Chapter 7.Pdf

410 Exam 2
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1.

53. A bank's GAP is defined as:
a. the dollar amount of rate-sensitive assets
divided by the dollar amount of
rate-sensitive liabilities.
b. the dollar amount of earning assets divided by
the dollar amount of total
liabilities.
c. the dollar amount of rate-sensitive assets minus
the dollar amount of ratesensitive
liabilities.
d. the dollar amount of rate-sensitive liabilities
minus the dollar amount of
rate-sensitive assets.
e. the dollar amount of earning assets times the
average liability interest rate.

Answer:
c

2.

According to the Federal Reserve's Functional
Cost and Profit Analysis, the least expensive
source of funds for a typical bank is:
a. certificates of deposit.
b. negotiable order of withdrawal accounts.
c. savings accounts.

d. demand deposit accounts.
e. federal funds purchased.

Answer:
d

3.

All of the following are considered transaction
accounts except:
a. negotiable orders of withdrawal.
b. automatic transfer from savings.
c. demand deposit accounts.
d. small time deposits.
e. all of the above are considered transaction
accounts.

Answer:
d

4.

An asset would normally be classified as ratesensitive if:
a. it matures during the examined time period.
b. it represents a partial principal payment.
c. the outstanding principal on a loan can be repriced when the base rate changes.
d. All of the above.
e. a. and c. only

Answer:

d

5.

A bank estimates that their average balance
on demand deposit accounts is $2,500, net
of float. Each account costs the bank $175
per year in processing costs. The bank
collects an average of $5 per month on each
account in service charges. Assume reserve
requirements are 10%.
If the bank can invest the deposit balance
(after adjusting for reserve requirements) at
7%, what is the break-even deposit balance?
a. $3,777
b. $3,500
c. $2,500
d. $1,825
e. $1,479

Answer: d
Net Cost =
(Non-Interest
Expense Non-Interest
Income)/[Avg
Balance * (1RR)]
7% = ($175 $60)/[Avg
Balance *
(1-.10)]
7% =

$115/(Avg
Balance * .9)
.9Average
Balance =
$115/.07
Average
Balance =
($115/.07)/.9 =
$1,825.40

6.

A bank estimates that their average balance
on demand deposit accounts is $2,500, net
of float. Each account costs the bank $175
per year in processing costs. The bank
collects an average of $5 per month on each
account in service charges. Assume reserve
requirements are 10%.
What is the net cost of an average demand
deposit?
a. 4.5%
b. 4.8%
c. 5.1%
d. 6.8%
e. 7.0%

Answer: c
Net Cost =
(Non-Interest

Expense Non-Interest
Income)/[Avg
Balance * (1RR)]
Annual NonInterest
Income = 12 *
$5 = $60
Net Cost =
($175 $60)/[$2,500
* (1-.10)] =
5.1%


7.

8.

9.

A bank has $100 million in earning assets,
a net interest margin of 5%, and a 1-year
cumulative GAP of $10 million. Interest
rates are expected to increase by 2%. If
the bank does not want net interest
income to fall by more than 25% during
the next year, how large can the
cumulative GAP be to achieve the
allowable change in net interest income.
a. $2 million
b. $12 million
c. $15 million

d. $50 million
e. $62.5 million

Answer: e
Target
Gap/Earning
Assets =
(Allowable %
change in NIM)
(Expected
NIM)/(Expected
% change in
interest rates)
Target
Gap/$100 =
(25%*5%/2%)
Target
Gap/$100 =
0.625
Target Gap =
$62.5

A bank is going to issue $10,000,000 in 5year par value bonds that pay a 5% annual
coupon. The bank must pay .7% of the
face value in floatation costs. What is the
bank's effective cost of borrowing?
a. 5.0%
b. 5.2%
c. 5.7%
d. 6.2%

e. 7.5%

Answer: b
Financial
calculator
solution
FV= 10,000,000
PMT =
10,000,000 *
5% = 500,000
N=5
PV =
-10,000,000 *
(1-.007) =
-9,930,000
I = ? = 5.2%

A bank's cumulative GAP will always be:
a. greater than the periodic GAP.
b. less than the periodic GAP.
c. positive.
d. negative.
e. the sum of the interim periodic GAPs.

Answer: e

10.

A bank's GAP is defined as:
a. the dollar amount of rate-sensitive assets

divided by the dollar amount of rate-sensitive
liabilities.
b. the dollar amount of earning assets divided by
the dollar amount of total liabilities.
c. the dollar amount of rate-sensitive assets
minus the dollar amount of rate-sensitive
liabilities.
d. the dollar amount of rate-sensitive liabilities
minus the dollar amount of rate-sensitive assets.
e. the dollar amount of earning assets times the
average liability interest rate.

Answer:
c

11.

A bank's periodic GAP:
a. is defined as the dollar amount of ratesensitive assets divided by the dollar amount of
rate-sensitive liabilities.
b. is defined as the dollar amount of earning
assets divided by the dollar amount of total
liabilities.
c. compares rate-sensitive assets with ratesensitive liabilities across all time buckets.
d. compares rate-sensitive assets with ratesensitive liabilities across a single time bucket.
compares the dollar amount of earning assets
times the average liability interest rate

Answer:
d

12.

Banks prefer money market deposit accounts to
demand deposits for all of the following reasons
except:
a. required reserves on money market deposit
accounts are lower.
b. money market deposit accounts are less
interest rate sensitive than demand deposit
accounts.
c. demand deposit accounts have fewer checks
written each month.
d. average demand deposit balances are higher
than money market deposit account balances.
e. money market deposits accounts are not
limited to the $100,000 deposit insurance limit
like demand deposit accounts.

Answer:
b


13.

A bank's stock is currently trading at $50
and currently pays a divided of $6 per year.
The average forecast is that next year's
dividend will be $6.42. Assuming a 34%
percent corporate tax bracket, what is the

pre-tax expected return on equity?
a. 12.8%
b. 19.8%
c. 30.1%
d. 28.8%
e. 58.2%

Answer: b
ke = D1/P + g
g = D1/D0 - 1
= 6.42/6.00 1 = .07
ke =
$6.42/$50.00
+ .07 = .1984
= 19.8%

14.

A bank with a negative GAP is said to be
liability sensitive.

Answer: True

A bond has a Macaulay's duration of 10.7
years. If rates fall from 7% to 6%,
the bonds price will:
a. increase by approximately 1%.
b. decrease by approximately 1%.
c. increase by approximately 10%.
d. decrease by approximately 10%.

e. Not enough information is given to
answer the question.

Answer: c
Modified
Duration =
Macaulay's
duration/(1+i)
= 10.7/1.07 =
10
% Change in
Price = Modified
duration
Change in
interest
rates = 10 1%
= 10%

A brokered deposit would most likely take
which of the following forms?
a. Demand deposit
b. NOW account
c. Jumbo CDs
d. Savings account
e. Small time deposit

Answer: c

17.

Core deposits are affected by all of the
following except:
a. location.
b. availability.
c. volatile liabilities.
d. service charges.
e. Core deposits are affected by all of the
above

Answer: c

18.

Discuss the difference between a bank's
periodic and cumulative GAP.

...

19.

Discuss the similarities and differences
between earnings sensitivity analysis and
income statement GAP analysis.

...

20.

Discuss three factors that affect net
interest income.

...

15.

16.

21.

Duration gap analysis:
a. applies he the concept of duration to the
bank's entire balance sheet.
b. applies he the concept of duration to the
bank's entire income statement.
c. applies he the concept of duration to the
bank's retained earnings.
d. indicates the difference in the GAP in the time
it takes to collect on loan payments versus the
time to attract deposits.
e. estimates when embedded options will be
exercised.

Answer:
a

22.

Earnings-at-risk:
a. considers only interest rate "shocks."
b. is only an effective measure for 90 day

intervals or less.
c. examines the change in asset composition,
given a change in bank liabilities.
d. examines the variation in net interest income
associated with various changes in interest rates.
e. None of the above.

Answer:
d

23.

The earnings change ratio:
a. is defined as yield on rate-sensitive liabilities
divided by the yield on rate-sensitive assets.
b. measures how the yield on an asset is assumed
to change given a 1% change in some base rate.
c. measures the change in net interest income
for a given change in some base rate.
d. All of the above.
e. a. and c.

Answer:
b

24.

Earnings sensitivity analysis differs from static
GAP analysis by:
a. looking at a wide range of interest rate

environments.
b. using perfect interest rate forecasts.
c. calculating a change in net interest income
given a change in interest rates.
d. Earnings sensitivity analysis differs from static
GAP analysis in all of the above ways.
e. Earnings sensitivity analysis and static GAP
analysis do not differ. They are different names
for the exact same analysis.

Answer:
a


25.

Earnings sensitivity analysis does not consider:
a. changes in interest rates.
b. changes in the volume of rate-sensitive assets
due to a change in interest rates.
c. changes in the volume of fixed-rate liabilities
due to a change in interest rates.
d. mortgage prepayments.
e. Earnings sensitivity analysis considers all of
the above.

Answer:
e

26.

Effective duration:
a. estimates when embedded options will be
used.
b. directly indicates how much the price of a
security will change given a change in interest
rates.
c. is always greater than maturity.
d. is a weighted average of the time until cash
flows are received.
e. All of the above

Answer:
a

27.

Federal funds are:
a. secured bank loans from the discount window.
b. unsecured short-term loans that are settled in
immediately available funds.
c. secured inter-bank loans of reserves.
d. secured core deposits.
e. secured overnight loans.

Answer:
b

28.

The GAP ratio:
a. is always greater than one for bank's with a
negative periodic GAP.
b. is equal to the volume of rate-sensitive
liabilities times the volume of rate-sensitive
assets.
c. is equal to the volume of rate-sensitive
liabilities divided by the volume of rate-sensitive
assets.
d. is equal to the volume of rate-sensitive assets
divided by the volume of rate-sensitive liabilities.
e. is always less than one for bank's with a
positive cumulative GAP.

Answer:
d

29.

A GAP ratio of less than one is consistent with a
negative gap.

True

30.

High interest rates in the late 1990's on large
CDs lead to the introduction of:
a. zero coupon CDs.
b. variable rate CDs.

c. callable CDs.
d. stock market indexed CDs.
e. immediately available funds CDs

Answer:
c

31.

If a bank expects interest rates to decrease in
the coming year, it should:
a. increase its GAP.
b. issue long-term subordinated debt today.
c. increase the rates paid on long-term
deposits.
d. issue more variable rate loans.
e. become more liability sensitive.

Answer: e

32.

If a bank has a positive GAP, a decrease in
interest rates will cause interest
income to __________, interest expense
to__________, and net interest
income to __________.
a. increase, increase, increase
b. increase, decrease, increase
c. increase, increase, decrease

d. decrease, decrease, decrease
e. decrease, increase, increase

Answer: d

33.

If rate-sensitive assets equal $500 million and
rate-sensitive liabilities equals
$400 million, what is the expected change in
net interest income if rates
increase by 1%?
a. Net interest income will increase by $1
million.
b. Net interest income will fall by $1 million.
c. Net interest income will increase by $10
million.
d. Net interest income will fall by $10 million.
e. Net interest income will be unchanged.

Answer: a
($500
million $400
million) *
1% =
$1,000,000

34.

If rate-sensitive assets equal $500 million and

rate-sensitive liabilities equals $400 million,
what is the expected change in net interest
income if rates increase by 1%?
a. Net interest income will increase by $1
million.
b. Net interest income will fall by $1 million.
c. Net interest income will increase by $10
million.
d. Net interest income will fall by $10 million.
e. None of the above.

Answer: a
($500
million $400
million) *
1% =
$1,000,000

35.

. If the yield curve is inverted, a portfolio
manager can take advantage of this by:
a. pricing more deposits on a fixed-rate basis.
b. buying more long-term securities
c. making variable-rate, callable loans.
d. increasing the number of rate-sensitive
assets.
e. All of the above.

Answer: b

36.

If you deposit $1,000 into a certificate of
deposit that quotes you a 5.5% APY, how much
will you have at the end of 1 year?
a. $1,050.00
b. $1,055.00
c. $1,550.00
d. $1,005.50
e. None of the above.

Answer:
b
FV = PV
* (1+i)n
$1,000 *
1.0551 =
$1,055.00

37.

In 1961, Citicorp introduced the first:
a. NOW account.
b. marketable certificate of deposit.
c. MMDA.
d. subordinated debenture.
e. zero coupon bond.

Answer:
b

Income statement GAP considers:
a. changes in interest rates.
b. changes in the volume of rate-sensitive
assets due to a change in interest rates.
c. changes in the volume of fix-rate liabilities
due to a change in interest rates.
d. mortgage prepayments.
e. Income statement GAP considers all of the
above.

Answer:
a

In regards to repurchase agreements, the
margin is:
a. a good faith deposit.
b. a loan against the repurchase agreement.
c. a risk-free guarantee.
d. the difference between the market value of
the collateral and the amount of the loan.
e. all of the above.

Answer:
d

Interest costs do not equal the effective cost
of bank liabilities because:

a. reserve requirements increase the effective
cost.
b. there may be substantial processing costs.
c. service charges may offset a portion of noninterest expense.
d. all of the above.
e. a. and c.

Answer:
d

Interest rate risk:
a. varies inversely with a bank's GAP.
b. can be measured by the volatility of a bank's
net interest income given changes in the level
of interest rates.
c. can be eliminated by matching fixed rate
assets with variable rate liabilities.
d. rarely has an impact on bank earnings.
e. All of the above

Answer:
b

38.

39.

40.

41.

42.

Keeping all other factors constant, banks can
reduce the volatility of net interest income by:
a. adjusting the dollar amount of rate-sensitive
assets.
b. adjusting the dollar amount of fixed-rate
liabilities.
c. using interest rate swaps.
d. Bank can reduce volatility of net interest
income by doing all of the above.
e. a. and c. only

Answer:
e

43.

Liability management decisions determines all of
the following except:
a. interest expense on borrowed funds.
b. check handling costs.
c. personnel costs.
d. fee income.
e. loan rates.

Answer:
e

44.

Macaulay's duration:
a. is a weighted average of the time until cash
flows are received.
b. is always greater than maturity.
c. is never equal to maturity.
d. directly indicates how much the price of a
security will change given a change in interest
rates.
e. estimates when embedded options will be
used.

Answer:
a

45.

Modified duration:
a. estimates when embedded options will be
used.
b. directly indicates how much the price of a
security will change given a change in interest
rates.
c. is always greater than maturity.
d. All of the above
e. a. and b.

Answer:
b

46.

Non-earning assets are classified as ratesensitive assets for GAP analysis purposes.

False

47.

On-us debits are:
a. checks drawn on any bank other than the bank
into which it was deposited.
b. the accounting transaction for selling fed
funds.
c. discount window loans.
d. illegal.
e. checks drawn on a bank's own customer's
account.

Answer:
e


48.

49.

A primary difference between "intelligent" smart
cards and "memory" smart cards is that:
a. intelligent smart cards can store information,

while memory smart cards cannot.
b. intelligent smart cards are larger than memory
smart cards.
c. intelligent smart cards contain a microchip,
while memory smart cards do not.
d. intelligent smart cards are "digital", while
memory smart cards are not.
e. intelligent smart cards are used in ACH
transactions, while memory smart cards are not.

Answer:
c

Put the following steps for conducting a Static
GAP analysis in the proper chronological order.
I. Forecast changes in net interest income for a
variety of interest rate scenarios.
II. Select the sequential time intervals for
determining when assets and liabilities are ratesensitive.
III. Group assets and liabilities into time
"buckets."
IV. Develop interest rate forecasts.

Answer:
e

a. I, II, III, IV
b. IV, I, III, II
c. IV, I, II, III
d. II, III, IV, I

e. IV, II, III, I
50.

51.

Repurchase agreements are:
a. riskier than fed funds loans.
b. unsecured short-term loans.
c. secured overnight loans.
d. secured loans of reserves.
e. secured Fed funds loans.

Answer:
c

A shift from core deposits to non-core deposits
will:
a. always increase the amount of fixed rate
assets.
b. always increase the amount of rate-sensitive
assets.
c. generally increase the amount of non-earning
assets.
d. generally reduce net interest income.
e. b. and d.

Answer:
d

52.

Small time deposits are characterized by all of
the following except:
a. they have denominations are less than
$100,000.
b. they have substantial interest penalties for
early withdrawal.
c. banks can pay market interest rates on them.
d. there is a substantial interest penalty for early
withdrawal.
e. they have a minimum maturity of 3 days.

Answer:
e

53.

Static GAP analysis focuses on managing net
interest income in the short-run.

Answer:
True

54.

There is a constant relationship between
changes in a bank's portfolio mix and net interest
income.

False

55.

To decrease liability sensitivity, a bank can:
a. buy longer-term securities.
b. attract more non-core deposits.
c. increase the number of floating rate loans.
d. pay premiums on longer-term deposits.
e. All of the above.

Answer:
d

56.

To increase asset sensitivity, a bank can:
a. buy longer-term securities.
b. pay premiums on subordinated debt.
c. shorten loan maturities.
d. make more fixed rate loans.
e. All of the above.

Answer:
c

57.

What are the advantages and disadvantages of
static GAP analysis?

...

58.

. What are the weaknesses of using static GAP
analysis versus duration gap
analysis?
a. Static GAP ignores the time value of money.
b. Static GAP ignores the cumulative impact of
interest rate changes on a bank's
risk profile.
c. Static GAP does not proscribe the treatment
of demand deposits.
d. All of the above are weaknesses of using
static GAP analysis versus duration
gap analysis.
e. a.and b.

Answer:
d


59.

60.

61.

62.

63.

64.

What does a bank's duration gap measure?
a. The duration of short-term buckets minus the
duration of long-term
buckets.
b. The duration of the bank's assets minus the
duration of its liabilities.
c. The duration of all rate-sensitive assets minus
the duration of rate-sensitive
liabilities.
d. The duration of the bank's liabilities minus the
duration of its assets.
e. The duration of all rate-sensitive liabilities
minus the duration of ratesensitive
assets.

Answer:
b

What type of GAP analysis directly measures a
bank's net interest sensitivity through the last
day of the analysis period?
a. Earnings
b. Net Income
c. Maturity
d. Periodic
e. Cumulative

Answer:
e

When is interest rate risk for a bank greatest?
a. When interest rates are volatile.
b. When interest rates are stable.
c. When inflation is high.
d. When inflation is low.
e. When loan defaults are high.

Answer:
a

When is interest rate risk for a bank greatest?
a. When interest rates are volatile.
b. When interest rates are stable.
c. When inflation is high.
d. When inflation is low.
e. When loan defaults are high.

Answer:
a

When the FDIC provides assistance in acquiring a
failed bank, which option is the FDIC using in
handling the failing institution?
a. Purchase and assumption
b. Open bank assistance
c. Insured deposit assumption or transfer

d. Bridge bank
e. Payout option

Answer:
b

Which beta for a bank stock would indicate the
greatest amount of market risk?
a. -2.5
b. -1.0
c. 0.0
d. 1.5
e. 2.0

Answer:
a

65.

. Which of the following allows a security's cash
flows to change when interest rates change?
a. Modified duration
b. Macaulay's duration
c. Effective duration
d. Balance sheet duration
e. Income statement duration

Answer:
c

66.

Which of the following are likely to occur when
interest rates rise sharply?
a. Fixed-rate loans are pre-paid.
b. Bonds are called.
c. Deposits are withdrawn early.
d. All of the above occur when interest rates rise
sharply.
e. a. and b.

Answer:
c

67.

Which of the following can a bank use as
collateral for borrowing from the Federal Home
Loan Bank Board?
a. Real estate loans
b. Treasury securities
c. Negotiable CDs
d. Credit card receivables
e. Repurchase agreement

Answer:
a

68.

Which of the following does not affect net
interest income?
a. Changes in the level of interest rates.
b. Changes in the volume of earning assets.
c. Changes in the portfolio mix of earning assets.
d. The yield curve changing from upward sloping
to inverted.
e. All of the above affect net interest income.

Answer:
e

69.

Which of the following does not have an
embedded option?
a. A callable Federal Home Loan Bank bond.
b. Demand deposit accounts.
c. A home mortgage loan.
d. An auto loan.
e. All of the above have embedded options.

Answer:
e

70.

Which of the following does not have an
embedded option?
a. A callable Wizard Home Loans bond.

b. Demand deposit accounts.
c. A home mortgage loan.
d. An auto loan.
e. All of the above have embedded options.

Answer:
e


71.

Which of the following Federal Reserve loans is
to help with systematic new loan demand?
a. Extended credit loans
b. Seasonal borrowing loans
c. Fed funds loans
d. Deposit insurance loans
e. Short-term adjustment loans

Answer:
e

72.

Which of the following is an advantage of static
GAP analysis?
a. Static GAP analysis considers the time value of
money.
b. Static GAP analysis indicates the specific
balance sheet items that are responsible for the

interest rate risk.
c. Static GAP analysis considers the cumulative
impact of interest rate changes on the bank's
position.
d. Static GAP analysis considers the embedded
options in loans, such as mortgage prepayments.
e. All of the above are advantages of static GAP
analysis.

Answer:
b

Which of the following is an example of
immediately available funds?
a. Deposits at the Federal Reserve
b. Stock market indexed CDs
c. Demand deposits
d. Money market deposit accounts
e. All of the above

Answer:
a

Which of the following is likely to have a
negative effective duration?
a. A high coupon, interest only mortgage-backed
security that is pre-paying at a high rate.
b. A low coupon Commonwealth Treasury bond.
c. Commonwealth Government Securities
purchased.

d. Demand deposits
e. None of the above can have a negative
effective duration.

Answer:
a

Which of the following is not a characteristic of
jumbo CDs?
a. They have a minimum maturity of 7 days.
b. Interest rates are quoted on a 365-day year.
c. They are generally issued at face value.
d. They are only insured up to $100,000 per
individual per institution.
e. All of the above are characteristics of jumbo
CDs

Answer:
b

73.

74.

75.

76.

Which of the following is not a disadvantage of
static GAP analysis?

a. Static GAP analysis depends on the
forecasted interest rates.
b. Static GAP analysis often considers demand
deposits as non-rate sensitive.
c. Static GAP analysis does not consider the
cumulative impact of interest rate changes on
the bank's position.
d. Static GAP analysis does not consider a
depositor's early withdrawal option.
e. All of the above are disadvantages of static
GAP analysis.

Answer:
c

77.

Which of the following is true regarding money
market deposit accounts (MMDAs)?
a. A maximum of three checks per month may be
written on a MMDA account.
b. The average check size on an MMDA account
is smaller than the average demand deposit
check size.
c. MMDAs are formally transaction accounts.
d. Required reserves on MMDAs are higher than
on demand deposit accounts.
e. Rates paid on MMDAs are generally higher
than rates on money market mutual funds.

Answer:
a

78.

Which of the following will cause a bank's 1-year
cumulative GAP to increase, everything else the
same.
a. An increase in 3-month loans and an
offsetting decrease in 6-month loans.
b. An increase in 3-month loans and an
offsetting increase in 3-month CDs.
c. A decrease in 3-month CD's and an offsetting
increase in 3-year CDs.
d. a. and c.
e. b. and c.

Answer:
c

79.

Which of the following would be an example of a
Eurodollar account?
a. A U.S. dollar denominated deposit held at a
Japanese bank.
b. A British pound denominated deposit held at a
New York bank.
c. A French franc denominated deposit held at a
Toronto bank.

d. A U.S. dollar denominated deposit held at a
Chicago bank.
e. A EMU euro denominated deposit held at a
London bank.

Answer:
a


80.

Which of the following would not be considered "hot money"?
a. Jumbo CDs
b. Fed funds purchased
c. Eurodollar time deposits
d. Retail demand deposits
e. Repurchase agreements

Answer: d

81.

With "relationship pricing":
a. banks unbundle services and charge separate prices for each.
b. service charges decline with larger customer deposit balances.
c. interest rates paid on deposit accounts decreases with customer deposit balances.
d. large depositors pay the highest fees.small depositors receive the highest interest rates

Answer: b