Commercial bank

10.1 The Bank Balance Sheet

1) Which of the following statements are true?

A) A bankʹs assets are its sources of funds.
B) A bankʹs liabilities are its uses of funds.
C) A bankʹs balance sheet shows that total assets equal total liabilities plus equity capital.
D) A bankʹs balance sheet indicates whether or not the bank is profitable.

2) Which of the following statements is false?

A) A bankʹs assets are its uses of funds.
B) A bank issues liabilities to acquire funds.
C) The bankʹs assets provide the bank with income.
D) Bank capital is recorded as an asset on the bank balance sheet.

3) Which of the following are reported as liabilities on a bankʹs balance sheet?

A) Reserves
B) Checkable deposits
C) Loans
D) Deposits with other banks

4) Which of the following are reported as liabilities on a bankʹs balance sheet?

A) Discount loans
B) Reserves
C) U.S. Treasury securities
D) Loans

5) The share of checkable deposits in total bank liabilities has

A) expanded moderately over time.
B) expanded dramatically over time.
C) shrunk over time.
D) remained virtually unchanged since 1960.

6) Which of the following statements is false?

A) Checkable deposits are usually the lowest cost source of bank funds.
B) Checkable deposits are the primary source of bank funds.
C) Checkable deposits are payable on demand.
D) Checkable deposits include NOW accounts.

7) In recent years the interest paid on checkable and time deposits has accounted for around
________ of total bank operating expenses, while the costs involved in servicing accounts have
been approximately ________ of operating expenses.
A) 45 percent; 55 percent
B) 55 percent; 4 percent
C) 25 percent; 50 percent
D) 50 percent; 30 percent

8) Which of the following statements are true?

A) Checkable deposits are payable on demand.
B) Checkable deposits do not include NOW accounts.
C) Checkable deposits are the primary source of bank funds.
D) Demand deposits are checkable deposits that pay interest.

9) Because checking accounts are ________ liquid for the depositor than passbook savings, they
earn ________ interest rates.
A) less; higher
B) less; lower
C) more; higher
D) more; lower

10) Which of the following are transaction deposits?

A) Savings accounts
B) Small-denomination time deposits
C) Negotiable order of withdraw accounts
D) Certificates of deposit

11) Which of the following is not a nontransaction deposit?

A) Savings accounts
B) Small-denomination time deposits
C) Negotiable order of withdrawal accounts
D) Certificate of deposit

12) Large-denomination CDs are ________, so that like a bond they can be resold in a ________
market before they mature.
A) nonnegotiable; secondary
B) nonnegotiable; primary
C) negotiable; secondary
D) negotiable; primary

13) Because ________ are less liquid for the depositor than ________, they earn higher interest
rates.
A) money market deposit accounts; time deposits
B) checkable deposits; passbook savings
C) passbook savings; checkable deposits
D) passbook savings; time deposits
14) Because ________ are less liquid for the depositor than ________, they earn higher interest
rates.
A) passbook savings; time deposits
B) money market deposit accounts; time deposits
C) money market deposit accounts; passbook savings
D) time deposits; passbook savings

15) Banks acquire the funds that they use to purchase income-earning assets from such sources
as
A) cash items in the process of collection
B) savings accounts.
C) reserves.
D) deposits at other banks.

16) Bank loans from the Federal Reserve are called ________ and represent a ________ of
funds.
A) discount loans; use
B) discount loans; source
C) fed funds; use
D) fed funds; source

17) Which of the following is not a source of borrowings for a bank?

A) Federal funds
B) Eurodollars
C) Transaction deposits
D) Discount loans

18) Bank capital is equal to ________ minus ________.

A) total assets; total liabilities
B) total liabilities; total assets
C) total assets; total reserves
D) total liabilities; total borrowings

19) Bank capital is listed on the ________ side of the bankʹs balance sheet because it represents
a________ of funds.
A) liability; use
B) liability; source
C) asset; use
D) asset; source

20) Bank reserves include

A) deposits at the Fed and short-term treasury securities.
B) vault cash and short-term Treasury securities.
C) vault cash and deposits at the Fed.
D) deposits at other banks and deposits at the Fed.

21) The fraction of checkable deposits that banks are required by regulation to hold are
A) excess reserves.
B) required reserves.
C) vault cash.
D) total reserves.

22) Which of the following are reported as assets on a bankʹs balance sheet?
A) Borrowings
B) Reserves
C) Savings deposits
D) Bank capital

23) Which of the following are not reported as assets on a bankʹs balance sheet?
A) Cash items in the process of collection
B) Deposits with other banks
C) U.S. Treasury securities
D) Checkable deposits

24) Through correspondent banking, large banks provide services to small banks, including
A) loan guarantees.
B) foreign exchange transactions.
C) issuing stock.
D) debt reduction.

25) The largest percentage of banksʹ holdings of securities consist of

A) Treasury and government agency securities.
B) tax-exempt municipal securities.
C) state and local government securities.
D) corporate securities.

26) Which of the following bank assets is the most liquid?

A) Consumer loans
B) Reserves
C) Cash items in process of collection
D) U.S. government securities

27) Secondary reserves include

A) deposits at Federal Reserve Banks.
B) deposits at other large banks.
C) short-term Treasury securities.
D) state and local government securities.
28) Because of their ________ liquidity, ________ U.S. government securities are called
secondary reserves.
A) low; short-term
B) low; long-term
C) high; short-term
D) high; long-term

29) Secondary reserves are so called because

A) they can be converted into cash with low transactions costs.
B) they are not easily converted into cash, and are, therefore, of secondary importance to
banking firms.
C) 50% of these assets count toward meeting required reserves.
D) they rank second to bank vault cash in importance of bank holdings.

30) Banksʹ asset portfolios include state and local government securities because
A) their interest payments are tax deductible for federal income taxes.
B) banks consider them helpful in attracting accounts of Federal employees.
C) the Federal Reserve requires member banks to buy securities from state and local
governments located within their respective Federal Reserve districts.
D) there is no default-risk with state and local government securities.

31) Bankʹs make their profits primarily by issuing ________.

A) equity
B) negotiable CDs
C) loans
D) NOW accounts

32) The most important category of assets on a bankʹs balance sheet is

A) discount loans.
B) securities.
C) loans.
D) cash items in the process of collection.

33) Which of the following are bank assets?

A) the building owned by the bank
B) a discount loan
C) a negotiable CD
D) a customerʹs checking account

10.2 Basic Banking

1) Banks earn profits by selling ________ with attractive combinations of liquidity, risk, and
return, and using the proceeds to buy ________ with a different set of characteristics.
A) loans; deposits
B) securities; deposits
C) liabilities; assets
D) assets; liabilities

2) In general, banks make profits by selling ________ liabilities and buying ________ assets.
A) long-term; shorter-term
B) short-term; longer-term
C) illiquid; liquid
D) risky; risk-free

3) Asset transformation can be described as

A) borrowing long and lending short.
B) borrowing short and lending long.
C) borrowing and lending only for the short term.
D) borrowing and lending for the long term.

4) When a new depositor opens a checking account at the First National Bank, the bankʹs assets
________ and its liabilities ________.
A) increase; increase
B) increase; decrease
C) decrease; increase
D) decrease; decrease

5) When Jane Brown writes a $100 check to her nephew (who lives in another state), Ms.
Brownʹs bank ________ assets of $100 and ________ liabilities of $100.
A) gains; gains
B) gains; loses
C) loses; gains
D) loses; loses

6) When you deposit a $50 bill in the Security Pacific National Bank,
A) its liabilities decrease by $50.
B) its assets increase by $50.
C) its reserves decrease by $50.
D) its cash items in the process of collection increase by $50.

7) When you deposit $50 in currency at Old National Bank,

A) its assets increase by less than $50 because of reserve requirements.
B) its reserves increase by less than $50 because of reserve requirements.
C) its liabilities increase by $50.
D) its liabilities decrease by $50.

8) Holding all else constant, when a bank receives the funds for a deposited check,
A) cash items in the process of collection fall by the amount of the check.
B) bank assets increase by the amount of the check.
C) bank liabilities decrease by the amount of the check.
D) bank reserves increase by the amount of required reserves.

9) When a $10 check written on the First National Bank of Chicago is deposited in an account at
Citibank, then
A) the liabilities of the First National Bank increase by $10.
B) the reserves of the First National Bank increase by $ 10.
C) the liabilities of Citibank increase by $10.
D) the assets of Citibank fall by $10.

10) When a $10 check written on the First National Bank of Chicago is deposited in an account
at Citibank, then
A) the liabilities of the First National Bank decrease by $10.
B) the reserves of the First National Bank increase by $10.
C) the liabilities of Citibank decrease by $10.
D) the assets of Citibank decrease by $10.

11) When you deposit $50 in your account at First National Bank and a $100 check you have
written on this account is cashed at Chemical Bank, then
A) the assets of First National rise by $50.
B) the assets of Chemical Bank rise by $50.
C) the reserves at First National fall by $50.
D) the liabilities at Chemical Bank rise by $50.

12) When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the
bank chooses not to hold any excess reserves but makes loans instead, then, in the bankʹs final
balance sheet,
A) the assets at the bank increase by $800,000.
B) the liabilities of the bank increase by $1,000,000.
C) the liabilities of the bank increase by $800,000.
D) reserves increase by $160,000.

13) When $1 million is deposited at a bank, the required reserve ratio is 20 percent, and the
bank chooses not to make any loans but to hold excess reserves instead, then, in the bankʹs
final balance sheet,
A) the assets at the bank increase by $1 million.
B) the liabilities of the bank decrease by $1 million.
C) reserves increase by $200,000.
D) liabilities increase by $200,000.

14) With a 10% reserve requirement ratio, a $100 deposit into New Bank means that the
maximum amount New Bank could lend is
A) $90.
B) $100.
C) $10.
D) $110.

10.3 General Principles of Bank Management

1) Which of the following are primary concerns of the bank manager?

A) Maintaining sufficient reserves to minimize the cost to the bank of deposit outflows
B) Extending loans to borrowers who will pay low interest rates, but who are poor credit
risks
C) Acquiring funds at a relatively high cost, so that profitable lending opportunities can be
realized
D) Maintaining high levels of capital and thus maximizing the returns to the owners.

2) If a bank has $100,000 of checkable deposits, a required reserve ratio of 20 percent, and it
holds $40,000 in reserves, then the maximum deposit outflow it can sustain without altering its
balance sheet is
A) $30,000.
B) $25,000.
C) $20,000.
D) $10,000.

3) If a bank has $200,000 of checkable deposits, a required reserve ratio of 20 percent, and it
holds $80,000 in reserves, then the maximum deposit outflow it can sustain without altering its
balance sheet is
A) $50,000.
B) $40,000.
C) $30,000.
D) $25,000.

4) If a bank has $10 million of checkable deposits, a required reserve ratio of 10 percent, and it
holds $2 million in reserves, then it will not have enough reserves to support a deposit outflow
of
A) $1.2 million.
B) $1.1 million.
C) $1 million.
D) $900,000.

5) If a bank has excess reserves greater than the amount of a deposit outflow, the outflow will
result in equal reductions in
A) deposits and reserves.
B) deposits and loans.
C) capital and reserves.
D) capital and loans.
6) A $5 million deposit outflow from a bank has the immediate effect of
A) reducing deposits and reserves by $5 million.
B) reducing deposits and loans by $5 million.
C) reducing deposits and securities by $5 million.
D) reducing deposits and capital by $5 million.

7) Bankersʹ concerns regarding the optimal mix of excess reserves, secondary reserves,
borrowings from the Fed, and borrowings from other banks to deal with deposit outflows is an
example of
A) liability management.
B) liquidity management.
C) managing interest rate risk.
D) managing credit risk.

8) If, after a deposit outflow, a bank needs an additional $3 million to meet its reserve
requirements, the bank can
A) reduce deposits by $3 million.
B) increase loans by $3 million.
C) sell $3 million of securities.
D) repay its discount loans from the Fed.

9) A bank with insufficient reserves can increase its reserves by

A) lending federal funds.
B) calling in loans.
C) buying short-term Treasury securities.
D) buying municipal bonds.

10) Of the following, which would be the first choice for a bank facing a reserve deficiency?
A) Call in loans
B) Borrow from the Fed
C) Sell securities
D) Borrow from other banks

11) In general, banks would prefer to acquire funds quickly by ________ rather than ________.
A) reducing loans; selling securities
B) reducing loans; borrowing from the Fed
C) borrowing from the Fed; reducing loans
D) ʺcalling inʺ loans; selling securities

12) ________ may antagonize customers and thus can be a very costly way of acquiring funds
to meet an unexpected deposit outflow.
A) Selling securities
B) Selling loans
C) Calling in loans
D) Selling negotiable CDs

13) Banks hold excess and secondary reserves to

A) reduce the interest-rate risk problem.
B) provide for deposit outflows.
C) satisfy margin requirements.
D) achieve higher earnings than they can with loans.

14) Which of the following statements most accurately describes the task of bank asset
management?
A) Banks seek the highest returns possible subject to minimizing risk and making adequate
provisions for liquidity.
B) Banks seek to have the highest liquidity possible subject to earning a positive rate of return
on their operations.
C) Banks seek to prevent bank failure at all cost; since a failed bank earns no profit, liquidity
needs supersede the desire for profits.
D) Banks seek to acquire funds in the least costly way.

15) The goals of bank asset management include

A) maximizing risk.
B) minimizing liquidity.
C) lending at high interest rates regardless of risk.
D) purchasing securities with high returns and low risk.

16) Banks that suffered significant losses in the 1980s made the mistake of
A) holding too many liquid assets.
B) minimizing default risk.
C) failing to diversify their loan portfolio.
D) holding only safe securities.

17) A bank will want to hold more excess reserves (everything else equal) when
A) it expects to have deposit inflows in the near future.
B) brokerage commissions on selling bonds increase.
C) the cost of selling loans falls.
D) the discount rate decreases.

18) As the costs associated with deposit outflows ________, the banks willingness to hold
excess reserves will ________.
A) decrease; increase
B) increase; decrease
C) increase; increase
D) decrease; not be affected
19) Which of the following would a bank not hold as insurance against the highest cost of
deposit outflow-bank failure?
A) Excess reserves
B) Secondary reserves
C) Bank capital
D) Mortgages

20) Which of the following has not resulted from more active liability management on the part
of banks?
A) Increased bank holdings of cash items
B) Aggressive targeting of goals for asset growth by banks
C) Increased use of negotiable CDs to raise funds
D) An increased proportion of bank assets held in loans

21) Banks that actively manage liabilities will most likely meet a reserve shortfall by
A) calling in loans.
B) borrowing federal funds.
C) selling municipal bonds.
D) seeking new deposits.

22) Modern liability management has resulted in

A) increased sales of certificates of deposits to raise funds.
B) increase importance of deposits as a source of funds.
C) reduced borrowing by banks in the overnight loan market.
D) failure by banks to coordinate management of assets and liabilities.

23) A bank failure occurs whenever

A) a bank cannot satisfy its obligations to pay its depositors and have enough reserves to
meet its reserve requirements.
B) a bank suffers a large deposit outflow.
C) a bank has to call in a large volume of loans.
D) a bank is not allowed to borrow from the Fed.

24) A bank is insolvent when

A) its liabilities exceed its assets.
B) its assets exceed its liabilities.
C) its capital exceeds its liabilities.
D) its assets increase in value.

25) Holding large amounts of bank capital helps prevent bank failures because
A) it means that the bank has a higher income.
B) it makes loans easier to sell.
C) it can be used to absorb the losses resulting from bad loans.
D) it makes it easier to call in loans.
26) Net profit after taxes per dollar of assets is a basic measure of bank profitability called
A) return on assets.
B) return on capital.
C) return on equity.
D) return on investment.

27) Net profit after taxes per dollar of equity capital is a basic measure of bank profitability
called
A) return on assets.
B) return on capital.
C) return on equity.
D) return on investment.

28) The amount of assets per dollar of equity capital is called the
A) asset ratio.
B) equity ratio.
C) equity multiplier.
D) asset multiplier.

29) For a given return on assets, the lower is bank capital,

A) the lower is the return for the owners of the bank.
B) the higher is the return for the owners of the bank.
C) the lower is the credit risk for the owners of the bank.
D) the lower the possibility of bank failure.

30) Bank capital has both benefits and costs for the bank owners. Higher bank capital ________
the likelihood of bankruptcy, but higher bank capital ________ the return on equity for a given
return on assets.
A) reduces; reduces
B) increases; increases
C) reduces; increases
D) increases; reduces

31) In the absence of regulation, banks would probably hold

A) too much capital, reducing the efficiency of the payments system.
B) too much capital, reducing the profitability of banks.
C) too little capital.
D) too much capital, making it more difficult to obtain loans.

32) Conditions that likely contributed to a credit crunch in 2008 include:

A) capital shortfalls caused in part by falling real estate prices.
B) regulated hikes in bank capital requirements.
C) falling interest rates that raised interest rate risk, causing banks to choose to hold more
capital.
D) increases in reserve requirements.

33) Which of the following would not be a way to increase the return on equity?
A) Buy back bank stock
B) Pay higher dividends
C) Acquire new funds by selling negotiable CDs and increase assets with them
D) Sell more bank stock

34) If a bank needs to raise the amount of capital relative to assets, a bank manager might
choose to
A) buy back bank stock.
B) pay higher dividends.
C) shrink the size of the bank.
D) sell securities the bank owns and put the funds into the reserve account.