ECON 3303 Exam 4 Summer MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

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1 ECON 3303 Exam 4 Summer 2017 Name MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question. 1) Which of the following would not be a way to increase the return on equity? A) Acquire new funds by selling negotiable CDs and increase assets with them B) Sell more bank stock C) Pay higher dividends D) Buy back bank stock 1) 2) Because of an expected rise in interest rates in the future, a banker will likely A) buy short-term rather than long-term bonds. B) make either short or long-term loans; expectations of future interest rates are irrelevant. C) buy long-term rather than short-term bonds. D) make long-term rather than short-term loans. 2) 3) As information technology improves, the lending role of financial institutions such as banks should A) increase significantly. B) stay the same. C) increase somewhat. D) decrease. 3) 4) A bank is insolvent when A) its capital exceeds its liabilities. B) its liabilities exceed its assets. C) its assets exceed its liabilities. D) its assets increase in value. 4) 5) The name economists give the process by which stockholders gather information by frequent monitoring of the firmʹs activities is A) the free-rider problem. B) debt intermediation. C) costly state verification. D) costly avoidance. 5) 6) Long-term customer relationships the cost of information collection and make it easier to credit risks. A) reduce; increase B) reduce; screen C) increase; screen D) increase; increase 6) 7) In general, banks make profits by selling liabilities and buying assets. A) risky; risk-free B) illiquid; liquid C) long-term; shorter-term D) short-term; longer-term 7) 8) Bank capital has both benefits and costs for the bank owners. Higher bank capital the likelihood of bankruptcy, but higher bank capital the return on equity for a given return on assets. A) increases; increases B) reduces; increases C) increases; reduces D) reduces; reduces 8) 1

2 First National Bank Assets Liabilities Rate-sensitive $20 million $50 million Fixed-rate $80 million $50 million 9) If interest rates rise by 5 percentage points, say, from 10 to 15%, bank profits (measured using gap analysis) will A) decline by $1.5 million. B) increase by $1.5 million. C) decline by $2.5 million. D) decline by $0.5 million. 9) 10) When a $10 check written on the First National Bank of Chicago is deposited in an account at Citibank, then A) the liabilities of Citibank decrease by $10. B) the assets of Citibank decrease by $10. C) the reserves of the First National Bank increase by $10. D) the liabilities of the First National Bank decrease by $10. 10) 11) The reduction in transactions costs per dollar of investment as the size of transactions increases is A) economies of scale. B) diversification. C) economies of trade. D) discounting. 11) 12) Although the National Bank Act of 1863 was designed to eliminate state -chartered banks by imposing a prohibitive tax on banknotes, these banks have been able to stay in business by A) branching into other states. B) issuing credit cards. C) ignoring the regulations. D) acquiring funds through deposits. 12) 13) The most important category of assets on a bankʹs balance sheet is A) securities. B) loans. C) discount loans. D) cash items in the process of collection. 13) 14) Bank capital is listed on the side of the bankʹs balance sheet because it represents a of funds. A) liability; use B) asset; use C) asset; source D) liability; source 14) 15) Financial intermediaries develop in things such as computer technology which allows them to lower transactions costs. A) regulations B) diversification C) equity D) expertise 15) 16) The share of checkable deposits in total bank liabilities has A) shrunk over time. B) remained virtually unchanged since C) expanded dramatically over time. D) expanded moderately over time. 16) 17) A bank will want to hold more excess reserves (everything else equal) when A) it expects to have deposit inflows in the near future. B) the discount rate decreases. C) brokerage commissions on selling bonds increase. D) the cost of selling loans falls. 17) 2

3 18) Government regulations require publicly traded firms to provide information, reducing A) the adverse selection problem. B) economies of scale. C) transactions costs. D) the need for diversification. 18) 19) The presence of so many commercial banks in the United States is most likely the result of A) consumersʹ preference for state banks. B) prior regulations that restricted the ability of these financial institutions to open branches. C) consumersʹ strong desire for dealing with only local banks. D) adverse selection and moral hazard problems that give local banks a competitive advantage over larger banks. 19) 20) Secondary reserves include A) deposits at Federal Reserve Banks. B) short-term Treasury securities. C) deposits at other large banks. D) state and local government securities. 20) 21) When you deposit a $50 bill in the Security Pacific National Bank, A) its assets increase by $50. B) its cash items in the process of collection increase by $50. C) its liabilities decrease by $50. D) its reserves decrease by $50. 21) 22) When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the bank chooses not to make any loans but to hold excess reserves instead, then, in the bankʹs final balance sheet, A) the liabilities of the bank decrease by $1 million. B) liabilities increase by $200,000. C) the assets at the bank increase by $1 million. D) reserves increase by $200, ) 23) Financial innovations occur because of financial institutions search for A) profits. B) stability. C) fame. D) recognition. 23) 24) Which of the following is not one of the eight basic puzzles about financial structure? A) Indirect finance, which involves the activities of financial intermediaries, is many times more important than direct finance, in which businesses raise funds directly from lenders in financial markets. B) There is very little regulation of the financial system. C) Collateral is a prevalent feature of debt contracts for both households and business. D) Debt contracts are typically extremely complicated legal documents that place substantial restrictions on the behavior of the borrower. 24) 25) Through correspondent banking, large banks provide services to small banks, including A) foreign exchange transactions. B) issuing stock. C) loan guarantees. D) debt reduction. 25) 26) If a bank has rate-sensitive assets than liabilities, then in interest rates will increase bank profits. A) more; a decline B) fewer; an increase C) fewer; a surge D) more; an increase 26) 3

4 27) One way of describing the solution that high net worth provides to the moral hazard problem is to say that it A) state verifies the debt contract. B) makes the debt contract incentive compatible. C) collateralizes the debt contract. D) removes all of the risk in the debt contract. 27) 28) The principal-agent problem A) in financial markets helps to explain why equity is a relatively important source of finance for American business. B) explains why direct finance is more important than indirect finance as a source of business finance. C) occurs when managers have more incentive to maximize profits than the stockholders-owners do. D) would not arise if the owners of the firm had complete information about the activities of the managers. 28) 29) The problem helps to explain why the private production and sale of information cannot eliminate. A) principal-agent; adverse selection B) free-rider; moral hazard C) principal-agent; moral hazard D) free-rider; adverse selection 29) 30) Property that is pledged to the lender in the event that a borrower cannot make his or her debt payment is called A) interest. B) good faith money. C) collateral. D) points. 30) 31) Adjustable rate mortgages A) allow borrowers to avoid paying interest on portions of their mortgage loans. B) benefit homeowners when interest rates rise. C) generally have higher initial interest rates than conventional fixed-rate mortgages. D) reduce the interest-rate risk for financial institutions. 31) 32) Which of the following are reported as liabilities on a bankʹs balance sheet? A) Loans B) Deposits with other banks C) Checkable deposits D) Reserves 32) 33) The government institution that has responsibility for the amount of money and credit supplied in the economy as a whole is the A) monetary fund. B) commercial bank. C) bank of settlement. D) central bank. 33) 34) Secondary reserves are so called because A) 50% of these assets count toward meeting required reserves. B) they can be converted into cash with low transactions costs. C) they are not easily converted into cash, and are, therefore, of secondary importance to banking firms. D) they rank second to bank vault cash in importance of bank holdings. 34) 4

5 35) The U.S. banking system is considered to be a dual system because A) it was established before the Civil War, requiring separate regulatory bodies for the North and South. B) it is regulated by both state and federal governments. C) banks offer both checking and savings accounts. D) it actually includes both banks and thrift institutions. 35) 36) If a bank needs to raise the amount of capital relative to assets, a bank manager might choose to A) sell securities the bank owns and put the funds into the reserve account. B) pay higher dividends. C) buy back bank stock. D) shrink the size of the bank. 36) 37) A problem for equity contracts is a particular type of called the problem. A) adverse selection; free-rider B) adverse selection; principal-agent C) moral hazard; principal-agent D) moral hazard; free-rider 37) 38) Nonfinancial businesses in Germany, Japan, and Canada raise most of their funds A) from nonbank loans. B) by issuing stock. C) by issuing bonds. D) from bank loans. 38) 39) Large-denomination CDs are, so that like a bond they can be resold in a market before they mature. A) nonnegotiable; secondary B) nonnegotiable; primary C) negotiable; secondary D) negotiable; primary 39) 40) A $5 million deposit outflow from a bank has the immediate effect of A) reducing deposits and capital by $5 million. B) reducing deposits and securities by $5 million. C) reducing deposits and loans by $5 million. D) reducing deposits and reserves by $5 million. 40) 41) One possible reason for slower growth in developing and transition countries is A) the lack of adverse selection and moral hazard problems. B) strict accounting standards are too stringent for the banks to meet. C) capital may not be directed to its most productive use. D) the weak link between government and financial intermediaries. 41) 42) Off-balance sheet activities involving guarantees of securities and back-up credit lines A) slightly reduce the risk a bank faces. B) increase the risk a bank faces. C) greatly reduce the risk a bank faces. D) have no impact on the risk a bank faces. 42) 43) A is a provision that restricts or specifies certain activities that a borrower can engage in. A) restrictive covenant B) residual claimant C) risk hedge D) restrictive barrier 43) 44) If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve requirements, the bank can A) repay its discount loans from the Fed. B) increase loans by $3 million. C) sell $3 million of securities. D) reduce deposits by $3 million. 44) 5

6 45) Of the following sources of external finance for American nonfinancial businesses, the least important is A) loans from banks. B) bonds and commercial paper. C) loans from other financial intermediaries. D) stocks. 45) 46) Bank loans from the Federal Reserve are called and represent a of funds. A) discount loans; use B) fed funds; use C) fed funds; source D) discount loans; source 46) 47) Net worth can perform a similar role to A) collateral. B) intermediation. C) diversification. D) economies of scale. 47) 48) A bank that wants to monitor the check payment practices of its commercial borrowers, so that moral hazard can be prevented, will require borrowers to A) place a corporate officer on the bankʹs board of directors. B) keep compensating balances in a checking account at the bank. C) purchase the bankʹs CDs. D) place a bank officer on their board of directors. 48) 49) In order to reduce the problem in loan markets, bankers collect information from prospective borrowers to screen out the bad credit risks from the good ones. A) moral hazard B) moral suasion C) adverse selection D) adverse lending 49) 50) The problem created by asymmetric information before the transaction occurs is called, while the problem created after the transaction occurs is called. A) free-riding; costly state verification B) moral hazard; adverse selection C) adverse selection; moral hazard D) costly state verification; free-riding 50) 6

7 Answer Key Testname: ECON3303_EXAM4_SUMMER_2017 1) B 2) A 3) D 4) B 5) C 6) B 7) D 8) D 9) A 10) D 11) A 12) D 13) B 14) D 15) D 16) A 17) C 18) A 19) B 20) B 21) A 22) C 23) A 24) B 25) A 26) D 27) B 28) D 29) D 30) C 31) D 32) C 33) D 34) B 35) B 36) D 37) C 38) D 39) C 40) D 41) C 42) B 43) A 44) C 45) D 46) D 47) A 48) B 49) C 50) C 7