G345 EXAM 2 CHAPTERS 8-15 QUESTIONS AND
ANSWERS
A bank finds that its ROE is too low because it has too much bank capital. Which of the
following will NOT raise its ROE? - Answers - ROE = Net Profit After Taxes / Equity
Capital
The bank can sell part of its holding of securities and hold more excess reserves.
Large-denomination CDs are __________, so that like a bond, they have a __________
degree of liquidity and can be sold in secondary markets. - Answers - negotiable;
greater
Using the T-accounts of the First National Bank and the Second National Bank,
describe what happens when Jane Brown writes a check for $70 on her account at the
First National Bank to pay her friend Joe Green, who in turn deposits that check in his
account at the Second National Bank. - Answers - First National Bank:
(70) leaves reserves and (70) leaves checkable deposits
Second National Bank
70 goes into reserves and 70 goes into checkable deposits
NewBank started its first day of operations with $132 million in capital. A total of $105
million in checkable deposits received. The bank makes a $27 million commercial loan
and another $23 million in mortgage loans. The required reserve ration is 7.5%.
Complete the bank's balance sheet. - Answers - Assets:
Required Reserves = $7.874 million
Excess Reserves = $179.125 million
Loans = $50 million
Liabilities:
Checkable Deposits = $105 million
Bank Capital = $132 million
If a bank experiences a deposit outflow of $50 million with a required reserve ratio on
deposits of 10%, which balance sheet would the bank rather have initially: Balance
Sheet A or Balance Sheet B? Why? - Answers - Balance Sheet B because the excess
reserves are adequate to cover the deposit outflow without the bank needing to alter its
balance sheet.
, If a bank you own has no excess reserves and a sound customer comes in asking for a
loan, should you automatically turn the customer down, explaining that you don't have
any excess reserves to lend out? Why or why not? What options are available for you to
provide the funds your customer needs? - Answers - No. There are several ways that
reserves can be acquired. For example, the bank can borrow at the discount window or
in the federal funds market, or it can acquire funds by issuing negotiable CDs.
If a bank doubles the amount if its capital and ROA stays constant, what will happen to
ROE? - Answers - ROA = Net Profit After Taxes / Assets
ROE = Net Profit After Taxes / Equity Capital
EM = Assets / Equity Capital
ROE = ROA x EM
Given ROA, if bank capital doubles, then ROE will fall by half
X-Bank reported an ROW of 16% and an ROA of 0.85%. What is the equity multiplier?
How well capitalized is the bank? - Answers - EM = Assets / Equity Capital
ROE = ROA x EM
Equity Multiplier = 18.82
This is well-capitalized bank because its equity/asset ratio exceeds the minimum
required level.
A bank almost always insists that the firm it lends to keep compensating balances at the
bank. Why? Check all that apply. - Answers - Compensating balances help establish
long-term customer relationships, which make it easier for the bank to collect
information about prospective borrowers, thus reducing the adverse selection problem.
Compensating balances help the bank monitor the activities of a borrowing firm, which
reduces the moral hazard problem.
Compensating balances can act as collateral.
"Because diversification is a desirable strategy for avoiding risk, it never makes sense
for a bank to specialize in making specific types of loans." Is this statement true of
false? - Answers - False. A bank may have developed expertise in screening and
monitoring a particular type of loan, thus improving its ability to handle problems of
adverse selection and moral hazard.
ANSWERS
A bank finds that its ROE is too low because it has too much bank capital. Which of the
following will NOT raise its ROE? - Answers - ROE = Net Profit After Taxes / Equity
Capital
The bank can sell part of its holding of securities and hold more excess reserves.
Large-denomination CDs are __________, so that like a bond, they have a __________
degree of liquidity and can be sold in secondary markets. - Answers - negotiable;
greater
Using the T-accounts of the First National Bank and the Second National Bank,
describe what happens when Jane Brown writes a check for $70 on her account at the
First National Bank to pay her friend Joe Green, who in turn deposits that check in his
account at the Second National Bank. - Answers - First National Bank:
(70) leaves reserves and (70) leaves checkable deposits
Second National Bank
70 goes into reserves and 70 goes into checkable deposits
NewBank started its first day of operations with $132 million in capital. A total of $105
million in checkable deposits received. The bank makes a $27 million commercial loan
and another $23 million in mortgage loans. The required reserve ration is 7.5%.
Complete the bank's balance sheet. - Answers - Assets:
Required Reserves = $7.874 million
Excess Reserves = $179.125 million
Loans = $50 million
Liabilities:
Checkable Deposits = $105 million
Bank Capital = $132 million
If a bank experiences a deposit outflow of $50 million with a required reserve ratio on
deposits of 10%, which balance sheet would the bank rather have initially: Balance
Sheet A or Balance Sheet B? Why? - Answers - Balance Sheet B because the excess
reserves are adequate to cover the deposit outflow without the bank needing to alter its
balance sheet.
, If a bank you own has no excess reserves and a sound customer comes in asking for a
loan, should you automatically turn the customer down, explaining that you don't have
any excess reserves to lend out? Why or why not? What options are available for you to
provide the funds your customer needs? - Answers - No. There are several ways that
reserves can be acquired. For example, the bank can borrow at the discount window or
in the federal funds market, or it can acquire funds by issuing negotiable CDs.
If a bank doubles the amount if its capital and ROA stays constant, what will happen to
ROE? - Answers - ROA = Net Profit After Taxes / Assets
ROE = Net Profit After Taxes / Equity Capital
EM = Assets / Equity Capital
ROE = ROA x EM
Given ROA, if bank capital doubles, then ROE will fall by half
X-Bank reported an ROW of 16% and an ROA of 0.85%. What is the equity multiplier?
How well capitalized is the bank? - Answers - EM = Assets / Equity Capital
ROE = ROA x EM
Equity Multiplier = 18.82
This is well-capitalized bank because its equity/asset ratio exceeds the minimum
required level.
A bank almost always insists that the firm it lends to keep compensating balances at the
bank. Why? Check all that apply. - Answers - Compensating balances help establish
long-term customer relationships, which make it easier for the bank to collect
information about prospective borrowers, thus reducing the adverse selection problem.
Compensating balances help the bank monitor the activities of a borrowing firm, which
reduces the moral hazard problem.
Compensating balances can act as collateral.
"Because diversification is a desirable strategy for avoiding risk, it never makes sense
for a bank to specialize in making specific types of loans." Is this statement true of
false? - Answers - False. A bank may have developed expertise in screening and
monitoring a particular type of loan, thus improving its ability to handle problems of
adverse selection and moral hazard.
