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Chapter : Summary
Final Self-Exam

Book Title: Financial Markets and Institutions

Printed By: Christine Joy Arancon (17101496@usc.edu.ph)

© 2021 Cengage Learning, Cengage Learning

Final Self-Exam

1. Flagstaff Bank currently has assets that are heavily concentrated in secured
loans and Treasury securities, whereas Mesa Bank has assets that are
concentrated in consumer loans and credit card loans. The managerial
capabilities of the two banks are similar. Mesa Bank’s performance was much
better than that of Flagstaff Bank last year, but Flagstaff Bank’s performance
is much better than that of Mesa Bank this year. Explain why the relative
performance of the two banks is likely to change over time.

2. The Sarbanes-Oxley Act of 2002 requires publicly traded firms to be more

transparent in their reporting. This may reduce the asymmetric information
problem between firms (including banks) and their investors. Do you think the
Sarbanes-Oxley Act will eliminate the need for CAMELS ratings?

3. Kentucky Bank has a new board of directors who believe that the bank has
opportunities for major growth and want to ensure that the CEO makes good
investment decisions to expand the bank’s business. To give the CEO a
strong incentive to perform well, the board set the CEO’s quarterly
compensation in line with the return on equity. The CEO immediately decided
to repurchase as many shares as possible while barely meeting the bank’s
capital requirements. Why would the CEO take this action? Will the
compensation structure used by the bank remove agency problems?

4. Last year, Alabama Bank had a net interest margin of percent, noninterest
income was percent of assets, noninterest expenses were percent of
assets, and loan loss reserves were percent of assets. Alabama Bank
wants to employ a strategy of using more of its resources to offer financial
services. It expects that it can increase its noninterest income by percent
as a percentage of assets. What other components (or ratios) of the income
statement may be affected by this strategy?

5. Maryland Savings Institution maintains most of its assets in fixed-rate

mortgages with maturities of between and years. Most of its deposits
have maturities of less than one year. Assume that the Fed implements a
restrictive monetary policy.

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a. Explain how that monetary policy will affect interest rates.

b. Assuming that interest rates change as expected, how will that affect the
spread between interest revenue and interest expenses?

c. Should Maryland hedge its asset portfolio based on its expectations? If

so, how should it hedge? If it should hedge, explain any limitations of
the hedge.

6. How do financial institutions vary in terms of their main uses of funds?

7. Explain the role that insurance companies and pension funds play in financial
markets.

8. Explain why a stock market benefits more when financial institutions are
investors than when individual investors invest all their money directly into the
stock market themselves.

9. Discuss the following argument. Money market funds attract money from
investors who do not know what else to do with their money. Thus, money
market funds are merely a last resort when there are no better alternatives for
investment. Since they invest only in short-term securities, they do not play a
role in financing economic growth.

10. Closed-end funds tend to hold stocks that are less liquid than stocks held by
open-end funds.

a. Do you think this characteristic is an advantage for closed-end funds

that want to achieve high returns?

b. Why is it easier for closed-end funds to manage a portfolio of less liquid

stocks than it would be for open-end funds?

11. Discuss the strategy of investing all of an investor’s money in four mutual
funds that focus on growth companies. The belief is that the investor is fully
insulated from market conditions because each fund contains different
stocks.

12. For a given type of mutual fund classification, what is a key characteristic that
causes some mutual funds to outperform others?

13. When a securities firm serves as an underwriter for an initial public offering
(IPO), is the firm working for the issuer or the institutional investors that may
purchase shares? Explain the dilemma.

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14. Do stock analysts reduce market inefficiencies?

15. Why might the value of an insurance company be affected by interest rate
movements?

16. Should financial institutions be regulated to reduce their risk? Offer at least
one argument for regulation and one argument against regulation.

17. Consider the typical sources and uses of funds at commercial banks, savings
institutions, and securities firms. Explain the risk of each type of institution
based on its typical sources and uses of funds.

Chapter : Summary
Final Self-Exam

Book Title: Financial Markets and Institutions

Printed By: Christine Joy Arancon (17101496@usc.edu.ph)

© 2021 Cengage Learning, Cengage Learning

© 2021 Cengage Learning Inc. All rights reserved. No part of this work may by reproduced or used in any form or by any means -
graphic, electronic, or mechanical, or in any other manner - without the written permission of the copyright holder.

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