Second Midterm
Part I: Multiple Choice Questions
1. Which of the following statements concerning external sources of financing for nonfinancial businesses in the United States are true?
a. Stocks are a far more important source of external funding for businesses in terms of dollar amount than are bonds.
b. Bonds are a far more important source of external funding for businesses in terms of dollar amounts than are stocks.
c. Financial intermediaries, such as banks, are the least important source of external funding for nonfinancial businesses in terms of dollar amount.
d. (b) and (c)
e. None of the above is true about external sources of financing for nonfinancial businesses in the United States.
2. The fact that only large, established corporations have access to securities markets
a. Explains why indirect finance is such an important source of external funding for businesses.
b. Is the result of the problem of adverse selection.
c. Can be explained as the result of government regulations that prohibit small firms from acquiring funds in securities markets.
d. All of the above statements help to explain this phenomenon.
e. (a) and (b) are correct explanations.
3. Most major financial crises in the United States have begun with
a. A decline in interest rates.
b. A decline in the stock market.
c. A increase in interest rates.
d. (a) and (b)
e. (b) and (c)
4. The principal-agent problem
a. Occurs when managers have a greater incentive to maximize profits than do the stockholders of the firm.
b. Would not arise if the owners of the firm had complete information about the activities of the managers and could control the managers.
c. In financial markets helps to explain why equity is a relatively important source of external funding for American businesses.
d. All of the above are true.
e. (b) and (c) are true.
5. Which of the following are reported as liabilities on a bank's balance sheet?
a. Reserves.
b. Discount loans.
c. U.S. Treasury bills.
d. Cash items in the process of collection.
e. Consumer car loans.
6. When a $10 check written on First National Bank of Chicago is deposited in an account at Citibank, then
a. The liabilities side of the First National Bank of Chicago balance sheet decreases by $10 after the Fed clears the check.
b. The liabilities side of Citibank's balance sheet increases by $10.
c. The assets side of Citibank's balance sheet increases by $10 before the Fed clears the check.
d. All of the above are true statements.
e. (a) and (b) are true statements.
7. Consider the following balance sheet of a bank. If the interest rate rises from 10% to 15%, what will happen to bank profits using gap analysis?
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Assets
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Liabilities
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Rate-sensitive
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$20 million
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$50 million
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Fixed-rate
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$80 million
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$50 million
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a. Decline by $0.5 million.
b. Decline by $1.5 million.
c. Increase by $0.5 million.
d. Increase by $1.5 million.
e. Decline by $2.5 million.
8. According to the article "Discrimination in Mortgage Lending", which of the following is true?
a. The results of a Federal Reserve Band (FRB) of Boston study about discrimination in mortgage lending and those of a recent Chicago Fed study about it are exactly the same.
b. The results of a Chicago Fed study about discrimination in mortgage lending shows that there is discrimination in mortgage lending only for applicants at the margins of creditworthiness.
c. Both (a) and (b) are true.
d. The results of a recent Chicago Fed study about discrimination in mortgage lending shows that there is no discrimination in mortgage lending.
e. None of the above are true statements.
9. The McFadden Act of 1927
a. Effectively prohibited banks from branching across state lines.
b. Required banks to maintain bank capital equal to at least 6% of their assets.
c. Effectively required that banks maintain a correspondent relationship with large money center banks.
d. (a) and (b) are true.
e. Included the capital requirements considered and accepted at the Basel Accord.
10. Eurodollars are
a. Dollar-denominated deposits held in banks outside the United States.
b. Deposits held by U.S. banks in Europe.
c. Deposits held by U.S. banks in foreign countries.
d. Dollar-denominated deposits held in U.S. banks by Europeans.
e. Euro-denominated deposits held by U.S. banks.
11. The practice of creating marketable debt instruments that are backed by otherwise illiquid assets is known as
a. Standardization.
b. Homogenization.
c. Securitization.
d. Adverse selection.
e. Arbitrage.
12. The process is in which people take their money out of financial institutions in order to seek higher interest rates is called
a. Capital mobility.
b. Loophole mining.
c. Disintermediation.
d. Credit rationing.
e. Centralization.
13. The primary difference between the "payoff" and the "purchase and assumption" methods of handling failed banks is
a. That the FDIC guarantees all deposits, not just those under the $100,000 limit when it uses the "purchase and assumption" method.
b. That the FDIC is more likely to use the "purchase and assumption" method when the bank is relatively large and it fears that depositor losses may spur business bankruptcies and other bank failures.
c. That the FDIC guarantees all deposits, not just those under the $100,000 limit, when it uses the "payoff" method.
d. (a) and (b).
e. (b and (c).
14. If the too-big-to-fail policy is always applied to a large bank, it
a. Can exacerbate moral hazard problems.
b. Puts the large bank at a competitive disadvantage in attracting large deposits.
c. Treats large depositors at small banks inequitably when compared to large depositors at large banks.
d. (a) and (c).
e. All of the above.
15. The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
a. Instructed the FDIC to develop a risk-based deposit insurance premium.
b. Expanded the FDIC's ability to use the "too-big-to-fail" policy.
c. Instructed the FDIC to wait longer before intervening when a bank gets into financial trouble.
d. (a), (b) and (c) are true.
e. None of the above are true.
16. Which of the following are part of the Federal Reserve System?
a. Federal Reserve District Banks.
b. The FDIC.
c. The Board of Advisors.
d. All of the above are part of the Federal Reserve System.
e. (a) and (c) are part of the Federal Reserve System.
17. Which of the following has over 30% of the Federal Reserve System's assets?
a. The Chicago Fed.
b. The Los Angeles Fed.
c. Miami Fed.
d. New York Fed.
e. Washington, D.C. Fed.
18. The United States did not have a central bank until
a. The 16th century.
b. The 17th century.
c. The 18th century.
d. The 19th century.
e. The 20th century.
19. The Board of Governors of the Federal Reserve System
a. Establishes, within limits, reserve requirements.
b. Effectively sets the discount rate.
c. Are the sole members of the Federal Open Market Committee.
d. All of the above are true statements.
e. (a) and (b) are true statements.
Part II: Problems
1. Suppose a bank has $100 reserves, $150 in cash items in the process of collection, $200 of deposits at other banks, and $220 in checkable deposits. Be sure to show your work and to indicate what abbreviations stand for in your work. (Be sure to show your work and to indicate what abbreviations stand for in your work. Partial credit is not possible unless we can follow the work that you are doing in the problem: i.e., neatness and organization matter.)
a. Show the bank's balance sheet by using t-accounts. Make sure to identify the columns, any entry, and make sure the balance sheet balances.
b. Calculate the bank's net worth ratio.
c. Calculate the debt-to-equity ratio of the bank.
2. Suppose a firm has $20 million of assets and $15 million of liabilities with an average duration of 3 years. Suppose interest rates rise by 6% and the firm's net worth after the rate increase is $3 million. What is the average duration of the firm's assets? (Be sure to show your work and to indicate what abbreviations stand for in your work. Partial credit is not possible unless we can follow the work that you are doing in the problem: i.e., neatness and organization matter.)
3. Consider a stock market where there is a buyer and ten sellers. In the market, there are two types of the stock: high-quality stock and low-quality stock. Each seller has only one of these two types of stock. In particular, nine sellers have the high-quality stock while the tenth seller has low-quality stock. High-quality stock is worth $1600 to the buyer while it is worth $1500 to the seller. Low-quality stock is worth $1200 to the buyer while it is worth $1100 to the seller. The table below recounts this information:
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Number of sellers
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Value to the buyer
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Value to the seller
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High-quality stock
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9
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$1600
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$1500
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Low-quality stock
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1
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$1200
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$1100
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Suppose there is asymmetric information: each seller knows the quality of the stock they hold, but the buyer does not know the quality of the stock.
a. Find the possible range(s) of the market price of the stock in this market.
b. For each range you find, be sure to explain who is driven out of the market and who remains in the market.
Be sure to show your work and to indicate what abbreviations stand for in your work. Partial credit is not possible unless we can follow the work that you are doing in the problem: i.e., neatness and organization matter.)
III. Essay
Referring to the articles "What's the Point of Credit Scoring" and "Meet the New Borrowers" answer the following questions:
a. Describe two benefits resulting from the use of credit scoring.
b. Describe two limitations to credit scoring and explain why they are limitations.
c. Referring to "Meet the New Borrowers", if a credit card issuer was to use credit scoring, which factors might it include in its model as a sign of delinquency risk? List three factors and describe why they would be included.
d. Explain the effect of credit scoring on the level of competition in the market for small business loans.