Bank Management 408 - Richard T. Farmer School of Business



Four digit and or letter code for grade posting: _ KEY VER B ______ (optional)

________1) Which of the following would be a reasonable order to use in analyzing ratios using the ROE decomposition model?

EM = equity multiplier = assets/equity PM = NI / Oper Rev

ROA = return on assets = NI / Assets AU = Oper Rev / Assets

ROE = return on equity = NI / equity

a) PM, AU, ROA, ROE, PM

b) ROE, ROA, PM, EM, AU

c) EM, ROE, PM, AU, EM

d) ROE, ROA, EM, PM, AU

e) ROA, ROE, PM, EM, AU

_________2) Your bank’s profit margin is higher than the median bank for your industry. This means….

a) Your bank is having difficulty controlling their expenses

b) Your bank controls their expenses better than the median bank in the industry

c) Your bank is having difficulty generating revenues

d) Your bank is generation revenues better than the median bank in the industry

e) Your bank is more highly levered than the median bank in the industry

_________3) Holding bank size constant, a typical wholesale bank has ____________ compared to a typical retail bank.

a) Both higher interest expense and higher non-interest expense

b) Both lower interest expense and lower non-interest expense

c) Higher interest expense & lower non-interest expense

d) Lower interest expense & higher non-interest expense

Fewer branches mean more purchased (investment grade) liabilities, which are more expensive. Fewer branches also means lower administrative expenses.

_________4) Which of the following is not recommended in the Stanford Bank Game, unless extreme circumstances warrant it?

a) Putting limits on the amount of new loans granted or the amount of fed funds borrowed.

b) Cutting the dividend.

c) High asset growth rates funded largely through fed funds borrowings.

d) In fact, none of the above are reasonable under normal circumstances

e) In fact, all of the above are reasonable under normal circumstances

_________5) Which of the following is indicative of bank liquidity problems?

a) The bank has insufficient cash to meet their reasonable loan demand

b) The bank sells fed funds

c) The bank sells investment grade CDs

d) The bank originates banker’s acceptances

e) All of the above

_________6) ABC holding company owns 100% of Alphabet bank stock. Alphabet bank is ABC’s only subsidiary. ABC holding company has $5000 in equity outstanding, and a debt/equity ratio of 1.0.

Alphabet bank’s capital structure consists of 10% equity, 90% debt. What proportion of Alphabet bank’s assets are funded by (individual) shareholder-originated capital? (Hint: sketch out the balance sheet for ABC holding company and Alphabet bank).

a) 5%

b) 8%

c) 4%

d) 10%

e) 50%

Construct the B/S of the holding company first. With a debt/equity ratio of 1.0 – this means equal amounts of debt and equity.

Holding Company:

|Assets |Liab + Eq |

|10,000 |5000 debt |

| |5000 equity |

The key to this problem is knowing that, if the BHC only has one subsidiary, and owns 100% of the equity in that subsidiary, the BHC’s assets must equal the bank subsidiary’s equity. The bank subsidiary has 10% equity, 90% debt, so, knowing equity, you should have been able to fill in the other numbers in the subsidiary’s balance sheet without use of a calculator:

Bank subsidiary:

|Assets |Liab + Eq |

|100,000 |90,000debt |

| |10,000 equity |

The owner-contributed equity/assets of the bank sub therefore equals 5000/100,000 or 5%.

__________7) SBA Bank originated 1 million in new 30-year fixed rate mortgage loans yesterday. Today, interest rates increase unexpectedly by 100 basis points for this type of loan. Which of the following is true?

a) If SBA attempts to securitize these mortgage loans, they will recognize a capital loss on their income statement

b) SBA will have to increase their provision for loan losses due to the increased interest rates.

c) If SBA attempts to securitize these mortgage loans, they will recognize a capital gain on their income statement

d) SBA will likely be unable to securitize these mortgage loans.

e) SBA can securitize these mortgage loans without recognizing a capital gain or loss on their sale.

__________8) The asset substitution problem occurs….

a) Only when the project’s potential gains accrue, in part, to the debtholders or the deposit insurance fund

b) Only when the firm’s debt is government insured

c) Only when the project’s potential losses exceed the market value of the firm’s equity

d) Only when the project is positive NPV

e) None of the above

Many of the other choices are relevant to the underinvestment problem.

__________9) You determine that your bank’s asset utilization ratio is less than the industry median, but their profit margin exceeds the industry median. You also note that your bank’s ROA, computed earlier, is lower than the industry median. Following the ROE decomposition model method of analysis, which of the following ratios would be a reasonable ratio to examine next?

a) Net interest margin (interest income – int expense)/Total Assets

b) Equity Multiplier

c) ROE

d) Non-interest expense/Operating Revenue

e) Interest income/Total assets

Actually, I was hoping that people would answer “e”. If ROA is below average because asset utilization is too low – look at particular sources of revenues. However, I did give credit if you identified any ratio relevant to the ROE decomposition model which could indicate a source of problems. “d” is not correct because profit margin is superior. Choice ‘a’ is not a part of the ROE decomposition model.

___________10) High Rollers bank is an FDIC insured financial institution. High Rollers is rumored to be on the brink of bankruptcy. High Rollers has MARKET VALUE Assets = $1 million, Insured deposits < 100K in denomination = $800,000 and face value of subordinated debt = $400,000. They also have 100,000 shares of common stock outstanding, which is currently selling at $0.03 per share. If High Rollers were to be liquidated at this time, would we be the cost to the deposit insurance fund? (Assume that this institution is NOT too big to fail.)

A) $200,000

B) $1,000,000

C) $0

D) $203,000

E) $800,000

F) More than $0, but none of the above listed values

The $1 million in assets would be sold to pay off the insured deposits of $800,000. Subordinated debt is not insured, and shareholders are never paid by the deposit insurance fund (unless the institution is TBTF).

___________11) Which of the following types of loans is LEAST LIKELY to be securitized?

A) Mortgage Loan

B) Credit Card Cash Advance

C) Commercial Loan

D) Student Loan

E) In fact, only government bonds can be securitized

____________12) Your bank purchases CD deposits from another bank. The CDs purchased by your bank are…

A) Liabilities of your bank and a source of funds

B) Assets of your bank and a use of funds

C) Assets of your bank and a source of funds

D) Liabilities of your bank and a use of funds

___________13) A correspondent bank is a bank that….

a) has applied, in writing, to acquire a failed bank

b) is in the process of getting their charter approved, and has limited lending authority

c) The regulatory agents have temporarily acquired, in anticipation of the liquidation of their assets

d) provides services to another bank

_________14) By combining a risky non-bank firm (like an underwriter) with a typical low-risk bank, the resulting conglomerate firm would be:

a) Higher risk than the bank, but lower risk than the non-bank firm

b) Lower risk than the bank

c) Higher risk than the non-bank firm

d) Either a or b (not enough information to determine which)

We discussed this in class using that curved diagram, where we plotted risk on the x-axis and return on the y-axis.

___________15) You wish to obtain more common stock equity for your bank in the Stanford Bank Game simulation. To do so, you…

a) Flag your intent to issue stock this quarter, and fill in the amount you wish to issue next quarter.

b) Flag your intent to issue stock this quarter. The simulation will automatically decide on the optimal amount of stock to issue - and issue it as soon as markets conditions will permit.

c) Flag your intent to issue stock this quarter, and fill in the amount you wish to issue this quarter.

d) Do nothing. The simulation will automatically decide when it is desirable to issue new shares of stock, and will do so when appropriate.

____________16) This Act phased-out Reg Q:

a) FDIC Improvement Act (1991)

b)Garn-St, Germain Dep Inst Act (1982)

c) Deposit Institutions Deregulation & Monetary Control Act (1980)

d) Financial Institutions Reform, Recovers and Enforcement Act (1989)

___________17) Which of the following regulations and/or government policies is/are still in effect?

a) The too big to fail policy

b) Regulations limiting bank expansion across state lines

c) Usury laws

d) Regulations prohibiting the combination of commercial banking activities and investment banking activities

e) All of the above

___________18) The market value of a 15 year mortgage loan which has been outstanding for 5-years can be obtained by computing the:

a) Loan origination value - accumulated loan payments

b) Sum of the discounted remaining payments, where the discount rate equals loan’s original interest rate

c) Sum of the remaining payments

d) Sum of the discounted remaining payments, where the discount rate equals the current risk-free rate.

e) None of the above methods correctly computes the market value of a loan

The correct answer would be to sum the discounted remaining payments where the discount rate equals the market interest rate on similar loans. This is not the same thing as the risk free rate, as loans are not riskless.

____________19) Your bank’s profits increase due to decreased unit costs in your mortgage lending department associated with the acquisition of additional mortgage loans from other banks. This is an example of:

a) Scope Economies

b) Scale Economies

c) Ray Scale Economies

d) Globalization

e) None of the above

____________20) Banknarski National Bank has market value assets of $10,000 and debt (all insured) of $11,000.

This bank has a project that can be funded by a $1000 equity issue. With 50% probability, the project will increase the value of the assets to $15,000, and with 50% probability, the project will increase the value of the assets to $12,000. All of the changes in market value will occur at time = 0 (immediately). Which of the following statements is true?

a) Although the project has a positive NPV, the project will be rejected because the bank will be unable to raise the equity needed to fund it.

b) The firm will be able to raise the equity proceeds, and the project will be accepted

c) Not enough information to determine.

At first, this seems like the underinvestment problem. But you will see that the expected value of the equity in this case exceed the cost to the equity holders of funding the project.

___________21) Which of the following is FALSE regarding banks, compared to a typical non-bank firm, non-financial firm (such as a manufacturing firm)?

a) Banks are more highly levered than the typical non-bank firms

b) Bank income statements group categories of revenues and expenses, non-bank firms list all revenue sources first followed by all expenses.

c) Banks have proportionately more real assets than do non-bank firms

d) Banks market products from both side of the balance sheet; non-bank firms generally do not

e) In fact, none of the above is false

____________22) A Zombie S&L can best be described as an:

a) An S&L that has been liquidated by the regulatory authorities

b) An S&L that is not legally bankrupt, but is economically bankrupt (insolvent)

c) An S&L that is acquiring other S&Ls through hostile tender offers

d) An S&L that is operating in the state of California

___________23) Which of the following is NOT one of the terms used in the CAMELS ratings?

A) Credit Risk

B) Asset Quality

C) Management Quality

D) Earnings Quality

E) Liquidity

F) Sensitivity to market risk

C stands for Capital Adequacy.

______________24) A bank originated 1 million in mortgage loans yesterday. The first payment on these loans is due 30 days from today. Today, interest rates decrease unexpectedly. As a result of the interest rate change, as of today, the book value of these loans is:

a) Less than 1 million

b) More than 1 million

c) Exactly 1 million

d) Not enough information to determine

Book values are unaffected by interest rate changes

____________25) For the typical commercial bank, bank loans account for:

a) Much less than 50% of bank assets

b) Much more than 50% of bank assets

c) Roughly 50% of bank assets

d) In fact, bank loans are bank liabilities, not assets.

___________26) The original definition of a bank was an institution that makes commercial loans and accepts demand deposits (BHC Act of 1956). In 1987, the definition was changed – or generalized - to an institution that makes loans and accepts deposits. Why was the definition of a bank changed in 1987?

a) Some banks found commercial loans too risky, and did not wish to make them.

b) Banks were spinning off their commercial lending business or changing the nature of their demand deposits to avoid the legal definition of a bank in order to avoid regulation.

c) Wholesale (commercial) banks did not wish to offer checking accounts, only NOW accounts

d) So that investment banks could be classified as banks and qualify for deposit insurance

___________27) The community reinvestment necessarily ensures that all banks….

a) Lend money to a given proportion of borrowers in the communities where their branches are located

b) Make at least 10% of their loans to minority borrowers

c) Make at least 30% of their loans to female borrowers

d) Practice redlining in their lending practices

e) All of the above, except “d”.

___________28) One unintended result of this Act or Law has been the demand for a black market for credit (Loan Sharks):

a) Reg Q

b) The Community Reinvestment Act

c) FIRREA

d) Usury Laws

___________29) The foreign country that has the most bank assets in the United States is…

A) Germany

B) Canada

C) Japan

D) Switzerland

E) In fact, banks incorporated in foreign countries are not allowed to own bank assets in the USA, as a term of the FDIC Improvement Act.

__________30) Banks are becoming…

A) Larger on average, and more diversified

B) Larger on average, and more specialized

C) Smaller on average, and more diversified

D) Smaller on average, and more specialized

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