the benefit are flat amount, flat percentage, and unit credit.

Question 23

Choose the one that does not apply to Savings and Loans associations (S&Ls).

A. Many times an S&L pays one-quarter percent more on savings accounts than commercial banks.
B. They fund fewer home mortgage loans than banks.
C. They operate on a smaller scale than do commercial banks.
D. The services they offer are very similar to commercial banks.

Answer 23

Correct Answer: B. They fund fewer home mortgage loans than banks.

Explanation: Funding of home mortgage loans is an important feature of S&Ls. Laws require that at least 70 percent of the loans of federally chartered S&Ls go toward home mortgages.

Question 24

Credit Unions have advantages because of their tax-exempt status. What are they?

A. Pay more than depositors would otherwise earn at a commercial bank.
B. Have lower fees and minimum balances associated with their accounts.
C. Their loans also tend to be at favorable rates, again owing to their tax-exempt status.
D. Have a “cost” advantage over other financial institutions.
E. Restrict membership to those who have a common bond with members.

Answer 24

Correct Answers: A., B., C. and D.

Explanation: Credit unions are a type of depositor-owned financial institution. Due to their “not-for-profit organizations” status they are tax-exempt. There are certain advantages attached to this status like: ablibilty to pay more than a commercial bank, lower fees and minimum balances, favorable rates for loans, and a “cost” advantage. Their exclusivity does not contribute to their tax advantage.

Question 25

Which of the following is true of FDIC insurance?

A. FDIC insurance insures up to $250,000 per depositor.
B. Guarantees recovery of funds up to $10,000.
C. Is backed by the Federal government.
D. FDIC guarantees up to $500,000 for joint accounts for spouses.

Answer 25

Correct Answers: A., C. and D.

Explanation: The Federal Deposit Insurance Corporation insures commercial banks and savings and loans accounts up to $250,000. The Federal government guarantees it. It is not available for any other financial institution, therefore giving commercial banks and savings and loans the lowest risk of financial institutions. The insurance is limited to $250,000 per account. A joint account would still have a maximum protection of $500,000.

Question 26

Which of the following can be found in an asset management account?

A. Checking Account
B. Credit Card
C. Debt Payment
D. Money Market Fund
E. Brokerage Services

Answer 26

Correct Answers: A., B., C., D. and E.

Explanation: An asset management account is a comprehensive financial service package offered by a brokerage firm, which can include a checking account, credit and debit cards, an MMMF, loans, automatic payment of fixed payments and a system for the direct payment of interest or dividends.

Question 27

Matching

1. Full Service Broker A. Lower commission with no advice
2. Discount Broker B. Online trading with lowest commissions
3. Deep Discount Broker C. Higher commission for advice on transactions

Answer 27

Correct Answer:

1. Full Service Broker C. Higher commission for advice on transactions
2. Discount Broker A. Lower commission with no advice
3. Deep Discount Broker B. Online trading with lowest commissions

Question 28

Which of the following statements are true about margin accounts?

A. Margin accounts allow investors to magnify their returns through leverage.
B. Margin calls are made when the securities increase in value.
C. Initial margin requires investors to put up at least 50% of purchase.
D. Are more suitable for novice investors than cash accounts.

Answer 28

Correct Answers: A. and C.

Explanation: Margin accounts allow investors to finance the purchase of a security. In doing so, the investor can magnify their return if the security appreciates in value. Federal regulation requires a 50% initial margin. Some brokerage firms may require more. When a security drops in price causing the investor’s equity amount to go below the maintenance margin requirement, he or she will receive a margin call to make up the difference.

Question 29

Which of the following fees is common to all mutual funds?

A. Management Fee
B. 12b-1 Fee
C. Load
D. Redemption Fee

Answer 29

Correct Answer: A. Management Fee

Explanation: All mutual funds charge a management fee as compensation for managing the fund. Some funds charge a 12b-1 fee to pay for the marketing and distribution cost of the fund. Some funds charge commissions known as loads. There are also some funds that charge redemption fees to discourage early redemptions.

Question 30

Which of the following financial institutions help companies raise capital?

A. Investment Banks
B. Venture Capital Firms
C. Asset Management Firms
D. Insurance Companies
E. Pension Funds

Answer 30

Correct Answers: A. Investment Banks and B. Venture Capital Firms

Explanation: Investment banks raise capital for large corporations while venture capital firms help bring investors’ money to start-up companies.

Question 31

Which of the following financial institutions advise and administer asset pools for individuals, firms and governments?

A. Investment Banks
B. Venture Capital Firms
C. Asset Management Firms
D. Insurance Companies
E. Pension Funds

Answer 31

Correct Answer: C. Asset Management Firms

Explanation: Asset Management Firms, sometimes known as Investment Management Firms, advise or manage mutual funds, pension funds or other pools of assets. Their clientele include individuals, companies, and governments.

Question 32

Matching

1. Property and Casualty Insurance A. Covers sickness
2. Health Insurance B. Covers the inability to work
3. Disability Insurance C. Covers death
4. Life Insurance D. Covers accidents, theft or fire

Answer 32

Correct Answer:

1. Property and Casualty Insurance D. Covers accidents, theft or fire
2. Health Insurance A. Covers sickness
3. Disability Insurance B. Covers the inability to work
4. Life Insurance C. Covers death