COMMERCIAL BANKING

TRUE/FALSE

1. Floating-rate loans completely eliminate interest rate risk. False

2. Interstate banking regulations presently allow commercial banks to acquire other banks
in their region of the country, but not to expand across the nation. False
3. Gross interest expenses of banks are normally higher in periods when market interest
rates are higher. True
4. The bank holding company structure allows more flexibility to borrow funds, issue stock,
repurchase the company's own stock, and acquire other firms. True
5. Return on assets (ROA) will usually reveal when a bank's performance is not up to par,
but it does not indicate the reason for poor performance. True
6. When interest rates fall, the rates that a bank pays on deposits typically decline less than
the interest rates that the bank earns on its loans and investments. False
7. Banks commonly use depositor funds to invest in stocks. False
8. Bank rates on credit card balances are usually similar to the rate charged on business
loans. False
9. A bank's net interest margin represents the proportion of its investments that are
financed with borrowed funds. False
10. If banks continue to offer new services (such as insurance or securities services), their
noninterest income will decrease over time. False
11. Commercial banks are allowed to invest in junk bonds. True
12. Floating-rate loans cannot completely eliminate interest rate risk; if the cost of funds is
changing more frequently than the rate on assets, the bank's net interest margin is still
affected by interest rate fluctuations. True
13. Banks are more liquid as a result of securitization because it allows them to request
repayment of the loan principal from the borrower upon demand. False
14. Banks tend to focus their loans in one industry so that they can specialize in that industry
and reduce the credit risk of their loan portfolio. False
15. If the duration of all of a bank’s assets with a maturity of greater than one year is similar
to that of its liabilities with a maturity greater than one year, interest rate risk is
nonexistent. False
16. Deposit insurance now covers all bank deposits without any limit. False
17. When a bank holds a lower level of capital, a given dollar level of profits represents a
lower return on equity. False
18. Banks are generally prohibited from making loans exceeding more than 10 percent of
their own equity capital to any one company or borrower. False
19. The quantity of notes and coins in the economy is called inside money but the bulk of the
money supply is outside money. False
20. A bank holding company that only has one bank is termed a unit bank. False

MCQ
1. The term disintermediation refers to
 a. The policy of not allowing banks to grow by creating a denovo branch outside
their traditional market area.
b. The withdrawal of deposits from depository institutions that are reinvested
in other types of intermediaries
c. The policy of not closing insolvent institutions in hopes they could eventually turn
around their performance
d. The policy of regulating the minimum rate of return institutions could pay on
deposits
e. Chartering restrictions that limit the ability of new banks to enter into a local
market
2. Areas of commercial bank regulation dealing with preventing banks from discriminating
unfairly in lending are termed ______________________ regulations.
a. consumer protection
b. investor protection
c. credit allocation
d. safety and soundness
e. monetary policy
3. Areas of commercial bank regulation designed to encourage banks to lend to socially
important sectors such as housing and farming are termed ______________________
regulations.
a. monetary policy
b. investor protection
c. credit allocation
d. safety and soundness
e. consumer protection
4. If a bank sells interest rate futures, it ____ the potential adverse effect of rising interest
rates and ____ the potential favorable effect of declining interest rates on its interest
expenses.
a. increases; increases
b. increases; reduces
c. reduces; increases
d. reduces; reduces
5. If a bank expects interest rates to consistently ____ over time, it will consider allocating
most funds to rate-____ assets.
a. decrease; sensitive
b. decrease; insensitive
c. increase; insensitive
d. None of these are correct.
6. During a period of ____ interest rates, a bank's net interest margin will likely ____ if its
liabilities are more rate sensitive than its assets.
a. decreasing; increase
b. decreasing; decrease
c. increasing; increase
d. increasing; remain stable
7. Because riskier assets offer ____ returns, a bank's strategy to increase its return will
typically entail a(n) ____ in the overall credit risk of its asset portfolio.
a. higher; increase
b. higher; decrease
c. lower; increase
d. lower; decrease
8. During a period of rising interest rates, a bank's net interest margin will likely ____ if its
liabilities are ____ its assets.
a. increase; equally rate sensitive as
b. decrease; equally rate sensitive as
c. increase; more rate sensitive than
d. decrease; more rate sensitive than
9. In a standby letter of credit, a bank agrees to
a. service credit card loans originated by another bank.
b. back a customer’s obligation to a third party.
c. provide a customer with funds up to a specified maximum amount over a
specified period.
d. charge a fixed interest rate for a line of credit for a specified period.
10. Which of the following is NOT a likely method used by a bank to reduce interest rate
risk?
a. using interest rate caps
b. using fixed-rate loans
c. using interest rate futures contracts
d. maturity matching
11. Banks can resolve a liquidity problem by
a. increasing dividend payouts.
b. selling assets.
c. buying back common stock.
d. extending new loans.
e. extending new loans AND selling assets.
12. If a bank increases its provisions for loan losses, its interest income is ____, and its
noninterest income is ____.
a. not affected; reduced
b. reduced; not affected
c. reduced; reduced
d. not affected; not affected
13. Interest paid on deposits and borrowed funds is called
a. net interest expense.
b. net interest margin.
c. gross interest expense.
d. net spread expense.
14. During the credit crisis, the level of ____ was much higher than in other periods.
a. loan loss provisions
b. noninterest expenses
 c. income expenses
d. interest income
15. Which of the following banks would likely have the highest return on equity?
a. low return on assets, high capital ratio
b. low return on assets, low capital ratio
c. high return on assets, high capital ratio
d. high return on assets, low capital ratio
16. Bank capital represents funds obtained through ____ and through ____.
a. offering long-term CDs; issuing bonds
b. issuing repurchase agreements; issuing bonds
c. issuing stock; retaining earnings
d. issuing stock; offering long-term CDs
17. For a commercial bank, when the average duration of assets exceeds the average
duration of liabilities, the duration gap is
a. zero
b. either b or c, depending on the maturities of the assets.
c. Negative
d. Positive
18. Changes in ____ are a factor affecting the value of a commercial bank over which the
bank has some control.
a. the risk-free interest rate
b. management abilities
c. industry conditions
d. economic growth
19. From a bank manager’s perspective, the differential in interest between a bank’s loans
and its deposits
a. must not exceed the federal funds rate.
b. must be sufficient to cover the bank’s deposit insurance premiums and its
reserve requirements at the Federal Reserve.
c. must be sufficient to cover the bank’s expenses and generate a reasonable
profit for the bank’s owners.
d. is called the primary credit rate.
20. The potential risk that financial problems can spread through financial institutions and
the financial system is referred to as ________ risk.
a. Market
b. Unsystematic
c. systematic
d. Systemic

FOREIGN EXCHANGE MARKET

1. Financial institutions rarely use the forward market. False

2. The indirect exchange rate is always the reciprocal of the direct exchange rate. True
3. Purchasing power parity suggests that the forward rate premium (or discount) should be
 about equal to the differential in interest rates between the countries of concern. False
4. A country that pegs its exchange rate to another exchange rate does not have complete
control over its interest rates. True
5. The forward rate is the exchange rate for immediate delivery. False
6. The act of capitalizing on the discrepancy between the forward rate premium and the
interest rate differential is called
a. locational arbitrage.
b. triangular arbitrage.
c. interest rate parity.
d. covered interest arbitrage.
7. A(n) ____ in the supply of euros for sale will cause the euro to ____.
a. increase; appreciate
b. decrease; depreciate
c. None of these are correct.
d. increase; depreciate
8. Currency futures contracts differ from forward contracts in that they
a. are not an obligation.
b. are an obligation.
c. are standardized
d. can specify any amount and maturity date.
9. At any given point in time, the price at which banks will buy a currency is ____ the price
at which they sell it.
a. None of these are correct.
b. higher than
c. lower than
d. the same as
10. ____ serve as financial intermediaries in the foreign exchange market by buying or
selling currencies to accommodate customers.
a. Pension funds
b. Commercial banks
c. International mutual funds
d. Insurance companies
11. The speculative risk of purchasing a ____ is that the foreign currency’s value ____ over
time.
a. put option; increases
b. put option; decreases
c. call option; increases
d. futures contract; increases
12. A system whereby exchange rates are market determined without boundaries but
subject to government intervention is called
a. the gold standard.
b. a dirty float.
c. a free float.
d. the Bretton Woods era.
13. The devaluation of a country’s currency
a. increases foreign demand for that country’s exports.
b. makes foreign products more expensive for consumers in that country.
c. can lead to deflation in that country.
d. makes foreign products more expensive for consumers in that country
AND increases foreign demand for that country’s exports.
14. If the spot rate ____ the exercise price, a currency ____ option will not be exercised.
a. remains above; call
b. remains below; call AND remains below; put
c. remains below; put
d. remains below; call
15. Which of the following is NOT a method of forecasting exchange rates?
a. using a time-series model that examines moving averages and allows the
forecaster to identify patterns in a currency’s movements
b. using the forward rate for a currency to predict the future spot rate
c. examining current values for economic variables along with their historical impact
on a currency’s value
d. using the volatility of future exchange rate movements
16. If U.S. interest rates suddenly become much higher than European interest rates (and if
this does not cause concern about higher inflation in the United States), the U.S.
demand for euros would ____, and the supply of euros to be exchanged for dollars
would ____, other factors held constant.
a. decrease; decrease
b. increase; decrease
c. increase; increase
d. decrease; increase
17. If a commercial bank expects the euro to appreciate against the dollar, it may take a
____ position in euros and a ____ position in dollars.
a. long; short
b. short; long
c. short; short
d. long; long
18. Which of the following are most likely to provide currency forward contracts to their
customers?
a. brokerage firms
b. international mutual funds
c. commercial banks
d. insurance companies
19. ____ are not foreign exchange derivatives.
a. Currency options
b. Currency swaps
c. Currency futures contracts
d. All of these are foreign exchange derivatives
e. Forward contracts
 20. Generally, a ____ home currency can ____ domestic economic growth.
a. weak; dampen AND strong; stimulate
b. strong; stimulate
c. weak; dampen
d. strong; dampen

INSURANCE COMPANIES

1. An insurance broker assesses and bears the actual risk of the insurance policy sold.
False
2. In a typical variable life policy the policyholder may vary the premium payments and the
maturity date of the policy. False
3. Policy reserves are the primary asset of the typical life insurer. False
4. The cash surrender value of a life insurance policy is the present value of expected
future payouts on the policy. False
5. Liability losses are more subject to social inflation than property losses. True
6. The term "variable" in a variable life policy refers to the
a. Insurer's ability to vary the premium
b. The policy holder's ability to cancel the plan
c. Variable growth rate of the cash value of the policy
d. Policyholder's ability to vary the premiums
e. Insurer's ability to vary the rate of return on the policy
7. The largest asset category of life insurers is _____ and the largest liability category is
_____.
a. Policy reserves, mortgage loans
b. Bonds, policy reserves
c. Separate account items, current policy claims
d. Common stock, dividend reserve
e. Bonds, separate account items
8. Premiums received before the coverage period are termed
a. Policyholder’s surplus
b. Loss reserves
c. Loss adjustment expenses
d. Unearned premiums
e. Lagged premiums
9. Which one of the following would provide an example of social inflation?
a. Increase in costs on auto physical damage claims
b. Losses to repair damages caused by hurricanes in Florida
c. Increase in prescription drug cost claims
d. Rising cost of funeral expenses due to inflation
e. Large malpractice awards beyond the level of damages incurred
10. Which of the following statements is NOT correct?
a. Insurance can cause the insured to take more risks because they are protected.
b. Insurance provides a payment to the insured under conditions specified by the
 insurance policy contract.
c. Insurance companies employ underwriters to calculate the risk of specific
insurance policies.
d. Individuals who are less exposed to specific conditions that cause financial
damage are more likely to purchase insurance against those conditions.
11. The practice of adapting insurance prices to interest rates by lowering premiums when
interest rates rise and raising premiums when interest rates decline is called
a. cyclical rate adjusting.
b. collateralizing premiums.
c. cash flow underwriting.
d. reinsurance.
12. An insurance company’s liquidity is measured as
a. net profit minus losses.
b. premium income minus policy expenses.
c. invested assets divided by loss reserves and unearned premium reserves.
d. None of these are correct.
13. Life insurance companies can attempt to reduce their exposure to interest rate risk by
a. diversifying the age distribution of their customer base.
b. increasing their proportion of long-term assets.
c. concentrating on an older age distribution of their customer base.
d. increasing their proportion of short-term assets.
14. ____ is(are) not a typical source of funds for life insurance companies.
a. Investment income
b. Life and health insurance premiums
c. Deposit insurance premiums
d. Annuity plans
15. The largest single source of funds for a life insurance company is
a. life insurance premiums.
b. health insurance premiums.
c. annuity plans.
d. investment income.

FINANCE COMPANIES

1. Many consumer finance companies provide personal loans directly to individuals to

finance purchases of large household items. True
2. The value of a finance company can be modeled as the present value of its future cash
flows. True
3. The main competition for finance companies in the consumer loan market comes from
pension funds and insurance companies. False (Commercial banks and savings and
institutions)
4. Although commercial paper is available only for short-term financing, finance companies
can continually roll over their issues to create a permanent source of funds. True
5. Finance companies are exempt from state regulations. False
6. Consumer finance companies sometimes provide mortgage loans to individuals. True
7. Unlike loans made by commercial banks, loans made by finance companies cannot be
securitized (bundled together and sold as securities to investors). False
8. Overall, the liquidity risk of finance companies is higher than that of other financial
institutions. False
9. When interest rates increase, finance companies tend to use more long-term debt to
lock in their cost of funds over an extended period of time. False
10. Some finance companies offer credit card loans through a particular retailer. True
11. Business finance companies focus on loans to very large businesses. False
12. Finance companies are not subject to state regulations on intrastate business. False
13. Finance companies are regulated by the states and are not subject to regulation by any
agency of the federal government. False
14. Finance companies commonly act as ____ for accounts receivable; that is, they
purchase a firm's receivables at a discount and are responsible for processing and
collecting the balances of these accounts.
a. market makers
b. dealers
c. None of these are correct
d. Brokers
e. Factors
15. ____ finance companies provide financing for customers of retail stores and provide
personal loans to individuals.
a. Sales
b. Consumer
c. None of these are correct.
d. Commercial
16. Finance companies are subject to
a. disclosure requirements and truth in lending rules.
b. regulations that require finance companies to only operate in one state.
c. minimum specified interest rates on loans provided.
d. a minimum length on loan maturity.
17. The most important risk for finance companies is ____ risk.
a. Credit
b. Accounting
c. exchange rate
d. settlement
18. If finance companies have liabilities that are more rate sensitive than their assets and
want to reduce interest rate risk, they could
a. shorten their average asset life.
b. make greater use of fixed-rate loans.
c. shorten the maturity of debt that they issue.
d. lengthen their average asset life.
19. Finance companies would prefer to increase their long-term debt when interest rates
a. are projected to decrease.
 b. are relatively low and are expected to increase.
c. have increased.
d. have been stable for several years.
20. Finance companies differ from commercial banks, savings institutions, and credit unions
in that they
a. focus on providing residential mortgages.
b. do not rely heavily on deposits as a source of funds.
c. use most of their funds to purchase stocks
d. focus on financing acquisitions by companies.

MORTGAGE MARKETS

1. Mortgages are rarely sold in the secondary market. False

2. An increase in either the risk-free rate or the risk premium on a fixed-rate mortgage
results in a higher required rate of return when investing in the mortgage and therefore
causes the mortgage price to decrease. True
3. Borrowers who have a lower level of income relative to their periodic loan payments are
more likely to default on their mortgages. True
4. An investor in interest-only collateralized mortgage obligations (CMOs) would not be
concerned that homeowners will prepay the underlying mortgages. False
5. The higher the level of equity invested by the borrower, the higher the probability that the
loan will default. False
6. A balloon-payment mortgage requires interest payments for a 10- to 20-year period, at
the end of which the borrower must pay the full amount of the principal. False
7. Strong economic growth tends to reduce the probability that borrowers will default on
their mortgage payments and therefore tends to decrease mortgage prices. False
8. Mortgage companies, commercial banks, and savings institutions are the primary
originators of mortgages. True
9. A balloon-payment mortgage requires only interest payments for a three- to five-year
period. At the end of this period, full payment of the principal (the balloon payment) is
required. True
10. "Securitization" refers to the private insurance of conventional mortgages. False
11. At a given point in time, the interest rate offered on a new fixed-rate mortgage is typically
____ the initial interest rate offered on a new adjustable-rate mortgage.
a. Above
b. equal to
c. below
12. ____ risk is the risk that a borrower may prepay the mortgage in response to a decline in
interest rates.
a. Credit
b. Prepayment
c. Interest rate
d. Reinvestment rate
13. ____ mortgages enable more people with relatively lower income, or high existing debt,
 or a small down payment to purchase homes.
a. Balloon
b. Prime
c. Amortized
d. Subprime
14. From the perspective of the lending financial institution, there is a ____ degree of
interest rate risk for ____-maturity mortgages.
a. lower; shorter
b. higher; longer
c. higher; longer AND lower; shorter
d. higher; shorter
15. For any given interest rate, the shorter the life of the mortgage, the ____ the monthly
payment and the ____ the total payments over the life of the mortgage.
a. lower; greater
b. lower; lower
c. greater; lower
d. greater; greater
16. The interest rate on a second mortgage is ____ the rate on a first mortgage created at
the same time, because the second mortgage is ____ the existing first mortgage in
priority claim against the property in the event of default.
a. equal to that; equal to
b. higher than; behind
c. higher than; ahead of
d. lower than; ahead of
17. A(n) _________ problem occurs when a person or institution does not have to bear the
full consequences of its behavior and therefore assumes more risk than it otherwise
would.
a. risk adjustment
b. moral hazard
c. asymmetric information
d. specific hazard
18. A financial institution has a higher degree of interest rate risk on a ____ than a ____.
a. 30-year variable-rate mortgage; 30-year fixed-rate mortgage
b. 15-year variable-rate mortgage; 15-year fixed-rate mortgage
c. 30-year fixed-rate mortgage; 15-year fixed-rate mortgage
d. 15-year fixed-rate mortgage; 30-year fixed-rate mortgage
19. ___ economic growth will probably ____ the risk premium on mortgages and cause the
price of mortgages in the secondary market to _____.
a. Weak; increase; decrease
b. Strong; increase; increase
c. Weak; increase; increase
d. Strong; increase; decrease
20. Financial institutions that hold fixed-rate mortgages in their asset portfolios are exposed
to ____ risk, because they commonly use funds obtained from short-term customer
 deposits to make long-term mortgage loans.
a. interest rate
b. exchange rate
c. Prepayment
d. reinvestment rate

STOCK RISK AND VALUATION

1. Regarding the implied standard deviation, by plugging in the actual option premium paid
by investors for a specific stock in the option pricing model, it is possible to derive the
anticipated volatility level. True
2. A relatively simple method of valuing a stock is to apply the mean price-earnings (PE)
ratio of all publicly traded competitors in the respective industry to the firm's expected
earnings for the year. True
3. A relatively simple method of valuing a stock is to apply the mean price-earnings (PE)
ratio of all publicly traded competitors in the respective industry to the firm's expected
earnings for the year. False
4. Stock price volatility increased during the credit crisis. True
5. When a firm’s announced earnings are lower than expected, investors will increase their
valuation of the firm’s future cash flows and its stock. False
6. A stock with a beta of 2.3 means that for every 1 percent change in the market overall,
the stock tends to change by 2.3 percent in the same direction. True
7. Beta serves as a measure of risk because it can be used to derive a probability
distribution of returns based on a set of market returns. True
8. The limitations of the dividend discount model are more pronounced when valuing
stocks
a. that have a long history of dividends.
b. that retain most of their earnings.
c. that have constant earnings growth
d. that pay most of their earnings as dividends.
9. If the returns of two stocks are perfectly correlated, then
a. their correlation coefficient should equal 1.0.
b. their betas should each equal 1.0.
c. their portfolio standard deviation should equal 1.0.
d. the sum of their betas should equal 1.0.
10. The demand by foreign investors for the stock of a U.S. firm sold on a U.S. exchange
may be higher when the dollar is expected to ____, other things being equal. (Assume
the firm's operations are unaffected by the value of the dollar.)
a. weaken and then stabilize
b. Weaken
c. Strengthen
d. stabilize
11. A stock's beta can be measured from the estimate of the ________ using regression
analysis.
 a. slope coefficient
b. intercept
c. market return
d. risk-free rate
12. The general mood of investors represents
a. unsystematic risk.
b. systematic risk.
c. Beta
d. investor sentiment.
13. Which of the following is NOT commonly used as an estimate of a stock's volatility?
a. the implied volatility derived from the stock option pricing model
b. a time-series trend of historical standard deviations of returns over recent periods
c. an estimate of its option premium derived from the stock option pricing
model
d. an estimate of its standard deviation of returns over a recent period
14. According to the capital asset pricing model, the required return by investors on a
security is
a. inversely related to the risk-free rate.
b. None of these are correct.
c. inversely related to the market return.
d. inversely related to the firm's beta.
15. Which of the following is NOT used to measure a stock's risk?
a. the stock's price volatility
b. the stock's return
c. the stock's beta
d. the value-at-risk method
16. When evaluating stock performance, ____ measures variability that is systematically
related to market returns; ____ measures total variability of a stock's returns.
a. standard deviation; beta
b. intercept; beta
c. beta; error term
d. beta; standard deviation
17. If security markets are semi strong-form efficient, investors cannot solely use ____ to
earn excess returns.
a. previous price movements AND publicly available information
b. previous price movements
c. publicly available information
d. insider information
18. The ____ is not a factor used in the capital asset pricing model (CAPM) to derive the
return of an asset.
a. dividend growth rate
b. covariance between the asset's return and the market return
c. market return
d. prevailing risk-free rate
19. Which of the following is NOT correct regarding the capital asset pricing model (CAPM)?
a. It is concerned with unsystematic risk.
b. All of these are correct.
c. It is based on the premise that the only important risk of a firm is systematic risk.
d. It is sometimes used to estimate the required rate of return for any firm with
publicly traded stock.
20. ____ are not a firm-specific factor that affects stock prices.
a. Exchange rates
b. Earnings surprises
c. Dividend policy changes
d. All of these are firm-specific factors that affect stock prices.
e. Acquisitions
21. The market risk premium is
a. the yield on newly issued Treasury bonds.
b. the return of the market in excess of the risk-free rate.
c. the covariance between the risk-free rate and the return of the market.
d. the return of the market in excess of expected cash flows.
22. LeBlanc Inc. currently has earnings of $10 per share, and investors expect that the
earnings per share will grow by 3 percent per year. Furthermore, the mean PE ratio of all
other firms in the same industry as LeBlanc Inc. is 15. LeBlanc is expected to pay a
dividend of $3 per share over the next four years, and an investor in LeBlanc requires a
return of 12 percent. What is the forecasted stock price of LeBlanc in four years, using
the adjusted dividend discount model?
a. $150.00
b. $45.00
c. $163.91
d. $168.83
23. Sorvino Company is expected to offer a dividend of $3.20 per share per year forever.
The required rate of return on Sorvino stock is 13 percent. Thus, the price of a share of
Sorvino stock, according to the dividend discount model, is $____.
a. 24.62
b. 4.16
c. 4.06
d. 40.63
24. Investors can avoid unsystematic risk by
a. using the free cash flow model.
b. investing in stocks with low PE ratios.
c. holding diversified portfolios.
d. using the capital asset pricing model.
25. The expected acquisition of a firm typically results in ____ in the target's stock price.
a. None of these are correct.
b. a decrease
c. an increase
d. no change
26. A beta of 1.1 means that for a given 1 percent change in the value of the market, the
_______ is expected to change by 1.1 percent in the same direction.
a. risk-free rate
b. correlation coefficient
c. stock's standard deviation
d. stock's value
27. Technical analysis relies on the use of ____ to make investment decisions.
a. interest rates
b. inflationary expectations
c. industry conditions
d. recent stock price trends
28. The beta of a stock portfolio is equal to a weighted average of the
a. standard deviations of stocks in the portfolio.
b. betas of stocks in the portfolio, plus their correlation coefficients.
c. correlation coefficients between stocks in the portfolio.
d. betas of stocks in the portfolio.
29. Value at risk estimates the ____ a particular investment for a specified confidence level.
a. risk-free rate of
b. largest expected loss to
c. beta of
d. standard deviation of
30. The capital asset pricing model (CAPM) suggests that the required rate of return on a
stock is directly influenced by the stock's
a. prevailing level of industry competition.
b. Beta.
c. size (market capitalization).
d. liquidity.