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Chapter10

BankingandtheManagementofFinancialInstitutions
10.1 TheBankBalanceSheet
1) Whichofthefollowingstatementsaretrue?
A) Abanksassetsareitssourcesoffunds.
B) Abanksliabilitiesareitsusesoffunds.
C) Abanksbalancesheetshowsthattotalassetsequaltotalliabilitiesplusequitycapital.
D) Abanksbalancesheetindicateswhetherornotthebankisprofitable.
Answer: C
QuesStatus: PreviousEdition

2) Whichofthefollowingstatementsisfalse?
A) Abanksassetsareitsusesoffunds.
B) Abankissuesliabilitiestoacquirefunds.
C) Thebanksassetsprovidethebankwithincome.
D) Bankcapitalisrecordedasanassetonthebankbalancesheet.
Answer: D
QuesStatus: PreviousEdition

3) Whichofthefollowingarereportedasliabilitiesonabanksbalancesheet?
A) Reserves
B) Checkabledeposits
C) Loans
D) Depositswithotherbanks
Answer: B
QuesStatus: PreviousEdition

4) Whichofthefollowingarereportedasliabilitiesonabanksbalancesheet?
A) Discountloans
B) Reserves
C) U.S.Treasurysecurities
D) Loans
Answer: A
QuesStatus: PreviousEdition

5) Theshareofcheckabledepositsintotalbankliabilitieshas
A) expandedmoderatelyovertime.
B) expandeddramaticallyovertime.
C) shrunkovertime.
D) remainedvirtuallyunchangedsince1960.
Answer: C
QuesStatus: PreviousEdition

182MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

6) Whichofthefollowingstatementsisfalse?
A) Checkabledepositsareusuallythelowestcostsourceofbankfunds.
B) Checkabledepositsaretheprimarysourceofbankfunds.
C) Checkabledepositsarepayableondemand.
D) CheckabledepositsincludeNOWaccounts.
Answer: B
QuesStatus: PreviousEdition

7) Inrecentyearstheinterestpaidoncheckableandtimedepositshasaccountedforaround
________oftotalbankoperatingexpenses,whilethecostsinvolvedinservicingaccountshave
beenapproximately________ofoperatingexpenses.
A) 45percent;55percent
B) 55percent;4percent
C) 25percent;50percent
D) 50percent;30percent
Answer: C
QuesStatus: PreviousEdition

8) Whichofthefollowingstatementsaretrue?
A) Checkabledepositsarepayableondemand.
B) CheckabledepositsdonotincludeNOWaccounts.
C) Checkabledepositsaretheprimarysourceofbankfunds.
D) Demanddepositsarecheckabledepositsthatpayinterest.
Answer: A
QuesStatus: PreviousEdition

9) Becausecheckingaccountsare________liquidforthedepositorthanpassbooksavings,they
earn________interestrates.
A) less;higher
B) less;lower
C) more;higher
D) more;lower
Answer: D
QuesStatus: PreviousEdition

10) Whichofthefollowingaretransactiondeposits?
A) Savingsaccounts
B) Small-denominationtimedeposits
C) Negotiableorderofwithdrawaccounts
D) Certificatesofdeposit
Answer: C
QuesStatus: PreviousEdition

11) Whichofthefollowingisnotanontransactiondeposit?
A) Savingsaccounts
B) Small-denominationtimedeposits
C) Negotiableorderofwithdrawalaccounts
D) Certificateofdeposit
Answer: C
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 183

12) Large-denominationCDsare________,sothatlikeabondtheycanberesoldina________
marketbeforetheymature.
A) nonnegotiable;secondary
B) nonnegotiable;primary
C) negotiable;secondary
D) negotiable;primary
Answer: C
QuesStatus: PreviousEdition

13) Because________arelessliquidforthedepositorthan________,theyearnhigherinterestrates.
A) moneymarketdepositaccounts;timedeposits
B) checkabledeposits;passbooksavings
C) passbooksavings;checkabledeposits
D) passbooksavings;timedeposits
Answer: C
QuesStatus: PreviousEdition

14) Because________arelessliquidforthedepositorthan________,theyearnhigherinterestrates.
A) passbooksavings;timedeposits
B) moneymarketdepositaccounts;timedeposits
C) moneymarketdepositaccounts;passbooksavings
D) timedeposits;passbooksavings
Answer: D
QuesStatus: PreviousEdition

15) Banksacquirethefundsthattheyusetopurchaseincome-earningassetsfromsuchsourcesas
A) cashitemsintheprocessofcollection
B) savingsaccounts.
C) reserves.
D) depositsatotherbanks.
Answer: B
QuesStatus: PreviousEdition

16) BankloansfromtheFederalReservearecalled________andrepresenta________offunds.
A) discountloans;use
B) discountloans;source
C) fedfunds;use
D) fedfunds;source
Answer: B
QuesStatus: PreviousEdition

17) Whichofthefollowingisnotasourceofborrowingsforabank?
A) Federalfunds
B) Eurodollars
C) Transactiondeposits
D) Discountloans
Answer: C
QuesStatus: PreviousEdition

184MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

18) Bankcapitalisequalto________minus________.
A) totalassets;totalliabilities
B) totalliabilities;totalassets
C) totalassets;totalreserves
D) totalliabilities;totalborrowings
Answer: A
QuesStatus: PreviousEdition

19) Bankcapitalislistedonthe________sideofthebanksbalancesheetbecauseitrepresentsa
________offunds.
A) liability;use
B) liability;source
C) asset;use
D) asset;source
Answer: B
QuesStatus: PreviousEdition

20) Bankreservesinclude
A) depositsattheFedandshort-termtreasurysecurities.
B) vaultcashandshort-termTreasurysecurities.
C) vaultcashanddepositsattheFed.
D) depositsatotherbanksanddepositsattheFed.
Answer: C
QuesStatus: PreviousEdition

21) Thefractionofcheckabledepositsthatbanksarerequiredbyregulationtoholdare
A) excessreserves.
B) requiredreserves.
C) vaultcash.
D) totalreserves.
Answer: B
QuesStatus: PreviousEdition

22) Whichofthefollowingarereportedasassetsonabanksbalancesheet?
A) Borrowings
B) Reserves
C) Savingsdeposits
D) Bankcapital
Answer: B
QuesStatus: PreviousEdition

23) Whichofthefollowingarenotreportedasassetsonabanksbalancesheet?
A) Cashitemsintheprocessofcollection
B) Depositswithotherbanks
C) U.S.Treasurysecurities
D) Checkabledeposits
Answer: D
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 185

24) Throughcorrespondentbanking,largebanksprovideservicestosmallbanks,including
A) loanguarantees.
B) foreignexchangetransactions.
C) issuingstock.
D) debtreduction.
Answer: B
QuesStatus: PreviousEdition

25) Thelargestpercentageofbanksholdingsofsecuritiesconsistof
A) Treasuryandgovernmentagencysecurities.
B) tax-exemptmunicipalsecurities.
C) stateandlocalgovernmentsecurities.
D) corporatesecurities.
Answer: A
QuesStatus: PreviousEdition

26) Whichofthefollowingbankassetsisthemostliquid?
A) Consumerloans
B) Reserves
C) Cashitemsinprocessofcollection
D) U.S.governmentsecurities
Answer: B
QuesStatus: PreviousEdition

27) Secondaryreservesinclude
A) depositsatFederalReserveBanks.
B) depositsatotherlargebanks.
C) short-termTreasurysecurities.
D) stateandlocalgovernmentsecurities.
Answer: C
QuesStatus: PreviousEdition

28) Becauseoftheir________liquidity,________U.S.governmentsecuritiesarecalledsecondary
reserves.
A) low;short-term
B) low;long-term
C) high;short-term
D) high;long-term
Answer: C
QuesStatus: PreviousEdition

29) Secondaryreservesaresocalledbecause
A) theycanbeconvertedintocashwithlowtransactionscosts.
B) theyarenoteasilyconvertedintocash,andare,therefore,ofsecondaryimportanceto
bankingfirms.
C) 50%oftheseassetscounttowardmeetingrequiredreserves.
D) theyranksecondtobankvaultcashinimportanceofbankholdings.
Answer: A
QuesStatus: PreviousEdition

186MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

30) Banksassetportfoliosincludestateandlocalgovernmentsecuritiesbecause
A) theirinterestpaymentsaretaxdeductibleforfederalincometaxes.
B) banksconsiderthemhelpfulinattractingaccountsofFederalemployees.
C) theFederalReserverequiresmemberbankstobuysecuritiesfromstateandlocal
governmentslocatedwithintheirrespectiveFederalReservedistricts.
D) thereisnodefault-riskwithstateandlocalgovernmentsecurities.
Answer: A
QuesStatus: PreviousEdition

31) Banksmaketheirprofitsprimarilybyissuing________.
A) equity
B) negotiableCDs
C) loans
D) NOWaccounts
Answer: C
QuesStatus: PreviousEdition

32) Themostimportantcategoryofassetsonabanksbalancesheetis
A) discountloans.
B) securities.
C) loans.
D) cashitemsintheprocessofcollection.
Answer: C
QuesStatus: PreviousEdition

33) Whichofthefollowingarebankassets?
A) thebuildingownedbythebank
B) adiscountloan
C) anegotiableCD
D) acustomerscheckingaccount
Answer: A
QuesStatus: New

10.2 BasicBanking
1) Banksearnprofitsbyselling________withattractivecombinationsofliquidity,risk,andreturn,
andusingtheproceedstobuy________withadifferentsetofcharacteristics.
A) loans;deposits
B) securities;deposits
C) liabilities;assets
D) assets;liabilities
Answer: C
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 187

2) Ingeneral,banksmakeprofitsbyselling________liabilitiesandbuying________assets.
A) long-term;shorter-term
B) short-term;longer-term
C) illiquid;liquid
D) risky;risk-free
Answer: B
QuesStatus: PreviousEdition

3) Assettransformationcanbedescribedas
A) borrowinglongandlendingshort.
B) borrowingshortandlendinglong.
C) borrowingandlendingonlyfortheshortterm.
D) borrowingandlendingforthelongterm.
Answer: B
QuesStatus: PreviousEdition

4) WhenanewdepositoropensacheckingaccountattheFirstNationalBank,thebanksassets
________anditsliabilities________.
A) increase;increase
B) increase;decrease
C) decrease;increase
D) decrease;decrease
Answer: A
QuesStatus: PreviousEdition

5) WhenJaneBrownwritesa$100checktohernephew(wholivesinanotherstate),Ms.Browns
bank________assetsof$100and________liabilitiesof$100.
A) gains;gains
B) gains;loses
C) loses;gains
D) loses;loses
Answer: D
QuesStatus: PreviousEdition

6) Whenyoudeposita$50billintheSecurityPacificNationalBank,
A) itsliabilitiesdecreaseby$50.
B) itsassetsincreaseby$50.
C) itsreservesdecreaseby$50.
D) itscashitemsintheprocessofcollectionincreaseby$50.
Answer: B
QuesStatus: PreviousEdition

7) Whenyoudeposit$50incurrencyatOldNationalBank,
A) itsassetsincreasebylessthan$50becauseofreserverequirements.
B) itsreservesincreasebylessthan$50becauseofreserverequirements.
C) itsliabilitiesincreaseby$50.
D) itsliabilitiesdecreaseby$50.
Answer: C
QuesStatus: PreviousEdition

188MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

8) Holdingallelseconstant,whenabankreceivesthefundsforadepositedcheck,
A) cashitemsintheprocessofcollectionfallbytheamountofthecheck.
B) bankassetsincreasebytheamountofthecheck.
C) bankliabilitiesdecreasebytheamountofthecheck.
D) bankreservesincreasebytheamountofrequiredreserves.
Answer: A
QuesStatus: PreviousEdition

9) Whena$10checkwrittenontheFirstNationalBankofChicagoisdepositedinanaccountat
Citibank,then
A) theliabilitiesoftheFirstNationalBankincreaseby$10.
B) thereservesoftheFirstNationalBankincreaseby$10.
C) theliabilitiesofCitibankincreaseby$10.
D) theassetsofCitibankfallby$10.
Answer: C
QuesStatus: PreviousEdition

10) Whena$10checkwrittenontheFirstNationalBankofChicagoisdepositedinanaccountat
Citibank,then
A) theliabilitiesoftheFirstNationalBankdecreaseby$10.
B) thereservesoftheFirstNationalBankincreaseby$10.
C) theliabilitiesofCitibankdecreaseby$10.
D) theassetsofCitibankdecreaseby$10.
Answer: A
QuesStatus: PreviousEdition

11) Whenyoudeposit$50inyouraccountatFirstNationalBankanda$100checkyouhavewritten
onthisaccountiscashedatChemicalBank,then
A) theassetsofFirstNationalriseby$50.
B) theassetsofChemicalBankriseby$50.
C) thereservesatFirstNationalfallby$50.
D) theliabilitiesatChemicalBankriseby$50.
Answer: C
QuesStatus: PreviousEdition

12) When$1millionisdepositedatabank,therequiredreserveratiois20percent,andthebank
choosesnottoholdanyexcessreservesbutmakesloansinstead,then,inthebanksfinalbalance
sheet,
A) theassetsatthebankincreaseby$800,000.
B) theliabilitiesofthebankincreaseby$1,000,000.
C) theliabilitiesofthebankincreaseby$800,000.
D) reservesincreaseby$160,000.
Answer: B
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 189

13) When$1millionisdepositedatabank,therequiredreserveratiois20percent,andthebank
choosesnottomakeanyloansbuttoholdexcessreservesinstead,then,inthebanksfinal
balancesheet,
A) theassetsatthebankincreaseby$1million.
B) theliabilitiesofthebankdecreaseby$1million.
C) reservesincreaseby$200,000.
D) liabilitiesincreaseby$200,000.
Answer: A
QuesStatus: PreviousEdition

14) Witha10%reserverequirementratio,a$100depositintoNewBankmeansthatthemaximum
amountNewBankcouldlendis
A) $90.
B) $100.
C) $10.
D) $110.
Answer: A
QuesStatus: New

15) UsingT-accountsshowwhathappenstoreservesatSecurityNationalBankifoneindividual
deposits$1000incashintohercheckingaccountandanotherindividualwithdraws$750incash
fromhercheckingaccount.
Answer: SecurityNationalBank
Liabilities
Assets
Reserves+$250
Checkabledeposits+$250
QuesStatus: PreviousEdition

10.3 GeneralPrinciplesofBankManagement
1) Whichofthefollowingareprimaryconcernsofthebankmanager?
A) Maintainingsufficientreservestominimizethecosttothebankofdepositoutflows
B) Extendingloanstoborrowerswhowillpaylowinterestrates,butwhoarepoorcredit
risks
C) Acquiringfundsatarelativelyhighcost,sothatprofitablelendingopportunitiescanbe
realized
D) Maintaininghighlevelsofcapitalandthusmaximizingthereturnstotheowners.
Answer: A
QuesStatus: PreviousEdition

2) Ifabankhas$100,000ofcheckabledeposits,arequiredreserveratioof20percent,anditholds
$40,000inreserves,thenthemaximumdepositoutflowitcansustainwithoutalteringits
balancesheetis
A) $30,000.
B) $25,000.
C) $20,000.
D) $10,000.
Answer: B
QuesStatus: PreviousEdition

190MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

3) Ifabankhas$200,000ofcheckabledeposits,arequiredreserveratioof20percent,anditholds
$80,000inreserves,thenthemaximumdepositoutflowitcansustainwithoutalteringits
balancesheetis
A) $50,000.
B) $40,000.
C) $30,000.
D) $25,000.
Answer: A
QuesStatus: PreviousEdition

4) Ifabankhas$10millionofcheckabledeposits,arequiredreserveratioof10percent,andit
holds$2millioninreserves,thenitwillnothaveenoughreservestosupportadepositoutflow
of
A) $1.2million.
B) $1.1million.
C) $1million.
D) $900,000.
Answer: A
QuesStatus: PreviousEdition

5) Ifabankhasexcessreservesgreaterthantheamountofadepositoutflow,theoutflowwill
resultinequalreductionsin
A) depositsandreserves.
B) depositsandloans.
C) capitalandreserves.
D) capitalandloans.
Answer: A
QuesStatus: PreviousEdition

6) A$5milliondepositoutflowfromabankhastheimmediateeffectof
A) reducingdepositsandreservesby$5million.
B) reducingdepositsandloansby$5million.
C) reducingdepositsandsecuritiesby$5million.
D) reducingdepositsandcapitalby$5million.
Answer: A
QuesStatus: PreviousEdition

7) Bankersconcernsregardingtheoptimalmixofexcessreserves,secondaryreserves,borrowings
fromtheFed,andborrowingsfromotherbankstodealwithdepositoutflowsisanexampleof
A) liabilitymanagement.
B) liquiditymanagement.
C) managinginterestraterisk.
D) managingcreditrisk.
Answer: B
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 191

8) If,afteradepositoutflow,abankneedsanadditional$3milliontomeetitsreserve
requirements,thebankcan
A) reducedepositsby$3million.
B) increaseloansby$3million.
C) sell$3millionofsecurities.
D) repayitsdiscountloansfromtheFed.
Answer: C
QuesStatus: Revised

9) Abankwithinsufficientreservescanincreaseitsreservesby
A) lendingfederalfunds.
B) callinginloans.
C) buyingshort-termTreasurysecurities.
D) buyingmunicipalbonds.
Answer: B
QuesStatus: PreviousEdition

10) Ofthefollowing,whichwouldbethefirstchoiceforabankfacingareservedeficiency?
A) Callinloans
B) BorrowfromtheFed
C) Sellsecurities
D) Borrowfromotherbanks
Answer: D
QuesStatus: PreviousEdition

11) Ingeneral,bankswouldprefertoacquirefundsquicklyby________ratherthan________.
A) reducingloans;sellingsecurities
B) reducingloans;borrowingfromtheFed
C) borrowingfromtheFed;reducingloans
D) callinginloans;sellingsecurities
Answer: C
QuesStatus: Revised

12) ________mayantagonizecustomersandthuscanbeaverycostlywayofacquiringfundsto
meetanunexpecteddepositoutflow.
A) Sellingsecurities
B) Sellingloans
C) Callinginloans
D) SellingnegotiableCDs
Answer: C
QuesStatus: PreviousEdition

13) Banksholdexcessandsecondaryreservesto
A) reducetheinterest-rateriskproblem.
B) providefordepositoutflows.
C) satisfymarginrequirements.
D) achievehigherearningsthantheycanwithloans.
Answer: B
QuesStatus: PreviousEdition

192MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

14) Whichofthefollowingstatementsmostaccuratelydescribesthetaskofbankasset
management?
A) Banksseekthehighestreturnspossiblesubjecttominimizingriskandmakingadequate
provisionsforliquidity.
B) Banksseektohavethehighestliquiditypossiblesubjecttoearningapositiverateofreturn
ontheiroperations.
C) Banksseektopreventbankfailureatallcost;sinceafailedbankearnsnoprofit,liquidity
needssupersedethedesireforprofits.
D) Banksseektoacquirefundsintheleastcostlyway.
Answer: A
QuesStatus: PreviousEdition

15) Thegoalsofbankassetmanagementinclude
A) maximizingrisk.
B) minimizingliquidity.
C) lendingathighinterestratesregardlessofrisk.
D) purchasingsecuritieswithhighreturnsandlowrisk.
Answer: D
QuesStatus: PreviousEdition

16) Banksthatsufferedsignificantlossesinthe1980smadethemistakeof
A) holdingtoomanyliquidassets.
B) minimizingdefaultrisk.
C) failingtodiversifytheirloanportfolio.
D) holdingonlysafesecurities.
Answer: C
QuesStatus: PreviousEdition

17) Abankwillwanttoholdmoreexcessreserves(everythingelseequal)when
A) itexpectstohavedepositinflowsinthenearfuture.
B) brokeragecommissionsonsellingbondsincrease.
C) thecostofsellingloansfalls.
D) thediscountratedecreases.
Answer: B
QuesStatus: PreviousEdition

18) Asthecostsassociatedwithdepositoutflows________,thebankswillingnesstoholdexcess
reserveswill________.
A) decrease;increase
B) increase;decrease
C) increase;increase
D) decrease;notbeaffected
Answer: C
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 193

19) Whichofthefollowingwouldabanknotholdasinsuranceagainstthehighestcostofdeposit
outflow-bankfailure?
A) Excessreserves
B) Secondaryreserves
C) Bankcapital
D) Mortgages
Answer: D
QuesStatus: PreviousEdition

20) Whichofthefollowinghasnotresultedfrommoreactiveliabilitymanagementonthepartof
banks?
A) Increasedbankholdingsofcashitems
B) Aggressivetargetingofgoalsforassetgrowthbybanks
C) IncreaseduseofnegotiableCDstoraisefunds
D) Anincreasedproportionofbankassetsheldinloans
Answer: A
QuesStatus: PreviousEdition

21) Banksthatactivelymanageliabilitieswillmostlikelymeetareserveshortfallby
A) callinginloans.
B) borrowingfederalfunds.
C) sellingmunicipalbonds.
D) seekingnewdeposits.
Answer: B
QuesStatus: PreviousEdition

22) Modernliabilitymanagementhasresultedin
A) increasedsalesofcertificatesofdepositstoraisefunds.
B) increaseimportanceofdepositsasasourceoffunds.
C) reducedborrowingbybanksintheovernightloanmarket.
D) failurebybankstocoordinatemanagementofassetsandliabilities.
Answer: A
QuesStatus: PreviousEdition

23) Abankfailureoccurswhenever
A) abankcannotsatisfyitsobligationstopayitsdepositorsandhaveenoughreservesto
meetitsreserverequirements.
B) abanksuffersalargedepositoutflow.
C) abankhastocallinalargevolumeofloans.
D) abankisnotallowedtoborrowfromtheFed.
Answer: A
QuesStatus: PreviousEdition

24) Abankisinsolventwhen
A) itsliabilitiesexceeditsassets.
B) itsassetsexceeditsliabilities.
C) itscapitalexceedsitsliabilities.
D) itsassetsincreaseinvalue.
Answer: A
QuesStatus: PreviousEdition

194MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

25) Holdinglargeamountsofbankcapitalhelpspreventbankfailuresbecause
A) itmeansthatthebankhasahigherincome.
B) itmakesloanseasiertosell.
C) itcanbeusedtoabsorbthelossesresultingfrombadloans.
D) itmakesiteasiertocallinloans.
Answer: C
QuesStatus: Revised

26) Netprofitaftertaxesperdollarofassetsisabasicmeasureofbankprofitabilitycalled
A) returnonassets.
B) returnoncapital.
C) returnonequity.
D) returnoninvestment.
Answer: A
QuesStatus: PreviousEdition

27) Netprofitaftertaxesperdollarofequitycapitalisabasicmeasureofbankprofitabilitycalled
A) returnonassets.
B) returnoncapital.
C) returnonequity.
D) returnoninvestment.
Answer: C
QuesStatus: PreviousEdition

28) Theamountofassetsperdollarofequitycapitaliscalledthe
A) assetratio.
B) equityratio.
C) equitymultiplier.
D) assetmultiplier.
Answer: C
QuesStatus: PreviousEdition

29) Foragivenreturnonassets,thelowerisbankcapital,
A) theloweristhereturnfortheownersofthebank.
B) thehigheristhereturnfortheownersofthebank.
C) theloweristhecreditriskfortheownersofthebank.
D) thelowerthepossibilityofbankfailure.
Answer: B
QuesStatus: PreviousEdition

30) Bankcapitalhasbothbenefitsandcostsforthebankowners.Higherbankcapital________the
likelihoodofbankruptcy,buthigherbankcapital________thereturnonequityforagiven
returnonassets.
A) reduces;reduces
B) increases;increases
C) reduces;increases
D) increases;reduces
Answer: A
QuesStatus: New

Chapter10BankingandtheManagementofFinancialInstitutions 195

31) Intheabsenceofregulation,bankswouldprobablyhold
A) toomuchcapital,reducingtheefficiencyofthepaymentssystem.
B) toomuchcapital,reducingtheprofitabilityofbanks.
C) toolittlecapital.
D) toomuchcapital,makingitmoredifficulttoobtainloans.
Answer: C
QuesStatus: PreviousEdition

32) Conditionsthatlikelycontributedtoacreditcrunchin2008include:
A) capitalshortfallscausedinpartbyfallingrealestateprices.
B) regulatedhikesinbankcapitalrequirements.
C) fallinginterestratesthatraisedinterestraterisk,causingbankstochoosetoholdmore
capital.
D) increasesinreserverequirements.
Answer: A
QuesStatus: Revised

33) Whichofthefollowingwouldnotbeawaytoincreasethereturnonequity?
A) Buybackbankstock
B) Payhigherdividends
C) AcquirenewfundsbysellingnegotiableCDsandincreaseassetswiththem
D) Sellmorebankstock
Answer: D
QuesStatus: PreviousEdition

34) Ifabankneedstoraisetheamountofcapitalrelativetoassets,abankmanagermightchooseto
A) buybackbankstock.
B) payhigherdividends.
C) shrinkthesizeofthebank.
D) sellsecuritiesthebankownsandputthefundsintothereserveaccount.
Answer: C
QuesStatus: PreviousEdition

35) Yourbankhasthefollowingbalancesheet:
Assets
Reserves
Securities
Loans

$50million
50million
150million

Liabilities
Checkabledeposits $200million
Bankcapital

50million

Iftherequiredreserveratiois10%,whatactionsshouldthebankmanagertakeifthereisan
unexpecteddepositoutflowof$50million?
Answer: Afterthedepositoutflow,thebankwillhaveareserveshortfallof$15million.Thebank
managercouldtrytoborrowintheFederalFundsmarket,takeoutadiscountloanfrom
theFederalReserve,sell$15millionofthesecuritiesthebankowns,selloff$15millionof
theloansthebankowns,orlastlycall-in$15millionofloans.Alloftheactionswillbe
costlytothebank.Thebankmanagershouldtrytoacquirethefundswiththeleast
costlymethod.
QuesStatus: PreviousEdition

196MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

10.4 ManagingCreditRisk
1) Banksfacetheproblemof________inloanmarketsbecausebadcreditrisksaretheonesmost
likelytoseekbankloans.
A) adverseselection
B) moralhazard
C) moralsuasion
D) intentionalfraud
Answer: A
QuesStatus: PreviousEdition

2) Ifborrowerswiththemostriskyinvestmentprojectsseekbankloansinhigherproportionto
thoseborrowerswiththesafestinvestmentprojects,banksaresaidtofacetheproblemof
A) adversecreditrisk.
B) adverseselection.
C) moralhazard.
D) lemonlenders.
Answer: B
QuesStatus: PreviousEdition

3) Becauseborrowers,oncetheyhavealoan,aremorelikelytoinvestinhigh -riskinvestment
projects,banksfacethe
A) adverseselectionproblem.
B) lemonproblem.
C) adversecreditriskproblem.
D) moralhazardproblem.
Answer: D
QuesStatus: PreviousEdition

4) Inordertoreducethe________probleminloanmarkets,bankerscollectinformationfrom
prospectiveborrowerstoscreenoutthebadcreditrisksfromthegoodones.
A) moralhazard
B) adverseselection
C) moralsuasion
D) adverselending
Answer: B
QuesStatus: PreviousEdition

5) Inonesense________appearssurprisingsinceitmeansthatthebankisnot________its
portfolioofloansandthusisexposingitselftomorerisk.
A) specializationinlending;diversifying
B) specializationinlending;rationing
C) creditrationing;diversifying
D) screening;rationing
Answer: A
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 197

6) Fromthestandpointof________,specializationinlendingissurprisingbutmakesperfectsense
whenoneconsidersthe________problem.
A) moralhazard;diversification
B) diversification;moralhazard
C) adverseselection;diversification
D) diversification;adverseselection
Answer: D
QuesStatus: PreviousEdition

7) Provisionsinloancontractsthatprohibitborrowersfromengaginginspecifiedriskyactivities
arecalled
A) proscriptionbonds.
B) restrictivecovenants.
C) due-on-saleclauses.
D) liens.
Answer: B
QuesStatus: PreviousEdition

8) Toreducemoralhazardproblems,banksincluderestrictivecovenantsinloancontracts.In
orderfortheserestrictivecovenantstobeeffective,banksmustalso
A) monitorandenforcethem.
B) bewillingtorewritethecontractiftheborrowercannotcomplywiththerestrictions.
C) trusttheborrowertodotherightthing.
D) bepreparedtoextendthedeadlinewhentheborrowerneedsmoretimetocomply.
Answer: A
QuesStatus: New

9) Long-termcustomerrelationships________thecostofinformationcollectionandmakeiteasier
to________creditrisks.
A) reduce;screen
B) increase;screen
C) reduce;increase
D) increase;increase
Answer: A
QuesStatus: PreviousEdition

10) Unanticipatedmoralhazardcontingenciescanbereducedby
A) screening.
B) long-termcustomerrelationships.
C) specializationinlending.
D) creditrationing.
Answer: B
QuesStatus: PreviousEdition

198MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

11) Abankscommitmenttoprovideafirmwithloansuptopre-specifiedlimitataninterestrate
thatistiedtoamarketinterestrateiscalled
A) anadjustablegaploan.
B) anadjustableportfolioloan.
C) loancommitment.
D) pre-creditloanline.
Answer: C
QuesStatus: PreviousEdition

12) Propertypromisedtothelenderascompensationiftheborrowerdefaultsiscalled________.
A) collateral
B) deductibles
C) restrictivecovenants
D) contingencies
Answer: A
QuesStatus: PreviousEdition

13) Abankthatwantstomonitorthecheckpaymentpracticesofitscommercialborrowers,sothat
moralhazardcanbeprevented,willrequireborrowersto
A) placeabankofficerontheirboardofdirectors.
B) placeacorporateofficeronthebanksboardofdirectors.
C) keepcompensatingbalancesinacheckingaccountatthebank.
D) purchasethebanksCDs.
Answer: C
QuesStatus: PreviousEdition

14) Ofthefollowingmethodsthatbanksmightusetoreducemoralhazardproblems,theonenot
legallypermittedintheUnitedStatesisthe
A) requirementthatfirmskeepcompensatingbalancesatthebanksfromwhichtheyobtain
theirloans.
B) requirementthatfirmsplaceontheirboardofdirectorsanofficerfromthebank.
C) inclusionofrestrictivecovenantsinloancontracts.
D) requirementthatindividualsprovidedetailedcredithistoriestobankloanofficers.
Answer: B
QuesStatus: PreviousEdition

15) Whenalenderrefusestomakealoan,althoughborrowersarewillingtopaythestatedinterest
rateorevenahigherrate,thebankissaidtoengagein
A) coercivebargaining.
B) strategicholdingout.
C) creditrationing.
D) collusivebehavior.
Answer: C
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 199

16) Whenbanksofferborrowerssmallerloansthantheyhaverequested,banksaresaidto
A) shavecredit.
B) rediscounttheloan.
C) razecredit.
D) rationcredit.
Answer: D
QuesStatus: PreviousEdition

17) Creditriskmanagementtoolsinclude
A) deductibles.
B) collateral.
C) interestrateswaps.
D) durationanalysis.
Answer: B
QuesStatus: PreviousEdition

18) Howcanspecializinginlendinghelptoreducetheadverseselectionprobleminlending?
Answer: Reducingtheadverseselectionproblemrequiresthebankstoacquireinformationto
screenbadcreditrisksfromgoodcreditrisks.Itiseasierforbankstoobtaininformation
aboutlocalbusinesses.Alsoifthebanklendstofirmsinafewspecificindustriesthey
willbecomemoreknowledgeableaboutthoseindustriesandabetterjudgeof
creditworthinessinthoseindustries.
QuesStatus: PreviousEdition

10.5 ManagingInterest-RateRisk
1) Riskthatisrelatedtotheuncertaintyaboutinterestratemovementsiscalled
A) defaultrisk.
B) interest-raterisk.
C) theproblemofmoralhazard.
D) securityrisk.
Answer: B
QuesStatus: PreviousEdition

2) Allelsethesame,ifabanksliabilitiesaremoresensitivetointerestratefluctuationsthanareits
assets,then________ininterestrateswill________bankprofits.
A) anincrease;increase
B) anincrease;reduce
C) adecline;reduce
D) adecline;notaffect
Answer: B
QuesStatus: PreviousEdition

200MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

3) Ifabankhas________rate -sensitiveassetsthanliabilities,then________ininterestrateswill
increasebankprofits.
A) more;adecline
B) more;anincrease
C) fewer;anincrease
D) fewer;asurge
Answer: B
QuesStatus: Revised

4) Ifabankhas________rate -sensitiveassetsthanliabilities,a________ininterestrateswill
reducebankprofits,whilea________ininterestrateswillraisebankprofits.
A) more;rise;decline
B) more;decline;rise
C) fewer;decline;decline
D) fewer;rise;rise
Answer: B
QuesStatus: PreviousEdition

5) Ifabanksliabilitiesaremoresensitivetointerestratemovementsthanareitsassets,then
A) anincreaseininterestrateswillreducebankprofits.
B) adecreaseininterestrateswillreducebankprofits.
C) interestrateschangeswillnotimpactbankprofits.
D) anincreaseininterestrateswillincreasebankprofits.
Answer: A
QuesStatus: New

6) Thedifferenceofrate-sensitiveliabilitiesandrate-sensitiveassetsisknownasthe
A) duration.
B) interest-sensitivityindex.
C) rate-riskindex.
D) gap.
Answer: D
QuesStatus: PreviousEdition

7) IftheFirstNationalBankhasagapequaltoanegative$30million,thena5percentagepoint
increaseininterestrateswillcauseprofitsto
A) increaseby$15million.
B) increaseby$1.5million.
C) declineby$15million.
D) declineby$1.5million.
Answer: D
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 201

8) Measuringthesensitivityofbankprofitstochangesininterestratesbymultiplyingthegap
timesthechangeintheinterestrateiscalled
A) basicdurationanalysis.
B) basicgapanalysis.
C) interest-exposureanalysis.
D) gap-exposureanalysis.
Answer: B
QuesStatus: PreviousEdition

9) Measuringthesensitivityofbankprofitstochangesininterestratesbymultiplyingthegapfor
severalmaturitysubintervalstimesthechangeintheinterestrateiscalled
A) basicgapanalysis.
B) thematuritybucketapproachtogapanalysis.
C) thesegmentedmaturityapproachtogapanalysis.
D) thesegmentedmaturityapproachtointerest-exposureanalysis.
Answer: B
QuesStatus: PreviousEdition

FirstNationalBank
Assets
Rate-sensitive $20million
$80million
Fixed-rate

Liabilities
$50million
$50million

10) Ifinterestratesriseby5percentagepoints,say,from10to15%,bankprofits(measuredusing
gapanalysis)will
A) declineby$0.5million.
B) declineby$1.5million.
C) declineby$2.5million.
D) increaseby$1.5million.
Answer: B
QuesStatus: PreviousEdition

11) Assumingthattheaveragedurationofitsassetsisfiveyears,whiletheaveragedurationofits
liabilitiesisthreeyears,thena5percentagepointincreaseininterestrateswillcausethenet
worthofFirstNationaltodeclineby________ofthetotaloriginalassetvalue.
A) 5percent
B) 10percent
C) 15percent
D) 25percent
Answer: B
QuesStatus: PreviousEdition

202MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

FirstNationalBank
Assets
Rate-sensitive $40million
$60million
Fixed-rate

Liabilities
$50million
$50million

12) Ifinterestratesriseby5percentagepoints,sayfrom10to15%,bankprofits(measuredusing
gapanalysis)will
A) declineby$0.5million.
B) declineby$1.5million.
C) declineby$2.5million.
D) increaseby$2.0million.
Answer: A
QuesStatus: PreviousEdition

13) Assumingthattheaveragedurationofitsassetsisfouryears,whiletheaveragedurationofits
liabilitiesisthreeyears,thena5percentagepointincreaseininterestrateswillcausethenet
worthofFirstNationalto________by________ofthetotaloriginalassetvalue.
A) decline;5percent
B) decline;10percent
C) decline;15percent
D) increase;20percent
Answer: A
QuesStatus: PreviousEdition

14) Durationanalysisinvolvescomparingtheaveragedurationofthebanks________tothe
averagedurationofits________.
A) securitiesportfolio;non-depositliabilities
B) assets;liabilities
C) loanportfolio;depositliabilities
D) assets;depositliabilities
Answer: B
QuesStatus: PreviousEdition

15) Becauseofanexpectedriseininterestratesinthefuture,abankerwilllikely
A) makelong-termratherthanshort-termloans.
B) buyshort-termratherthanlong-termbonds.
C) buylong-termratherthanshort-termbonds.
D) makeeithershortorlong-termloans;expectationsoffutureinterestratesareirrelevant.
Answer: B
QuesStatus: PreviousEdition

16) Ifabankerexpectsinterestratestofallinthefuture,herbeststrategyforthepresentis
A) toincreasethedurationofthebanksliabilities.
B) tobuyshort-termbonds.
C) toselllong-termcertificatesofdeposit.
D) toincreasethedurationofthebanksassets.
Answer: D
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 203

17) BrucetheBankManagercanreduceinterestrateriskby________thedurationofthebanks
assetstoincreasetheirratesensitivityor,alternatively,________thedurationofthebanks
liabilities.
A) shortening;lengthening
B) shortening;shortening
C) lengthening;lengthening
D) lengthening;shortening
Answer: A
QuesStatus: PreviousEdition

18) Yourbankhasthefollowingbalancesheet
Assets
Rate-sensitive
Fixed-rate

$100million
100million

Liabilities
Rate-sensitive $75million
Fixed-rate
125million

Whatwouldhappentobankprofitsiftheinterestratesintheeconomygodown?Isthere
anythingthatyoucoulddotokeepyourbankfrombeingsovulnerabletointerestrate
movements?
Answer: Thebanksprofitswouldgodownbecauseithasmoreinterest-ratesensitiveassetsthan
liabilities.Inordertoreduceinterest-ratesensitivity,thebankmanagercoulduse
financialderivativessuchasinterest-rateswaps,options,orfutures.Thebankmanager
couldalsotrytoadjustthebalancesheetsothatthebanksprofitsarenotvulnerableto
themovementoftheinterestrate.
QuesStatus: PreviousEdition

10.6 Off-Balance-SheetActivities
1) Examplesofoff-balance-sheetactivitiesinclude
A) loansales.
B) extendingloanstodepositors.
C) borrowingfromotherbanks.
D) sellingnegotiableCDs.
Answer: A
QuesStatus: PreviousEdition

2) Allofthefollowingareexamplesofoff-balancesheetactivitiesthatgeneratefeeincomefor
banksexcept
A) foreignexchangetrades.
B) guaranteeingdebtsecurities.
C) back-uplinesofcredit.
D) sellingnegotiableCDs.
Answer: D
QuesStatus: PreviousEdition

204MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

3) Whichofthefollowingisnotanexampleofabackuplineofcredit?
A) loancommitments
B) overdraftprivileges
C) standbylettersofcredit
D) mortgages
Answer: D
QuesStatus: PreviousEdition

4) Off-balancesheetactivitiesinvolvingguaranteesofsecuritiesandback-upcreditlines
A) havenoimpactontheriskabankfaces.
B) greatlyreducetheriskabankfaces.
C) increasetheriskabankfaces.
D) slightlyreducetheriskabankfaces.
Answer: C
QuesStatus: PreviousEdition

5) Whenbanksinvolvedintradingactivitiesattempttooutguessmarkets,theyare
A) forecasting.
B) diversifying.
C) speculating.
D) engaginginrisklessarbitrage.
Answer: C
QuesStatus: PreviousEdition

6) Tradersworkingforbanksaresubjecttothe
A) principal-agentproblem.
B) free-riderproblem.
C) double-jeopardyproblem.
D) exchange-riskproblem.
Answer: A
QuesStatus: PreviousEdition

7) Areasonwhyroguetradershavebankrupttheirbanksisdueto
A) theseparationoftradingactivitiesfromthebookkeepers.
B) stringentsupervisionoftradingactivitiesbybankmanagement.
C) accountingerrors.
D) afailuretomaintainproperinternalcontrols.
Answer: D
QuesStatus: PreviousEdition

8) Onewayforbankstoreducetheprincipal-agentproblemsassociatedwithtradingactivitiesis
to
A) setlimitsonthetotalamountofatraderstransactions.
B) makesurethatthepersonconductingthetradesisalsothepersonresponsiblefor
recordingthetransactions.
C) encouragetraderstotakeonmoreriskifthepotentialrewardsarehigher.
D) reducetheregulationsonthetraderssothattheyhavemoreflexibilityinconducting
trades.
Answer: A
QuesStatus: New

Chapter10BankingandtheManagementofFinancialInstitutions 205

9) Theprincipal-agentproblemthatexistsforbanktradingactivitiescanbereducedthrough
A) creationofinternalcontrolsthatcombinetradingactivitieswithbookkeeping.
B) creationofinternalcontrolsthatseparatetradingactivitiesfrombookkeeping.
C) eliminationofregulationofbanking.
D) eliminationofinternalcontrols.
Answer: B
QuesStatus: PreviousEdition

10) Banksdevelopstatisticalmodelstocalculatetheirmaximumlossoveragiventimeperiod.This
approachisknownasthe
A) stress-testingapproach.
B) value-at-riskapproach.
C) trading-lossapproach.
D) doomsdayapproach.
Answer: B
QuesStatus: PreviousEdition

11) Whenbankscalculatethelossestheinstitutionwouldincurifanunusualcombinationofbad
eventshappened,thebankisusingthe________approach.
A) stress-test
B) value-at-risk
C) trading-loss
D) maximumvalue
Answer: A
QuesStatus: PreviousEdition

10.7 WebAppendix1:DurationGapAnalysis
1) Assumeabankhas$200millionofassetswithadurationof2.5,and$190millionofliabilities
withadurationof1.05.Ifinterestratesincreasefrom5percentto6percent,thenetworthofthe
bankfallsby
A) $1million.
B) $2.4million.
C) $3.6million.
D) $4.8million.
Answer: D
QuesStatus: PreviousEdition

2) Assumeabankhas$200millionofassetswithadurationof2.5,and$190millionofliabilities
withadurationof1.05.Thedurationgapforthisbankis
A) 0.5year.
B) 1year.
C) 1.5years.
D) 2years.
Answer: C
QuesStatus: PreviousEdition

206MishkinTheEconomicsofMoney,Banking,andFinancialMarkets,9thEdition

3) Ifinterestratesincreasefrom9percentto10percent,abankwithadurationgapof2years
wouldexperienceadecreaseinitsnetworthof
A) 0.9percentofitsassets.
B) 0.9percentofitsliabilities.
C) 1.8percentofitsliabilities.
D) 1.8percentofitsassets.
Answer: D
QuesStatus: PreviousEdition

4) Oneoftheproblemsinconductingadurationgapanalysisisthatthedurationgapiscalculated
assumingthatinterestratesforallmaturitiesarethesame.Thatmeansthattheyieldcurveis
A) flat.
B) slightlyupwardsloping.
C) steeplyupwardsloping.
D) downwardsloping.
Answer: A
QuesStatus: New

10.8 WebAppendix2:MeasuringBankPerformance
1) Mostofabanksoperatingincomeresultsfrom
A) interestonassets.
B) servicechargesondepositaccounts.
C) off-balance-sheetactivities.
D) feesfromstandbylinesofcredit.
Answer: A
QuesStatus: New

2) Allofthefollowingareoperatingexpensesforabankexcept
A) servicechargesondepositaccounts.
B) salariesandemployeebenefits.
C) rentonbuildings.
D) servicingcostsofequipmentsuchascomputers.
Answer: A
QuesStatus: New

3) Whenabanksuspectsthata$1millionloanmightprovetobebaddebtthatwillhavetobe
writtenoffinthefuturethebank
A) cansetaside$1millionofitsearningsinitsloanlossreservesaccount.
B) reducesitsreportedearningsby$1,eventhoughithasnotyetactuallylostthe$1million.
C) reducesitsassetsimmediatelyby$1million,eventhoughithasnotyetlostthe$1million.
D) reducesitsreservesby$1million,sothattheycanusethosefundslater.
Answer: A
QuesStatus: PreviousEdition

Chapter10BankingandtheManagementofFinancialInstitutions 207

4) Forbanks,
A) returnonassetsexceedsreturnonequity.
B) returnonassetsequalsreturnonequity.
C) returnonequityexceedsreturnonassets.
D) returnonequityisanothernamefornetinterestmargin.
Answer: C
QuesStatus: PreviousEdition

5) Thequantityinterestincomeminusinterestexpensesdividedbyassetsisameasureofbank
performanceknownas
A) operatingincome.
B) netinterestmargin.
C) returnonassets.
D) returnonequity.
Answer: B
QuesStatus: PreviousEdition

6) LookingattheNetInterestMarginindicatesthatthepoorbankperformanceinthelate1980s
A) wasnottheresultofinterest-ratemovements.
B) wasnottheresultofriskyloansmadeintheearly1980s.
C) resultedfromanarrowingofthegapbetweeninterestearnedonassetsandinterspaidon
liabilities.
D) resultedfromahugedecreaseinprovisionsforloanlosses.
Answer: A
QuesStatus: New