Commercial Banking
Midterm Exam
Course Introduction
This course offers an in-depth exploration of the structure, functions, and operations of commercial banks within the financial system. Students will examine key topics such as bank asset and liability management, lending practices, credit analysis, regulatory frameworks, and risk management strategies. The course also explores the impact of technological advancements, evolving regulations, and global trends on the commercial banking sector. Through case studies and practical applications, students will gain insights into the challenges facing modern banks and the strategies they employ to achieve profitability, ensure stability, and promote economic growth.
Recommended Textbook
Financial Institutions Management A Risk Management Approach 8th Edition by Saunders
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Which function of an FI reduces transaction and information costs between a corporation and individual which may encourage a higher rate of savings?
A)Brokerage services.
B)Asset transformation services.
C)Information production services.
D)Money supply management.
E)Administration of the payments mechanism.
Answer: A
Q2) What distinguishes financial intermediaries from industrial firms?
A)FI balance sheets are almost totally comprised of financial assets while commercial firms hold substantial amounts of real assets.
B)Industrial firms are the customers of FIs, but FIs cannot be customers of industrial firms.
C)FIs deal exclusively in primary securities, but industrial firms specialize in secondary securities.
D)Industrial firms produce real goods or services while FIs only produce money.
E)Industrial firms are unregulated while FIs are heavily regulated.
Answer: A
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3
Chapter 2: Financial Services: Depository Institutions
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Sample Questions
Q1) Regulatory forbearance refers to a policy of
A)allowing insolvent banks to continue to operate.
B)foreclosing real estate properties in the event on non-payments of mortgages.
C)strict regulation of banks, closing them down as soon as they are insolvent.
D)rescheduling of all loans of a client in the event of non-payment.
E)Answers B and C only.
Answer: A
Q2) The securitization of mortgages involves the pooling of mortgage loans for sale in the financial markets.
A)True
B)False
Answer: True
Q3) Negotiable certificates of deposits are differentiated from fixed time deposits by their negotiability and active trading in the secondary markets.
A)True
B)False
Answer: True
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Chapter 3: Financial Services: Finance Companies
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Sample Questions
Q1) Finance companies have traditionally been subject to state-imposed usury ceilings on the maximum loan rate charged to any individual customers.
A)True
B)False
Answer: True
Q2) The typical customer of a payday lender has income of between $25,000 and $50,000 per year.
A)True
B)False
Answer: True
Q3) Securitized mortgage assets are used as collateral backing secondary market securities.
A)True
B)False
Answer: True
Q4) The FDIC allows its member banks to participate in payday lending.
A)True
B)False Answer: True
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Chapter 4: Financial Services: Securities Brokerage and Investment Banking
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Sample Questions
Q1) Securities firms have equity ratios that are lower than those for commercial banks because their balance sheets contain a larger portion of
A)illiquid assets.
B)current liabilities.
C)long term liabilities.
D)fixed assets.
E)liquid assets.
Q2) What is the profit (loss) to the investment banker?
A)Profit of $1,000,000.
B)Profit of $2,000,000.
C)Profit of $7,000,000.
D)Loss of $7,500,000.
E)Loss of $1,000,000.
Q3) Activity and performance trends in the investment banking industry are highly correlated with general economic expansions and recessions.
A)True
B)False
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Page 6
Chapter 5: Financial Services: Mutual Funds and Hedge Funds
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Sample Questions
Q1) The SEC requires that prospectuses or advertisements regarding a mutual fund contain information that returns of the mutual fund carry some risk.
A)True
B)False
Q2) Which of the following refers to the process used to determine the value of mutual fund shares each per day?
A)Directed brokerage.
B)Marking-to-market.
C)Late trading.
D)Market timing.
E)Spinning.
Q3) Mutual funds that purchase Treasury bills, bank negotiable certificates of deposit, commercial paper, and other short-term securities would be classified as
A)contractual institutions.
B)investment institutions.
C)money market funds.
D)securities dealers.
E)PC insurance companies.
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Chapter 6: Financial Services: Insurance
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Sample Questions
Q1) Variable universal life insurance policies
A)have fixed premiums and a fixed benefit payout.
B)have fixed premiums, but allow the benefit payout to vary with investment returns.
C)have a fixed benefit payout, but allow the premium to vary with investment returns.
D)allow both the premium and benefit payout to vary with investment returns.
E)allow both the premium and benefit payout to vary with investment returns, but have a fixed maturity date.
Q2) Loss adjustment expenses refer to the costs surrounding the loss settlement process. A)True
B)False
Q3) The Insurance Regulatory Information System (IRIS) is a standardized examination system used to measure the profitability of insurance companies.
A)True B)False
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Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) With regard to market value risk, rising interest rates
A)increase the value of fixed rate liabilities.
B)increase the value of fixed rate assets.
C)increase the value of variable-rate assets.
D)decrease the value of fixed rate liabilities.
E)decrease the value of variable-rate assets.
Q2) During a liquidity crisis assets normally must be sold at a loss because of the rising interest rates caused by financial institutions attempting to raise funds.
A)True
B)False
Q3) Which of the following refers to an FI's ability to generate cost synergies by producing more than one output with the same inputs?
A)Market intermediation.
B)Economies of scope.
C)Break-even point.
D)Economies of scale.
E)Business continuity plan.
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) What is the repricing gap if a 3-year maturity gap is used? Ignore runoffs.
A)$21 million.
B)$44 million.
C)-$80 million.
D)-$60 million.
E)-$120 million.
Q2) The repricing gap approach calculates the gaps in each maturity bucket by subtracting the
A)current assets from the current liabilities.
B)long term liabilities from the fixed assets.
C)rate sensitive assets from the total assets.
D)rate sensitive liabilities from the rate sensitive assets.
E)current liabilities from tangible assets.
Q3) The gap ratio is
A).015.
B)-.015.
C).025.
D)-.144.
E).154.
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Page 10
Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) Duration is the weighted-average present value of the cash flows using the timing of the cash flows as weights.
A)True
B)False
Q2) Investing in a zero-coupon asset with a maturity equal to the desired investment horizon is one method of immunizing against changes in interest rates.
A)True
B)False
Q3) What is the duration of the two-year loan (per $100 face value) if it is selling at par?
A)2.00 years
B)1.92 years
C)1.96 years
D)1.00 year
E)0.91 years
Q4) Deep discount bonds are semi-annual fixed-rate coupon bonds that sell at a market price that is less than par value.
A)True
B)False
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Chapter 10: Credit Risk: Individual Loan Risk
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Sample Questions
Q1) Which of the following is NOT characteristic of the consumer loans at U.S. banks?
A)Non revolving consumer loans is the largest class of loans.
B)Credit card loans often have default rates between four and eight percent.
C)Usury ceilings affect the rate structure for consumer loans.
D)Consumer loans differ widely with respect to collateral, rates, maturity, and noninterest fees.
E)Revolving consumer loans include new and used automobile loans, mobile home loans, and fixed-term consumer loans.
Q2) Which of the following statements does NOT reflect credit decisions at the retail level?
A)Loans to retail customers are more likely to be rationed through interest rates than loan quantity restrictions.
B)Most loan decisions at the retail level tend to be accept or reject decisions.
C)Mortgage loans often are discriminated based on loan to price ratios rather than interest rates.
D)Household borrowers require higher costs of information collection for lenders.
E)Retail loans tend to be smaller than wholesale loans.
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Page 12
Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Sample Questions
Q1) What is the expected return on the loan using the Moody's Analytics model?
A)6.50 percent.
B)5.50 percent.
C)6.00 percent.
D)14.0 percent.
E)13.5 percent.
Q2) According to Moody's Analytics, default correlations tend to be _____ and lie between _______.
A)Low; 0.002 and 0.15
B)High; 1.86 and 2.99
C)Low; 0.001 and 0.002
D)High; 2.99 and 3.50
E)Low; 0 and 0.001
Q3) The simple model of migration analysis tracks the credit ratings of companies that have borrowed from the FI.
A)True
B)False
Q4) Included in the Moody's Analytics model are recovery rates on defaulted loans.
A)True
B)False
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) A contagious run, or bank panic, differs from a run on a bank in that a contagious run involves loss of faith in the entire banking system as opposed to just one bank.
A)True
B)False
Q2) The future liquidity position of a DI cannot be forecasted.
A)True
B)False
Q3) Purchased liquidity risk management usually involves purchased funds such as fed funds, repurchase agreements and CDs.
A)True
B)False
Q4) For a DI, what does a high ratio of loans to deposits indicate?
A)DI relies heavily on the short-term money market to fund loans.
B)High degree of loan commitments.
C)DI has large amounts of asset-side liquidity.
D)Liquidity concerns are at a bare minimum for the FI.
E)DI relies heavily on core deposits to fund loans.
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) An FI can control its FX risk exposure by on-balance-sheet and off-balance-sheet hedging.
A)True B)False
Q2) As the U.S. dollar appreciates against the Japanese yen, U.S. goods become less expensive to Japanese consumers.
A)True B)False
Q3) What must be the forward exchange rate to eliminate the preference for the yen loans?
A)$0.6416/×.
B)$0.5798/×.
C)$0.6118/×.
D)$0.5991/×.
E)Insufficient information.
Q4) State regulation of the U.S. insurance industry has an effect on the ability of insurance companies to invest in foreign securities.
A)True B)False
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Chapter 14: Sovereign Risk
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Sample Questions
Q1) The Economist Intelligence Unit is a rating of sovereign risk based on economic and political risk within a country.
A)True
B)False
Q2) The relationship of this variable with the probability of rescheduling is often disputed.
A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The investment ratio.
E)Domestic money supply growth.
Q3) The export revenue variance (VAREX) should be negatively related to the probability of debt rescheduling.
A)True
B)False
Q4) International loan contracts that contain cross-default provisions allow the country to select specific lenders for special default treatment.
A)True
B)False
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Page 16
Chapter 15: Market Risk
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Sample Questions
Q1) Depository institutions are prohibited from proprietary trading by the Volker Rule.
A)True
B)False
Q2) Which term defines the risk related to the uncertainty of an FI's earnings on its trading portfolio caused by changes, and particularly extreme changes in market conditions?
A)Interest rate risk.
B)Credit risk.
C)Sovereign risk.
D)Market risk.
E)Default risk.
Q3) Which of the following securities is most unlikely to have a symmetrical return distribution, making the use of RiskMetrics model inappropriate?
A)Common stock.
B)Preferred stock.
C)Option contracts.
D)Consol bonds.
E)30-year U.S.Treasury bonds.
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) Off-balance-sheet items often are called contingent assets and liabilities because they may, or may not, affect the balance sheet in the future.
A)True
B)False
Q2) What is the expected return on the loan at the end of the year if 50 percent of the loan is drawn? Estimate using future values of fee and interest income received, that is, return is defined as all fee and interest income earned at year-end as a percentage of funds used. Assume the cost of funds to the bank is 8 percent.
A)13.45 percent.
B)13.57 percent.
C)13.60 percent.
D)13.72 percent.
E)13.90 percent.
Q3) When-issued trading involves the commitment to buy and sell securities before they are issued.
A)True
B)False
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18
Chapter 17: Technology and Other Operational Risks
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Sample Questions
Q1) Recent evidence suggests that economies of scale may exist for banks up to the $10 billion to $25 billion range.
A)True
B)False
Q2) As of January 2012, credit cards used in either a credit or debit function accounted for less than 5 percent of the dollar value of payments made in the U.S.
A)True
B)False
Q3) Which of the following are potential benefits of technology for an FI?
A)Improved service quality, especially for customers of large banks.
B)The rate of innovation of new products can be increased.
C)FIs can more easily cross-market new and existing products to customers.
D)Improved flexibility in financial transactions for retail customers.
E)All of the above.
Q4) Daylight overdraft risk occurs because banks often provide immediate credit to customers for deposits, even though the funds may not arrive until later in the day.
A)True
B)False
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Page 19
Chapter 18: Liability and Liquidity Management
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Sample Questions
Q1) Many states in the U.S. impose liquid asset ratios on insurance companies which may be met by
A)cash and excess reserves.
B)cash and municipal bonds from within the state of operation.
C)cash and government securities.
D)cash and policyholder reserves.
E)cash only.
Q2) Which of the following observations concerning the federal funds rate is NOT true?
A)The cost of fed funds for the purchasing institution is the federal funds rate.
B)The federal funds rate is set by DIs that trade in the fed funds market.
C)The federal funds rate can vary considerably within the day.
D)The federal funds rate can vary considerably across days.
E)Rate variability has increased since the introduction of lagged reserve accounting.
Q3) Managing a bank's reserve position requires knowing only the target reserve ratio and the period over which reserves must be maintained.
A)True
B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) What is the cost to the uninsured depositors if the insured depositor transfer resolution method is used by the regulators to resolve the bank failure?
A)$0.
B)$20 million.
C)$30 million.
D)$40 million.
E)$60 million.
Q2) The FDIC deposit insurance program is also available to credit unions.
A)True
B)False
Q3) What is the cost to the insured depositors if the insured depositor transfer resolution method is used by the regulators to resolve the bank failure?
A)$0.
B)$100 million
C)$30 million.
D)$40 million.
E)$60 million.
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Page 21
Chapter 20: Capital Adequacy
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Sample Questions
Q1) Which of the following assets is deducted from Common Equity Tier I capital?
A)Trademarks.
B)Goodwill.
C)Patents.
D)Bank premises.
E)None of the above.
Q2) The determination of risk-adjusted on-balance-sheet assets under Basel III requires the segregation of assets into nine categories of credit risk exposure.
A)True
B)False
Q3) From a regulatory perspective, what is the impact on book value capital of a 25 basis point decrease in interest rates if the FI is holding a 20-year, fixed-rate, 11 percent annual coupon $100,000 par value bond?
A)A decrease of $250.
B)An increase of $250.
C)An increase of $2,023.
D)A decrease of $1,959.
E)No impact on capital since the book value is unchanged.
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22
Chapter 21: Product and Geographic Expansion
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Q1) A level _____ of the Herfindahl-Hirschman Index (HHI) is considered to reflect a highly concentrated market.
A)above 1,000
B)above 10,000
C)between 1,000 and 1,500
D)above 1,800
E)below 1,000
Q2) A value below 1,000 of the Herfindahl-Hirschman Index (HHI) is considered to reflect
A)a highly concentrated market.
B)an unconcentrated market.
C)a high growth market.
D)a moderately concentrated market.
E)an untapped market.
Q3) U.S. financial institutions have expanded abroad in recent years, although their foreign counterparts have been prohibited from expanding into the U.S.
A)True
B)False
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Chapter 22: Futures and Forwards
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Q1) If a 12-year, 6.5 percent semi-annual $100,000 T-bond, currently yielding 4.10 percent, is used to deliver against a 6-year, 5 percent T-bond at 110-17/32, what is the conversion factor? What would the buyer have to pay the seller?
A)1.1027; $110,531.
B)1.2257; $135,478.
C)1.8370; $253,830.
D)1.3622; $163,339.
E)1.7263; $141,788.
Q2) Which of the following group of derivative securities had the smallest notational value among the top 25 FIs as of June 2012?
A)Futures and forwards.
B)Caps, floors, and collars.
C)Options.
D)Swaps.
E)Credit derivatives.
Q3) A credit forward agreement specifies a credit spread on a benchmark U.S. Treasury bond.
A)True
B)False
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Page 24
Chapter 23: Options, Caps, Floors, and Collars
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Q1) Buying a cap is similar to
A)writing a call option on interest rates.
B)buying a call option on interest rates.
C)buying a put option on interest rates.
D)buying a floor on interest rates.
E)buying a collar on interest rates.
Q2) Exercise of a put option on futures by the buyer of the option will occur if interest rates have increased.
A)True
B)False
Q3) Open interest refers to the dollar amount of outstanding option contracts. A)True
B)False
Q4) Simultaneously buying a bond and a put option on a bond produces the same payoff as buying a call option on a bond.
A)True
B)False
Q5) Buying a cap is like buying insurance against a decrease in interest rates. A)True
B)False
25
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Chapter 24: Swaps
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Q1) In terms of valuation, a 12-year interest rate swap can be can be considered in terms of
A)a series of option contracts.
B)a zero-coupon bond.
C)a U.S.Treasury STRIP.
D)bond-equivalent valuation.
E)securitization of a derivative contract.
Q2) The Commodity Futures Trading Commission (CFTC) has jurisdiction over swaps. A)True
B)False
Q3) Swapping an obligation to pay interest at a specified fixed or floating rate for payments representing the total return on a loan or a bond of a specified amount is an example of
A)a commodity swap.
B)a credit swap.
C)a currency swap.
D)an equity swap.
E)an interest rate swap.
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26
Chapter 25: Loan Sales
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Q1) The growth of the commercial paper market has hurt the market for loan sales by
A)offering some borrowers alternatives to bank loans.
B)underpricing the banks that sell loans.
C)fostering the credit crunch.
D)adding another regulatory layer since the SEC requires shelf registration of new issues.
E)increasing moral hazard concerns in the market.
Q2) Which observation is true of vulture funds?
A)Their decisions based on developing and maintaining long-term relationships.
B)Their sole agenda is to helping the distressed firm to survive.
C)Their investments are always passive.
D)They are relationship based, not transaction driven.
E)In a restructuring, they are looking for a return on capital invested.
Q3) One way to boost the capital to assets ratio of an FI is through loan sales.
A)True
B)False
Q4) Mutual funds are prohibited from purchasing/participating in the FI loan sales market by the SEC.
A)True
B)False
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Chapter 26: Securitization
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Q1) When a Special Purpose Vehicle (SPV) creates asset-backed securities, the SPV retains ownership of the original assets.
A)True
B)False
Q2) FNMA securitizes conventional mortgage loans as well as FHA/VA insured loans.
A)True
B)False
Q3) Most mortgage-backed bond issues conducted by depository institutions are under-collateralized.
A)True
B)False
Q4) The availability of a liquid secondary market for asset-backed securities provided an incentive for FIs to follow an originate-to-distribute strategy of loan origination.
A)True
B)False
Q5) CMOs are typically created from existing GNMA pass-through securities that are held in trust.
A)True
B)False
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