Chapter 15

The Management of Capital

Fill in the Blank Questions

1. The risk that has to do with banks trading in foreign currencies is called
________________________.

________________________________________

2. The risk that has to do with fraud, embezzlement and bank robberies is called
_________________.

________________________________________

3. _________________________ is measured by the par value of the shares of common equity

outstanding.

________________________________________

4. __________________ is the amount in excess of stock's par value paid by the bank's
shareholders.

________________________________________

5. _________________________ are the net earnings of a bank, which have been kept by the bank
rather than being distributed as dividends to stockholders.

________________________________________

6. Core capital such as common stock and surplus, undivided profits, qualifying noncumulative
perpetual preferred stock, etc. is referred to as __________________ capital, as defined by the
Basel agreement.

________________________________________

7. The international treaty involving representatives from the U.S. and 12 other leading industrialized
countries to impose common capital requirements on all banks is known as the
________________________.

________________________________________

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8. Supplemental capital such as the allowance for loan and lease losses, subordinated debt capital
instruments, mandatory convertible debt, intermediate-term preferred stock, cumulative perpetual
preferred stock with unpaid dividends, and equity notes and other long-term capital instruments
that combine both debt and equity features is more commonly known as
________________________.

________________________________________

9. When the assets items on a bank's balance sheet and each off-balance-sheet commitment it has
made are multiplied by the appropriate risk-weighting factor, they are often called
________________________.

________________________________________

10. The fact that a bank may suffer deficiencies in quality control, inefficiencies in producing and
delivering of services, natural disasters, terrorist acts, weather damage, aging or faulty computer
systems, errors in judgment by management, and fluctuations in economy that could adversely
affect the bank's performance, is known as _________________________ risk.

________________________________________

11. One defense against risk for a bank is to spread out its credit accounts and deposits among a
wide variety of customers, including large and small business accounts, different industries, etc.
This defense is known as ________________________.

________________________________________

12. One defense against risk for a bank is to seek out customers located in different communities or
in different countries. This defense is known as ________________________.

________________________________________

13. When all else fails, the ultimate defense against risk in banking is ________________________.

________________________________________

14. The largest component of capital among thrift institutions is ____________.

________________________________________

15. The largest component of capital among commercial banks is ___________.

________________________________________

16. ____________ models attempt to measure price or market risk of a portfolio of assets and
attempt to determine the maximum loss they might sustain over a designated period of time.

________________________________________

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17. The latest revision to the Basel accord is known as __________ and will cover capital, liquidity,
and debt positions of individual international banks and also the much broader issues associated
with controlling global business cycles and financial system-wide risks.

________________________________________

18. ____________ models measure a lender's exposure to defaults or credit downgrades.

________________________________________

19. _________________ risk measures are being developed to be used when Basel III takes effect.

________________________________________

20. At the center of the debate of the Basel Agreement is the ____________, headquartered in
Basel, Switzerland, which assists central banks in their transactions with each other and serves
as a forum for international financial issues.

________________________________________

21. _____________ represents funds set aside for contingencies, such as legal action against the
institution, as well as providing a reserve for dividends expected to be paid but not yet declared,
and a sinking fund to retire stock or debt in the future.

________________________________________

22. _________ are debt securities repayable from the sale of stock.

________________________________________

23. __________ is a hybrid form of debt and equity capital issued to investors.

________________________________________

24. _________ are a type of long-term debt capital whose claims legally follow after the claims of
depositors.

________________________________________

25. _________ for banks include assets like mortgage servicing rights and purchased credit card
relationships and such assets can be counted as part of bank capital.

________________________________________

True / False Questions

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26. In the field of banking, capital refers principally to those funds contributed by a bank's owners.

True False

27. According to the textbook, capital and risk are intimately related to each other.

True False

28. One fundamental purpose for regulating capital is to limit losses to the government and other
institutions arising from deposit insurance claims.

True False

29. Deposit insurance subsidized by government encourages banks to increase their ratios of capital
to deposits.

True False

30. Under the terms of Basel I, Tier 2 capital includes undivided profits.

True False

31. Core capital includes the surplus value of common stock.

True False

32. Under the international capital (Basel) agreement, Tier 2 capital must be raised to a minimum of 4
percent of risk-weighted assets.

True False

33. Off-balance-sheet commitments of banks carry capital requirements under the international
(Basel) capital standards.

True False

34. Portfolio diversification refers to seeking out customers located in different communities or
countries, which presumably will experience different economic conditions.

True False

35. Geographic diversification refers to the spreading out credit accounts and deposits among a wide
variety of customers within a country, including large and small business accounts, different
industries, and households with a variety of sources of income and collateral.

True False

36. The last line of defense against bank failure is owner's capital, according to the textbook.

True False
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37. Under the FDIC Improvement Act of 1991, a U.S. bank possessing a leverage ratio greater than 4
percent would be considered well capitalized.

True False

38. Under the FDIC Improvement Act of 1991, a bank whose leverage ratio drops to 2 percent or less
is considered to be critically undercapitalized.

True False

39. Recent research suggests that interest-rate contracts display considerably less risk exposure
than do foreign-currency contracts.

True False

40. The Basel Agreement on new capital standards, as drafted in the 1980s, failed to deal with
market risk.

True False

41. If the ratio of tangible equity capital to total assets is 2 percent or less, it is subject to being placed
in conservatorship or receivership unless the institution's principal regulator and the FDIC
determine that it would be in the public interest to allow the institution to continue under present
ownership and management.

True False

42. According to recent research, bank stock prices usually drop within a week after a dividend cut is
announced.

True False

43. Equity notes are considered to be part of Tier 1 capital.

True False

44. The largest source of thrift capital in terms of dollar volume is common stock (par value).

True False

45. Recently, the daily rate at which robberies have occurred in the U.S. has continued to climb.

True False

46. One of the reasons to regulate the capital position of banks is to limit the risk of bank failures,
especially large bank failures.

True False

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47. Deposits with the Federal Reserve banks are considered to have moderate credit risk and are
therefore placed in the 50 percent risk-weight category.

True False

48. The largest component of capital among banks is retained earnings.

True False

49. VaR models measure the market risk and indicate the potential for losses on a portfolio of
assets.

True False

50. VaR models are most successful in assessing potential risk when the assets are non-traded.

True False

51. Credit risk models measure the market risk of a portfolio whose value may decline due to adverse
movements in interest rates, stock prices, currency values, or commodity prices.

True False

52. One of the key pillars for capital regulation in Basel II was to require banks to hold capital against
its own estimated risk exposure from operational risk.

True False

53. Basel II requires each bank to determine its own capital requirements based on its own calculated
risk exposure.

True False

54. It is anticipated that Basel III may increase capital requirements for banks.

True False

55. The global financial crisis of 2007-2009 highlighted the importance of taking into consideration a
bank's exposure to market risk that arise from changes in interest rates, security prices, and
currency.

True False

56. Smaller banks rely more heavily on internally generated capital than larger banks.

True False

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57. A well-capitalized institution has a ratio of capital to risk-weighted assets of at least 10 percent
and faces no significant regulatory restrictions on its expansion.

True False

58. Regulatory capital focuses on the market value of equity.

True False

Multiple Choice Questions

59. According to the textbook, the role(s) of capital is to:

A. provide a cushion against failure

risk.
B. provide funds needed to charter, organize, and operate a bank.

C. promote public
confidence.
D. support growth and the development of new services.

E. All of the options are correct.

60. The textbook discusses several alternative defenses banks have against risk. These defenses
include:

A. quality management.

B. portfolio diversification.

C. geographic
diversification.
D. deposit
insurance.
E. All of the options are correct.

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61. Measured by dollar volume, the largest category of capital at U.S. banks is:

A. par value of common stock.

B. subordinated notes and debentures.

C. surplus.

D. undivided profits and capital reserves.

E. None of the options is

correct.

62. The fundamental purposes of regulating bank capital cited in the textbook include which of the
following?

A. To reduce liquid funds held by the banks.

B. To preserve public confidence in banks.

C. To limit losses to the public arising from insurance claims.

D. To increase the risk taking ability of the banks.

E. To reduce liquid funds held by the banks and to increase the risk taking ability of the banks.

63. The internal capital growth rate for a bank is a function of which of the following factors?

A. Profit
margin.
B. Asset
utilization.
C. Equity multiplier.

D. Earnings retention ratio.

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 E. All of the options are correct.

64. Second National Bank is forecasting a return on equity of 15 percent for this year. The board of
directors wants to maintain its current policy of paying the bank's stockholders 40 percent of any
net earnings the bank will earn. How fast can the bank's assets grow this year without
jeopardizing its ratio of capital to assets?

A. 15 percent

B. 9 percent

C. 8 percent

D. 6 percent

E. None of the options is

correct.

65. Possible breakdowns in quality control, inefficiencies in producing and delivering financial
services, weather damage, aging or faulty computer systems, and errors in judgment by bank
management illustrate what form of risk faced by banks?

A. Credit risk

B. Liquidity
risk
C. Interest-rate
risk
D. Operational
risk
E. None of the options is
correct.

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66. The ratio of core capital to average total assets is called the:

A. supplemental capital ratio.

B. leverage ratio.

C. long-term capital ratio.

D. GAAP capital ratio.

E. None of the options is

correct.

67. The risk that a customer with whom the bank has entered into a contract with, will fail to pay or to
perform, forcing the bank to find a replacement contract with another party that may be less
satisfactory is what form of risk listed below?

A. Counterparty risk

B. Interest-rate
risk
C. Operating risk

D. Credit risk

E. Liquidity
risk

68. In the United States a 'well capitalized' bank must have a ratio of capital to risk-weighted assets
of at least:

A. 6
percent.
B. 8
percent.
C. 10 percent.

D. 5
percent.
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forwarded, distributed, or posted on a website, in whole or part.
 E. None of the options is
correct.

69. In the United States a bank to be considered 'adequately capitalized' must have a ratio of Tier 1
(or core) capital to risk-weighted assets of at least:

A. 8 percent

B. 6 percent

C. 10 percent

D. 4 percent

E. None of the options is

correct.

70. A 'well capitalized' bank in the United States must have a leverage ratio of at least:

A. 4 percent

B. 5 percent

C. 6 percent

D. 8 percent

E. None of the options is

correct.

71. A bank has $100 million in assets in the 0 percent risk-weight category, $200 million in assets in
the 20 percent risk-weight category, $500 million in assets in the 50 percent risk-weight category,
and $750 million in assets in the 100 percent risk-weight category. This bank has $57 million in
core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to risk-weighted assets?

A. 3.68
percent

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 B. 7.60
percent
C. 18.25 percent

D. 5.48
percent
E. None of the options is
correct.

72. A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent, an equity multiplier
of 12, and a retention ratio of 60 percent. What is this bank's ICGR?

A. 6.60
percent
B. 3.96
percent
C. 7.20
percent
D. 0.33
percent
E. None of the options is
correct.

73. Which of the following would be an example of Tier 1 capital?

A. Subordinated debt capital instruments with an original maturity of at least 5 years

B. Allowance for loan and lease losses

C. Minority interest in the equity accounts of consolidated

subsidiaries
D. Intermediate-term preferred stock

E. All of the options are correct.

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74. Which of the following would be an example of Tier 2 capital?

A. Subordinated debt capital instruments

B. Undivided
profits
C. Minority interest in the equity accounts of consolidated
subsidiaries
D. Qualifying noncumulative preferred stock

E. All of the options are correct.

75. Which of the following would be an example of crime risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest and principal has been collected in
2 years.
D. A bank manager predicts that interest rates will rise. However, interest rates fall causing the
bank 's net income to fall by $250,000.
E. All of the options are examples of crime risk.

76. Which of the following assets fit(s) into the 0 percent risk-weight category?

A. Cas
h
B. Deposits at the Federal
Reserve
C. Treasury Bills

D. GNMA mortgage-backed securities

E. All of the options are assets that fit into the 0 percent risk-weight category.

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77. A bank that is 'well-capitalized':

A. faces no significant regulatory restriction on its expansion.

B. cannot accept broker placed deposits without regulatory

approval.
C. has limits on dividends and management fees it is allowed to pay and limits on the maximum
asset growth rate among other restrictions.
D. will be placed into conservatorship or receivership if its capital level is not increased within a
certain time limit.
E. None of the options is
correct.

78. A bank that is 'critically undercapitalized':

A. faces no significant regulatory

restrictions.
B. can only grant loan to highly leveraged borrowers.

C. cannot avoid seizure in all circumstances.

D. will be placed into conservatorship or receivership if its capital level is not increased within a
certain time limit.
E. None of the options is
correct.

79. A bank that is adequately capitalized:

A. faces no significant regulatory

restrictions.
B. cannot accept broker-placed deposits without regulatory approval.

C. has limits on dividends and management fees it is allowed to pay and limits on the maximum
asset growth rate among other restrictions.
D. will be placed into conservatorship or receivership if its capital level is not increased within a
certain time limit.
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 E. None of the options is
correct.

80. Which of the following is in the 100 percent risk-weight category?

A. Cas
h
B. General obligation municipal
bonds
C. Residential mortgage loans

D. Credit card loans

E. None of the options is

correct.

81. Which of the following is in the 50 percent risk-weight (moderate credit risk) category?

A. Cas
h
B. General obligation municipal
bonds
C. Residential mortgage loans

D. Credit card loans

E. None of the options is

correct.

82. Which of the following is in the 20 percent risk-weight (low credit risk) category?

A. Cas
h
B. General obligation municipal
bonds
C. Residential mortgage loans

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 D. Credit card loans

E. None of the options is

correct.

83. A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity capital to
total assets ratio?

A. 7.00
percent
B. 14.29 percent

C. 28.00 percent

D. 16.00 percent

E. None of the options is

correct.

84. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of Tier 1 capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent

D. 5.54
percent
E. None of the options is
correct.

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forwarded, distributed, or posted on a website, in whole or part.
85. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of Tier 2 capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent

D. 5.54
percent
E. None of the options is
correct.

86. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of total capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent

D. 5.54
percent
E. None of the options is
correct.

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forwarded, distributed, or posted on a website, in whole or part.
87. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent and
has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this bank's
internal capital growth rate?

A. 28.35 percent

B. 2.36
percent
C. 11.34 percent

D. 4.80
percent
E. None of the options is
correct.

88. The revised Basel I rules imposed capital requirements for market risk on:

A. only the largest

banks.
B. only the smallest
banks.
C. only moderate size banks.

D. all
banks.
E. no banks.

89. Which of the following is a bank debt that appears to be highly sensitive to the market perception
of the bank's risk?

A. Deposits

B. Fed
funds
C. Repos

D. Subordinated debt
capital
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 E. Preferred
stock

90. As per the Basel Committee, a bank's operational risk includes:

A. employee fraud.

B. accounting errors.

C. computer breakdowns.

D. natural disasters.

E. All of the options are correct.

91. The task of correctly adding up all of the different types of bank risk exposures is known as:

A. risk tallying.

B. summing
risk.
C. risk aggregation.

D. risk accumulation.

E. risk totality.

92. For a bank with deficient capital ratios, which of the following actions could be required by
regulators to increase the capital ratios, all else constant?

A. Cut the bank's dividend payment.

B. Increase the bank's leverage.

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 C. Reduce the bank's holdings of cash.

D. Increase the bank's growth rate by making additional commercial loans.

E. Reduce the bank's holdings of Treasury securities.

93. Basel II had a different set of capital rules for different banks, and the number of categories is:

A. two
.
B. thre
e
C. four.

D. five
.
E. ten
.

94. Which of the following would be an example of exchange risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been collected in
2 years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank's
net income to fall by $250,000.
E. All of the options are examples of exchange risk.

95. Which of the following would be an example of credit risk?

A. A bank manager embezzles $1,000,000 from the bank.

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 B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been collected in
2 years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank's
net income to fall by $250,000.
E. All of the options are examples of credit risk.

96. Which of the following would be an example of interest rate risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest or principal has been collected in 2
years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the bank's
net income to fall by $250,000.
E. All of the options are examples of interest rate
risk.

97. Which of the following would be an example of operational risk?

A. A robber steals $250,000 from the bank locker.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of depositors.

D. A $500,000 loan that the bank has made has been deemed
uncollectible.
E. None of the examples are of operational
risk.

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98. Which of the following would be an example of liquidity risk?

A. A bank teller manages to steal $250,000 over a period of several months.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of depositors.

D. A $500,000 that loan the bank has made has been deemed
uncollectible.
E. None of the examples are of liquidity risk.

99. Which of the following would not be an example of operational risk?

A. A bank, on the coast of Louisiana, is hit by a hurricane and is flooded for 6 weeks.

B. A bank employee working as a derivatives trader, is also the one who writes the reports on
profits and losses in derivatives trading every day.
C. The banks older computer system breaks down causing a loss of service to customers for 2
weeks.
D. A bank robber robs a teller at gun point and gets away before police can get to the bank.

E. All of the examples are of operational

risk.

100.The Jennings Bank of Texas, wants to protect itself from credit risk by making large loans to
corporate customers, by making residential mortgages to families, by making agriculture loans to
farmers and ranchers in the area, by making small business loans to business along main street
and by making automobile loans for the car dealership across the street from the bank. What
defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management

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 D. Increasing owners' capital

E. None of the options is

correct.

101.The Michelson Bank of Stetson, wants to protect itself from risk. It decides to make loans in
Florida, Georgia, Texas, and Oklahoma as well as invest in municipal bonds from California and
Oregon. What defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management

D. Increasing owners' capital

E. None of the options is

correct.

102.The Perdue Bank of Houston, has just hired a new manager who has a reputation of anticipating
potential problems and acting quickly to prevent those problems so that the bank stays healthy
and profitable. What defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management

D. Increasing owners' capital

E. None of the options is

correct.

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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
103.The Norton Bank of Illinois, has just issued trust preferred stock. What defense against risk is this
bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management

D. Increasing owners' capital

E. None of the options is

correct.

104.What type of preferred stock has appeared recently that carry a lower cost?

A. Cumulative preferred
stock
B. Noncumulative preferred stock

C. Convertible preferred
stock
D. Trust preferred stock

E. None of the options is

correct.

105.Even if individual banks are good at forecasting risk using VaR models, there may still be
problems because losses may occur at several banks at the same time due to the
interdependency of the financial system, magnifying each bank's risk exposure and possibly
causing a major problem for regulators. The book calls this:

A. systemic risk.

B. operational
risk.
C. credit risk.

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 D. market risk.

E. liquidity risk.

106.There are three pillars of Basel II. One of them is to make market discipline a powerful force
compelling risky banks to lower their risk exposure. What does Basel II want to do to make this
happen?

A. Require minimum capital requirement based on the bank's own evaluation of its risk.

B. Require greater public disclosure of each bank's true financial

condition.
C. Expand the risks to be evaluated to include credit risk market risk, and operational
risk.
D. Require a supervisory review of each bank's risk evaluation
procedures.
E. All of the options are correct.

107.A bank has capital to risk-weighted assets of 11.5%, Tier 1 capital to risk-weighted assets of
7.2% and a leverage ratio of 5.8%. What type of bank is this?

A. Well capitalized

B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized

E. Critically
undercapitalized

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forwarded, distributed, or posted on a website, in whole or part.
108.A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of 5%
and a leverage ratio of 4.8%. What type of bank is this?

A. Well capitalized

B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized

E. Critically
undercapitalized

109.A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of 4.5%
and a leverage ratio of 3.7%. What type of bank is this?

A. Well capitalized

B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized

E. Critically
undercapitalized

110.A bank has capital to risk-weighted assets of 5.5%, Tier 1 capital to risk-weighted assets of 2.8%
and a leverage ratio of 2.6%. What type of bank is this?

A. Well capitalized

B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized

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forwarded, distributed, or posted on a website, in whole or part.
 E. Critically
undercapitalized

111. A bank has capital to risk-weighted assets of 1.8%. What type of bank is this?

A. Well capitalized

B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized

E. Critically
undercapitalized

112.Which of the following is not a weakness of Basel I risk-based capital standards?

A. They ignore interest rate risk

B. They ignore changes in value due to currency value changes

C. They ignore changes in value due to commodity price changes

D. They ignore credit

risk
E. They ignore the market value

113.A bank has decided to retain more of their earnings, moving their retention ratio from 40% to
70%. What way of meeting their capital needs is the bank taking?

A. Changing their dividend policy

B. Issuing common stock

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 C. Issuing preferred stock

D. Issuing subordinated notes and debentures

E. Selling assets and leasing

facilities

114.The First National Bank of Tucson has determined that the value of their property in Tucson has
tripled in the last three years. They decide that they would like to use this property to raise funds
and will rent space from the new owners of the building. What way of meeting their capital needs
is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing

facilities
E. Swapping stock for debt instruments

115.The Second National Bank of Lincoln has decided that, to raise funds it is going to issue new
common equity through a pre-emptive rights offering, so that current owners will not have that
ownership diluted. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing

facilities
E. Swapping stock for debt instruments

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116.The Third State Bank of Denton has decided to issue stock through a trust company and borrow
the funds from the trust company. This stock pays a fixed dividend and because of the way the
stock has been issued it is tax deductible. What way of meeting their capital needs in the bank
taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing

facilities
E. Swapping stock for debt instruments

117.The Northwest Bank of Charlotte has decided to issue new securities that have five years to
maturity that have claims to assets that follow the claims of depositors. What way of meeting their
capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing

facilities
E. Swapping stock for debt instruments

118.Why do regulators prefer higher capital requirements?

A. It justifies the existence of regulatory

agencies.
B. It protects the deposit insurance fund from serious losses.

C. It enhances bank asset quality.

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 D. It decreases bank profitability.

E. It increases bank
leverage.

119.Why do banks generally prefer lower capital requirements?

A. To minimize the impact shareholders have on management decisions

B. To increase the influence of bank regulators

C. To increase a bank's return on equity

D. To increase depositor protection

E. To maximize operating leverage

120.A bank has issued $5,000,000 in long term debt and since that time interest rates have risen so
that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides to
issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way of
meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing

facilities
E. Swapping stock for debt instruments

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121.Which of the following are the reasons for having the government set capital standards for
financial institutions as opposed to letting the private marketplace set those standards?

A. To preserve public confidence

B. To remove each bank's unique asset risk exposure

C. To limit losses to the federal government arising from deposit insurance claims

D. To preserve public confidence and to limit losses to the federal government arising from
deposit insurance claims
E. None of the options is
correct.

122.The following are the advantages of Basel II over Basel I except that:

A. it performs supervisory review of each bank's risk-assessment procedures.

B. it provides for greater sensitivity to arbitrage and financial innovations.

C. it applies the same minimum capital requirements to all banks.

D. it broadens the types of risk considered.

E. All are advantages of using Basel II.

123.Which of the following is an internal assessment tool that is used by the participating banks to
ensure that they are prepared for the possibly damaging impact of ever changing market
conditions?

A. Backtesting

B. Risk
aggregation
C. Stress testing

D. Systemic
testing
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 E. Damage
testing

124.According to the text, Basel II agreement had resulted in less total capital and:

A. less concentration on operating

risk.
B. a weaker mix of
capital.
C. more retention
ratio.
D. less concentration on assets.

E. a weaker leverage
ratio.

125.A standby letter of credit, backing the issue of state and local government general obligation
bonds, is given a credit risk-weight of 20 percent because of its:

A. modest credit
risk.
B. zero credit
risk.
C. moderate credit risk.

D. low credit
risk.
E. highest credit
risk.

126.Along with the value at risk model, which is the other model that determines each bank's unique
market risk exposure and the amount of capital it needs?

A. Internal modeling.

B. Systemic modeling.

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 C. Credit risk modeling.

D. Borrower credit ratings.

E. Damage
testing.

127.________________________ represent(s) funds set aside for contingencies, such as legal

action against the institution or a sinking fund to retire stock or debt in the future.

A. Undivided
profits
B. Surplu
s
C. Preferred
stock
D. Common stock

E. Equity reserves

128.Interbank deposits generally carry:

A. low credit
risk.
B. high credit risk.

C. highest credit
risk.
D. moderate credit risk.

E. zero credit
risk.

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forwarded, distributed, or posted on a website, in whole or part.
129.Under Basel III, more flexible capital standards which includes the "buffer concept" means
involvement of which two ratios?

A. Base capital and leverage

ratio
B. Base capital and buffer ratio

C. Capital and risk-weighted assets ratio

D. Leverage and buffer ratio

E. Risk-weighted assets ratio and buffer ratio

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 Chapter 15 The Management of Capital Answer Key

Fill in the Blank Questions

1. The risk that has to do with banks trading in foreign currencies is called
________________________.

exchange risk

2. The risk that has to do with fraud, embezzlement and bank robberies is called
_________________.

crime risk

3. _________________________ is measured by the par value of the shares of common equity

outstanding.

Common stock

4. __________________ is the amount in excess of stock's par value paid by the bank's
shareholders.

Surplus

5. _________________________ are the net earnings of a bank, which have been kept by the
bank rather than being distributed as dividends to stockholders.

Undivided profits (or retained earnings)

6. Core capital such as common stock and surplus, undivided profits, qualifying noncumulative
perpetual preferred stock, etc. is referred to as __________________ capital, as defined by
the Basel agreement.

Tier 1

7. The international treaty involving representatives from the U.S. and 12 other leading
industrialized countries to impose common capital requirements on all banks is known as the
________________________.

Basel Agreement

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8. Supplemental capital such as the allowance for loan and lease losses, subordinated debt
capital instruments, mandatory convertible debt, intermediate-term preferred stock, cumulative
perpetual preferred stock with unpaid dividends, and equity notes and other long-term capital
instruments that combine both debt and equity features is more commonly known as
________________________.

Tier 2 capital

9. When the assets items on a bank's balance sheet and each off-balance-sheet commitment it
has made are multiplied by the appropriate risk-weighting factor, they are often called
________________________.

risk-weighted assets

10. The fact that a bank may suffer deficiencies in quality control, inefficiencies in producing and
delivering of services, natural disasters, terrorist acts, weather damage, aging or faulty
computer systems, errors in judgment by management, and fluctuations in economy that could
adversely affect the bank's performance, is known as _________________________ risk.

operational

11. One defense against risk for a bank is to spread out its credit accounts and deposits among a
wide variety of customers, including large and small business accounts, different industries,
etc. This defense is known as ________________________.

portfolio diversification

12. One defense against risk for a bank is to seek out customers located in different communities
or in different countries. This defense is known as ________________________.

geographic diversification

13. When all else fails, the ultimate defense against risk in banking is
________________________.

owners' capital (net worth)

14. The largest component of capital among thrift institutions is ____________.

retained earnings

15. The largest component of capital among commercial banks is ___________.

surplus

16. ____________ models attempt to measure price or market risk of a portfolio of assets and
attempt to determine the maximum loss they might sustain over a designated period of time.

Value at risk (VaR)

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forwarded, distributed, or posted on a website, in whole or part.
17. The latest revision to the Basel accord is known as __________ and will cover capital,
liquidity, and debt positions of individual international banks and also the much broader issues
associated with controlling global business cycles and financial system-wide risks.

Basel III

18. ____________ models measure a lender's exposure to defaults or credit downgrades.

Credit risk

19. _________________ risk measures are being developed to be used when Basel III takes
effect.

Systemic

20. At the center of the debate of the Basel Agreement is the ____________, headquartered in
Basel, Switzerland, which assists central banks in their transactions with each other and
serves as a forum for international financial issues.

Bank for International Settlements (BIS)

21. _____________ represents funds set aside for contingencies, such as legal action against the
institution, as well as providing a reserve for dividends expected to be paid but not yet
declared, and a sinking fund to retire stock or debt in the future.

Equity reserves

22. _________ are debt securities repayable from the sale of stock.

Equity commitment notes

23. __________ is a hybrid form of debt and equity capital issued to investors.

Trust preferred stock

24. _________ are a type of long-term debt capital whose claims legally follow after the claims of
depositors.

Subordinated notes and debentures

25. _________ for banks include assets like mortgage servicing rights and purchased credit card
relationships and such assets can be counted as part of bank capital.

Identifiable intangible assets

True / False Questions

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26. In the field of banking, capital refers principally to those funds contributed by a bank's owners.

TRUE

27. According to the textbook, capital and risk are intimately related to each other.

TRUE

28. One fundamental purpose for regulating capital is to limit losses to the government and other
institutions arising from deposit insurance claims.

TRUE

29. Deposit insurance subsidized by government encourages banks to increase their ratios of
capital to deposits.

FALSE

30. Under the terms of Basel I, Tier 2 capital includes undivided profits.

FALSE

31. Core capital includes the surplus value of common stock.

TRUE

32. Under the international capital (Basel) agreement, Tier 2 capital must be raised to a minimum
of 4 percent of risk-weighted assets.

FALSE

33. Off-balance-sheet commitments of banks carry capital requirements under the international
(Basel) capital standards.

TRUE

34. Portfolio diversification refers to seeking out customers located in different communities or
countries, which presumably will experience different economic conditions.

FALSE

35. Geographic diversification refers to the spreading out credit accounts and deposits among a
wide variety of customers within a country, including large and small business accounts,
different industries, and households with a variety of sources of income and collateral.

FALSE

36. The last line of defense against bank failure is owner's capital, according to the textbook.

TRUE
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37. Under the FDIC Improvement Act of 1991, a U.S. bank possessing a leverage ratio greater
than 4 percent would be considered well capitalized.

FALSE

38. Under the FDIC Improvement Act of 1991, a bank whose leverage ratio drops to 2 percent or
less is considered to be critically undercapitalized.

TRUE

39. Recent research suggests that interest-rate contracts display considerably less risk exposure
than do foreign-currency contracts.

TRUE

40. The Basel Agreement on new capital standards, as drafted in the 1980s, failed to deal with
market risk.

TRUE

41. If the ratio of tangible equity capital to total assets is 2 percent or less, it is subject to being
placed in conservatorship or receivership unless the institution's principal regulator and the
FDIC determine that it would be in the public interest to allow the institution to continue under
present ownership and management.

TRUE

42. According to recent research, bank stock prices usually drop within a week after a dividend cut
is announced.

TRUE

43. Equity notes are considered to be part of Tier 1 capital.

FALSE

44. The largest source of thrift capital in terms of dollar volume is common stock (par value).

FALSE

45. Recently, the daily rate at which robberies have occurred in the U.S. has continued to climb.

FALSE

46. One of the reasons to regulate the capital position of banks is to limit the risk of bank failures,
especially large bank failures.

TRUE

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forwarded, distributed, or posted on a website, in whole or part.
47. Deposits with the Federal Reserve banks are considered to have moderate credit risk and are
therefore placed in the 50 percent risk-weight category.

FALSE

48. The largest component of capital among banks is retained earnings.

FALSE

49. VaR models measure the market risk and indicate the potential for losses on a portfolio of
assets.

TRUE

50. VaR models are most successful in assessing potential risk when the assets are non-traded.

FALSE

51. Credit risk models measure the market risk of a portfolio whose value may decline due to
adverse movements in interest rates, stock prices, currency values, or commodity prices.

FALSE

52. One of the key pillars for capital regulation in Basel II was to require banks to hold capital
against its own estimated risk exposure from operational risk.

TRUE

53. Basel II requires each bank to determine its own capital requirements based on its own
calculated risk exposure.

TRUE

54. It is anticipated that Basel III may increase capital requirements for banks.

TRUE

55. The global financial crisis of 2007-2009 highlighted the importance of taking into consideration
a bank's exposure to market risk that arise from changes in interest rates, security prices, and
currency.

TRUE

56. Smaller banks rely more heavily on internally generated capital than larger banks.

TRUE

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57. A well-capitalized institution has a ratio of capital to risk-weighted assets of at least 10 percent
and faces no significant regulatory restrictions on its expansion.

TRUE

58. Regulatory capital focuses on the market value of equity.

FALSE

Multiple Choice Questions

59. According to the textbook, the role(s) of capital is to:

A. provide a cushion against failure

risk.
B. provide funds needed to charter, organize, and operate a bank.
C. promote public
confidence.
D. support growth and the development of new services.
E. All of the options are correct.

60. The textbook discusses several alternative defenses banks have against risk. These defenses
include:

A. quality management.
B. portfolio diversification.
C. geographic
diversification.
D. deposit
insurance.
E. All of the options are correct.

61. Measured by dollar volume, the largest category of capital at U.S. banks is:

A. par value of common stock.

B. subordinated notes and debentures.
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 C. surplus.
D. undivided profits and capital reserves.
E. None of the options is
correct.

62. The fundamental purposes of regulating bank capital cited in the textbook include which of the
following?

A. To reduce liquid funds held by the banks.

B. To preserve public confidence in banks.
C. To limit losses to the public arising from insurance claims.
D. To increase the risk taking ability of the banks.
E. To reduce liquid funds held by the banks and to increase the risk taking ability of the banks.

63. The internal capital growth rate for a bank is a function of which of the following factors?

A. Profit
margin.
B. Asset
utilization.
C. Equity multiplier.
D. Earnings retention ratio.
E. All of the options are correct.

64. Second National Bank is forecasting a return on equity of 15 percent for this year. The board
of directors wants to maintain its current policy of paying the bank's stockholders 40 percent of
any net earnings the bank will earn. How fast can the bank's assets grow this year without
jeopardizing its ratio of capital to assets?

A. 15 percent
B. 9 percent
C. 8 percent
D. 6 percent
E. None of the options is
correct.

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forwarded, distributed, or posted on a website, in whole or part.
65. Possible breakdowns in quality control, inefficiencies in producing and delivering financial
services, weather damage, aging or faulty computer systems, and errors in judgment by bank
management illustrate what form of risk faced by banks?

A. Credit risk
B. Liquidity
risk
C. Interest-rate
risk
D. Operational
risk
E. None of the options is
correct.

66. The ratio of core capital to average total assets is called the:

A. supplemental capital ratio.

B. leverage ratio.
C. long-term capital ratio.
D. GAAP capital ratio.
E. None of the options is
correct.

67. The risk that a customer with whom the bank has entered into a contract with, will fail to pay or
to perform, forcing the bank to find a replacement contract with another party that may be less
satisfactory is what form of risk listed below?

A. Counterparty risk
B. Interest-rate
risk
C. Operating risk
D. Credit risk
E. Liquidity
risk

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68. In the United States a 'well capitalized' bank must have a ratio of capital to risk-weighted
assets of at least:

A. 6
percent.
B. 8
percent.
C. 10 percent.
D. 5
percent.
E. None of the options is
correct.

69. In the United States a bank to be considered 'adequately capitalized' must have a ratio of Tier
1 (or core) capital to risk-weighted assets of at least:

A. 8 percent
B. 6 percent
C. 10 percent
D. 4 percent
E. None of the options is
correct.

70. A 'well capitalized' bank in the United States must have a leverage ratio of at least:

A. 4 percent
B. 5 percent
C. 6 percent
D. 8 percent
E. None of the options is
correct.

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forwarded, distributed, or posted on a website, in whole or part.
71. A bank has $100 million in assets in the 0 percent risk-weight category, $200 million in assets
in the 20 percent risk-weight category, $500 million in assets in the 50 percent risk-weight
category, and $750 million in assets in the 100 percent risk-weight category. This bank has
$57 million in core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to risk-weighted
assets?

A. 3.68
percent
B. 7.60
percent
C. 18.25 percent
D. 5.48
percent
E. None of the options is
correct.

72. A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent, an equity
multiplier of 12, and a retention ratio of 60 percent. What is this bank's ICGR?

A. 6.60
percent
B. 3.96
percent
C. 7.20
percent
D. 0.33
percent
E. None of the options is
correct.

73. Which of the following would be an example of Tier 1 capital?

A. Subordinated debt capital instruments with an original maturity of at least 5 years

B. Allowance for loan and lease losses
C. Minority interest in the equity accounts of consolidated
subsidiaries
D. Intermediate-term preferred stock
E. All of the options are correct.

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74. Which of the following would be an example of Tier 2 capital?

A. Subordinated debt capital instruments

B. Undivided
profits
C. Minority interest in the equity accounts of consolidated
subsidiaries
D. Qualifying noncumulative preferred stock
E. All of the options are correct.

75. Which of the following would be an example of crime risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.
C. A $1,000,000 loan given to a business on which no interest and principal has been
collected in 2 years.
D. A bank manager predicts that interest rates will rise. However, interest rates fall causing
the bank 's net income to fall by $250,000.
E. All of the options are examples of crime risk.

76. Which of the following assets fit(s) into the 0 percent risk-weight category?

A. Cas
h
B. Deposits at the Federal
Reserve
C. Treasury Bills
D. GNMA mortgage-backed securities
E. All of the options are assets that fit into the 0 percent risk-weight category.

77. A bank that is 'well-capitalized':

A. faces no significant regulatory restriction on its expansion.

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 B. cannot accept broker placed deposits without regulatory
approval.
C. has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions.
D. will be placed into conservatorship or receivership if its capital level is not increased within
a certain time limit.
E. None of the options is
correct.

78. A bank that is 'critically undercapitalized':

A. faces no significant regulatory

restrictions.
B. can only grant loan to highly leveraged borrowers.
C. cannot avoid seizure in all circumstances.
D. will be placed into conservatorship or receivership if its capital level is not increased within
a certain time limit.
E. None of the options is
correct.

79. A bank that is adequately capitalized:

A. faces no significant regulatory

restrictions.
B. cannot accept broker-placed deposits without regulatory approval.
C. has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions.
D. will be placed into conservatorship or receivership if its capital level is not increased within
a certain time limit.
E. None of the options is
correct.

80. Which of the following is in the 100 percent risk-weight category?

A. Cas
h

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 B. General obligation municipal
bonds
C. Residential mortgage loans
D. Credit card loans
E. None of the options is
correct.

81. Which of the following is in the 50 percent risk-weight (moderate credit risk) category?

A. Cas
h
B. General obligation municipal
bonds
C. Residential mortgage loans
D. Credit card loans
E. None of the options is
correct.

82. Which of the following is in the 20 percent risk-weight (low credit risk) category?

A. Cas
h
B. General obligation municipal
bonds
C. Residential mortgage loans
D. Credit card loans
E. None of the options is
correct.

83. A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity capital to
total assets ratio?

A. 7.00
percent
B. 14.29 percent
C. 28.00 percent

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 D. 16.00 percent
E. None of the options is
correct.

84. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of Tier 1 capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent
D. 5.54
percent
E. None of the options is
correct.

85. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of Tier 2 capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent
D. 5.54
percent
E. None of the options is
correct.

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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
86. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1,000 million in assets in the 50 percent
risk-weight category and has $1,000 million in assets in the 100 percent risk-weight category.
This bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's
ratio of total capital to risk assets?

A. 6.08
percent
B. 3.04
percent
C. 9.11 percent
D. 5.54
percent
E. None of the options is
correct.

87. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent
and has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this
bank's internal capital growth rate?

A. 28.35 percent
B. 2.36
percent
C. 11.34 percent
D. 4.80
percent
E. None of the options is
correct.

88. The revised Basel I rules imposed capital requirements for market risk on:

A. only the largest

banks.
B. only the smallest
banks.
C. only moderate size banks.
D. all
banks.

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forwarded, distributed, or posted on a website, in whole or part.
 E. no banks.

89. Which of the following is a bank debt that appears to be highly sensitive to the market
perception of the bank's risk?

A. Deposits
B. Fed
funds
C. Repos
D. Subordinated debt
capital
E. Preferred
stock

90. As per the Basel Committee, a bank's operational risk includes:

A. employee fraud.
B. accounting errors.
C. computer breakdowns.
D. natural disasters.
E. All of the options are correct.

91. The task of correctly adding up all of the different types of bank risk exposures is known as:

A. risk tallying.
B. summing
risk.
C. risk aggregation.
D. risk accumulation.
E. risk totality.

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forwarded, distributed, or posted on a website, in whole or part.
92. For a bank with deficient capital ratios, which of the following actions could be required by
regulators to increase the capital ratios, all else constant?

A. Cut the bank's dividend payment.

B. Increase the bank's leverage.
C. Reduce the bank's holdings of cash.
D. Increase the bank's growth rate by making additional commercial loans.
E. Reduce the bank's holdings of Treasury securities.

93. Basel II had a different set of capital rules for different banks, and the number of categories is:

A. two
.
B. thre
e
C. four.
D. five
.
E. ten
.

94. Which of the following would be an example of exchange risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.
C. A $1,000,000 loan given to a business, on which no interest or principal has been collected
in 2 years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the
bank's net income to fall by $250,000.
E. All of the options are examples of exchange risk.

95. Which of the following would be an example of credit risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

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forwarded, distributed, or posted on a website, in whole or part.
 C. A $1,000,000 loan given to a business, on which no interest or principal has been collected
in 2 years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the
bank's net income to fall by $250,000.
E. All of the options are examples of credit risk.

96. Which of the following would be an example of interest rate risk?

A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.
C. A $1,000,000 loan given to a business on which no interest or principal has been collected
in 2 years.
D. A bank manager predicts interest rates will rise. However, interest rates fall causing the
bank's net income to fall by $250,000.
E. All of the options are examples of interest rate
risk.

97. Which of the following would be an example of operational risk?

A. A robber steals $250,000 from the bank locker.

B. An out-of-date computer system causes the bank to lose $750,000.
C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of
depositors.
D. A $500,000 loan that the bank has made has been deemed
uncollectible.
E. None of the examples are of operational
risk.

98. Which of the following would be an example of liquidity risk?

A. A bank teller manages to steal $250,000 over a period of several months.

B. An out-of-date computer system causes the bank to lose $750,000.
C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of
depositors.
D. A $500,000 that loan the bank has made has been deemed
uncollectible.

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forwarded, distributed, or posted on a website, in whole or part.
 E. None of the examples are of liquidity risk.

99. Which of the following would not be an example of operational risk?

A. A bank, on the coast of Louisiana, is hit by a hurricane and is flooded for 6 weeks.
B. A bank employee working as a derivatives trader, is also the one who writes the reports on
profits and losses in derivatives trading every day.
C. The banks older computer system breaks down causing a loss of service to customers for
2 weeks.
D. A bank robber robs a teller at gun point and gets away before police can get to the bank.
E. All of the examples are of operational
risk.

100. The Jennings Bank of Texas, wants to protect itself from credit risk by making large loans to
corporate customers, by making residential mortgages to families, by making agriculture loans
to farmers and ranchers in the area, by making small business loans to business along main
street and by making automobile loans for the car dealership across the street from the bank.
What defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management
D. Increasing owners' capital
E. None of the options is
correct.

101. The Michelson Bank of Stetson, wants to protect itself from risk. It decides to make loans in
Florida, Georgia, Texas, and Oklahoma as well as invest in municipal bonds from California
and Oregon. What defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management
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forwarded, distributed, or posted on a website, in whole or part.
 D. Increasing owners' capital
E. None of the options is
correct.

102. The Perdue Bank of Houston, has just hired a new manager who has a reputation of
anticipating potential problems and acting quickly to prevent those problems so that the bank
stays healthy and profitable. What defense against risk is this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management
D. Increasing owners' capital
E. None of the options is
correct.

103. The Norton Bank of Illinois, has just issued trust preferred stock. What defense against risk is
this bank making?

A. Portfolio
diversification
B. Geographic
diversification
C. Quality management
D. Increasing owners' capital
E. None of the options is
correct.

104. What type of preferred stock has appeared recently that carry a lower cost?

A. Cumulative preferred
stock
B. Noncumulative preferred stock
C. Convertible preferred
stock

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forwarded, distributed, or posted on a website, in whole or part.
 D. Trust preferred stock
E. None of the options is
correct.

105. Even if individual banks are good at forecasting risk using VaR models, there may still be
problems because losses may occur at several banks at the same time due to the
interdependency of the financial system, magnifying each bank's risk exposure and possibly
causing a major problem for regulators. The book calls this:

A. systemic risk.
B. operational
risk.
C. credit risk.
D. market risk.
E. liquidity risk.

106. There are three pillars of Basel II. One of them is to make market discipline a powerful force
compelling risky banks to lower their risk exposure. What does Basel II want to do to make this
happen?

A. Require minimum capital requirement based on the bank's own evaluation of its risk.
B. Require greater public disclosure of each bank's true financial
condition.
C. Expand the risks to be evaluated to include credit risk market risk, and operational
risk.
D. Require a supervisory review of each bank's risk evaluation
procedures.
E. All of the options are correct.

107. A bank has capital to risk-weighted assets of 11.5%, Tier 1 capital to risk-weighted assets of
7.2% and a leverage ratio of 5.8%. What type of bank is this?

A. Well capitalized
B. Adequately
capitalized
C. Undercapitalize
d
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forwarded, distributed, or posted on a website, in whole or part.
 D. Significantly undercapitalized
E. Critically
undercapitalized

108. A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of 5%
and a leverage ratio of 4.8%. What type of bank is this?

A. Well capitalized
B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized
E. Critically
undercapitalized

109. A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted assets of
4.5% and a leverage ratio of 3.7%. What type of bank is this?

A. Well capitalized
B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized
E. Critically
undercapitalized

110. A bank has capital to risk-weighted assets of 5.5%, Tier 1 capital to risk-weighted assets of
2.8% and a leverage ratio of 2.6%. What type of bank is this?

A. Well capitalized
B. Adequately
capitalized
C. Undercapitalize
d

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forwarded, distributed, or posted on a website, in whole or part.
 D. Significantly undercapitalized
E. Critically
undercapitalized

111. A bank has capital to risk-weighted assets of 1.8%. What type of bank is this?

A. Well capitalized
B. Adequately
capitalized
C. Undercapitalize
d
D. Significantly undercapitalized
E. Critically
undercapitalized

112. Which of the following is not a weakness of Basel I risk-based capital standards?

A. They ignore interest rate risk

B. They ignore changes in value due to currency value changes
C. They ignore changes in value due to commodity price changes
D. They ignore credit
risk
E. They ignore the market value

113. A bank has decided to retain more of their earnings, moving their retention ratio from 40% to
70%. What way of meeting their capital needs is the bank taking?

A. Changing their dividend policy

B. Issuing common stock
C. Issuing preferred stock
D. Issuing subordinated notes and debentures
E. Selling assets and leasing
facilities

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forwarded, distributed, or posted on a website, in whole or part.
114. The First National Bank of Tucson has determined that the value of their property in Tucson
has tripled in the last three years. They decide that they would like to use this property to raise
funds and will rent space from the new owners of the building. What way of meeting their
capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock
C. Issuing subordinated notes and debentures
D. Selling assets and leasing
facilities
E. Swapping stock for debt instruments

115. The Second National Bank of Lincoln has decided that, to raise funds it is going to issue new
common equity through a pre-emptive rights offering, so that current owners will not have that
ownership diluted. What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock
C. Issuing subordinated notes and debentures
D. Selling assets and leasing
facilities
E. Swapping stock for debt instruments

116. The Third State Bank of Denton has decided to issue stock through a trust company and
borrow the funds from the trust company. This stock pays a fixed dividend and because of the
way the stock has been issued it is tax deductible. What way of meeting their capital needs in
the bank taking?

A. Issuing common stock

B. Issuing preferred stock
C. Issuing subordinated notes and debentures
D. Selling assets and leasing
facilities
E. Swapping stock for debt instruments

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forwarded, distributed, or posted on a website, in whole or part.
117. The Northwest Bank of Charlotte has decided to issue new securities that have five years to
maturity that have claims to assets that follow the claims of depositors. What way of meeting
their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock
C. Issuing subordinated notes and debentures
D. Selling assets and leasing
facilities
E. Swapping stock for debt instruments

118. Why do regulators prefer higher capital requirements?

A. It justifies the existence of regulatory

agencies.
B. It protects the deposit insurance fund from serious losses.
C. It enhances bank asset quality.
D. It decreases bank profitability.
E. It increases bank
leverage.

119. Why do banks generally prefer lower capital requirements?

A. To minimize the impact shareholders have on management decisions

B. To increase the influence of bank regulators
C. To increase a bank's return on equity
D. To increase depositor protection
E. To maximize operating leverage

120. A bank has issued $5,000,000 in long term debt and since that time interest rates have risen
so that it will only cost the bank $3,000,000 to buy the long term debt back. The bank decides
to issue $3,000,000 in new stock and use the proceeds to retire the long term debt. What way
of meeting their capital needs is the bank taking?

A. Issuing common stock

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forwarded, distributed, or posted on a website, in whole or part.
 B. Issuing preferred stock
C. Issuing subordinated notes and debentures
D. Selling assets and leasing
facilities
E. Swapping stock for debt instruments

121. Which of the following are the reasons for having the government set capital standards for
financial institutions as opposed to letting the private marketplace set those standards?

A. To preserve public confidence

B. To remove each bank's unique asset risk exposure
C. To limit losses to the federal government arising from deposit insurance claims
D. To preserve public confidence and to limit losses to the federal government arising from
deposit insurance claims
E. None of the options is
correct.

122. The following are the advantages of Basel II over Basel I except that:

A. it performs supervisory review of each bank's risk-assessment procedures.

B. it provides for greater sensitivity to arbitrage and financial innovations.
C. it applies the same minimum capital requirements to all banks.
D. it broadens the types of risk considered.
E. All are advantages of using Basel II.

123. Which of the following is an internal assessment tool that is used by the participating banks to
ensure that they are prepared for the possibly damaging impact of ever changing market
conditions?

A. Backtesting
B. Risk
aggregation
C. Stress testing
D. Systemic
testing

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forwarded, distributed, or posted on a website, in whole or part.
 E. Damage
testing

124. According to the text, Basel II agreement had resulted in less total capital and:

A. less concentration on operating

risk.
B. a weaker mix of
capital.
C. more retention
ratio.
D. less concentration on assets.
E. a weaker leverage
ratio.

125. A standby letter of credit, backing the issue of state and local government general obligation
bonds, is given a credit risk-weight of 20 percent because of its:

A. modest credit
risk.
B. zero credit
risk.
C. moderate credit risk.
D. low credit
risk.
E. highest credit
risk.

126. Along with the value at risk model, which is the other model that determines each bank's
unique market risk exposure and the amount of capital it needs?

A. Internal modeling.
B. Systemic modeling.
C. Credit risk modeling.
D. Borrower credit ratings.

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forwarded, distributed, or posted on a website, in whole or part.
 E. Damage
testing.

127. ________________________ represent(s) funds set aside for contingencies, such as legal
action against the institution or a sinking fund to retire stock or debt in the future.

A. Undivided
profits
B. Surplu
s
C. Preferred
stock
D. Common stock
E. Equity reserves

128. Interbank deposits generally carry:

A. low credit
risk.
B. high credit risk.
C. highest credit
risk.
D. moderate credit risk.
E. zero credit
risk.

129. Under Basel III, more flexible capital standards which includes the "buffer concept" means
involvement of which two ratios?

A. Base capital and leverage

ratio
B. Base capital and buffer ratio
C. Capital and risk-weighted assets ratio
D. Leverage and buffer ratio
E. Risk-weighted assets ratio and buffer ratio

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authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.
© 2013 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not
authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated,
forwarded, distributed, or posted on a website, in whole or part.