Financial Services
Test Questions
Course Introduction
This course provides an in-depth exploration of the financial services industry, covering the broad spectrum of institutions, products, and regulatory frameworks that facilitate the flow of capital and financial information in modern economies. Students will examine the roles of banks, insurance companies, investment firms, and other financial intermediaries, while gaining insight into the development and delivery of financial products such as loans, deposits, insurance policies, and investment vehicles. Emphasis is placed on understanding risk management, regulatory compliance, technological innovations, ethical considerations, and the impact of globalization on financial markets. Through case studies and practical examples, learners will develop analytical skills necessary for evaluating financial service strategies and making informed decisions in a dynamic environment.
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) You are a corporate treasurer seeking to raise funds for your firm. What are some advantages of raising funds via a financial intermediary (FI)rather than by selling securities to the public?
Answer: Advantages include:
* Speed: Funds can normally be raised more quickly through FIs.
* Registration process/cost: The registration process can be quite costly and time-consuming in terms of workers' hours,audit fees,and fees to investment bankers. Raising funds via a FI can be less expensive,particularly for smaller capital needs or when funds are needed for only a short time period. (Maturities of 270 days or less do not require registration,nor do private placements).
* Nonstandard terms can be negotiated with FIs but are difficult to sell to the public. For example,if a borrower can only begin paying interest after two years,he or she would have a difficult time selling bonds to the public.
* There is a greater ability to renegotiate terms if necessary. Terms of public issue generally cannot be changed outside of court.
* Less information is made public.
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Chapter 2: Determinants of Interest Rates
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Q1) Households generally supply more funds to the markets as their income and wealth increase,ceteris paribus.
A)True
B)False
Answer: True
Q2) Upon graduating from college this year,you expect to earn $25,000 per year. If you get your MBA,in one year you can expect to start at $35,000 per year. Over the year,inflation is expected to be 5 percent. In today's dollars,how much additional (less)money will you make from getting your MBA (to the nearest dollar)in your first year?
A)$10,000
B)$8,750
C)$8,333
D)-$2,462
E)$9,524
Answer: C
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Chapter 3: Interest Rates and Security Valuation
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Q1) What is convexity?
How does convexity affect duration-based predicted price changes for interest rates changes?
Convexity is a measure of the nonlinearity (curvature)of a change in a bond's price caused by a change in interest rates. The level of convexity increases for greater interest rate changes. Duration is a linear estimate of a bond's price change as the interest rate changes from its current level. Due to convexity,the greater the interest rate change,the greater the error in using duration to estimate the bond's price change. For a multimillion-dollar bond portfolio,the dollar errors can be quite significant. In abnormal markets,bond investors may face more or less risk than the bond's duration would imply. Calculus
Answer: Duration is the first derivative of the bond price formula with respect to a change in interest rates. As such,it is accurate only for extremely small changes in interest rates. Duration gives only an approximation of the actual value change for interest rate movements that are normally observed in the market.
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Chapter 4: The Federal Reserve System,
Rates
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Q1) The major asset of the Federal Reserve is
A)U.S. Treasury securities.
B)depository institution reserves.
C)currency outside banks.
D)vault cash of commercial banks.
E)gold and foreign exchange.
Q2) Why did the Fed switch from increasing rates prior to 2007 to reducing interest rates in 2007 and 2008?
Q3) The 12 Federal Reserve Banks perform what functions?
Q4) 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
Q5) The major asset of the Federal Reserve is currency outside banks and the major liability is U.S. Treasury securities.
A)True
B)False
Q7) Explain how the deposit multiplier works. Page 6
Q6) What are the four major functions of the Federal Reserve System?
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Page 7
Chapter 5: Money Markets
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Q1) The discount yield on a T-bill differs from the T-bill's bond equivalent yield (BEY)because
I. the discount yield is the return per dollar of face value and the BEY is a return per dollar originally invested.
II. a 360-day year is used on the discount yield and the BEY uses 365 days.
III. the discount yield is calculated without compounding,and the BEY is calculated with compounding.
A)I only
B)II only
C)I and II only
D)II and III only
E)I,II,and III
Q2) A time draft payable to a seller of goods,with payment guaranteed by a bank is a A)commercial paper security.
B)T-bill.
C)repurchase agreement.
D)negotiable CD.
E)banker's acceptance.
Q3) How does a banker's acceptance (BA)help create more international trade?
Q4) Why do most money market securities have large denominations?
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Chapter 6: Bond Markets
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Q1) What do bond rating agencies look at in setting a bond's rating?
Q2) Bonds rated below Baa by Moody's or BBB by S&P are junk bonds.
A)True
B)False
Q3) 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
Q4) SEC Rule 144 A does which of the following?
A)allows privately placed investments to be traded on a limited basis
B)allows bond issuers to call their bonds when desired
C)determines the limits of responsibility of bond covenants
D)requires that bonds traded on the NYSE bond market utilize the ABS system
E)none of the options
Q5) An unsecured bond that has no specific collateral other than the general creditworthiness of the issuing firm is called a debenture.
A)True
B)False
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Chapter 7: Mortgage Markets
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Q1) a(n.___________________ is used to help retired people receive monthly income in exchange for the equity in their home.
A)SAM
B)Equity Participation Mortgage
C)RAM
D)PLAM
E)GEM
Q2) Who are the major buyers of mortgages after they have been originated? What is the difference between selling with recourse or without recourse? Which is most common?
Q3) Which of the following statements about GNMA is/are true?
I. GNMA provides timing insurance.
II. GNMA creates pools of mortgages and issues securities.
III. GNMA insures only FHA,VA,and FMHA loans.
IV. GNMA requires that all mortgages in the pool have the same interest rate.
A)I,II,III,and IV are true
B)I,III,and IV only
C)I,II,and III only
D)II,III,and IV only
E)III and IV only
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Chapter 8: Stock Markets
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Q1) In cumulative voting,a stockholder who owns 51 percent of the shares can be assured of the ability to elect the entire board of directors.
A)True
B)False
Q2) 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
Q3) The largest single type of holder of common stock is A)pension funds.
B)households.
C)mutual funds.
D)brokers and dealers.
E)life insurance firms.
Q4) What are the advantages and disadvantages of foreign investing? How does an ADR help overcome the disadvantages?
Q5) What are weak form,semi-strong form,and strong form efficiency? Does one form of efficiency imply another?
Q6) Answer the following questions concerning the given partial stock quote:
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Chapter 9: Foreign Exchange Markets
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Q1) A Swiss bank converted 1 million Swiss francs to euros to make a euro loan to a customer when the exchange rate was 1.85 francs per euro. The borrower agreed to repay the principal plus 3.75 percent interest in one year. The borrower repaid euros at loan maturity and when the loan was repaid the exchange rate was 1.98 francs per dollar. What was the bank's franc rate of return?
A)7.75 percent
B)11.04 percent
C)9.94 percent
D)-2.82 percent
E)5.71 percent
Q2) New York is the global center of foreign exchange trading with the largest daily volume of currency trading.
A)True
B)False
Q3) The dollar's value increased when the Fed cut interest rates in late 2007.
A)True
B)False
Q4) An FI's position in FX markets generally reflects four trading activities. What are they,and which one(s)cause the FI to bear FX risk?
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Chapter 10: Derivative Securities Markets
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Q1) Using the Black-Scholes model,explain what happens to the value of a call as S,T,and <sup>2</sup> change. Why is the relationship between risk and price different for options than for other securities?
Q2) The purchaser of a T-bond futures contract priced at 101-16 at the time of sale agrees to deliver $100,000 face value Treasury bonds in exchange for receiving $101,500 at contract maturity.
A)True
B)False
Q3) What determines the success or failure of an exchange-traded derivative contract? Why were currency and interest rate futures introduced in the early and late 1970s,respectively?
Q4) Writing a put option results in a potentially limited gain and a potentially unlimited loss.
A)True
B)False
Q5) Forward contracts are marked to market daily.
A)True
B)False
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Chapter 11: Commercial Banks: Industry Overview
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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) Nontransaction deposits at banks include NOW accounts and demand deposits.
A)True
B)False
Q3) Since 1980,the number of banks in the United States has been increasing dramatically due to deregulation of the industry.
A)True
B)False
Q4) On average,bank liabilities tend to have shorter maturities and greater liquidity than bank assets.
A)True
B)False
Q5) Why did bank profitability decline beginning in late 2006 and through 2008?
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Chapter 12: Commercial Banks Financial Statements and Analysis
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Q1) The largest market available for purchased funds is the ___________________.
A)wholesale CD market
B)Eurodollar deposit market
C)banker's acceptances market
D)discount window purchases
E)Fed funds market
Q2) A municipal bond is paying a 6 percent annual yield. An equivalent risk corporate bond is paying 7 percent. Investors with a tax rate of _______________ or higher would prefer the municipal bond.
A)65.13 percent
B)14.28 percent
C)25.00 percent
D)80.75 percent
E)25.75 percent
Q3) 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.
Q4) What is the difference between a loan commitment and a letter of credit?
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Chapter 13: Regulation of Commercial Banks
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Q1) How do risk-based deposit insurance premiums and risk-based capital requirements help reduce the moral hazard problem of deposit insurance?
(Hint:
Moral hazard means that because of deposit insurance,banks may take on excessive amounts of risk.)
Q2) The Financial Services Modernization Act allowed bank holding companies to open insurance underwriting affiliates and allowed insurance companies to open banks.
A)True
B)False
Q3) The difference between the private costs of regulations and the private benefits for the producers of financial services is called the net regulatory burden.
A)True
B)False
Q4) Discuss the four layers of regulation designed to preserve the safety and soundness of DIs.
Q5) Look at the following simplified bank balance sheet. Assume that the bank has no off-balance-sheet commitments.
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Page 16
Chapter 14: Other Lending Institutions: Savings Institutions, Credit Unions,
and Finance Companies
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Q1) Because of the differences in the makeup of their major loan types,finance companies typically have shorter-term loans than banks.
A)True
B)False
Q2) The QTL test requires that thrifts
A)limit the amount of mortgage-related assets on the balance sheet to improve diversification.
B)invest in a minimum percentage of government-backed securities to protect their mortgage loans.
C)lend no more than 80 percent of the value of a home to a borrower to ensure mortgage safety.
D)keep 35 percent of their assets in safe liquid investments to ensure adequate deposit liquidity.
E)invest at least 65 percent of their assets in mortgages or mortgage-related assets.
Q3) What are home equity loans?
What has happened to the average balance of home equity loans in recent years?
Why do finance companies prefer home equity loans to unsecured debt?
Q4) What are the major advantages that credit unions enjoy over banks?
Page 17
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Chapter 15: Insurance Companies
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Q1) Why are P&C insurers dependent on investment yields? Is this an argument for changing how this industry operates and/or how we regulate the industry? Explain.
Q2) The largest asset category of life insurers is _______________ and the largest liability category is ___________.
A)bonds; separate account items
B)separate account items; current policy claims
C)bonds; policy reserves
D)policy reserves; mortgage loans
E)common stock; dividend reserve
Q3) Policy reserves are the primary asset of the typical life insurer.
A)True
B)False
Q4) Premiums on standard annual renewable term life will generally increase as the policyholder ages.
A)True
B)False
Q5) How do insurance guarantee funds differ from bank deposit insurance funds?
Q6) What are the main lines of P&C insurance?
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Chapter 16: Securities Firms and Investment Banks
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Q1) _____________ are examples of investment bankers offering traditional commercial banking services.
A)Online brokers
B)Cash management accounts
C)Underwriting corporate debt and equity offers
D)Venture capital funds
E)Mergers and acquisition services
Q2) In July 2002,the U.S. Congress passed the Sarbanes-Oxley bill. Among other things,this bill
I. created an independent auditing oversight board run by the SEC.
II. increased penalties for corporate wrongdoers.
III. eliminated the use of stock options for executive compensation.
A)I only
B)I and II only
C)I and III only
D)II and III only
E)I,II,and III
Q3) What are the major types of firms in the investment banking industry? Briefly describe each.
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Chapter 17: Investment Companies
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Q1) 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
Q2) Hybrid mutual funds normally invest significant amounts in
A)common stock.
B)commercial paper.
C)long-term bonds.
D)treasury bills.
E)both common stock and long-term bonds.
Q3) Hedge funds can short sell securities,whereas most mutual funds cannot.
A)True
B)False
Q4) Offshore hedge funds are not subject to taxation on fund distributions nor to U.S. estate taxes.
A)True
B)False
Q5) Why is it important to regulate the mutual fund industry?
Page 20
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Chapter 18: Pension Funds
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Q1) An individual is considering contributing $4,000 per year to either a traditional or a Roth IRA. Payments would begin in one year. If she uses the traditional IRA,her contributions would be fully deductible. She is 40 years old and is in a 28 percent tax bracket. On either IRA she can earn 7 percent. When she retires at age 65,she believes she will be in a 15 percent tax bracket. Which type of IRA should she choose if she invests not only the $4,000 per year,but any tax savings due to the deductibility of her contributions in a taxable investment earning a pretax rate of 7 percent? She will withdraw all her money upon retirement and may owe taxes then,depending on the type of IRA chosen.
Q2) You are 30 years old and you make $110,000 per year. You calculate that you can't retire until you have accumulated a lump sum amount of $2,000,000 to live on after retirement. You contribute 6 percent of your salary to your 401(k)and your employer contributes 3 percent of your salary. You plan on investing 65 percent of your funds in equities on which you expect to earn an average rate of return of 10 percent,and the rest in bonds projected to earn 5 percent. If your salary does not grow,how old will you be when you can retire?
Q3) How do public pension plans differ in other countries? Has privatization worked overseas?
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21
Chapter 19: Types of Risks Incurred by Financial Institutions
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Q1) The terrorist attacks on the World Trade Center in 2001 are an example of
A)regulatory risk
B)liquidity risk
C)credit risk
D)insolvency risk
E)event risk
Q2) A corporate borrower failing to repay a loan on time due to equipment breakdowns is an example of firm specific credit risk.
A)True
B)False
Q3) Assets in a bank's trading book tend to be held for a longer time than assets held in the banking book.
A)True
B)False
Q4) What is sovereign risk?
How is this different from credit risk on a domestic loan? How can sovereign risk be limited?
Q5) What are the three major objectives of technological investments at FIs? What are the major risks involved with these investments?
Page 22
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Chapter 20: Managing Credit Risk on the Balance Sheet
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Q1) The more variable a borrower's cash flows are,the lower the fixed charge coverage ratio should be to limit risk
A)True
B)False
Q2) Mid-market commercial lending may be typically defined as borrowers
I. with sales revenue between $5 million and $100 million.
II. with a recognizable corporate structure.
III. with ready access to deep and liquid capital markets.
A)I only
B)II only
C)III only
D)I and II only
E)I,II,and III
Q3) Explain what each ratio in the Altman credit model measures and explain why higher values of each of the variables predict lower default probability.
Q4) Individuals with higher levels of income must have higher GDS and TDS ratios to qualify for a loan.
A)True
B)False
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Chapter 21: Managing Liquidity Risk on the Balance Sheet
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Q1) Bank A has a loan-to-deposit ratio of 110 percent,core deposits equal 55 percent of total assets,and borrowed funds are 25 percent of assets. Bank B has a loan-to-deposit ratio of 80 percent. Core deposits are 65 percent of assets and borrowed funds are 5 percent of assets. Which bank has more liquidity risk? Ceteris paribus,which bank will probably be more profitable when interest rates are low?
A)Bank A; Bank A
B)Bank A; Bank B
C)Bank B; Bank A
D)Bank B; Bank B
E)You can't tell
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) The fear that liquidity problems at one bank may cause depositors to worry about the solvency of other banks is called the disease effect.
A)True
B)False
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Chapter 22: Managing Interest Rate Risk and Insolvency
Risk on the Balance Sheet
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Q1) Explain how an FI's capital protects against credit risk and interest rate risk.
Q2) The repricing gap is the most comprehensive measure of interest rate risk used by financial intermediaries.
A)True
B)False
Q3) A bank has D<sub>A</sub> = 2.4 years and D<sub>L</sub>= 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Interest rates are at 6 percent. If interest rates increase 100 basis points the predicted dollar change in equity value will equal
A)$10,171,698.
B)-$10,171,698.
C)$12,724,528.
D)-$12,724,528.
E)$4,928,756.
Q4) For a one-year maturity bucket,the repricing model assumes that a nine-month loan is as equally rate-sensitive as a three-month loan.
A)True
B)False
Q5) 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) The largest two categories of swaps are
A)credit risk and interest rate swaps.
B)currency and commodity swaps.
C)interest rate and currency swaps.
D)equity and interest rate swaps.
E)none of the options.
Q2) 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.
Q3) A naïve hedge is one
A)in which the hedger is not fully informed.
B)in which the hedger attempts to eliminate all of the risk of the underlying spot position.
C)in which the hedger uses microhedges rather than macrohedges to limit risk.
D)in which the hedger unwittingly increases the risk of the FI's position.
E)that does not have to be reported on the FI's financial statements.
Q4) What are the advantages and disadvantages of forwards versus futures contracts?
Page 26
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Chapter 24: Managing Risk Off the Balance Sheet With Loan
Sales and Securitization
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Q1) Advantages of Brady bonds over LDC loans include improved liquidity and higher coupon rates.
A)True
B)False
Q2) Loans sold to correspondent banks are predominantly sales of distressed HLT loans.
A)True
B)False
Q3) Vulture funds specialize in buying distressed loans.
A)True
B)False
Q4) What are the major differences in the traditional and HLT segments of the loan sale market with respect to the types of loans sold?
Q5) In selling loans,FIs act as an asset _____ and in creating CMOs,FIs act as an asset
A)transformer; broker
B)transformer; transformer
C)broker; broker
D)broker; transformer
Q6) Why are MBBs the least used form of mortgage securitization?
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