Commercial Banking
Exam Answer Key
Course Introduction
Commercial Banking is an in-depth course that explores the principles, operations, and structure of modern commercial banks. Students will examine the key roles of commercial banks in the financial system, including their functions as financial intermediaries, lenders, and providers of payment services. The course covers topics such as asset and liability management, credit analysis, risk management, loan structuring, regulatory frameworks, and ethical considerations in banking. By analyzing real-world case studies and current trends, students will gain practical insights into how commercial banks assess borrower risk, develop products, manage profitability, respond to economic changes, and ensure compliance with laws and regulations. This course is ideal for those interested in pursuing careers in banking, finance, or related fields.
Recommended Textbook
Financial Markets and Institutions 6th Edition by Anthony Saunders
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Page 2
Chapter 1: Introduction
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Sample Questions
Q1) Depository institutions include A)banks.
B)thrifts.
C)finance companies.
D)all of the options presented.
E)banks and thrifts.
Answer: E
Q2) The most diversified type of depository institutions is A)credit unions.
B)savings associations.
C)commercial banks.
D)finance companies.
E)mutual funds.
Answer: C
Q3) The New York Stock Exchange (NYSE)is an example of a secondary market.
A)True
B)False
Answer: True
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Chapter 2: Determinants of Interest Rates
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Q1) The real risk-free rate is the increment to purchasing power that the lender earns in order to induce him or her to forego current consumption.
A)True
B)False
Answer: True
Q2) Inflation causes the demand curve for loanable funds to shift to the _____ and causes the supply curve to shift to the _____.
A)left; right
B)left; left
C)right; left
D)right; right
Answer: C
Q3) The term structure of interest rates is the relationship between interest rates on bonds similar in terms except for maturity.
A)True
B)False
Answer: True
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Chapter 3: Interest Rates and Security Valuation
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Sample Questions
Q1) The duration of a 180-day T-Bill is (in years)
A)0.493.
B)0.246.
C)1.
D)0.
E)indeterminatE.180/365
Answer: A
Q2) Is the realized rate of return related to the expected return? the required return? Explain.
Answer: Yes and no. The required return determines the initial size of the coupon and the offer price and,as the r changes,forces the market price to change. As the buy and sell prices and reinvestment rates on coupons change,the realized return will be affected. However,the required return is an ex-ante rate designed to compensate investors for risk. The realized return may be less than or more than the expected or the required. That is the nature of risk. If you repeated the same investment with the same terms over and over,you should,on average,earn a realized return equal to the required return.
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Page 5
Chapter 4: The Federal Reserve System, Monetary Policy, and Interest
Rates
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Q1) The major asset of the Federal Reserve is currency outside banks and the major liability is U.S. Treasury securities.
A)True
B)False
Q2) From October 1983 to July 1993,the Federal Reserve targeted
A)the Fed funds rate.
B)borrowed reserves.
C)nonborrowed reserves.
D)M1.
E)M3.
Q3) Four seats on the Federal Open Market Committee (FOMC)are allocated to Federal Reserve Bank presidents on an annual rotating basis.
A)True
B)False
Q4) The 12 Federal Reserve Banks perform what functions?
Q5) How have recent changes in discount window credit programs affected the use of this tool for monetary policy?
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Q6) Is there a trade-off between controlling domestic inflation and maintaining a sustainable pattern of international trade?
Chapter 5: Money Markets
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Q1) A repo is in essence a collateralized A)banker's acceptance.
B)certificate of deposit.
C)Fed funds loan.
D)commercial paper loan.
E)Eurodollar deposit.
Q2) The U.S. Treasury switched from a discriminating price auction to a single price auction because the latter lowered the average price paid by investors.
A)True
B)False
Q3) A short-term unsecured promissory note issued by a company is A)commercial paper.
B)a T-bill.
C)a repurchase agreement.
D)a negotiable CD.
E)a banker's acceptance.
Q4) Euro commercial paper is a short-term obligation of the European Central Bank.
A)True
B)False
Q5) Why do most money market securities have large denominations?
Page 7
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Chapter 6: Bond Markets
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Q1) The ask yield on a 6 percent coupon Treasury bond maturing in eight years is 5.488 percent. If the face value is $1,000,what should be the QUOTED cost of the bond today (use semiannual compounding)?
A)103:6
B)103:7
C)103:8
D)103:9
E)103:10
Q2) Which one of the following bonds is likely to have the highest required rate of return,ceteris paribus?
A)AAA-rated non-callable corporate bond with a sinking fund
B)AA-rated callable corporate bond with a sinking fund
C)AAA-rated callable corporate bond with a sinking fund
D)High-quality municipal bond
E)AA-rated callable corporate bond without a sinking fund
Q3) TIPS are a Treasury offering that protects investors from unexpected increases in inflation.
A)True
B)False
Q4) What is the difference between General Obligation and Revenue bonds?
Page 8
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Chapter 7: Mortgage Markets
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Sample Questions
Q1) If a borrower makes a 20 percent down payment on a conventional mortgage,she will be required to obtain
A)FHA insurance.
B)VA insurance.
C)private mortgage insurance.
D)GNMA payment guarantees.
E)none of the options.
Q2) Explain each term of the following pass-through quote:
Q3) You bought your house five years ago and you believe you will be in the house only about five more years before it gets too small for your family. Your original home value when you bought it was $250,000,you paid 20 percent down,and you financed closing costs equal to 3 percent of the mortgage amount. The mortgage was a 30-year fixed-rate mortgage with a 6.5 percent annual interest rate. Rates on 30-year mortgages are now at 5 percent if you pay 2 points. Your refinancing costs will be 1.5 percent of the new mortgage amount (excluding points). You won't finance the points and closing costs this time. A new down payment is not required. Should you refinance? Ignore all taxes and show your work.
Q4) How does GNMA improve mortgage marketability?
Q5) Why were CMOs created?
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Chapter 8: Stock Markets
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Q1) At year-end a firm has assets of $100 and debts due of $120. In this situation,the stockholders must pay an additional $20 out of their own pocket.
A)True
B)False
Q2) Which of the following is/are true about specialists?
I. Investment banks generally cannot be specialists.
II. Specialists are used by the NASDAQ system.
III. Market and limit orders are transacted at specialist posts,but the specialist's own account orders are executed elsewhere.
IV. Specialists help maintain continuous trading.
A)I,II,and III only
B)I and IV only
C)II,III,and IV only
D)I only
E)III only
Q3) Why have international stock prices fallen as a result of the subprime crisis in the United States?
Q4) Answer the following questions concerning the given partial stock quote:
Q5) In what major ways do stocks differ from bonds?
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Chapter 9: Foreign Exchange Markets
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Q1) If the euro per yen ratio falls,the value of the yen has risen.
A)True
B)False
Q2) The ongoing accumulation of foreign currency reserves by foreign monetary authorities contributed to the dollar's drop in 2006.
A)True
B)False
Q3) At the beginning of the year the exchange rate between the Brazilian real and the U.S. dollar was 2.2 reals per dollar. Over the year,Brazilian inflation was 12 percent and U.S. inflation was 4 percent. If purchasing power parity holds,at year-end the exchange rate should be approximately ________________ dollars per real.
A)2.3913
B)0.4895
C)2.8498
D)0.4182
E)0.3440
Q4) What are the major purposes of the foreign exchange markets?
Q5) Explain how a drop in the value of the dollar could affect the U.S. import and export sectors.
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Chapter 10: Derivative Securities Markets
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Sample Questions
Q1) Writing a put option results in a potentially limited gain and a potentially unlimited loss.
A)True
B)False
Q2) FNMA has direct holdings of 30-year fixed-rate mortgages financed by three- to five-year agency securities sold to the public.
Q3) A contract wherein the buyer agrees to pay a specified interest rate on a loan that will be originated at some future time is called a(n)
A)forward rate agreement.
B)futures loan.
C)option on a futures contract.
D)interest rate swap contract.
E)currency swap contract.
Q4) If you think that interest rates are likely to rise substantially over the next several years,you might sell a T-bond futures contract or buy an interest rate cap to take advantage of your expectations.
A)True
B)False
Q5) How does a futures or option clearinghouse assist traders?
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Chapter 11: Commercial Banks: Industry Overview
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Q1) Which of the following could result in a negative NIM?
A)Growth in net interest income
B)Lower non-interest expense
C)Decline in net interest income
D)Higher non-interest income
E)Positive net interest spread
Q2) In comparison to small banks,larger banks typically have
A)more equity capital.
B)more core deposits.
C)more off-balance-sheet activities.
D)larger net interest margins.
E)all of the options.
Q3) In 2010,the notional value of bank off-balance-sheet activities was greater than bank industry assets.
A)True
B)False
Q4) The majority of banks are nationally chartered and insured by the FDIC.
A)True
B)False
Q5) Why are banks different from other depository institutions?
Page 13
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Chapter 12: Commercial Banks Financial Statements and Analysis
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Sample Questions
Q1) Purchased funds include all but which one of the following?
A)Brokered deposits
B)Wholesale CDs
C)Fed funds purchased
D)Repurchase agreements
E)Demand deposits
Q2) Core deposits are deposits that are
A)at the bank solely for the interest rate earned.
B)very stable funds sources.
C)typically for larger denominations than hot money sources.
D)very frequently turned over.
Q3) Fernando Bank has interest expense of $150 million,earning assets of $1,400 million and a NIM of 5.00 percent. The bank also has interest-bearing liabilities of $1,100 million. Fernando Bank's spread is
A)1.10 percent.
B)1.65 percent.
C)1.94 percent.
D)2.08 percent.
E)2.16 percent.
Q4) What are the differences between purchased funds and core deposits?
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Chapter 13: Regulation of Commercial Banks
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Q1) Among other things,the Financial Institutions Reform,Recovery,and Enforcement Act stipulated the creation of the A)FDIC.
B)OTS.
C)OCC.
D)Warren Commission.
E)CRA.
Q2) (a)What are the mandatory Prompt Corrective Action (PCA)Provisions for an undercapitalized bank?
Explain why these provisions are required. (b)Why does one of the mandatory PCA Provisions for a critically undercapitalized bank include appointing a receiver/conservator within 90 days?
Q3) Why were the FIRREA of 1989 and the FDICIA of 1991 passed? What were their major provisions? How did these laws differ from earlier acts of the 1980s?
Q4) Unit banking states are states that do not allow interstate branch banking but allow the creation of intrastate branch banks.
A)True
B)False
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Chapter 14: Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies
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Q1) After deposits,the second largest source of funds at savings institutions is FHLB loans. A)True
B)False
Q2) Why have larger credit unions experienced greater profitability than smaller credit unions?
Do you expect this to continue? Why or why not?
Q3) A savings institution (SI)has funded $12 million of 30-year fixed-rate mortgages with an average interest rate of 5.75 percent. These assets are funded with time deposits with an average maturity of six months. The deposits are currently paying 3.5 percent. In six months' time,however,the Fed has raised interest rates twice and the depositors now must be paid 4.25 percent. What will happen to the SI's ROA and NIM?
How would your answer change if the SI normally sells the mortgages every six months and originates additional new mortgage loans?
Q4) What are the major advantages that credit unions enjoy over banks?
Q5) Explain why low interest rates and strong mortgage markets help keep profitability high at savings institutions.
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Chapter 15: Insurance Companies
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Q1) Policy reserves are the primary asset of the typical life insurer.
A)True
B)False
Q2) Life insurers write over 50 percent of all health insurance premiums.
A)True
B)False
Q3) The primary asset for P&C insurers is bonds.
A)True
B)False
Q4) In 2010 the average combined ratio after dividends for the P&C industry was
A)102.4
B)105.6 C)107.2
D)97.6
E)93.5
Q5) Life insurance policy reserves are the estimated current worth of expected future payouts.
A)True
B)False
Page 17
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Chapter 16: Securities Firms and Investment Banks
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Q1) Which one of the following securities firms' activities is normally the most risky?
A)Best efforts offering
B)Private placement
C)Firm commitment offering
D)Pure arbitrage
E)Program trading
Q2) An investment banker agrees to a firm commitment offering of 1.2 million shares of Bally stock. The offer price is set at $25.50 and the spread is 30 cents per share. If the stock is actually sold to the public at $26.00,however,what is the amount of funds Bally receives? (Ignore any other fees or expenses.)
A)$31,200,000
B)$30,600,000
C)$30,240,000
D)$29,280,000
E)$28,120,000
Q3) A stock broker acts as a principal on behalf of the customer.
A)True
B)False
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Chapter 17: Investment Companies
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Q1) Load funds typically provide investors with higher rates of return and offer more services such as check writing,transfers between funds,and so forth,than no load funds.
A)True
B)False
Q2) The shares of a closed-end fund with market value assets of $200 million and two million shares outstanding will always trade at a market value of $100 per share.
A)True
B)False
Q3) Households are the largest owner of money market mutual funds.
A)True
B)False
Q4) In what ways are hedge funds different from mutual funds?
Q5) By type of fund,there are more ______________ funds than any other.
A)equity
B)bond
C)taxable money market
D)tax-exempt money market
E)hybrid
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Chapter 18: Pension Funds
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Q1) Employee plus employer contributions to a 401(k)are $11,000 per year. Equity funds are earning 10 percent; bond funds,5 percent; and money market funds,3 percent. The employee will retire in 30 years. How much money will he have if he earns the average return from putting 65 percent of his money in equities,30 percent in bond funds,and the rest in money market funds?
A)$1,280,925
B)$1,838,526
C)$1,654,320
D)$1,978,565
E)$1,248,550
Q2) Assets in 401(k)plans are now greater than assets in private defined benefit plans. A)True
B)False
Q3) What are the main provisions of ERISA?
Q4) Noninsured pension plans generally invest in riskier assets than insured pension plans.
A)True
B)False
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Chapter 19: Types of Risks Incurred by Financial Institutions
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Q1) A bank has invested in U.S. Treasury investments that mature in two years. They will be held until maturity. The investments are funded with three-year maturity time deposits. The primary risk this bank faces is
A)refinancing risk.
B)reinvestment risk.
C)liquidity risk.
D)credit risk.
E)off-balance-sheet risk.
Q2) A bank that has made floating rate loans funded by longer maturity deposits is at risk from falling interest rates.
A)True
B)False
Q3) The risk that an unanticipated increase in liability withdrawals may cause an FI to have to sell assets at fire sale prices is an example of A)credit risk.
B)liquidity risk.
C)interest rate risk.
D)sovereign risk.
E)technology risk.
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Chapter 20: Managing Credit Risk on the Balance Sheet
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Q1) A $40,000 one-year loan with a 1 percent origination fee and a 7.50 percent interest rate is funded with money on which the bank owes 3 percent. What is the expected pretax dollar spread on the loan?
If the bank needs to net at least 3.5 percent on the funds lent to make its ROE,how many dollars can the bank spend on credit investigation,loan servicing,and so forth? Would the bank be able to spend more if the loan amount was greater? What does this example suggest about credit analysis?
Q2) Which one of the following five Cs of credit is NOT correctly defined?
A)Capacity-Whether the borrower has enough other credit available to pay off the loan in the event of cash flow problems.
B)Capital- The borrower's equity.
C)Character-A measure of the borrower's intention/willingness to repay the loan.
D)Conditions-Assessing how economic conditions could affect the borrower's ability to repay the loan.
E)Collateral-An asset of the borrower that the lender may seize in the event of default on the loan.
Q3) Describe the credit analysis process for a mid-market corporate loan applicant.
Q4) Explain how the Moody's Analytics Model predicts bankruptcy probability.
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Page 22
Chapter 21: Managing Liquidity Risk on the Balance Sheet
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Q1) A bank's financing gap is calculated as average loans minus average deposits plus liquid assets.
A)True
B)False
Q2) Which of the following statements,if any,is (are)true?
I. Mutual funds never have runs.
II. Funds invested with insurers are as safe as deposits at a bank.
III. Pension funds generally have less liquidity risk than banks.
A)All three are true.
B)Only I is true.
C)Only II and III are true.
D)Only III is true.
E)None are true.
Q3) Which one of the following situations creates the most liquidity risk?
A)Long-term assets funded by long-term liabilities
B)Short-term assets funded by short-term liabilities
C)Long-term assets funded by short-term liabilities
D)Short-term assets funded by long-term liabilities
E)Long-term liabilities funded by short-term assets
Q4) Explain how liquidity risk can lead to insolvency risk.
Page 23
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Chapter 22: Managing Interest Rate Risk and Insolvency
Risk on the Balance Sheet
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Q1) A thrift has an annual CGAP of -$25 million. A credit union has an annual CGAP of +$5 million. The thrift has total assets of $500 million and net income of $7.5 million,and the credit union has total assets of $40 million and net income of $0.7 million.
Q2) A bank has a positive repricing gap. This implies that
A)some RSAs are financed by fixed-rate liabilities.
B)some RSLs are financing fixed-rate assets.
C)some RSAs are financing equity.
D)the bank has no fixed-rate assets.
Q3) A bank has a negative repricing gap. This implies that
A)some RSAs are financed by fixed-rate liabilities.
B)some RSLs are financing fixed-rate assets.
C)some RSAs are financing equity.
D)the bank has no fixed-rate assets.
Q4) The repricing gap fails to consider how the value of fixed income accounts will change when rates change.
A)True
B)False
Q5) Explain how an FI's capital protects against credit risk and interest rate risk.
Q6) What are three major weaknesses of the repricing model?
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Chapter 23: Managing Risk Off the Balance Sheet With
Derivative Securities
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Q1) A bank wishes to hedge its $25 million face value bond portfolio (currently priced at 106 percent of par). The bond portfolio has a duration of five years. It will hedge with put options that have a delta of 0.67. The bond underlying the option contract has a market value of $112,000 and a duration of eight years. How many put options are needed? Assume that there is no basis risk on the hedge.
Q2) An FI has D<sub>A</sub> = 2.45 years and kD<sub>L</sub> = 0.97 years. The FI has total assets equal to $375 million. The FI wishes to effectively reduce the duration gap to one year by hedging with T-bond futures that have a market value of $115,000 and a D<sub>Fut</sub> = 8 years. How many contracts are needed and should the FI buy or sell them?
(D = Duration)
Q3) Gains and losses on a futures contract must be recognized daily.
A)True B)False
Q4) Swaps and forwards are subject to contingent risk; exchange-traded futures and options are not.
A)True B)False
Page 25
Q5) What are the advantages and disadvantages of forwards versus futures contracts?
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Chapter 24: Managing Risk Off the Balance Sheet With Loan
Sales and Securitization
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Q1) Fraudulent conveyance proceedings are
A)charges that a loan was improperly sold according to the conditions of the original loan agreement.
B)charges of improprieties in HLTs.
C)evidence of moral hazard on the part of the loan buyer.
D)illegal methods to boost borrower's earnings to increase probability of loan acceptance.
E)the primary cause of the subprime mortgage crisis.
Q2) You own a mortgage-backed security and you will receive fixed semiannual interest payments and no principal payments as long as prepayments remain within a given range. If prepayments move outside the range,you will receive prepayments. You must be holding a ______________________.
A)class C or lower sequential pay CMO
B)PAC CMO
C)PO security
D)pass-through security
E)CDO
Q3) How does a PAC CMO differ from a sequential pay CMO?
Q4) Why are most loan sales on an assignment basis rather than a participation basis?
Page 26
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