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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?

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You might employ the concept of too-big-...

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A bank run involves:


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.

E) A) and B)
F) B) and D)

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

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The lender of last resort function provi...

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


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.

E) B) and C)
F) All of the above

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


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.

E) C) and D)
F) A) and B)

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


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.

E) B) and C)
F) A) and C)

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


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.

E) None of the above
F) A) and B)

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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?

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The insurance company takes premiums fro...

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

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The Basel Accord of 1988 was an attempt ...

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


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.

E) A) and B)
F) B) and C)

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

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The CAMELS criteria are: Capital adequac...

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

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A bank that is insolvent is in a positio...

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

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Depository institutions receive this att...

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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:


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.

E) All of the above
F) None of the above

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


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.

E) A) and B)
F) C) and D)

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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.

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It does make a difference. Under the pay...

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

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Deposit insurance creates moral hazard f...

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


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.

E) All of the above
F) B) and C)

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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?


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.

E) B) and D)
F) B) and C)

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Bank panics have often begun as a result of:


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

E) A) and C)
F) B) and C)

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