Principles of Banking
Mock Exam
Course Introduction
Principles of Banking introduces students to the foundational concepts and operations of the banking industry. The course covers the history and evolution of banking, the role of financial intermediaries, and different types of financial institutions. Key topics include the functions of banks, types of deposits and lending products, bank regulation and supervision, risk management, and the impact of technology on banking services. Students will also explore ethical practices in banking and the importance of maintaining public trust and financial stability in the broader economy. This course provides a solid grounding for those interested in pursuing careers or further studies in banking and financial services.
Recommended Textbook
Financial Institutions Management A Risk Management Approach 8th Edition by Saunders
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Chapter 1: Why Are Financial Institutions Special
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Q1) If not done by FIs, the process of monitoring the actions of borrowers would reduce the attractiveness and increase the risk of investing in corporate debt and equity by individuals.
A)True
B)False
Answer: True
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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Q1) This broad class of loans constitutes the highest percentage of total assets for all U.S. commercial banks as of the end of 2012.
A)Commercial and industrial.
B)Commercial and residential real estate.
C)Individual loans.
D)Credit card debt.
E)Less developed country loans.
Answer: B
Q2) According to the American Bankers Association, the tax-exempt status of credit unions is the equivalent of a $1 billion per-year subsidy to the industry.
A)True
B)False
Answer: True
Q3) Savings institutions enjoyed record profitability during the late 1990s and early 2000s.
A)True
B)False
Answer: True
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Chapter 3: Financial Services: Finance Companies
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Q1) Finance companies have been among the slowest growing FI groups in recent years.
A)True
B)False Answer: False
Q2) Finance companies differ from banks in that they do not accept deposits.
A)True
B)False Answer: True
Q3) Finance companies often prefer to lease equipment to customers because
A)repossession in the event of default is easier.
B)a lease with little or no down payment is more attractive to business customers.
C)the finance company receives the benefit of depreciation expense.
D)All of the above.
E)Answers A and C only.
Answer: D
Q4) Business loans represent 60% of the loan portfolio of finance companies.
A)True
B)False Answer: False
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Chapter 4: Financial Services: Securities Brokerage and Investment Banking
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Q1) The largest category of liabilities of broker-dealers as of the beginning of 2012 was A)bank loans payable.
B)securities sold under repurchase agreements.
C)payables to customers.
D)short positions in securities and commodities.
E)payables to non-customers.
Q2) In order for an investment bank to perform a firm commitment offering of securities, they must maintain at least 20% equity on their balance sheet.
A)True
B)False
Q3) The change to decimalization of stock market transactions has lead to an increase in income from the market making activity of investment banks and securities firms.
A)True
B)False
Q4) As of 2012, there were over 4,900 securities firms in operation.
A)True
B)False
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Chapter 5: Financial Services: Mutual Funds and Hedge Funds
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Q1) The type of abusive activity that involves cases where investors were able to buy or sell mutual fund shares long after the price had been set each day is
A)market timing.
B)late trading.
C)directed brokerage.
D)improper fee assessment.
E)None of the above.
Q2) Mutual funds are required to hire chief compliance officers whose job is to monitor whether the mutual fund company follows exchange and regulatory rules.
A)True
B)False
Q3) The Securities Act of 1933 sets rules and procedures regarding a mutual fund's prospectus sent to potential investors.
A)True
B)False
Q4) Equity mutual funds may contain common stock, but not preferred stock. A)True
B)False
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Chapter 6: Financial Services: Insurance
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Q1) What is essentially understood to be insurance for property-casualty insurance companies?
A)Policy reserves.
B)Conditional reserve funds.
C)Reinsurance.
D)Unearned premiums.
E)Surplus notes.
Q2) The surrender value of an insurance policy is
A)the expected payment commitment on existing policy contracts.
B)a fund established and held separately from the company's other assets.
C)the cash value paid to the policyholder if the policy is terminated before it matures.
D)the same as the endowment payout.
E)the price at which the company may repurchase the policy.
Q3) For property-casualty insurers, loss rates are more predictable for
A)low-severity high-frequency events.
B)low-severity low-frequency events.
C)high-severity high-frequency events.
D)high severity low-frequency events.
E)low severity medium-frequency events.
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Chapter 7: Risks of Financial Institutions
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Q1) FIs that make loans or buy bonds with long maturity liabilities are more exposed to interest rate risk than FIs that make loans or buy bonds with short maturity liabilities.
A)True
B)False
Q2) Funding a portion of assets with equity capital means that hedging risk does not require perfect matching of the assets and liabilities.
A)True
B)False
Q3) Systematic credit risk can be reduced significantly by diversification.
A)True
B)False
Q4) Credit risk exposes the lender to the uncertainty that only interest payments may not be received.
A)True
B)False
Q5) Active trading of assets and liabilities creates market risk.
A)True
B)False
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) 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.
Q2) In the repricing gap model, assets or liabilities are rate sensitive within a given time period if the dollar values of each are subject to receiving a different interest rate should market rates change.
A)True
B)False
Q3) What is the repricing gap for the FI?
A)$0.
B)$5,000,000.
C)$9,800,000.
D)-$5,000,000.
E)-$8,000,000.
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10
Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) An FI has financial assets of $800 and equity of $50. If the duration of assets is 1.21 years and the duration of all liabilities is 0.25 years, what is the leverage-adjusted duration gap?
A)0.9000 years.
B)0.9600 years.
C)0.9756 years.
D)0.8844 years.
E)Cannot be determined.
Q2) What is the duration of the bond?
A)4.677 years.
B)5.000 years.
C)4.674 years.
D)4.328 years.
E)4.223 years
Q3) For a given maturity fixed-income asset, duration increases as the promised interest payment declines.
A)True
B)False
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11
Chapter 10: Credit Risk: Individual Loan Risk
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Q1) Relationship pricing involves pricing for specific services which depend, in part, on the amount or number of services that are used by the customer.
A)True
B)False
Q2) If the cumulative mortality rate in year 3 is 3.46 percent for the B-rated loan, what is its yearly mortality rate in year 3?
A)1.25 percent.
B)1.21 percent.
C)1.00 percent.
D)0.90 percent.
E)0.875 percent.
Q3) Cumulative default probability refers to
A)probability that a borrower will default over a specified multiyear period.
B)expected maximum change in the loan rate due to a change in the risk factor on the loan.
C)historic default rate experience of a bond or loan.
D)expected maximum change in the loan rate due to a change in the credit premium.
E)probability that a borrower will default in any given year.
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
Risk
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Q1) Recent Federal Reserve policy for measuring credit concentration risk favors technical models over subjective analysis.
A)True
B)False
Q2) 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.
Q3) Which of the following is a source of loan volume data?
A)Commercial bank call reports.
B)Data on shared national credits.
C)Commercial databases.
D)All of the above.
E)Only the Federal Reserve has this data.
Q4) Concentration limits are used to either reduce or increase exposure to specific industries.
A)True B)False
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Chapter 12: Liquidity Risk
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Q1) Which of the following observations is NOT true?
A)Traditionally, DI managers have relied on purchased liquidity management as the primary mechanism of liquidity management.
B)Today, many DIs rely on purchased liquidity management to deal with the risk of cash shortfalls.
C)The largest banks with access to the money market and other nondeposit markets for funds rely on purchased liquidity management to deal with the risk of cash shortfalls.
D)Purchased liquidity management and stored liquidity management are ways of managing a drain on deposits.
E)None of the above.
Q2) In terms of liquidity risk measurement, the financing gap is defined as rate sensitive assets minus rate sensitive liabilities.
A)True
B)False
Q3) Asset-side liquidity risk may be a result of OBS lending commitments.
A)True
B)False
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Page 14
Chapter 13: Foreign Exchange Risk
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Q1) The reason an FI receives a fee when purchasing foreign currencies to allow customers to complete international transactions is because the FI assumes some FX risk.
A)True
B)False
Q2) According to purchasing power parity (PPP), foreign currency exchange rates between two countries adjust to reflect changes in each country's A)unemployment rates.
B)export competitiveness.
C)inflation rates.
D)foreign exchange reserves.
E)reserve requirements.
Q3) What is the FI's net exposure in the Japanese yen?
A)+30,000.
B)+40,600.
C)-19,400.
D)-40,600.
E)+20,600.
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Chapter 14: Sovereign Risk
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Questions
Q1) In international finance, the investment ratio is determined by dividing the value of real investment by the
A)total foreign exchange reserves.
B)real investment.
C)gross national product.
D)value of exports.
E)money supply.
Q2) The allocation of country resources between present and future consumption is measured by which of the following variables of the credit scoring model of sovereign country risk exposure?
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) In exchange for the loss of some present value of the interest and principal on a loan after a rescheduling, the lender avoids the permanent loss that would result from a default.
A)True
B)False
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Chapter 15: Market Risk
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Sample Questions
Q1) Losses among FIs that actively traded mortgage-backed securities reached over $3 trillion world-wide by mid-2009.
A)True
B)False
Q2) What is the one-day, 99% confidence level, value at risk (VAR) of securities Alpha and Beta, respectively (in millions)?
A)$3 and $25.50
B)$3 and $0.75
C)$248 and 248
D)$300 and $300
E)300 and 3,300
Q3) Which of the following items is not considered to be an advantage of using back simulation over the RiskMetrics approach in developing market risk models?
A)Back simulation is less complex.
B)Back simulation creates a higher degree of confidence in the estimates.
C)Asset returns do not need to be normally distributed.
D)The correlation matrix does not need to be calculated.
E)A worst-case scenario value is determined by back simulation.
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Chapter 16: Off-Balance-Sheet Risk
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Q1) Which of the following is true of the market price of an options contract over time?
A)It is set at time 0.
B)It is fixed over the life of the contract.
C)It changes based on the market value of the underlying asset.
D)It increases with time to expiration.
E)It is based on supply and demand.
Q2) All call options are eventually exercised and the underlying asset must be delivered.
A)True
B)False
Q3) In the early 1980s
A)banks increased their off-balance-sheet activities to avoid competition from nonbank banks.
B)banks decreased their off-balance-sheet activities to avoid regulatory taxes.
C)banks decreased their off-balance-sheet activities to avoid competition from nonbank banks.
D)banks increased their off-balance-sheet activities to avoid regulatory costs.
E)banks increased their off-balance-sheet activities to avoid interest rate risk exposure.
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18
Chapter 17: Technology and Other Operational Risks
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Q1) What can you conclude about the cost structure of the market consisting of the two FIs?
A) There are significant economies of scale because both companies A and B coexist in the industry.
B) There are no significant economies of scale because company A is much larger than company B.
C) There are no significant economies of scale because the unit costs are constant.
D) There are significant economies of scale because the unit costs decline as size increases.
E) There are no significant economies of scale because the unit costs increase as size increases.
Q2) Technological efficiency focuses exclusively on the cost side of financial intermediation.
A)True B)False
Q3) CHIPS guarantees that any wire transfer is final at the time it is made. A)True
B)False
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19
Chapter 18: Liability and Liquidity Management
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Q1) Most large banks in the U.S. directly issue commercial paper to meet their liquidity needs.
A)True B)False
Q2) The DI manager can change the pricing on NOW accounts by changing both implicit and explicit interest payments.
A)True B)False
Q3) In the U.S., a subsidiary bank can issue commercial paper to meet short-term liquidity needs, but the bank's parent holding company cannot.
A)True
B)False
Q4) In most countries, assets used to satisfy the liquid assets ratio may include liquid government securities.
A)True B)False
Q5) Passbook savings accounts are less liquid than demand deposit accounts. A)True B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) During the 1980s, a high proportion of brokered deposits at a DI became an early warning signal of its risk for failure.
A)True
B)False
Q2) How is the cost of a systemic risk exemption to the least-cost resolution of bank failures shared among banks?
A)It is shared equally among all other insured banks.
B)Additional deposit insurance premiums are imposed on FIs based on their size as measured by their total deposits and borrowed funds excluding subordinated debt.
C)Additional deposit insurance premiums are imposed on FI based on their size as measured by their total deposits and borrowed funds including subordinated debt.
D)It is shared equally among all other insured banks based on the profits earned by the FI during the year.
E)The cost is borne by the bank whose run was responsible for the contagion.
Q3) The risk of moral hazard increases when capital levels are low.
A)True
B)False
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Chapter 20: Capital Adequacy
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Q1) What is the minimum Tier 1 and Total risk-based capital Fifth Bank needs in order to be considered adequately capitalized under Basel III capital requirements for both on-balance sheet and off-balance sheet items?
A)$40.71 million; $63.0 million.
B)$38.91 million; $51.88 million.
C)$51.88 million; $64.85 million.
D)$50.40 million; $67.5 million.
E)$38.91 million; $50.40 million.
Q2) If the loan portfolio consists of five-year, 10 percent annual coupon par value loans, what is the market, or economic, value of capital if interest rates decrease 2 percent?
A)$35 million.
B)$96 million.
C)$60 million.
D)-$7 million.
E)$0.
Q3) Under Basel II (2006), total capital is equal to Tier I capital plus Tier II capital.
A)True
B)False
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Chapter 21: Product and Geographic Expansion
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Q1) Concern about the cost of managing a widely diversified financial company has been used to justify product segmentation on the grounds of
A)safety and soundness issues.
B)economy of scale and scope issues.
C)conflict of interest issues.
D)deposit insurance issues.
E)regulatory oversight issues.
Q2) Prior to the International Banking Act of 1978, foreign banks operating with state licenses
A)were not subject to the Federal Reserve's reserve requirements.
B)were not subject to interstate branching restrictions.
C)were not subject to restrictions on corporate securities underwriting.
D)All of the above.
E)Answers A and B only.
Q3) The Herfindahl-Hirschman Index (HHI) is a measure of
A)market concentration.
B)profitability.
C)market performance.
D)annual sector growth.
E)investor reaction.
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Chapter 22: Futures and Forwards
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Sample Questions
Q1) If at the end of the year, the exchange rate is $1.65/ , what is the spread earned on the loan by the FI in dollars after adjusting fully for exchange rates?
A)-$3,750,000.
B)-$1,250,000.
C)+$1,250,000.
D)+$3,750,000.
E)+$5,000,000.
Q2) The Financial Accounting Standards Board requires that all derivatives be marked-to-market with any losses and gains transparent on FI's financial statements.
A)True
B)False
Q3) The uniform guidelines issued by bank regulators for trading in futures and forwards
A)require a bank to establish trading limits.
B)require a bank to disclose large contract positions.
C)require a bank to establish internal guidelines regarding hedging activities.
D)All of the above are correct.
E)Answers A and C only.
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24
Chapter 23: Options, Caps, Floors, and Collars
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Q1) The purchase often of a series of put options with multiple exercise dates results in a A)open interest.
B)pull-to-par.
C)cap.
D)floor.
E)collar.
Q2) What is the advantage of an options hedge over a futures hedge?
A)The options hedge has lower credit risk exposure.
B)The options hedge has lower transaction costs.
C)The options hedge is marked to market less frequently.
D)The options hedge offers the most downside risk protection.
E)The options hedge offers the most upside gain potential.
Q3) A contract whose payoff increases as a yield spread increases above some stated exercise spread is a A)put option.
B)call option.
C)digital default option.
D)futures option.
E)credit spread call option.
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Chapter 24: Swaps
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Q1) What will be the net after-swap cost of funds for the bank if the cash market liabilities are included in the analysis?
A)Variable-rate at LIBOR.
B)Fixed-rate at 8 percent.
C)Fixed-rate at 1 percent.
D)Fixed-rate at 2 percent.
E)None of the abovE.
Q2) The type of swap that is in the largest segment of the global swap market is
A)a commodity swap.
B)a credit swap.
C)a currency swap.
D)an equity swap.
E)an interest rate swap.
Q3) The vast majority of credit derivative contracts held by commercial banks consist of credit
A)forward contracts.
B)futures contracts.
C)options.
D)swaps.
E)currency contracts.
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Chapter 25: Loan Sales
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Q1) Selling loans without recourse is a way for FIs to remove loans from their balance sheet for the purpose of reducing the cost associated with reserve requirements.
A)True
B)False
Q2) The move toward market value accounting
A)increases banks' incentives to sell loans to avoid reporting capital losses.
B)decreases banks' incentives to sell loans to avoid reporting capital losses.
C)increases banks' incentives to sell loans since all assets will automatically be marked to market.
D)decreases banks' incentives to sell loans since all assets will automatically be marked to market.
E)has no impact on the banks' incentives to sell loans.
Q3) The growth of the commercial paper market as well as the increased ability of banks to underwrite commercial paper has reduced the importance of short-term segment of the loan sales market.
A)True
B)False
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Chapter 26: Securitization
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Q1) Which of the following are functions of GNMA?
A)Engaging in swap transactions where it swaps mortgage-backed securities with an FI for original mortgages.
B)Sponsors mortgage-backed securities programs by FIs such as banks, thrifts, and mortgage bankers.
C)Acts as a guarantor to investors in mortgage-backed securities regarding the timely pass-through of principal and interest payments on their sponsored bonds.
D)All of the above.
E)Answers B and C only.
Q2) A bad news effect of increased mortgage prepayments on a mortgage pool caused by decreasing market interest rates includes a reduction in the discount rate on the mortgage cash flow.
A)True
B)False
Q3) Investors in a Structured Investment Vehicle (SIV) have no direct right to the cash flows on the underlying portfolio of the SIV.
A)True
B)False
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