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Chapter 17 Homework Questions Record answers on the answer sheet. 1. Nontransaction deposits are a. deposits that are checkable deposits on which banks do not pay interest. b. deposits that typically pay a lower interest payment. c. deposits that cannot be immediately withdrawn, and which typically pay higher interest. d. deposits that can be immediately withdrawn. 2. Borrowings are a. money borrowed by the bank through reverse repurchase agreements. b. money borrowed by the bank in the federal funds market. c. money borrowed by the bank through discount loans from the Federal Reserve System. d. All of the above. 3. Reserves are a. the difference between the value of a bank's assets and a bank's liabilities. b. cash on hand in a bank, including deposits with other banks. c. those bank assets consisting of vault cash plus bank deposits with the Federal Reserve. d. money the Fed requires banks to hold against demand deposits. 4. Bank capital is a. a bank's asset consisting of vault cash plus bank deposits with the Federal Reserve. b. the value of a bank not directly attributable to its assets and liabilities. c. cash on hand in a bank, including deposits with other banks. d. the bank's net worth, or the difference between the value of a bank's assets and a bank's liabilities. 5. What is the difference between a bank's return on assets (ROA) and its return on equity (ROE)? a. A bank's return on assets (ROA) is the ratio of a bank's gross profit to the value of its assets. Return on equity (ROE) is the ratio of the value of a bank's after-tax profit to the value of its capital. b. A bank's return on assets (ROA) is the ratio of a bank's after-tax profit to the value of its assets. Return on equity (ROE) is the ratio of the value of a bank's after-tax profit to the value of its capital. c. A bank's return on assets (ROA) is the ratio of a bank's after-tax profit to the value of its assets. Return on equity (ROE) is the ratio of the value of a bank's gross profit to the value of its capital. d. A bank's return on assets (ROA) is the ratio of a bank's gross profit to the value of its assets. Return on equity (ROE) is the ratio of the value of a bank's gross profit to the value of its capital. 6. How are a bank's return on assets (ROA) and its return on equity (ROE) related? a. ROE is equal to ROA multiplied by the ratio of bank capital to bank assets. b. ROE is equal to ROA multiplied by the ratio of bank assets to bank capital. c. ROA is equal to ROE multiplied by the ratio of bank assets to bank capital. d. ROA is equal to ROE divided by the ratio of bank capital to bank assets. 7. Bank leverage is a. the ratio of the value of a bank's liabilities to the value of its capital. b. the ratio of the value of a bank's liabilities to the value of its assets. c. the ratio of the value of a bank's assets to the value of its capital. d. the ratio of the value of a bank's capital to the value of its assets. 8. How is bank leverage related to a bank's ROE? a. Leverage can diminish ROE. b. Bank leverage and ROE are not related at all. c. Leverage can magnify ROE. d. Bank leverage and ROE are the same measures. 9. Why might the managers of a bank want the bank to be highly leveraged? a. Managers of the bank make bonuses on quarterly performance of the company and on its stock, which gives them an incentive to take high risks and keep the banks highly leveraged to increase ROE. b. Managers want the bank to be highly leveraged in order to minimize operational risk. c. Managers want the bank to be highly leveraged in order to minimize counter-party risk. d. Managers of the bank make bonuses on quarterly performance of the company and on its stock, which gives them an incentive to take high risks and keep the banks highly leveraged to increase ROA. 10. Why might the bank's shareholders want the bank to be less highly leveraged? a. Shareholders want to increase their dividend payments, which are correlated with low leverage. b. Shareholders want the bank to be less leveraged because low leverage implies that the size of bank's assets is high. c. Shareholders want the bank to be less leveraged in order to maximize the risk and profit. d. Shareholders who have invested in the company often want the best return over 10-20 years, and want the bank to take less risk which would typically be associated with less leverage. 11. Suppose that the value of a bank's assets is $35 billion and the value of its liabilities is $32 billion. If the bank has ROA = 2%, then what is its ROE? ROE= _______%. (Enter your answer rounded to two decimal places). 12. i. Suppose First National Bank has S200 million in assets and S20 million in equity capital. If First National has a 2% ROA, what is its ROE? ROE= _______%. (Enter your answer rounded to two decimal places). ii. Now suppose First National's equity capital declines to $10 million, while its assets and ROA are unchanged. What is First National's ROE now? ROE= _______%. (Enter your answer rounded to two decimal places) 13. Liquidity risk is a. the risk associated with the change in value of assets because of an increase or decrease in interest rates. b. the possibility that depositors may collectively decide to withdraw more funds than the bank has on hand. c. the risk that banks face from an inadequate capital to assets ratio. d. the risk that borrowers might default on their loans. 14. How do banks manage liquidity risk? (Circle all that apply.) a. Banks can increase their lending to cover liquidity risk. b. Banks manage this risk by keeping some funds very liquid, such as a reverse repurchase agreement. c. Banks can increase their borrowings to cover liquidity risk. d. Banks manage this risk by keeping some funds very liquid, such as in the Federal Funds market. 15. Credit risk is a. the risk that borrowers might default on their loans. b. the risk that banks face from an inadequate capital to assets ratio. c. the possibility that depositors may collectively decide to withdraw more funds than the bank has on hand. d. the risk associated with the change in value of assets because of an increase or decrease in interest rates. 16. How do banks manage credit risk? a. Banks can manage risk by creating long-term business relationships through which the bank would acquire information about a creditor. b. Banks can manage credit risk by performing credit risk analysis, requiring borrowers to put up collateral and using credit rationing. c. Banks can manage credit risk by diversifying their assets. d. All answers are correct. 17. In general, banks make profits by selling _________liabilities and buying _________assets. a. risky; risk -free c. illiquid; liquid b. long - term; shorter-term d. short- term; longer -term 18. A bank is insolvent when a. its capital exceeds its liabilities. b. its assets exceed its liabilities. c. its liabilities exceed its assets. d. its assets increase in value. 19. Holding large amounts of bank capital helps prevent bank failures because a. it makes it easier to call in loans. b. it means that the bank has a higher income. c. it makes loans easier to sell. d. it can be used to absorb the losses resulting from bad loans. 20. Bank capital has both benefits and costs for the bank owners. Higher bank capital _________ the likelihood of bankruptcy, but higher bank capital _________ the return on equity for a given return on assets. a. reduces; increases c. increases; reduces b. increases; increases d. reduces; reduces