Money and Banking Exam 2

If borrowers with the most risky investment projects are more likely to seek bank loans as compared to those borrowers with the safest investment? projects, banks are said to face the problem? of:

Adverse Selection.

Which of the following is not an asset on a? bank's balance? sheet?

Checkable Deposits.

Risk that is related to the uncertainty about future? interest-rate movements is? called:

Interest-Rate Risk.

?Large-denomination CDs are? ________, so that like a? bond, they have a? ________ degree of liquidity and can be sold in secondary markets.

negotiable; greater

Which of the following is a main responsibility of the bank? manager?

Maintaining reserves at a level to minimize the cost to the bank of deposit outflows.

Examples of off-balance-sheet activities include:

Selling loan portfolios.

Banks generate profits by earning higher returns on their? ____________ than they pay in interest on? _____________.

loans; deposits

Bank loans from the Federal Reserve are called? ________ and represent a source of new funds for financial intermediaries.

Discount Loans.

Gap analysis measures the difference between a bank's:

rate-sensitive liabilities and rate-sensitive assets.

The volume of checkable deposits relative to total bank liabilities has:

declined over time.

In order to reduce the? ________ problem in loan? markets, banks often insist on collateral from potential borrowers.

moral hazard.

Which of the following may not be used as a backup line of credit?


Transformation of assets can be accomplished by:

borrowing short and lending long.

The bank panic of 1907 led to the passage of the:

Federal Reserve Act of 1913.

Which of the following repealed the Glass-Steagall Act?

Gramm-Leach-Bliley Act.

?________ is the process of researching and developing new instruments to address the needs of investors and institutions in a rapidly changing financial climate.

Financial Engineering.

Deposits in European banks denominated in dollars for the purpose of international transactions are known as:


Which of the following is responsible for the supervision of savings and loan associations?

Federal Home Loan Bank System.

Bank holding companies that rival money center banks in size but are not located in money center cities are known as:

Superregional banks.

Which of the following is likely as a result of increased interest-rate volatility?

An increase in demand for financial services and products.

Currency in circulation that cannot be redeemed for gold is called:

Fiat money.

The presence of so many commercial banks in the United States is most likely the result of:

previous restrictions on branch banking.

The McFadden Act of 1927:

prohibited banks from branching across state lines.

What is the major difference between banking systems in the United States and Japan?

American banks are not allowed to hold substantial equity stakes in commercial firms, whereas Japanese banks can.

Why might American businesses want to hold Eurodollars?

Many commercial transactions and international contracts are denominated in dollars.

Uncertainty about future interest-rate volatility and returns is known as:

interest-rate risk.

The ability to use one common resource to provide different products and services is:

economies of scope.

Agreements to provide a standardized commodity to a buyer at a specific price on a specific date are:

futures contracts.

The _________ established the Office of the Comptroller of the Currency.

National Bank Act of 1863.

Thrift institutions include:

mutual savings banks.

Federally chartered banks are supervised by:

the Office of the Comptroller of the Currency.

In recent years, the tendency for central banks has been to:

increase independence.

The ability of a central bank to set monetary policy instruments is ________, while the ability of a central bank to set goals of monetary policy is _________.

instrument independence; goal independence.

The European System of Central Bank (ECSB) is similar to the Federal Reserve System in that:

it is structured such that the central banks for each country have a similar role to that of the Federal Reserve banks.

The public interest view of central bank behavior suggests that the objective of a bureaucracy is to maximize:

the public's welfare.

When the charter of the Second Bank of the United States expired in 1836:

there was no lender of last resort to provide reserves to the banking system.

Which of the following functions is not performed by any of the 12 regional Federal Reserve banks?

Setting interest rates payable on time deposits.

Eliminating the Fed's independence might lead to a more pronounced political business cycle because a politically exposed Fed would be more concerned with:

short-run objectives and thus be more likely to engage in expansionary policies designed to lower unemployment and interest rates before an election.

The Board of Governors of the Federal Reserve System:

1. establishes, within limits, reserve requirements 2. effectively sets the discount rate 3. sets margin requirements

The Federal Reserve is remarkably free from political pressure because

it has an independent source of revenue.

While the Fed enjoys a relativity high degree of independence for a government agency, it feels political pressure from the president and Congress because of the following except

the Fed must go to Congress each year operating revenues.

Critics of Fed independence argue that:

it is undemocratic to have monetary policy controlled by an elite group responsible to no one.

A dilemma challenging the existing structure of the European Central Bank (ECB) has been brought on by:

the possibility of expanding the membership in the Eurosystem.

The theory of bureaucratic behaviour when applied to the Fed helps to explain why the Fed:

is so secretive about the conduct of future monetary policy.

In England, the Chancellor of the Exchequer (the equivalent of the US Secretary of Treasury) sets the goal of monetary policy, a target for inflation. Thus, when compared to the Fed, the Bank of England has:

less goal independence.

Loans that the Fed makes to banks appear on the balance sheet as part of its __________, and deposits made by banks appear on the Fed's balance sheet as part of its _________.

assets; liabilities.

If the required reserve ratio on checkable deposits increases to 20%, how much multiple deposit creation will take place when reserves are increased by $100? Assume that banks do not hold any excess reserves and the public's holding of currency do not cha


A purchase of government bonds from the public by the Federal Reserve Bank:

increases the monetary base directly and may increase reserves.

The ratio of the money supply to the monetary base is called:

the money multiplier.

The monetary base is comprised of:

currency in circulation and reserves.

The Federal Reserve System is the _____ for the United States, which is defined as the government agency responsible for ________.

central bank; the conduct of monetary policy.

Traveler's checks have no reserve requirements and are included in the M1 measure of the money supply. When people travel during the summer and convert some of their checking account deposits into traveler's checks, what happens to the money supply? Why?

The money supply increases due to a shift from one component of the money supply (checkable deposits) with less multiple expansion to another (traveler's checks) with more.

Predict what till happen to the money supply if there is a sharp rise in the currency ratio.

The money supply falls.

The M2 money multiplier increases in value when the:

required reserve ratio decreases.

What do you predict would happen to the money supply if expected inflation suddenly increased?

The money supply will increase.

If the economy starts to boom and loan demand picks up, what do you predict will happen to the money supply?

The money supply will increase.

If a bank decides that it wants to hold $1 million of excess reserves, what effect will this have on checkable deposits in the banking system? Assume that the required reserve ratio on checkable deposits is 10% and the public's holdings of currency do not

Checkable deposits decline by $10 million.

The interest rate charged to banks that borrow funds from the Fed is known as the:

discount rate.

If Jane Brown closes her account at the First National Bank and uses the money instead to open a money market mutual fund account, what happens to M1? Why?

M1 does not change because the funds that go to the money market mutual fund are first deposited into the mutual fund's bank account.

Two primary assets of the Federal Reserve System are:

government securities and loans to commercial banks.

Under 100% reserve banking, the money multiplier will be:


The monetary base is affected by:

1) the Federal Reserve through open market operations, 2) the Federal Reserve through its extension of discount loans, and 3) float and Treasury deposits at the Federal Reserve.

The M2 money multiplier increases in value when the (2 answers):

time deposit ratio (t) and money market fund ratio (mm) increases.

As financial intermediaries, banks:

accept deposits and make loans.

The money multiplier when people hold currency and when banks hold excess reserves is _________________ the simple multiplier (the multiplier when currency held and excess reserves are both zero).

smaller than.

The Fed;s most commonly used means of changing the money supply is:

open market operations.

The zero-lower-bound problem:

occurs because people can always earn more from holding bonds than holding cash.

Credit easing refers to:

altering the composition of the Fed's balance sheet in order to improve the functioning of particular segments of the credit markets.

When the Fed increases reserve requirements, it reduces the money supply by causing:

the money multiplier to fall.

The federal funds interest rate is determined by the:

equilibrium of supply and demand in the market for reserves.

The European system of central banks' primary tool for conducting monetary policy is open market operations. It uses this tool to set the interest rate for very short-term interbank loans, which is known as the:

overnight cash rate.

The most important advantage of discount policy is that the Fed can use it to:

perform its role as lender of last resort.

When the zero-lower-bound problem occurs, central banks can rely on:

the liquidity provision.

The Fed's lender-of-last-resort function:

creates a moral hazard problem.

The management of expectations is a strategy best defined by:

keeping the federal funds rate at zero for an extended period to lower the market's expectations of future short-term interest rates.

Banking institutions in the European Monetary Union can borrow (against eligible collateral) overnight loans from national central banks at the:

marginal lending rate.

The graph to the right shows a fall in the vertical section of the supply curve of reserves. The fall in the supply curve is caused by:

a decrease in the discount rate.

Asset Management

The pursuit of an acceptably low level of risk by acquiring assets that have a low rate of default and by diversifying asset holdings.

What is a banks balance sheet?

A list of its sources of bank funds (liabilities and capital) and uses to which the funds are put (assets).

Capital Adequacy Management

The amount of capital the bank should maintain and then acquire the needed capital.

Credit Risk

The risk arising because borrowers may default.

Deposit Outflows


Discount Loans

A bank's borrowings from the Federal Reserve System; also known as advances.

Discount Rate

The interest rate that the Federal Reserve charges banks on discount loans.

Excess Reserves

Reserves in excess of requires reserves.


Inability to pay one's debts.

Liability Management

The acquisition of funds at low cost to increase profits.

Liquidity Management

the acquisition of sufficiently liquid assets to meet the bank's obligations to depositors.

Required Reserve Raio

The fraction of deposits that the Fed requires be kept as reserves.

Required Reserves

Reserves that are held to meet the Fed's requirement that for every dollar of deposits at a bank, a certain fraction must be kept as reserves.


Banks' holding deposits in accounts with the Fed plus currency that is physically held by banks (vault cash).

Secondary Reserves

Short-term U.S. government and agency securities held by banks.


A simplified balance sheet with lines in the form of a T that lists only the changes that occur in balance sheet items starting from some initial balance sheet position.

Vault Cash

Currency that is physically held by banks and stored in vaults overnight.

Deposits at the Fed

The reserves at a commercial bank.

What is the equation for the bank balance sheet?

Total Assets = Total Liabilities + Bank Capital

A bank's liabilities represent it's _________ of funds?


A bank's assets represent it's _________ of funds?


On what liability are banks required to keep reserves?

Checkable Deposits.

What are the major categories of bank liabilities?

Checkable deposits, Nontransaction Deposits, Borrowings.

What are the major categories of bank assets?

Reserves and cash items, Securities, Loans, Physical Capital.

What is the cheapest source of funds for a bank?

Federal funds.

What is the banks most liquid asset?

Excess reserves.

What asset represents the banks major source of profit?


Why are government securities called "secondary reserves"?

Because of their high liquidity.

What items are included in nontransaction deposits?

Small-denomination time deposits, savings deposits, large-denomination time deposits.

What is the difference between required and excess reserves?

Required reserves are held because of reserve requirements on checkable deposits, excess reserves are held to meet obligations when funds are withdrawn.

Where will you find a bank's reserves?

Included in total assets.