Commercial Banking Exam
Questions
Course Introduction
Commercial Banking explores the foundational and advanced concepts of banking institutions that primarily deal with businesses and individuals, including the structure and functions of commercial banks, their role in the financial system, and the regulation that governs their operations. The course examines topics such as the asset-liability management, lending practices, risk assessment, credit analysis, and the impact of changing financial regulations and technologies on bank operations. Students will also analyze financial statements, study banking products and services, and assess the strategic challenges faced by banks in competitive domestic and international markets.
Recommended Textbook
Financial Markets and Institutions 6th Edition by Anthony Saunders
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Page 2
Chapter 1: Introduction
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Q1) Money markets are the markets for securities with an original maturity of one year or less.
A)True
B)False
Answer: True
Q2) What does an asset transformer do?
Why is asset transformation a risky activity?
Answer: An asset transformer buys one security from a customer or makes and creates a separate claim in order to raise funds. This is normally a risky activity because the asset acquired will be riskier than the security (or deposit)used to raise funds because the intermediary hopes to profit on the spread between the rate earned on the asset claim and the rate paid on the liability claim. In order for this spread to be positive,generally speaking,the asset must be riskier than the liability.
Q3) Central governments sometimes intervene in foreign exchange markets by affecting foreign exchange rates indirectly through raising or lowering interest rates.
A)True
B)False
Answer: False
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3
Chapter 2: Determinants of Interest Rates
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Q1) According to the market segmentation theory,short-term investors will not normally switch to intermediate- or long-term investments.
A)True
B)False
Answer: True
Q2) What is the difference between the expected real interest rate and the real risk-free interest rate actually earned?
Answer: The expected real rate of interest is the nominal rate minus the expected inflation rate. The actual (or realized)real rate is the nominal rate of interest (absent default)minus the actual rate of inflation.
Q3) Suppose you borrow $15,000 and then repay the loan by making 12 monthly payments of $1,297.92 each. What rate will you be quoted on the loan?
Answer: The interest rate is the solution to the following: PV = PMT * [(1 - (1+r)<sup>-N</sup>))/r] or $15,000=$1,297.92 * [(1(1+r)<sup>-12</sup>))/r] r = 0.5836% per month
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Page 4
Chapter 3: Interest Rates and Security Valuation
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Sample Questions
Q1) A corporate bond has a coupon rate of 10 percent and a required return of 10 percent. This bond's price is
A)$924.18.
B)$1,000.00.
C)$879.68.
D)$1,124.83.
E)not possible to determine from the information given.
Answer: B
Q2) At equilibrium,a security's required rate of return will be less than its expected rate of return.
A)True
B)False Answer: False
Q3) If interest rates increase,the value of a fixed income contract decreases and vice versa.
A)True
B)False Answer: True
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Page 5
Chapter 4: The Federal Reserve System, Monetary Policy, and
Interest Rates
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Q1) If the FOMC wished to generate faster economic growth,they could issue a policy directive to the Federal Reserve Board Trading Desk to purchase U.S. government securities.
A)True
B)False
Q2) Suppose that oil prices hit an all-time high of $200 a barrel,driving U.S. inflation up to 7 percent per year. At the same time,weak U.S. growth and increasing foreign competition has generated unacceptably high levels of unemployment in the United States. You are the chair of the Federal Reserve. What do you suggest?
Q3) The seven members of the Board of Governors of the Federal Reserve System serve 14-year nonrenewable terms. Each Board member is appointed by the president and confirmed by the Senate.
A)True
B)False
Q4) How do Federal Reserve Banks generate income? Do they require supplemental funding from Congress?
Q5) What are the main responsibilities of the FOMC?
Q6) Explain how the deposit multiplier works.
Page 6
Q7) What are the four major functions of the Federal Reserve System?
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Chapter 5: Money Markets
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Q1) For the purposes for which they are used,money market securities should have which of the following characteristics?
I. Low trading costs
II. Little price risk
III. High rate of return
IV. Life greater than one year
A)I and III
B)II and IV
C)III and IV
D)I and II
E)I,II,and III
Q2) One-hundred-eighty-day commercial paper can be bought at a 3.75 percent discount. What are the bond equivalent yield and the effective annual rate on the commercial paper? Why do these rates differ?
Q3) Commercial paper,Treasury bills,and banker's acceptance rates are all quoted as discount yields.
A)True
B)False
Q4) Why do most money market securities have large denominations?
Page 7
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Chapter 6: Bond Markets
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Q1) Standard revenue bonds are
A)backed by the full taxing authority of the municipality.
B)collateralized by the earnings from a specific project.
C)bonds backed by mortgages.
D)backed by the U.S. Treasury.
E)always offered with a best efforts offering.
Q2) In a Treasury bond quote with a $1,000 face value,you find the bid is equal to 100: 24 and the ask is equal to 100: 26. You could buy this bond for $1,008.125.
A)True
B)False
Q3) You purchase a $1,000 face value convertible bond for $975. The bond can be converted into 150 shares of stock. The stock is currently priced at $5.25. At what minimum stock price would you be willing to convert?
A)$4.50
B)$5.26
C)$6.50
D)$7.10
E)$7.25
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Page 8
Chapter 7: Mortgage Markets
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Sample Questions
Q1) The process of packaging and/or selling mortgages that are then used to back publicly traded debt securities is called
A)collateralization.
B)securitization.
C)market capitalization.
D)stock diversification.
E)mortgage globalization.
Q2) Why were CMOs created?
Q3) One fixed-rate mortgage pool has a 750 PSA and a second fixed-rate pool has 150 PSA. The pool with the higher PSA ______________________ than the pool with the lower PSA.
I. probably has a higher coupon
II. probably has lower default risk
III. will mature more quickly
A)I,II,and III
B)I and II only
C)II and III only
D)I and III only
E)I only
Q4) How does GNMA improve mortgage marketability?
Page 9
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Chapter 8: Stock Markets
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Sample Questions
Q1) A firm desires to sell stock to the public. The underwriter charges $0.45 million in fees and offers to buy six million shares from the firm at a price of $35 per share. In addition,registration and audit fees total $130,000,and marketing and miscellaneous fees add up to another $75,000. The underwriter expects to earn gross proceeds per share of $38. What is the issuing firm's out-of-pocket dollar transaction cost to issue the stock? Immediately after the stock was issued,the stock price rose to $40. What is the issuing firm's opportunity cost? What is the total issuance cost,including opportunity costs,as a percentage of the total funds available to the issuing firm?
Q2) A long-term investor in a high marginal tax bracket will normally prefer a dollar of capital gain to a dollar of dividend yield.
A)True
B)False
Q3) 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
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Page 10
Chapter 9: Foreign Exchange Markets
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Q1) Is it reasonable to expect real rates of interest to be identical across countries? Explain. What does this imply about parity?
Q2) The spot rate for the Argentine peso is $0.3600 per peso. Over the year,inflation in Argentina is 10 percent and U.S. inflation is 4 percent. If purchasing power parity holds,at year-end the exchange rate should be approximately ______________ dollars per peso.
A)0.2987
B)0.3614
C)0.2875
D)0.3384
E)0.3015
Q3) A U.S. bank has made £50 million in Britain and has £40 million in deposits. The bank's currency trading desk has also contracted to buy £20 million and has short positions of £15 million. What is the bank's net exposure? How could they use forward contracts to hedge the exposure? If the bank has exposures in euros and yen,would you recommend they use the forward hedge?
Why or why not?
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11
Chapter 10: Derivative Securities Markets
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Q1) You have agreed to deliver the underlying commodity on a futures contract in 90 days. Today the underlying commodity price rises and you get a margin call. You must have
A)a long position in a futures contract.
B)a short position in a futures contract.
C)sold a forward contract.
D)purchased a forward contract.
E)purchased a call option on a futures contract.
Q2) You would expect the price quote for a put option to be at least $10 if the put had an exercise price of $40 and the underlying stock was selling for $50.
A)True
B)False
Q3) 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
Q4) When would a forward contract be better for hedging than a futures contract?
Q5) When would an option hedge be better than a futures or forward hedge?
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Chapter 11: Commercial Banks: Industry Overview
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Sample Questions
Q1) The provision of banking services to other banks,such as check clearing,foreign exchange trading,and so forth,is an example of
A)correspondent banking.
B)trust services.
C)off-balance-sheet assets.
D)economies of scope.
E)credit derivatives.
Q2) 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
Q3) Why are loans such a high percentage of total assets at the typical bank? What four broad classes of loans do banks engage in?
Q4) What are the major advantages a bank gains by expanding into international bank services?
What are three disadvantages of international expansion?
Q5) Why did bank profitability decline beginning in late 2006 and through 2008?
Page 13
Q6) Why are banks different from other depository institutions?
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Chapter 12: Commercial Banks Financial Statements and Analysis
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Q1) What is the difference between a loan commitment and a letter of credit?
Q2) 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
Q3) Which one of the following is the definition of the NIM?
A)(Net interest income - Net noninterest income)/Earning assets
B)Net interest income/Interest-bearing liabilities
C)(Interest income - Interest expense)/Earning assets
D)(Interest income - Interest expense)/Interest-bearing liabilities
E)(Interest income/Earning assets)- (Interest expense/Interest-bearing liabilities)
Q4) How has the negotiable feature of wholesale CDs improved banks' ability to manage their liquidity?
Q5) What are the differences between purchased funds and core deposits?
Q6) Composite rating 5 is the rating for the soundest financial institutions.
A)True
B)False
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Chapter 13: Regulation of Commercial Banks
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Q1) A securities subsidiary of a bank holding company that engages in investment banking is called a Riegle-Neal affiliate.
A)True
B)False
Q2) Banks are generally prohibited from making loans exceeding more than 15 percent of their own equity capital to any one company or borrower.
A)True
B)False
Q3) The FDIC may require an undercapitalized bank to
I. provide the FDIC with a capital restoration plan.
II. cease acquiring brokered deposits.
III. obtain FDIC approval for all acquisitions.
IV. suspend dividends and management fees.
V. suspend payments on subordinated debt.
A)I and II only
B)III only
C)I,II,III,and IV only
D)I,II,III,IV,and V
E)I,II,III,and V only
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Page 15
Chapter 14: Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies
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Q1) Sales finance companies
A)specialize in making loans to customers of a specific retailer or manufacturer.
B)specialize in making installments and other loans to whatever consumers are interested.
C)specialize in providing loans to businesses.
D)specialize in international factoring and forfeiting.
E)none of the options
Q2) How do the primary risks of credit unions differ from banks? from savings institutions (SIs)? from finance companies?
Q3) A captive finance company is one that
A)is owned by a retailer or manufacturer.
B)is owned by a bank holding company.
C)is owned by its depositors.
D)lends only to high-risk individuals that cannot obtain loans elsewhere (i.e.,captives).
E)is regulated at the federal level.
Q4) Why have postal savings institutions flourished in many foreign countries? What unique advantages do they have and what services do many offer?
Page 16
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Chapter 15: Insurance Companies
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Q1) Why do P&C insurers place a large percentage of their investments in bonds and maintain large surpluses?
Q2) An insurance line has a pure loss ratio of 65 percent,LAE of 16 percent and an expense ratio of 26 percent; the firm pays 3 percent of premiums to policyholders as dividends and has an investment yield to premium ratio of 6 percent. Which one of the following statements is true?
A)The line is profitable because the operating ratio is greater than 100.
B)The line is profitable because the operating ratio is less than 100.
C)The line is not profitable because the operating ratio is greater than 100.
D)The line is profitable because the combined ratio after dividends is greater than 100.
E)The line is profitable because the combined ratio after dividends is less than 100.
Q3) In terms of dollar costs,the worst U.S. catastrophe since 2000 was caused by
A)the terrorist attacks on the World Trade Center and the Pentagon.
B)Hurricane Katrina.
C)the California fires of 2007.
D)the Florida hurricanes of 2004.
E)Hurricane Rita of 2005.
Q4) What three main sources of underwriter risk exist for insurers?
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Page 17
Chapter 16: Securities Firms and Investment Banks
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Q1) As a result of the alleged conflicts of interest between analysts and underwriting,which of the following changes were implemented?
I. Analysts cannot participate in nor attend certain presentations to potential investors conducted by investment bankers associated with underwriting an issue.
II. Analyst compensation can no longer be tied to the amount of underwriting business a firm generates.
III. Securities firms must divest stock research divisions to ensure independence from their investment banking business.
A)I only
B)I and II only
C)I and III only
D)II and III only
E)I,II,and III
Q2) What are soft dollar fees or commissions?
How can these lead to conflicts of interest for investment bankers?
Q3) A stock broker acts as a principal on behalf of the customer.
A)True
B)False
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18
Chapter 17: Investment Companies
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Q1) Why are mutual funds popular with individual investors?
Q2) You have $16,000 to invest in a mutual fund with a NAV = $45. You choose a fund with a 4 percent front load,a 1 percent management fee,and a 0.25 percent 12b-1 fee. Assume that the management and 12b-1 fees are charged on year-end assets. The gross annual return on the fund's shares was 9 percent. What was your net annual rate of return to the nearest basis point?
A)3.33 percent
B)7.64 percent
C)6.25 percent
D)4.52 percent
E)4.64 percent
Q3) Offshore hedge funds are not subject to taxation on fund distributions nor to U.S. estate taxes.
A)True
B)False
Q4) Funds that specialize in municipal bonds and certain types of real estate to minimize tax liabilities are called hybrid funds.
A)True
B)False
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Chapter 18: Pension Funds
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Q1) An employee who has worked for his firm for 30 years can retire right now and receive a constant annual benefit of $45,000. He has a final pay plan that pays his average salary over his final five years times 2 percent times years of service. He has decided he will keep working five more years but only if by doing so his retirement benefits will grow at 6 percent per year. How much would his expected average salary (to the nearest dollar)have to be over the next five years to keep him working?
A)$54,198
B)$86,029
C)$51,617
D)$66,911
E)$53,147
Q2) Pension plans administered by the federal government are called insured pension plans.
A)True
B)False
Q3) How do public pension plans differ in other countries? Has privatization worked overseas?
Q4) Why do insured pension plans invest in less risky assets than uninsured pension plans?
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Chapter 19: Types of Risks Incurred by Financial Institutions
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Q1) A bank invests $250 million to add the ability to provide online bill paying for its customers. Usage of the new service is at about 50 percent of expected usage. This is an example of
A)technological risk.
B)operational risk.
C)market risk.
D)credit risk.
E)derivative risk.
Q2) A bank has on-balance-sheet assets with a book value of $940 million and a market value of $985 million and on-balance-sheet liabilities with a book value of $900 million and a market value of $930 million. The bank also has off-balance-sheet assets currently valued at $150 million and off-balance-sheet liabilities worth $160 million. Stockholders' net worth should be valued at _________________ million.
A)$30
B)$40
C)$45
D)$50
E)$55
Q3) How does foreign exchange risk arise for an FI?
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Page 21
Chapter 20: Managing Credit Risk on the Balance Sheet
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Q1) A corporate customer obtains a $1.5 million loan from a bank. The customer agrees to pay a 6.25 percent interest rate and agrees to make compensating balances of 4 percent of the loan amount. These will be held in noninterest-bearing transactions deposits at the bank for one year. The bank charges a 1 percent loan origination fee on the amount borrowed. Reserve requirements are 10 percent. What is the expected rate of return to the bank (k)(to the nearest basis point)?
A)6.95 percent
B)7.52 percent
C)7.99 percent
D)8.01 percent
E)8.45 percent
Q2) Big Valley's use of debt to finance assets indicates that Big Valley has ____________ the typical firm in the industry.
A)more long-term solvency risk than
B)the same long-term solvency risk as
C)less interest expense than
D)less long-term solvency risk than
E)a lower market value of equity to book value of equity ratio than
Q3) Describe the credit analysis process for a mid-market corporate loan applicant.
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Page 22
Chapter 21: Managing Liquidity Risk on the Balance Sheet
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Q1) What are the trade-offs involved between storing liquidity and purchasing liquidity as needed for a bank?
Q2) When money market interest rates are higher than deposit rates,using purchased liquidity to replace deposit drains can reduce a bank's profit margin.
A)True
B)False
Q3) Core deposits include all but which of the following?
A)Retail demand deposits
B)NOW accounts
C)MMDAs
D)Savings accounts
E)Negotiable CDs
Q4) If a bank meets a net deposit drain by borrowing money in the fed funds market,it is using purchased liquidity.
A)True
B)False
Q5) Explain the relationship between each of the following ratios and liquidity risk.
Q6) Explain how liquidity risk can lead to insolvency risk.
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Chapter 22: Managing Interest Rate Risk and Insolvency
Risk on the Balance Sheet
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Q1) A bank has three assets. It has $75 million invested in consumer loans with a three-year duration,$39 million invested in T-bonds with a 16-year duration,and $39 million in six-month maturity T-bills. What is the duration of the bank's asset portfolio in years?
A)3.95 years
B)4.83 years
C)6.50 years
D)7.38 years
E)11.51 years
Q2) Due to convexity problems,banks are actually better off using the simpler repricing model to manage interest rate risk rather than the duration model.
A)True
B)False
Q3) An FI's balance sheet is characterized by long-term fixed-rate assets funded by short-term variable-rate securities. Most likely the bank has a
A)positive repricing gap and a positive duration gap.
B)positive repricing gap and a negative duration gap.
C)negative repricing gap and a positive duration gap.
D)negative repricing gap and a negative duration gap.
Page 24
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Chapter 23: Managing Risk Off the Balance Sheet With
Derivative Securities
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Q1) The maximum gain (ignoring commissions and taxes)from buying an at-the-money bond put option is the bond price at time of option purchase less the put premium. The maximum loss is the put premium.
A)True
B)False
Q2) A purchaser of a bond call option gains if interest rates fall.
A)True
B)False
Q3) Basis risk occurs because it is generally impossible to A)hedge unanticipated rate changes.
B)exactly predict interest rate changes.
C)exactly match the terms of the hedging instrument with the terms of the asset or liability at risk.
D)find negatively correlated asset prices.
E)All of the options.
Q4) A U.S. corporation has a yen-denominated loan it must repay in six months. A long position in yen futures could help offset the corporation's foreign exchange risk.
A)True
B)False
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Chapter 24: Managing Risk Off the Balance Sheet With Loan
Sales and Securitization
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Q1) In a three-class sequential pay CMO,if we consider Class B holders as having average prepayment risk,then Class A holders have _____________ prepayment risk and Class C holders have _____________ prepayment risk. A)above average; below average B)below average; below average C)below average; above average D)above average; above average
Q2) The buyer of a loan in a participation has a double-risk exposure: one to the borrower and one to the selling bank.
A)True
B)False
Q3) Explain the payment pattern on a GNMA pass-through and a new Class B CMO when interest rates fall. Which has more predictable payments,and why would an investor care?
Q4) Advantages of Brady bonds over LDC loans include improved liquidity and higher coupon rates.
A)True
B)False
Page 26
Q5) What loans,other than mortgages,are currently being securitized?
Q6) How does a PAC CMO differ from a sequential pay CMO?
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