Question 1

We saw in the text that regulations, specifically deposit insurance and the Basel Accord
(of 1988), can create moral hazard. Explain.

Accepted Answer

Deposit insurance creates moral hazard f

Question 2

The government regulates bank mergers, sometimes denying the proposed merger. Often the reason given for the denial is to protect small investors. What are small investors being protected from?

Accepted Answer

A)  with a larger bank the bank is likely to take greater risk and may fail. 
B)  in order to pay for the merger, the bank may seek higher returns putting the depositors' funds at greater risk. 
C)  mergers can increase the monopoly power of banks and the bank may seek to exploit this power by raising prices and earning unwarranted profits. 
D)  bank runs hurt larger banks more than smaller banks. 
A)  with a larger bank the bank is likely to take greater risk and may fail. 
B)  in order to pay for the merger, the bank may seek higher returns putting the depositors' funds at greater risk. 
C)  mergers can increase the monopoly power of banks and the bank may seek to exploit this power by raising prices and earning unwarranted profits. 
D)  bank runs hurt larger banks more than smaller banks.

Question 3

Define the components of the CAMELS criteria and explain how a CAMELS rating is calculated.

Accepted Answer

The CAMELS criteria are: Capital adequac

Question 4

You have a retirement account in a bank that has failed. The balance in your account is
$330,000. Does it make a difference to you if FDIC uses the payoff method or the purchase-and-assumption method for resolving this insolvency? Explain.

Accepted Answer

It does make a difference. Under the pay

Question 5

One reason a bank's officer may be reluctant to write off a past-due loan is that it will:

Accepted Answer

A)  increase the bank's liabilities. 
B)  decrease the bank's assets and capital. 
C)  increase the bank's liabilities and assets, requiring more capital to be held. 
D)  make the bank's accounts less transparent. 
A)  increase the bank's liabilities. 
B)  decrease the bank's assets and capital. 
C)  increase the bank's liabilities and assets, requiring more capital to be held. 
D)  make the bank's accounts less transparent.

Question 6

You are the head of finance for a very large corporation located in a relatively small town. At a local chamber of commerce meeting, the president of the local bank asks you why
you keep the corporation's bank accounts in a very large mid-western bank and not in his local bank. From a risk reduction perspective, how could you answer his question?

Accepted Answer

You might employ the concept of too-big-

Question 7

Financial regulators set capital requirements for banks. One characteristic about these requirements is:

Accepted Answer

A)  every bank will have to hold the same level. 
B)  the riskier the asset holdings of a bank, the more capital it will be required to have. 
C)  the more branches a bank has, the more capital it must have. 
D)  the amount of capital required is inversely related to the amount of assets the bank owns. 
A)  every bank will have to hold the same level. 
B)  the riskier the asset holdings of a bank, the more capital it will be required to have. 
C)  the more branches a bank has, the more capital it must have. 
D)  the amount of capital required is inversely related to the amount of assets the bank owns.

Question 8

Besides regulating banks, the government also regulates nondepository financial institutions, such as insurance companies. Consider a property casualty insurance company; why would the government need to regulate them?

Accepted Answer

The insurance company takes premiums fro

Question 9

How does the lender of last resort potentially create a moral hazard problem?

Accepted Answer

The lender of last resort function provi

Question 10

A moral hazard situation arises in the lender of last resort function because:

Accepted Answer

A)  a central bank finds it difficult to distinguish illiquid from insolvent banks. 
B)  a central bank usually will only make a loan to a bank after it becomes insolvent. 
C)  a central bank usually undervalues the assets of a bank in a crisis. 
D)  the central bank is the first place a bank facing a crisis will turn. 
A)  a central bank finds it difficult to distinguish illiquid from insolvent banks. 
B)  a central bank usually will only make a loan to a bank after it becomes insolvent. 
C)  a central bank usually undervalues the assets of a bank in a crisis. 
D)  the central bank is the first place a bank facing a crisis will turn.

Question 11

During the financial crisis of 2007-2009 in the United States it was revealed that the function of a lender of last resort had not kept pace with the evolving financial system because:

Accepted Answer

A)  financial intermediaries had grown sufficiently large so as not to need a lender of last resort. 
B)  shadow banks lacked access to the financial resources available through the lender of last resort. 
C)  banks were sufficiently linked to one another that the need for a lender of last resort had diminished. 
D)  banks had become sufficiently diversified so as to be able to provide for their own liquidity. 
A)  financial intermediaries had grown sufficiently large so as not to need a lender of last resort. 
B)  shadow banks lacked access to the financial resources available through the lender of last resort. 
C)  banks were sufficiently linked to one another that the need for a lender of last resort had diminished. 
D)  banks had become sufficiently diversified so as to be able to provide for their own liquidity.

Question 12

The existence of a lender of last resort creates moral hazard for bank managers because:

Accepted Answer

A)  they have an incentive to take too much risk in their operations. 
B)  officials are likely to undervalue the bank's portfolio of assets. 
C)  they are less likely to apply for a direct loan from the central bank. 
D)  banks seek loans from the central bank only after exploring other options. 
A)  they have an incentive to take too much risk in their operations. 
B)  officials are likely to undervalue the bank's portfolio of assets. 
C)  they are less likely to apply for a direct loan from the central bank. 
D)  banks seek loans from the central bank only after exploring other options.

Question 13

Which of the following is not an important addition made to the Basel Accords by Basel III in 2010?

Accepted Answer

A)  It supplements capital requirements based on risk-weighted assets with restrictions on leverage. 
B)  It introduces three buffers over and above capital requirements itself. 
C)  It adds a liquidity requirement that compels banks to hold a quantity of high-quality liquid assets. 
D)  It ends the too-big-to-fail problem. 
A)  It supplements capital requirements based on risk-weighted assets with restrictions on leverage. 
B)  It introduces three buffers over and above capital requirements itself. 
C)  It adds a liquidity requirement that compels banks to hold a quantity of high-quality liquid assets. 
D)  It ends the too-big-to-fail problem.

Question 14

The reasons for the government to get involved in the financial system include each of the following, except:

Accepted Answer

A)  to protect the bank's monopoly position. 
B)  to protect investors. 
C)  to ensure the stability of the financial system. 
D)  to protect bank customers from monopolistic exploitation. 
A)  to protect the bank's monopoly position. 
B)  to protect investors. 
C)  to ensure the stability of the financial system. 
D)  to protect bank customers from monopolistic exploitation.

Question 15

A bank run involves:

Accepted Answer

A)  illegal activities on the part of the bank's officers. 
B)  a bank being forced into bankruptcy. 
C)  a large number of depositors withdrawing their funds during a short time span. 
D)  a bank's return on assets being below the acceptable level. 
A)  illegal activities on the part of the bank's officers. 
B)  a bank being forced into bankruptcy. 
C)  a large number of depositors withdrawing their funds during a short time span. 
D)  a bank's return on assets being below the acceptable level.

Question 16

What were the positive effects of the 1988 Basel Accord? What were its shortcomings?

Accepted Answer

The Basel Accord of 1988 was an attempt

Question 17

What is the difference between a bank that is insolvent and one that is illiquid?

Accepted Answer

A bank that is insolvent is in a positio

Question 18

Banks are required to disclose certain information. This disclosure is done for all of the following reasons except:

Accepted Answer

A)  to enable regulators to more easily assess the financial condition of banks. 
B)  to allow financial market participants to penalize banks that carry additional risk. 
C)  to allow customers to more easily compare prices for services offered by banks. 
D)  create uniform prices for standard bank services. 
A)  to enable regulators to more easily assess the financial condition of banks. 
B)  to allow financial market participants to penalize banks that carry additional risk. 
C)  to allow customers to more easily compare prices for services offered by banks. 
D)  create uniform prices for standard bank services.

Question 19

Explain why depository institutions receive a disproportionate amount of attention from government regulators (compared to most other industries).

Accepted Answer

Depository institutions receive this att

Question 20

Bank panics have often begun as a result of:

Accepted Answer

A)  rumors only. 
B)  real economic events only. 
C)  both rumors and real economic events. 
D)  neither rumors nor economic events. 
A)  rumors only. 
B)  real economic events only. 
C)  both rumors and real economic events. 
D)  neither rumors nor economic events.

Exam 14: Regulating the Financial System

We saw in the text that regulations, specifically deposit insurance and the Basel Accord (of 1988), can create moral hazard. Explain.

The government regulates bank mergers, sometimes denying the proposed merger. Often the reason given for the denial is to protect small investors. What are small investors being protected from?

Define the components of the CAMELS criteria and explain how a CAMELS rating is calculated.

You have a retirement account in a bank that has failed. The balance in your account is $330,000. Does it make a difference to you if FDIC uses the payoff method or the purchase-and-assumption method for resolving this insolvency? Explain.

One reason a bank's officer may be reluctant to write off a past-due loan is that it will:

Financial regulators set capital requirements for banks. One characteristic about these requirements is:

Besides regulating banks, the government also regulates nondepository financial institutions, such as insurance companies. Consider a property casualty insurance company; why would the government need to regulate them?

How does the lender of last resort potentially create a moral hazard problem?

A moral hazard situation arises in the lender of last resort function because:

During the financial crisis of 2007-2009 in the United States it was revealed that the function of a lender of last resort had not kept pace with the evolving financial system because:

The existence of a lender of last resort creates moral hazard for bank managers because:

Which of the following is not an important addition made to the Basel Accords by Basel III in 2010?

The reasons for the government to get involved in the financial system include each of the following, except:

A bank run involves:

What were the positive effects of the 1988 Basel Accord? What were its shortcomings?

What is the difference between a bank that is insolvent and one that is illiquid?

Banks are required to disclose certain information. This disclosure is done for all of the following reasons except:

Explain why depository institutions receive a disproportionate amount of attention from government regulators (compared to most other industries).

Bank panics have often begun as a result of:

An Introduction to Money and the Financial System

Money and the Payments System

Financial Instruments, Financial Markets, and Financial Institutions

Future Value, Present Value and Interest Rates

Understanding Risk

Bonds, Bond Prices, and the Determination of Interest Rates

The Risk and Term Structure of Interest Rates

Stocks, Stock Markets and Market Efficiency

Derivatives: Futures, Options, and Swaps

Foreign Exchange

The Economics of Financial Intermediation

Depository Institutions: Banks and Bank Management

Financial Industry Structure

Central Banks in the World Today

The Structure of Central Banks: The Federal Reserve and the European Central Bank

The Central Bank Balance Sheet and the Money Supply Process

Monetary Policy: Stabilizing the Domestic Economy

Exchange Rate Policy and the Central Bank

Money Growth, Money Demand and Modern Monetary Policy

Output, Inflation, and Monetary Policy

Understanding Business Cycle Fluctuations

Modern Monetary Policy and the Challenges Facing Central Bankers

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