Chapters 11

Chapter 11
True/False Questions
1. The merger of banks with assets of $1 billion or more in total assets is called a megamerger.
Answer: True Page: 326 Level: Easy
2. The primary source of funds for a bank is equity capital.
Answer: False Page: 316 Level: Easy
3. Loans comprise the single largest asset category for a bank.
4. The major risk faced by commercial banks today is credit risk.
5. Banks are more highly leveraged than most non-financial firms.
6. Revenue economies of scale are cost reductions that occur as banks add related product lines.
Answer: False Page: 326 Level: Medium
7. Time deposits of more than $100,000 with a maturity of at least fourteen days are negotiable instruments
and may be sold before maturity.
114
Saunders, Financial Markets and Institutions, 2/e
8. Technology has had the greatest impact on wholesale banking in the area of cash management.
9. Since 1980 the number of banks in the U.S. has been increasing dramatically due to deregulation of the
industry.
Answer: False Page: 325-326 Level: Medium
10. If average costs to produce a given product are lower for larger firms, cost economies of scope exist.
11. The proportion of industry assets controlled by small banks has increased over the last 10 years.
12. Commercial letters of credit are off balance sheet items that are used to back issues of commercial paper
by corporate borrowers.
Answer: False Page: 322-324 Level: Difficult
13. All banks having total assets over $1 billion are considered money center banks.
Multiple Choice Questions
14. Major liabilities for banks include
A) Business loans
B) Interest expense paid on deposits
C) Deposits
D) Equity capital
E) Securities held for sale
Answer: C Page: 318 Level: Medium
115
15. A decline in the average cost of producing bank services as the size of the bank expands is called
A) Cost economies of scope
B) Revenue economies of scope
C) Cost economies of scale
D) Revenue economies of scale
E) X efficiencies
16. A decrease in unit costs after a merger due to joint use of inputs in producing multiple products is an
example of:
E) X efficiencies
Answer: A Page: 326-327 Level: Medium
17. Revenue or cost reduction resulting in gains from mergers that are not due to scale or scope economies
are called
E) X efficiencies
Answer: E Page: 326-327 Level: Medium
18. Banks with total assets under _____ are normally called community banks.
A) $50 million
B) $100 million
C) $500 million
D) $1 billion
Answer: D Page: 331 Level: Medium
116 Saunders, Financial Markets and Institutions, 2/e
19. A money center bank is a bank that is

A) Large
B) Operates in a major financial center
C) Rely on non-deposit sources of funds
D) A. and C. only
E) A. B. and C.
20. In comparison to small banks, larger banks typically have
A) More equity capital
B) More core deposits
C) More off balance sheet activities
D) Larger net interest margins
E) All of the above
21. In terms of profitability, a well run bank usually has an ROA of
A) 0.5-3%
B) 3-5%
C) 5-10%
D) 10-15%
E) 15-20%
Answer: A Page: 334 Level: Medium
22. A card that has a chip implanted in the card that allows the customer to store and spend money for
various transactions is called a
A) POS card
B) Smart card
C) Debit card
D) ATM card
E) Platinum credit card
Answer: B Page: 337 Level: Easy
117
23. As a percentage of the typical bank's balance sheet, over the last 50 years _________ have risen and
___________ have fallen.
A) Securities ; consumer loans
B) Business loans ; mortgages
C) Securities ; all loans
D) Mortgages ; securities
E) Consumer loans ; mortgages
24. Key federal regulators of the banking industry include:
A) Office of Comptroller of Currency
B) Federal Deposit Insurance Corporation
C) Federal Reserve System
D) State bank regulators
E) Office of Thrift Supervision
F) Only A, B, and C
Answer: F Page: 338 Level: Easy
25. Nationally chartered banks receive chartering and merger approval from the
A) Federal Deposit Insurance Corporation
B) Office of Comptroller of the Currency
C) Federal Reserve System
D) Office of Thrift Supervision
E) Any of the above may grant a charter and approve a merger
Answer: B Page: 338 Level: Medium
26. State chartered banks _____ be members of the Federal Reserve System and nationally chartered banks
_____ be members of the Federal Reserve System:
A) Must, may
B) Must, must
C) May, must
D) May, may
Answer: C Page: 339-340 Level: Easy
27. The largest single category of loans on the typical bank's balance sheet in 2002 was:
A) Real estate loans
B) U.S. government securities
C) Commercial and industrial loans
D) Consumer loans
E) Inter-bank loans
28. Deposit sources of funds at commercial banks in 2001 comprised almost _____ of liabilities and equity:
A) 50%
B) 60%
C) 70%
D) 80%
E) 90%
29. From 1951 to the present the fastest growing asset on the balance sheet for U.S. commercial banks has
been:
A) Consumer loans
B) Mortgages
C) Business loans
D) Securities
E) Equities
30. The provision of banking services to other banks, such as check clearing, foreign exchange trading, etc.
are examples of
A) Correspondent banking
B) Trust services
C) Off balance sheet assets
D) Economies of scope
E) Credit derivatives
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31. Economies of scale imply that the average cost curve is _____ with respect to bank size.
A) Downward sloping
B) Upward sloping
C) Flat
D) Vertical
Answer: A Page: 327 Level: Difficult
32. A bank had average revenues of $130 million and average costs of $100 million. An insurer had average
revenues of $75 million and average costs of $60 million. After a merger between the two, the new
institution had average revenues of $220 million and average costs of $160 million. This is an example
of
A) Cost economies of scale
B) Cost economies of scope
C) Revenue economies of scale
D) Revenue economies of scope
E) X efficiencies
Answer: D Page: 329-330 Level: Difficult
33. Recently, the largest off balance sheet activity by banks has been in
A) Swap agreements
B) Standby letters of credit and commercial letters of credit
C) Futures and forward contracts
D) Loan commitments
E) Commitments to buy/sell foreign exchange
Answer: A Page: 320-323 Level: Medium
34. A contingent item that may eventually be placed on the right hand side of the balance sheet or expensed
on the income statement is a/an
A) Loan commitment
B) Off balance sheet liability
C) Off balance sheet asset
D) Net charge off
E) Loan sold without recourse
Chapter 12
1. Thrifts are comprised of three types of depository institutions: savings banks, credit unions, and finance
companies.
2. Federally chartered savings banks first appeared in the U.S. in the 1980s
3. There are more savings associations than banks, but banks are usually quite a bit larger.
4. To help overcome the adverse effects of rising rates and disintermediation, Congress passed the
DIDMCA in 1980 and the Garn St - German Act in 1982.
5. Interest income minus interest expense divided by earning assets is called the net interest margin.
6. The FIRREA of 1989 abolished the FSLIC and created the FDIC in its place.
7. The FDICIA of 1991 introduced risk based deposit insurance premiums and a prompt corrective action
policy to force regulators to more quickly close insolvent banks and thrifts.
Answer: True Page: 349 Level: Medium
121
8. After deposits, the second largest source of funds at savings associations is FHLB loans.
9. Savings associations must have at least 65% of their assets in mortgage related areas in order to maintain
their favorable tax status and obtain FHLB loans.
10. In a mutual organization the depositors and common stockholders are co-owners of the institution.
11. In recent years larger savings institutions have had better profit margins than smaller institutions.
12. Most mutual savings banks were traditionally found in the northeast United States.
13. A steepening yield curve is likely to improve profitability of a savings association.
14. The FDIC operates the bank insurance fund but has nothing to do with insuring thrifts.
15. Anyone can choose to become a member of a credit union, but no one can be a member of two or more
credit unions.
16. Credit unions are not taxed, as a result well run credit unions are able to charge lower loan rates and pay
slightly higher deposit rates than banks.
Answer: True Page: 356-357 Level: Medium
17. The National Credit Union Administration is the primary regulator of federally chartered credit unions.
Answer: True Page: 362-363 Level: Easy
18. Credit union equity is composed of common stock sold, paid in capital and retained earnings.
19. Credit unions currently have about 80 million members.
20. There are more credit unions than other types of thrifts, but credit unions are generally quite small.
21. The largest U.S. banks are larger than the entire credit union industry.
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22. There has never been a savings association crisis in any other country of the world other than the U.S.
This is probably true because:
A) Only in the U.S. have most savings association managers been crooks.
B) Only in the U.S. have we had a Congress that have mostly been crooks.
C) The rest of the world has had a more stable economy than the U.S.
D) We have less regulatory overlap of financial services than most of the world.
E) Only in the U.S. have the savings associations been insulated from competition, then deregulated
and allowed to operate without adequate supervision.
Answer: E Page: None Level: Difficult
23. Which type of thrift has the greatest percentage of commercial loans on their balance sheet?
A) Mutual savings associations
B) Stock savings associations
C) Federal Credit unions
D) Savings Banks
E) State Credit unions
24. 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% of the value of a home to a borrower to ensure mortgage safety
D) Keep 35% of their assets in safe liquid investments to ensure adequate deposit liquidity
E) Invest at least 65% of their assets in mortgages or mortgage related assets
25. Which one of the following has the highest concentration of mortgage related assets on the balance
sheet?
A) Savings institutions
B) Commercial banks
C) Credit unions
D) Finance companies
E) Pension funds
Answer: A Page: 350-351 Level: Easy
26. After 1989 savings institutions have primarily been regulated by:
A) Federal Home Loan Bank Board
B) Federal Deposit Insurance Corporation
C) Office of Thrift Supervision
D) National Credit Union Administration
Answer: C Page: 349 Level: Easy
27. Disintermediation refers to
A) Taking money out of depository institutions
B) Putting money in depository institutions
C) A negative net interest margin
D) Making disparaging remarks about banks and thrifts
Answer: A Page: 347 Level: Easy
28. Regulatory forbearance refers to
A) The creation of the Resolution Trust Corporation
B) Not enforcing existing regulations
C) Regulation Q ceilings on deposit rates
D) The creation of the Office of Thrift Supervision
29. The majority of assets of savings associations are
A) Mortgage related
B) Commercial loans
C) Consumer loans
D) Consumer checking accounts
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30. The predominant liabilities for savings associations are

A) Commercial deposits and FHLB borrowings
B) Wholesale money market notes and reserves at the Fed
C) Small time and savings deposits and FHLB borrowings
D) Checking accounts and money market mutual funds
31. Historically, most savings associations and savings banks were established as
A) Mutual organizations
B) Stockholder organizations
C) Partnerships
D) Charitable organizations
32. Deposits at savings banks are insured under the _____ and deposits at savings associations are insured
under the _____.
A) BIF, BIF
B) BIF, SAIF
C) SAIF, BIF
D) SAIF, SAIF
E) SAIF, NCVSIF
33. _________ are the most numerous of depository institutions and ___________ are on average the
smallest depository institutions.
A) Banks ; savings institutions
B) Credit unions ; banks
C) Credit unions ; credit unions
D) Banks ; credit unions
E) Savings institutions ; banks
Answer: C Page: 357,360 Level: Medium
34. Throughout the 1990s to the present, assets of credit unions have _________ and the number of credit
unions has __________.
A) increased ; increased
B) decreased ; decreased
C) increased ; decreased
D) decreased ; increased
E) increased ; stayed the same
35. Credit unions are
I. Mutual associations
II. Not open to the general public
III. For profit institutions
A) I only
B) II only
C) I and II only
D) I, II and III
E) II and III only
36. The U.S. central credit union and the corporate credit union
A) Are the primary regulators of the credit union industry
B) Pool funds and provide investment services to local credit unions
C) Serve as the trade organization for the industry
D) Charter credit unions
E) Provide deposit insurance for credit unions
37. Credit unions have several advantages over banks. These include:
I. Credit unions are not taxed
II. Credit unions can collectively pool funds
III. Credit unions are better diversified than banks
A) I only
B) II only
C) III only
D) I and III only
E) I and II only
Answer: E Page: 359-360 Level: Difficult
127
38. As a percentage of total assets, credit unions invest _______ in securities than banks and ______ in
consumer loans than banks.
A) More ; more
B) Less ; less
C) More ; less
D) Less ; more
E) Less ; about the same
39. About what percentage of credit union funds come from member deposits?
A) 50%
B) 60%
C) 70%
D) 80%
E) 90%
Answer: E Page: 361 Level: Easy
40. The American Banker's Association claims that the tax advantage of credit unions is worth about how
much money per year?
A) $100 million
B) $500 million
C) $1 billion
D) $50 billion
E) None of the above
41. Throughout the 1990s the number of credit unions has steadily _____ while the assets and the number of
members of credit unions has steadily _____.
A) Fallen, fallen
B) Fallen, risen
C) Risen, fallen
D) Risen, risen
Chapter 13
1. The report of condition presents the bank's major categories of revenues and expenses over a period of
time.

2. Foreign deposits at commercial banks are explicitly insured by the FDIC.
3. Banks have higher leverage than most manufacturing firms.
4. Vault cash is used primarily to meet reserve requirements and check clearing.
5. Deferred availability credit items are checks that the bank owes to other banks but has not yet paid.
6. C&I loans are loans to businesses used to finance capital needs, equipment purchases and plant
expansions.
7. For the typical commercial bank, commercial real estate is the largest type of real estate loan on the
balance sheet today.
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8. The allowance for loan and lease losses is bank management's estimate of the amount of gross loans and
leases that will not be repaid to the bank.
9. Investment securities plus net loans and leases is equal to a bank's earning assets.
10. In ratio analysis, the profit margin times the asset utilization ratio equals return on equity.
11. Loans are the major item on a bank's balance sheet, and they generate the largest amount of revenue.
12. Net loans and leases plus unearned income plus the allowance for loan and lease losses equals gross
loans and leases.
13. Unearned income on a loan is the amount of income that the bank has received on a loan from a
customer but has not yet recorded on the income statement.
14. Banks generally pay higher interest rates on NOW accounts than on MMDAs.
15. Wholesale CDs obtained from an investment house rather than directly from a customer are referred to
as brokered deposits.
16. The largest market available for purchased funds is the Fed funds market.
17. A loan commitment is a contra asset account.
18. A commercial letter of credit is often issued by a bank to guarantee that an exporter of goods will
receive payment even if the importer of goods defaults.
19. Financial standby letters of credit are an alternative to loan commitments.
20. Loans sold with recourse may be returned to the selling bank in the event of borrower default.

21. 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
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22. The following definition refers to which CAMELS composite rating? Institutions in this group have an
immoderate volume of serious financial weaknesses or a combination of other conditions that are
unsatisfactory.
A) Composite 1
B) Composite 2
C) Composite 3
D) Composite 4
E) Composite 5
Answer: D Page: 366-367 Level: Medium
23. In the acronym CAMELS the S stands for what?
A) Satisfactory level of capital
B) Sensitivity to market risk
C) Sufficient accounting controls
D) Satisfactory level of reserves at the Fed
E) Sufficient level of provision for loan losses
24. Uniform principles, standards and report forms for depository institutions are prescribed by the
A) FDIC
B) Federal Reserve
C) Federal Financial Institutions Examination Council
D) Office of Comptroller of Currency
25. The bank's top earning asset category is
A) Cash and balances due from other depository institutions
B) Investment securities
C) Loans
D) Physical plant and equipment
26. Deposits at the Federal Reserve are used for all of the following except
A) To meet legal reserve requirements
B) To assist in check clearing
C) To purchase Treasury securities
D) To earn interest
E) To facilitate wire transfers
27. Cash in the process of collection is
A) A deposit at another financial institution
B) A Fed funds transaction
C) Checks the bank owes other institutions that have not yet been paid
D) Checks that the bank is owed but has not yet collected
E) Equity capital
28. More than _____ percent of Fed funds transaction have a maturity of one day
A) 50
B) 60
C) 70
D) 80
E) 90
Answer: E Page: 371 Level: Medium
29. Interest bearing retail accounts with limited checking features designed to compete with money market
mutual fund investments are called ________________.
A) NOWs
B) Retail CDs
C) MMDAs
D) Special savings deposits
E) Negotiable CDs
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30. Long maturity investments for a bank typically include all but which one of the following?
A) U.S. Treasury bonds
B) U.S. agency securities
C) Mortgage backed securities
D) Common stocks
E) Municipal bonds
Answer: D Page: 371 Level: Easy
31. Purchased funds include all but which one of the following?
A) Brokered deposits
B) Wholesale CDs
C) Fed funds purchased
D) Repurchase agreements
E) Demand deposits
32. Core deposits include all except which one of the following?
A) Demand deposits
B) NOW accounts
C) MMDAs
D) Eurodollar deposits
E) Passbook savings accounts
33. A corporate customer gets a one year $5 million loan commitment from a bank. The commitment
requires a facility fee of 1/2 of 1% of the commitment and a back end fee of 1/4 of 1%. The bank
charges a 9% interest rate on the amount borrowed. If the firm borrows $3 million for one year, what is
the total amount of both fees and interest paid to the bank over the year?
A) $480,000
B) $300,000
C) $270,000
D) $295,000
E) $292,500
Answer: B Page: 386 Level: Difficult
34. A person who enters a forward contract to sell British pounds in six months would worry about the
counterparty defaulting on the contract if over the next six months:
A) The dollar depreciated
B) The pound appreciated
C) The exchange rate remained unchanged
D) The NYSE went out of business
E) The dollar appreciated
Answer: E Page: 380-381 Level: Easy
35. A person who purchased a futures contract on British pounds on an exchange would worry about
counterparty default only if:
A) The counterparty declared bankruptcy
B) The pound appreciated
C) The exchange rate remained unchanged
D) The exchange went bankrupt
E) The dollar appreciated
36. The largest source of income at a typical bank is
A) Interest income on securities held for sale
B) Interest income on securities held for investment
C) Interest income on loans and leases
D) Non-interest income
E) Dividends or stock
37. A municipal bond is paying a 6% annual coupon. An equivalent risk corporate bond is paying 7%.
Investors in a tax bracket of _____ or higher would prefer the municipal bond.
A) 85.7%
B) 14.28%
C) 19.25%
D) 80.75%
E) 25.75%
135
38. A bank raises the rate from 3% to 4% on $100,000 of its 6 month CD liabilities that are currently
maturing. Assuming no change in volume of deposits, pre-tax net income would
A) Rise by $1000
B) Fall by $1000
C) Be unchanged
D) Rise or fall but can't tell by how much
Use the following to answer questions 39-43:
B ank A
A s s e ts
L ia b ility a n d E q u ity
C ash
$ 3 D e p o s its
S e c u ritie s
1 8 O th e r B o rro w in g
L oans
6 2 E q u ity
O th e r
1 7 T o ta l
T o ta l
$100
In c o m e S ta te m e n t
In te re s t In c o m e o n L o a n s
$7
In te re s t In c o m e o n S e c u ritie s
4
In te re s t E x p e n s e
3
N o n -in te re s t In c o m e
2
N o n -in te re s t E x p e n s e
4
P ro v is io n fo r L o a n L o s s
1
T a x e s (4 0 % )
2
N I
$3
39. The bank's ROA is

A) 33.0%
B) 3.0%
C) 3.75%
D) 2.21%
$ 65
26
9
$100
40. The bank's ROE is approximately

A) 33.33%
B) 3.00%
C) 22.22%
D) 11.66%
41. The profit margin and the asset utilization ratios are
A) 60.00%; 5.00%
B) 27.27%; 11.00%
C) 23.08%; 13.00%
D) 19.43%; 14.25%
42. If the average net interest margin for this type of bank is 5%, then, ceteris paribus, this particular bank is
performing
A) The same as average because this bank has a NIM of 5%
B) Better than average because this bank has a NIM of 10%
C) Better than average because this bank has a NIM of 7%
D) Poorer than average because this bank has a NIM of 3%
E) One can't determine with the information given
Answer: B Page: 393-394 Level: Medium
43. If the typical bank of this type has an overhead efficiency ratio of 0.90, then this particular bank is,
ceteris paribus, ___________________ than the typical bank.
A) Doing a better job generating profitable off-balance sheet activities
B) Having a more difficult time managing non-interest income and expenses
C) Is paying higher taxes
D) Has fewer loan losses
137
44. If a bank has more purchased funds than the average bank, you would not be surprised to see a higher
than average _____ ratio
A) Provision for loan loss
B) Tax ratio
C) Non-interest expense ratio
D) Interest expense ratio
45. The AU ratio measures the bank's ability to _____ and the PM ratio measures the bank's ability to
_____.
A) Control expenses; generate income from assets
B) Generate income from assets; control expenses
C) Maximize interest revenue; minimize interest expense
D) Control leverage; minimize physical plant
Answer: B Page: 391-393 Level: Medium
Chapter 14
1. Banks are prohibited from making loans exceeding more than 10 percent of their own equity capital to
any one company or borrower.
2. Regulators impose minimum capital requirements on all depository institutions.
3. The part of the money supply produced by the private banking system is called inside money.
4. The higher the net regulatory burden on DIs the more efficiently the DIs produce financial services.
Answer: False Page: 401-402 Level: Easy
5. The quantity of notes and coin in the economy is called inside money but the bulk of the money supply
is outside money.

6. The Federal Deposit Insurance Corporation Improvement Act introduced the prompt corrective action
policy that requires the FDIC to intervene when a bank's capital falls below certain minimums.
7. The reserve requirement in the U.S. is essentially costless to banks.
139
8. A financial intermediary that can engage in a broad range of financial service activities is termed a
universal FI.
9. During the Great Depression over 10,000 banks failed.
10. The Community Reinvestment Act and the Home Mortgage Disclosure Act are designed to ensure banks
do not discriminate against potential borrowers and participate in lending in their local community.
11. Restricting the number of institutions that can enter an industry increases profitability of firms already in
the industry.
12. A bank that offers demand deposits or makes commercial loans, but does not do both is called a nonbank
bank.
13. The QTL test is an example of a credit allocation regulation.
14. States that only allow unit banking often still allow existing banks to create new de novo branches.
15. The Glass-Steagall Act came about due to concerns about excessive risk taking at banks and conflicts of
interest between commercial and investment banking activities.
16. Beginning in 1987 a bank could establish a Section 20 affiliate to underwrite all types of insurance.
17. There were a greater number of bank failures from 1980 to 1990 inclusive than from 1933 to 1979.
18. Insurance companies are regulated solely at the state level.
19. The FDIC is required to collect additional insurance premiums from insured institutions if the BIF
reserves fall below 1.5% of insured deposits.
Response: 1.25% is correct
20. The Financial Services Modernization Act of 1999 allows the establishment of full service financial
institutions in the U.S.

21. A bank that has an equity to asset ratio equal to 15% can normally lend no more than _____ of its assets
to any one borrower.
A) 0.95%
B) 1.05%
C) 15.00%
D) 1.50%
E) 2.25%
141
22. The FDIC manages the

A) Bank insurance fund
B) Savings association insurance fund
C) National credit union share insurance fund
D) All of the above
E) A and B only
23. The reduction in deposit funds cost brought about by government insurance is an example of the
A) Social benefit of regulation
B) Private cost of regulation to DIs
C) Private benefits of regulation to DIs
D) Net regulatory burden
Answer: C Page: 401-402 Level: Medium
24. U.S. depository institutions may be subject to as many as ____ separate regulators.
A) 4
B) 5
C) 6
D) 7
E) 8
25. The act that first established the Federal Deposit Insurance Corporation was the
A) Glass-Steagall Act
B) McCarran-Ferguson Act
C) National Bank Act 1863
D) Federal Reserve Act
E) McFadden Act
26. The Glass-Steagall Act prohibited affiliations between commercial and investment banking activities
with three major securities underwriting exemptions. Which one of the following underwriting activities
was not exempted
A) Issues of treasury bills, notes, and bonds
B) Issues of municipal general obligation bonds
C) Private placements of all types
D) Issues of municipal revenue bonds
E) All of the above were exempted
Answer: D Page: 406 Level: Difficult
27. Major provisions of the Financial Services Modernization Act of 1999 include all of the following
except:
A) Allowing bank holding companies to open insurance underwriting affiliates and vice versa
B) Allowing bank holding companies to open or merge with investment banks
C) Created one regulator to oversee all activities of financial service firms
D) All of the above are included
28. Commercial banks belonging to a financial service holding company can have a controlling interest in a
nonfinancial enterprise only if:
I. The investment in the nonfinancial is only for a limited time period
II. The investment arises as a result of a foreclosure on a loan
III. The bank does not engage in management of the nonfinancial enterprise
A) I only
B) II only
C) III only
D) II and III only
E) I and III only
143
29. Under the Financial Services Modernization Act of 1999 a financial services holding company is defined
as a holding company that has at least ____ percent of its total assets in the form of financial assets.
A) 70
B) 75
C) 80
D) 85
E) 90
30. Which act has led to interstate banking in the U.S.?
B) DIDMCA
C) McFadden Act
D) Riegle-Neal Act
E) Financial Services Modernization Act
31. The _____________ created the Savings Association Insurance Fund.
A) FDIC Improvement Act
B) Financial Institutions Reform, Recovery and Enforcement Act
C) Financial Services Modernization Act
D) Riegle-Neal Act
E) Competitive Equality in Banking Act
32. Moral hazard
A) Is reduced by providing deposit insurance.
B) Causes bankers to overstate the provision for loan loss account.
C) Requires the FDIC to charge all banks a constant deposit insurance premium.
D) Refers to the increased risk of lending to sovereign states.
E) Arises when the insured takes on more risk because he or she is insured.
33. Deposit insurance

A) Reduces bank runs
B) Helped cause the insolvency of the FSLIC
C) Induced moral hazard at DIs
D) All of the above
Answer: D Page: 414-416 Level: Easy
34. All banks located in the European Union offer deposits that are insured for __________ Euros, although
depositors are subject to a _________________ in the event of loss.
A) 100,000; 2.5% insurance premium
B) 50,000; 95% recovery rate
C) 20,000; 10% deductible
D) 45,000; 5% fine
E) 75,000; 90% recovery rate
35. To be classified as an adequately capitalized bank, the bank must have a leverage ratio of at least _____
%, Tier I capital to risk adjusted asset ratio of at least _____ % and a total risk based capital ratio of at
least _____ % and does not meet the definition of a well capitalized bank.
A) 4; 4; 8
B) 5; 6; 10
C) 3; 3; 8
D) 4; 8; 4
E) 4; 6; 10
Answer: A Page: 420-422 Level: Difficult
Response: See Table14-5
36. To be well capitalized a bank must have a leverage ratio of at least _____%, Tier I capital to risk
adjusted asset ratio of at least _____ % and a total risk based capital ratio of at least _____ %.
A) 4; 4; 8
B) 5; 6; 10
C) 3; 3; 8
D) 4; 8; 4
E) 4; 6; 10
Answer: B Page: 420-422 Level: Difficult
Response: See Table14-5
145
37. The FDIC may require an undercapitalized bank to

I. Provide the FDIC with a capital restoration plan
II. Cease acquiring brokered deposits
III. Obtain FDIC approval for all acquisitions
IV. Suspend dividends and management fees
V. Suspend payments on subordinated debt
A) I and II only
B) III only
C) I, II, III and IV only
D) I, II, III, IV and V
E) I, II, III and V only
Answer: C Page: 423 Level: Difficult
38. Basel II consists of three overlapping areas that are designed to bolster the safety and soundness of the
financial system. The three areas are
I. Regulatory capital requirements for credit, market and operational risk.
II. Eliminating complex risk based capital requirements for on and off balance sheet accounts.
III. Ensuring that banks have sound internal control procedures in place to measure and limit risk.
IV. Requirements to disclose to market participants the institution's capital structure, risk exposure and
capital adequacy.
V. Increasing deposit insurance premiums on all accounts.
A) I, II and III
B) I, III and IV
C) II, III and V
D) I, IV and V
E) II, III and IV
39. Recent regulation such as the Reigle-Neal Act of 1994 has removed some of the federal banking laws
that formerly constrained profitable opportunities for commercial banks. The Reigle-Neal Act removes
the major restrictions on banks' ability to _____.
A) Diversify geographically
B) Diversify their product line
C) Engage in securities underwriting
D) Engage in insurance underwriting
E) Engage in loan brokerage
40. Tier I (core) capital includes all but which one of the following?
A) Common stockholders' equity
B) Qualifying cumulative and noncumulative perpetual preferred stock
C) Minority interest in equity accounts of consolidated subsidiaries
D) Allowance for loan and lease losses
E) All of the above may be counted as Tier I capital.

Response: See Table 14-6
41. Mandatory provisions for undercapitalized banks under the FDIC Improvement Act include which of the
following?
A) Suspend payment of dividends and management fees
B) Require the bank to file a capital restoration plan
C) Restrict the bank's ability to increase assets
D) Require FDIC approval before the bank may acquire another institution
E) All of the above are mandatory provisions
Response: See Table 14-7
42. Requiring foreign banks to operate under the same rules as domestic banks is termed
A) Favored status
B) IBA clause
C) National treatment
D) NAFTA
E) Post-patriotism requirement
43. When banks play the "weekend game" they are
A) Minimizing deposits on Friday to help reduce required reserves
B) Maximizing deposits on Friday to help make the most of required reserves
C) Minimizing their tax liability by recognizing profits before the weekend
D) Maximizing the reserve maintenance period with Fed funds loans
E) Doing A, C and D
Answer: A Page: Appendix C Level: Medium
147
44. In the U.S. regulators currently use a _____ to calculate required reserve balances
A) Lagged reserve accounting system
B) Contemporaneous reserve system
C) Homoscedastic reserve system
D) Two day computation period
E) Accrual accounting period
Answer: A Page: Appendix C Level: Medium
45. The potential exposure of an off balance sheet currency forward measures the
A) Likely loss to the bank if the counter-party defaults in the future
B) Replacement cost of the contract today
C) Current net present value of the contract
D) The maximum of B. or C.
Answer: A Page: Appendix D Level: Difficult
46. Among other things, the _____________ prohibits U.S. banks from providing banking services to
foreign shell banks.
A) International Banking Act
B) Financial Services Modernization Act
C) USA Patriot Act
D) Foreign Bank Supervision Enhancement Act
E) Foreign Banking Activity Powers Enforcement Act
Chapter 15
1. The primary function of insurance companies is to compensate policy holders or their beneficiaries if
some specific adverse event occurs.
2. Most insurance companies fund their activities by accepting insured deposits.
3. In the U.S., group life policies are the most dominant form of life insurance, followed by ordinary life.
4. Two of the newer life insurance policy types first developed in the 1970s and 1980s are variable life and
endowment life.
5. A 65 year old person has saved $450,000 and wishes to receive 15 annual annuity payments, beginning
in one year. If the annuity rate is 8%, he can expect to receive $56,750 per year.
6. On a term life policy, if the policyholder continues to make payments, the insurance company is
guaranteed to have to make a payout.
7. Policy reserves are the primary asset of the typical life insurer.
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8. Health insurance protects against morbidity risk.

9. Over 70 percent of life insurance assets are invested in long term securities.
10. The cash surrender value of a life insurance policy is the present value of expected future payouts on the
policy.
11. The McFadden Act allows states the primary right to regulate insurance companies.
12. The National Association of Insurance Commissions (NAIC) examines and regulates insurance
companies.
13. Most states maintain a permanent reserve fund to resolve insurance companies failures.
14. The top ten property and casualty firms underwrite over 70% of all the P&C premiums written.
15. There are more life insurers than there are property and casualty insurers in the U.S.
16. As of 2000, life insurers held a greater percentage of assets in common stocks than property and casualty
insurers.
17. Property loss risk is generally easier to estimate than liability loss risk.
18. In property and casualty insurance the combined ratio is equal to the sum of the loss ratio plus loss
adjustment expenses all divided by total premiums written.
Answer: False Page: 445-446 Level: Difficult
19. Liability lawsuits related to breast implants are an example of long tail losses.
20. Liability losses are more subject to social inflation than property losses.

21. Policy reserves are a/an
A) Balance sheet liability
B) Balance sheet asset
C) Separate account item
D) Insurance guarantee fund payment
E) Income statement revenue item
151
22. The following type(s) of life insurance policies do not have a savings feature
A) Term life
B) Whole life
C) Variable life
D) Universal life
E) Both C and D do not
23. The four basic classes of life insurance are
I. Ordinary
II. Group
III. Annuities
IV. Industrial
V. Credit
A) I, II, III and IV
B) I, III, IV and V
C) I, II, IV and V
D) II, III, IV and V
24. The three forms of traditional ordinary life are
A) Term life, whole life and credit life
B) Variable life, whole and term life
C) Universal life, variable life and variable/universal life
D) Term life, whole life and endowment life
E) Whole life, credit life and industrial life
25. The term "variable" in a variable life policy refers to the
A) Policyholder's ability to vary the premiums
B) Insurer's ability to vary the rate of return on the policy
C) Variable growth rate of the cash value of the policy
D) Insurer's ability to vary the premiums
E) The policy holder's ability to cancel the plan
26. The primary regulator of insurance firms is the

A) NAIC
B) McCarran-Ferguson Commission
C) FDIC
D) State insurance regulator
E) SEC
27. Which one of the following statements concerning annuities offered by insurers is not true?
A) Interest on annuities is not taxed until the investor receives the payments.
B) Annuity payments may be fixed or variable.
C) Annuity contributions are not capped by the IRS.
D) Annuities can be deferred or immediate.
E) Annuity payments must cease upon the policyholder's death.
28. An investor has $30,000 which he can invest today. In addition to this amount, he can also invest
$9,000 per year for twenty years (beginning one year from now) at which time he will retire. He plans
on living for twenty-five years after he retires. If interest rates are 8%, what size annual annuity
payment can he obtain for his retirement years? (All annuity payments are at year end)
A) $551,686
B) $51,681
C) $56,190
D) $47,248
E) $44,674
Response: [($30,000*1.0820) + ($9,000*FVIFA(8%,20 yrs)] / PVIFA(8%, 25 yrs)
153
29. A policy holder wishes to annuitize the cash value of her insurance policy at retirement. She desires an
annual payment of $65,000 per year and the cash value is expected to be $750,000 at retirement. How
many payments can she expect to receive if the annuity interest rates are 6%?
A) 12
B) 11
C) 16
D) 9
E) 8
Response: $750,000 / $65,000 = PVIFA(6%, N yrs)
30. 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
31. The most important legislation affecting regulation of life insurance companies prior to 1999 was the
A) McCarran-Ferguson Act
B) McFadden Act
C) Investment Company Act
D) SEC Act
E) Insurance Freedom Act
32. Insurance companies, commercial banks and investment banks may now affiliate with each other and
engage in similar lines of business. These powers were granted by the
B) Depository Deregulation Act
C) Garn-St Germain Act
D) Riegle-Neal Act
E) Financial Services Modernization Act
33. In 2000, the singly largest category of assets on the typical property-casualty insurer's balance sheet was
A) Common stock
B) Mortgage loans
C) Preferred stock
D) Bonds
E) Policy reserves

34. In 2000, the average loss to premium ratio was about_____.
A) 109%
B) 89%
C) 71%
D) 65%
E) 53%
35. Flood insurance is an examples of a ____________________ for which it is difficult to predict loss
interest.
A) Low severity, low frequency event
B) High severity, high frequency event
C) Low severity, high frequency event
D) High severity, low frequency event
36. Property and casualty insurers hold _____ short term assets than life insurers because property and
casualty loss rates are _____ predictable than life insurance loss rates.
A) More, more
B) More, less
C) Less, less
D) Less, more
Answer: B Page: 439,442 Level: Medium
155
37. The operating ratio is calculated as

A) The combined ratio minus the investment yield
B) The loss ratio plus the loss adjustment expense ratio plus the commission to premium ratio
C) The combined ratio minus the loss ratio
D) The loss ratio minus the underwriting cycle lag
38. An insurance line has a loss ratio of 82%, an expense ratio of 25%, and the firm pays 2% of premiums to
policyholders as dividends. What level of investment yield is needed to make the P&C firm breakeven?
A) 5%
B) 7%
C) 9%
D) 11%
E) 13%
39. The two major components of expense risk for P&C insurers are
A) The combined ratio and the premium ratio
B) Loss adjustment expenses and variations in commission and other expenses
C) Investment yield and premiums earned
D) Dividend ratio and investment yield
40. At P&C insurers, if the combined ratio is less than 100%, the premiums charged were sufficient to cover
A) Losses only
B) Expenses only
C) Both losses and expenses
D) Losses, expenses and investment returns on premiums
41. For P&C insurers if the combined ratio is more than 100%, that firm
A) Could not have been profitable.
B) Must have been profitable.
C) May have been profitable if investment returns were high enough.
D) Was profitable if the LAE was low enough.
42. Estimates of the cost of the September 11, 2001 terrorist attacks on the World Trade Center indicate that
the cost to insurance companies may be as high as
A) $20 billion
B) $30 billion
C) $40 billion
D) $50 billion
E) $60 billion
157

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Chapter 11

Saunders, Financial Markets and Institutions, 2/e

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19. A money center bank is a bank that is

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Multiple Choice Questions

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30. The predominant liabilities for savings associations are

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Answer: False Page: 367 Level: Easy

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39. The bank's ROA is

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40. The bank's ROE is approximately

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Answer: False Page: 402 Level: Medium

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Multiple Choice Questions

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22. The FDIC manages the

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33. Deposit insurance

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37. The FDIC may require an undercapitalized bank to

Answer: D Page: 421 Level: Medium

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8. Health insurance protects against morbidity risk.

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Multiple Choice Questions

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26. The primary regulator of insurance firms is the

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Answer: D Page: 442 Level: Medium

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37. The operating ratio is calculated as

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