Chapter 15 The Management of Capital

Fill in the Blank Questions

1. The risk that has to do with banks trading in foreign currencies is called _________________________. Answer: exchange risk

2. The risk that has to do with fraud, embezzlement and bank robberies is called __________________. Answer: crime risk

3. _________________________ is measured by the par value of the shares of common equity outstanding. Answer: Common stock

4. __________________ is the amount in excess of par value paid by the bank's shareholders. Answer: Surplus

5. _________________________ are the net earnings of the bank which have been kept by the bank rather than distributed as dividends to stockholders. Answer: Undivided Profits (or retained earnings)

6. Core capital such as common stock, surplus, undivided profits, qualifying noncumulative preferred stock, etc. is referred to as __________________ capital as defined by the Basel agreement. Answer: Tier 1

7. The international treaty involving the U.S. and 11 other leading industrialized countries to impose common capital requirements on all banks is known as the _________________________. Answer: Basel Agreement

8. Supplemental capital such as the allowance for loan losses, subordinated debt, mandatory convertible debt, intermediate-term preferred stock, cumulative preferred perpetual stock and equity notes is more commonly known as _________________________. Answer: Tier 2 capital

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9. When items on a bank's balance sheet are multiplied by the appropriate risk-weighting factor they are often called _________________________. Answer: risk-weighted assets

10. The fact that a bank may suffer deficiencies in quality control, inefficiencies in producing and delivering of services, weather damage, aging or faulty computer systems, errors in judgment by management and fluctuations in economy that could adversely affect the bank's performance is known as _________________________ risk. Answer: operational

11. One defense against risk for the bank is to spread out a bank's credit accounts and deposits among a wide variety of customers, including large and small accounts different industries, etc. This defense is known as _________________________. Answer: portfolio diversification

12. One defense against risk is for the bank to seek out customers located in different communities or in different countries. This defense is known as _________________________. Answer: geographic diversification

13. When all else fails, the ultimate defense against risk in banking is _________________________. Answer: owners' capital (net worth)

14. The largest component of capital among thrift institutions is _____________. Answer: retained earnings

15. The largest component of capital among banks is ____________. Answer: surplus

16. ____________ models attempt to measure price or market risk of a portfolio of assets and attempt to determine the maximum loss they might sustain over a designated period of time. Answer: Value at risk (VaR)

17. The latest revision to the Basel accord is known as __________ and will affect only about 20 of the largest U.S. banks and a handful of leading foreign banks. Answer: Basel II

18. ____________ models measure lender exposure to defaults or credit downgrades. Answer: Credit Risk

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19. Credit risk models will be ________ widely used when Basel II takes effect. Answer: more

20. At the center of the debate of the Basel Agreement is the

, headquartered in Basel Switzerland , which assists central banks in their transactions with each other and serves as a forum for international financial issues. Answer: Bank for International Settlements (BIS)

21.

represents funds set aside for contingencies such as legal action against the institution as well as providing a reserve for dividends expected to be paid but not yet declared and a sinking fund to retire stock or debt in the future. Answer: Equity reserves

22.
sale of stock. Answer: Equity commitment notes

are debt securities repayable from the

23.

is a hybrid form of equity capital issued to investors through a trust company, The funds raise are loaned to the financial firm. Dividends paid to stockholders on this time of capital are tax deductible. Answer: Trust preferred stock

24.

is long-term debt capital whose claims legally follow claims of depositors. Answer: Subordinated notes and debentures

25.

for banks include mortgage servicing rights and purchased credit card relationships and can be counted as part of bank capital. Answer: Identifiable intangible assets

True/False Questions

F 26. In the field of banking, capital refers principally to those funds contributed by a bank's owners.

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Answer: True

F 27. According to the textbook capital and risk are intimately related to each other. Answer: True

F 28. One fundamental purpose for regulating capital is to limit losses to the federal government arising from deposit insurance claims. Answer: True

F 29. Deposit insurance subsidized by government encourages banks to increase their ratios of capital to deposits. Answer: False

F 30. Tier 2 includes undivided profits. Answer: False

F 31. Core capital includes the surplus account for stock. Answer: True

F 32. Under the international capital (Basel) agreement Tier 2 capital must be raised to a minimum of 4 percent of risk-weighted assets. Answer: False

F 33. Off-balance-sheet commitments of banks carry capital requirements under the international (Basel) capital requirements. Answer: True

F 34. Portfolio diversification refers to seeking out customers located in different communities or countries, which presumably will experience different economic conditions. Answer: False

F 35. Geographic diversification refers to the spreading out credit accounts and deposits among a wide variety of customers, including large and small business accounts, different industries, and households with a variety of sources of income and collateral. Answer: False

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F 36. The last line of defense against bank failure is owner's capital, according to the textbook. Answer: True

F 37. Under the FDIC Improvement Act of 1991 a U.S. bank possessing a leverage ratio greater than 4 percent would be considered well capitalized. Answer: False

F 38. Under the FDIC Improvement Act of 1991 a bank whose leverage ratio drops to 2 percent or less is considered to be critically undercapitalized. Answer: True

F 39. Recent research suggests that interest-rate contracts display considerably less risk exposure than do foreign-currency contracts. Answer: True

F 40. The Basel Agreement on capital as drafted in the 1980s failed to deal with market risk. Answer: True

F 41. If a bank benefits when the value of a foreign currency rises, the bank is said to be in a short position. Answer: False

F 42. If a bank benefits when a foreign currency declines in value, then the bank is in a long position. Answer: False

F 43. If the ratio of tangible equity capital to total assets is 2 percent or less it is subject to being placed in conservatorship or receivership if its capital ratios are not increased within a prescribed period of time even if its net worth is still positive. Answer: True

F 44. According to recent research, bank stock prices usually drop within a week after a dividend cut is announced. Answer: True

F 45. Equity notes are considered to be part of Tier 1 capital. Answer: False

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F 46. The most important source of thrift capital in terms of dollar volume is common stock (par value). Answer: False

F 47. The daily rate at which robberies have occurred in the U.S. has continued to climb in the 1990s. Answer: False

F 48. One of the reasons to regulate the capital position of banks is to limit the risk of bank failures, especially large bank failures. Answer: True

F 49. Deposits with the Federal Reserve banks are considered to have moderate credit risk and are therefore placed in the 50 percent risk weight category. Answer: False

F 50. The largest component of capital among banks is retained earnings. Answer: False

F 51. VaR models provide a single number which indicates the potential for losses on a portfolio of assets. Answer: True

F 52. VaR models are most successful in assessing potential risk when the assets are nontraded. Answer: False

F 53. Credit risk models will probably not be needed when Basel II takes effect. Answer: False

F 54. One of the key innovations which have been proposed in Basel II is to require banks to hold capital against operational risk. Answer: True

F 55. Basel II will require each bank to determine its own capital requirements based on its own calculated risk exposure.

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Answer: True

F 56. It is anticipated that Basel II may lower capital requirements for the largest banks. Answer: True

F 57. The global financial crisis of 2007-2009 highlighted the importance of taking into consideration a banks exposure to market risk that arise from changes in interest rates, security prices, and currency. Answer: True

T T

F 58. Smaller banks rely more heavily on internally generated capital than larger banks. Answer: True F 59. A well-capitalized institution has a ratio of capital to risk-weighted assets of at least 10 percent and faces no significant regulatory restrictions on its expansion. Answer: True

F 60. Regulatory capital focus on the market value of equity. Answer: False

Multiple Choice Questions

61.

According to the textbook the role of capital is to: A) Provide a cushion against failure risk. B) Provide funds needed to organize, open, and operate a bank. C) Promote public confidence D) Support growth and the development of new services E) All of the above. Answer: E

62.

The textbook discusses several alternative defenses banks have against risk. These defenses include: A) Quality management B) Portfolio diversification C) Geographic diversification D) Deposit insurance E) All of the above. Answer: E

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63.

Measured by dollar volume the largest category of capital at U.S. banks is: A) Par value of common stock B) Subordinated notes and debentures C) Surplus D) Undivided profits and capital reserves E) None of the above. Answer: C

64.

The fundamental purposes of regulating bank capital cited in the textbook include which of the following? A) To limit the risk of bank failures. B) To preserve public confidence in banks. C) To limit losses to the federal government arising from insurance claims. D) All of the above. E) A and B only. Answer: D

65.

The Internal Capital Growth Rate for a bank is a function of which of the following factors? A) Profit margin. B) Asset utilization. C) Equity multiplier. D) Earnings retention ratio. E) All of the above. Answer: E

66. Second National Bank is forecasting a return on equity of 15 percent for this year. The board of
directors wants to maintain its current policy of paying the bank's stockholders 40 percent of any net earnings the bank will earn. How fast can the bank's assets grow this year without jeopardizing its ratio of capital to assets? A) 15 percent. B) 9 percent. C) 8 percent. D) 6 percent. E) None of the above Answer: B

67.

Possible breakdowns in quality control, inefficiencies in producing and delivering financial services, weather damage, aging or faulty computer systems and simple errors in judgment by bank management illustrate what form of risk faced by banks? A) Credit risk B) Liquidity risk C) Interest-rate risk D) Operational risk

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E) None of the above Answer: D

68.

The ratio of core capital to average assets is called the: A) Supplemental Capital ratio B) Leverage ratio C) Long-term capital ratio D) GAAP capital ratio E) None of the above. Answer: B

69. The risk that a customer the bank has entered into a contract with will fail to pay or to perform,
forcing the bank to find a replacement contract that may be less satisfactory is what form of risk listed below? A) Counterparty risk B) Interest-rate risk C) Operating risk D) Credit risk E) Liquidity risk Answer: A

70.

If a bank benefits when a foreign currency declines in value, then the bank must be in a __________ position. The term below that correctly fills in the blank in the preceding sentence is: A) Long B) Short C) Negative D) Credit risk E) None of the above Answer: B

71.

In the United States a 'well capitalized' bank must have a ratio of capital to risk-weighted assets of at least: A) 6 percent B) 8 percent C) 10 percent. D) 5 percent. E) None of the above Answer: C

72.

In the United States a bank to be considered 'adequately capitalized' must have a ratio of Tier 1 (or core) capital to risk-weighted assets of at least: A) 8 percent B) 6 percent

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C) 10 percent D) 4 percent E) None of the above Answer: D

73.

A "well capitalized" bank in the United States must have a leverage ratio of at least: A) 5 percent B) 4 percent C) 6 percent D) 8 percent E) None of the above Answer: B

74. A bank has $100 million in assets in the 0 percent risk weight category, $200 million in assets in
the 20 percent risk weight category, $500 million in assets in the 50 percent risk weight category and $750 million in assets in the 100 percent risk weight category. This bank has $57 million in core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to risk-weighted assets? A) 3.68 percent B) 7.6 percent C) 18.25 percent D) 5.48 percent E) None of the above Answer: D

75.

A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent , an equity multiplier of 12 and a retention ratio of 60 percent. What is this bank's ICGR? A) 6.6 percent B) 3.96 percent C) 7.2 percent D) .33 percent E) None of the above Answer: B

76.

Which of the following would be an example of Tier 1 capital? A) Subordinated debt capital instruments with an original maturity of at least 5 years B) Allowance for loan and lease losses C) Minority interest in the equity accounts of consolidated subsidiaries D) Intermediate term preferred stock E) All of the above Answer: C

77.

Which of the following would be an example of Tier 2 capital? A) Subordinated debt capital instruments with an original maturity of at least 5 years B) Undivided profits C) Minority interest in the equity accounts of consolidated subsidiaries

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D) Qualifying noncumulative preferred stock E) All of the above Answer: A

78.

Which of the following would be an example of crime risk? A) A bank manager that embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest and principal has been collected in 2 years D) A bank manager predicts that interest rates will rise. However interest rates fall causing the bank 's net income to fall by $250,000 E) All of the above are examples of crime risk Answer: A

79.

Which of the following assets fits into the 0 percent risk weight category? A) Cash B) Deposits at the Federal Reserve C) Treasury Bills D) GNMA mortgage-backed securities E) All of the above fit into the 0 percent risk weight category Answer: E

80.

A bank that is 'well-capitalized': A) Faces no significant regulatory restrictions B) Cannot accept broker placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E) None of the above Answer: A

81.

A bank that is 'critically undercapitalized': A) Faces no significant regulatory restrictions B) Cannot accept broker-placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E) None of the above Answer: D

82.

A bank that is adequately capitalized: A) Faces no significant regulatory restrictions

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B) Cannot accept broker-placed deposits without regulatory approval C) Has limits on dividends and management fees it is allowed to pay and limits on the maximum asset growth rate among other restrictions D) Will be placed into conservatorship or receivership if it its capital level is not increased within a certain time limit. E) None of the above Answer: B

83.

Which of the following is in the 100 percent risk-weight category? A) Cash B) General obligation municipal bonds C) Residential mortgage loans D) Credit card loans E) None of the above Answer: D

84.

Which of the following is in the 50 percent risk-weight (moderate) category? A) Cash B) General Obligation Municipal Bonds C) Residential Mortgage Loans D) Credit Card Loans E) None of the above Answer: C

85.

Which of the following is in the 20 percent risk-weight (low) category? A) Cash B) General obligation municipal bonds C) Residential mortgage loans D) Credit card loans E) None of the above Answer: B

86.

A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity capital to total assets ratio? A) 7.00 percent B) 14.29 percent C) 28.00 percent D) 16 percent E) None of the above Answer: B

87. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent riskweight category and has $1000 million in assets in the 100 percent risk-weight category. This

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bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of Tier 1 capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above Answer: A

88. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent riskweight category and has $1000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of Tier 2 capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above Answer: B

89. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent riskweight category and has $1000 million in assets in the 100 percent risk-weight category. This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio of total capital to risk assets? A) 6.08 percent B) 3.04 percent C) 9.11 percent D) 5.54 percent E) None of the above Answer: C

90. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent and
has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this bank's internal capital growth rate? A) 28.35 percent B) 2.36 percent C) 11.34 percent D) 4.8 percent E) None of the above Answer: C

91.

The revised Basel I rules impose capital requirements for market risk on: A) Only the largest banks

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B) Only the smallest banks C) Only moderate size banks D) All banks E) No banks Answer: A

92. Bank debt which appears to be highly sensitive to the market perception of the bank's risk is
which of the following? A) Deposits B) Fed funds C) Repos D) Subordinated debt capital E) Preferred stock Answer: D

93.

Bank operational risk includes: A) Employee fraud B) Account errors C) Computer breakdowns D) Natural disasters E) All of the above Answer: E

94.

The issue of correctly adding up all of the different types of bank risk exposure is known as: A) Risk tallying B) Summing risk C) Risk aggregation D) Risk accumulation E) Risk totality Answer: C

95.

For a bank with deficient capital ratios, which of the following actions could be required by regulators to increase the capital ratios, all else constant? A) Cut the bank's dividend payment B) Increase the bank's leverage C) Reduce the banks holdings of cash D) Increase the bank's growth rate by making additional commercial loans. E) Reduce the bank's holdings of Treasury securities. Answer: A

96.

Basel II has a different set of rules for different bank size categories and the number of categories is: A) two

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B) three C) four D) five E) ten Answer: A

97.

Which of the following would be an example of exchange risk? A) A bank manager embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years D) A bank manager predicts interest rates will rise. However interest rates fall causing the banks net income to fall by $250,000 E) All of the above are examples of exchange risk Answer: B

98.

Which of the following would be an example of credit risk? A bank manager embezzles $1,000,000 from the bank A bank that loses $500,000 from trading in foreign currencies A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years A bank manager predicts interest rates will rise. However interest rates fall causing the banks net income to fall by $250,000 E) All of the above are examples of credit risk Answer: C A) B) C) D)

99.

Which of the following would be an example of interest rate risk? A) A bank manager embezzles $1,000,000 from the bank B) A bank that loses $500,000 from trading in foreign currencies C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2 years D) A bank manager predicts interest rates will rise. However interest rates fall causing the banks net income to fall by $250,000 E) All of the above are examples of interest rate risk? Answer: D

100.

Which of the following would be an example of operational risk? A) A bank teller manages to steal $250,000 over a period of several months B) An out of date computer system causes the bank to lose $750,000 C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors D) A $500,000 loan the bank has made has been deemed uncollectable E) None of the above are examples of operational risk Answer: B

101.

Which of the following would be an example of liquidity risk? A) A bank teller manages to steal $250,000 over a period of several months B) An out of date computer system causes the bank to lose $750,000

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C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors D) A $500,000 loan the bank has made has been deemed uncollectable E) None of the above are examples of liquidity risk Answer: C

102.

Which of the following would not be an example of operational risk? A) A bank on the coast of Louisiana is hit by a hurricane and is flooded for 6 weeks B) A bank employee acting as a derivatives trader is also the one who writes the reports on profits and losses in derivatives trading at the end of each day C) The banks older computer system breaks down causing a loss of service to customers for 2 weeks D) A bank robber robs a teller at gun point and gets away before police can get to the bank E) All of the above are examples of operational risk Answer: D

103. The Jennings Bank of Texas wants to protect itself from credit risk by making large loans to
corporate customers, by making residential mortgages to families, by making agriculture loans to farmers and ranchers in the area, by making small business loans to business along main street and by making automobile loans for the car dealership across the street from the bank. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners capital E) All of the above Answer: A

104.

The Michelson Bank of Stetson wants to protect itself from risk. It decides to make loans in Florida, Georgia, Texas and Oklahoma as well as invest in municipal bonds from California and Oregon. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners capital E) All of the above Answer: B

105. The Perdue Bank of Houston has just hired a new manager who has a reputation of anticipating
potential problems and acting quickly to prevent those problems so that the bank stays healthy and profitable. What defense against risk is this bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners capital

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E) All of the above Answer: C

106. The Norton Bank of Illinois has just issued trust preferred stock. What defense against risk is this
bank making? A) Portfolio diversification B) Geographic diversification C) Quality management D) Increasing owners capital E) All of the above Answer: D

107. What type of preferred stock has become popular among large banks in recent years, partly
because dividends paid are tax deductible for the issuing institution? A) Cumulative preferred stock B) Noncumulative preferred stock C) Convertible preferred stock D) Trust preferred stock E) All of the above Answer: D

108. Even if individual banks are good at forecasting risk using VAR models there may still be
problems because losses may occur at several banks at the same time due to the interdependency of the financial system, magnifying each banks risk exposure and possibly causing a major problem for regulators. The book calls this: A) Systematic risk B) Operational risk C) Credit risk D) Market risk E) Liquidity risk Answer: A

109. There are three pillars of Basel II. One of them wants to make market discipline a powerful force
compelling risky banks to lower their risk exposure. What does Basel II want to do to make this happen? A) Require minimum capital requirement based on the banks own evaluation of its risk B) Require greater public disclosure of each banks true financial condition C) Expand the risks to be evaluated to include credit risk, market risk and operational risk D) Require supervisory review of each banks risk evaluation procedures E) All of the above Answer: B

110. A bank has capital to risk weighted assets of 11.5%, Tier 1 capital to risk weighted assets of 7.2%
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and a leverage ratio of 5.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized Answer: A

111. A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 5%
and a leverage ratio of 4.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized Answer: B

112. A bank has capital to risk weighted assets of 9.2%, Tier 1 capital to risk weighted assets of 4.5%
and a leverage ratio of 3.7%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized Answer: C

113.

A bank has capital to risk weighted assets of 5.5%, Tier 1 capital to risk weighted assets of 2.8% and a leverage ratio of 2.6%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized Answer: D

114.

A bank has capital to risk weighted assets of 1.8%. What type of bank is this? A) Well capitalized B) Adequately capitalized C) Undercapitalized D) Significantly undercapitalized E) Critically undercapitalized Answer: E

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115.

Which of the following is not a weakness of Basel I risk-based capital standards? They ignore interest rate risk They ignore changes in value due to currency value changes They ignore changes in value due to commodity price changes They ignore credit risk They ignore the market value Answer: D

A) B) C) D) E)

116. A bank has decided to retain more of their earnings, moving their retention ratio from 40% to
70%. What way of meeting their capital needs is the bank taking? A) Changing their dividend policy B) Issuing common stock C) Issuing preferred stock D) Issuing subordinated notes and debentures E) Selling assets and leasing facilities Answer: A

117. The First National Bank of Tucson has determined that the value of their property in Tucson has
tripled in the last three years. They decide that they would like to use this property to raise funds and will rent space from the new owners of the building. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments Answer: D

118. The Second National Bank of Lincoln has decided that to raise funds it is going to issue new
common equity through a pre-emptive rights offering so that current owners will not have that ownership diluted. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments Answer: A

119. The Third State Bank of Denton has decided to issue stock through a trust company and borrow
the funds from the trust company. This stock pays a fixed dividend and because of the way the stock has been issued it is tax deductible. What way of meeting their capital needs in the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures
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D) Selling assets and leasing facilities E) Swapping stock for debt instruments Answer: B

120. The Northwest Bank of Charlotte has decided to issue new securities that have five years to
maturity that have claims to assets that follow the claims of depositors. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments Answer: C

121.

Why do regulators prefer higher capital requirements? A) It justifies the existence of regulatory agencies B) It better protects the deposit insurance fund C) It enhances bank asset quality D) It decreases bank profitability E) It increases bank leverage Answer: B

122.

Why do banks generally prefer lower capital requirements? To minimize the impact shareholders have on management decisions To increase the influence of bank regulators To increase a banks return on equity To increase depositor protection To maximize operating leverage Answer: C

A) B) C) D) E)

123. A bank has issued $5,000,000 in long term debt and since that time interest rates have risen so
that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides to issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way of meeting their capital needs is the bank taking? A) Issuing common stock B) Issuing preferred stock C) Issuing subordinated notes and debentures D) Selling assets and leasing facilities E) Swapping stock for debt instruments Answer: E

124. Which of the following are the reasons for having the government set capital standards for

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financial institutions as opposed to letting the private marketplace set those standards? A) To preserve public confidence B) To alleviate market imperfections arising from the mispriced effect of systemic failures C) To limit losses to the federal government arising from deposit insurance claims D) All of the above E) None of the above Answer: D

125. The following are the advantages of Basel II over Basel I except: A) Uses bifurcated system that takes into consideration differences in risk exposures by bank
size Provides for greater sensitivity to arbitrage and financial innovations Applies the same minimum capital requirements to all banks Broadens the types of risk considered All of the above are the advantages of using Basel II Answer: C

B) C) D) E)

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