Liberty University BUSI 321 test 3 exam solutions answers right

Liberty University BUSI 321 test 3 exam solutions answers right

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Question 1 ____ trade futures contracts for their own account.

Question 2 Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102­12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103­15. What is Baher's nominal profit? The par value of the futures contract is $100,000.

Question 3 The prices of stock index futures

Question 4 ____ risk is the risk of losses as a result of inadequate management or controls.

Question 5 Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund

Question 6 Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia's position in the S&P 500 futures contract is ____ percent.

Question 7 _________ take positions in financial futures to reduce their exposure to future movements in interest rates or stock prices; ________ commonly take the opposite position and thus serve as counterparties on many transactions.

Question 8 Financial futures contracts on U.S. securities are ____ by non­U.S. financial institutions.

Question 9 Put options are typically used to hedge

Question 10 If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____ than the exercise price when the payables are due.

Question 11 The ____ is the most important exchange for trading options.

Question 12 Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar.

Question 13 Assuming the same expiration date, an option with a ____ exercise price has a ____ call option premium and a ____ put option premium.

Question 14 A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.

Question 15 The ____, the higher the call option premium, other things being equal.

Question 16 A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29, and rises to $32 before the expiration date. What is the stock price at which the speculator would break even?

Question 17 Which of the following can normally be found in quotations for stock options provided by the financial media?

Question 18 A firm is involved in an agreement in which it makes payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has

Question 19 A firm is involved in an agreement in which it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement. This means that the firm has

Question 20 Savings institutions participate in the swap market primarily to

Question 21 A(n) ____ swap allows the party making fixed­rate payments to terminate the swap prior to maturity.

Question 22 Interest rate ____ are interest rate derivative instruments that are normally classified separately from interest rate swaps.

Question 24 The most likely users of plain vanilla swaps would be

Question 25 Financial institutions such as U.S. savings institutions and commercial banks traditionally had fewer interest rate­sensitive ____ than ____ and therefore were adversely affected by ____ interest rates.

Question 26 Which of the following is not a reason for financial institutions to engage in interest rate swaps?

Question 27 Currency futures contracts differ from forward contracts in that they

Question 28 According to interest rate parity, if the interest rate in a foreign country is ____ than in the home country, the forward rate of the foreign country will have a ____.

Question 29 Which of the following is not a method of forecasting exchange rate volatility?

Question 30 If the spot rate of the British pound is $2, and the 180­day forward rate is $2.05, what is the annualized premium or discount?

Question 31 The devaluation of a country’s currency:

Question 32 Which of the following statements is incorrect?

Question 33 Beginning with an equilibrium situation, if European inflation suddenly ____ than U.S. inflation, this forced ____ pressure on the value of the euro.

Question 34 ____ forecasting involves the use of historical exchange rate data to predict future values.

Question 35 When a bank obtains funds through ____, households are not a common provider of the funds.

Question 36 The primary credit lending rate is determined by

Question 37 Transaction deposits do not include

Question 38 Money market deposit accounts (MMDAs)

Question 39 Banks sometimes prefer to minimize their amount of capital since

Question 40 The federal funds rate is ____ the yield on a Treasury security with a similar term remaining until maturity.

Question 41 Which of the following is most appropriate for a business that may experience a sudden need for funds but does not know precisely when?

Question 42 The interest rate banks charge their most creditworthy customers is known as the

Question 43 A bank's net interest margin will likely decline if it has a large amount of

Question 44 Which of the following is not a likely method used by a bank to reduce interest rate risk?

Question 45 If a bank expects interest rates to consistently ____ over time, it will consider allocating most of its funds to rate­____ assets.

Question 46 The risk of a loss due to closing out a transaction is referred to as ____ risk.

Question 47 Assume a bank accepts deposits on Australian dollars (A$) and makes some fixed­rate loans in British pounds. Which of the following would reduce the bank's profit margin?

Question 48 Banks can reduce their required capital levels by

Question 49 Banks can resolve cash deficiencies by

Question 50 If a bank desired to maximize its net interest margin, it would best achieve its goal by attempting to obtain most of its funds through ____ and use most of its funds for ____ (assuming that all loans will be repaid).

       1.    A(n) ____ is a standardized agreement to deliver or receive a specified amount of a specified financial instrument at a specified price and date.

a.	option contract
b.	brokerage contract
c.	financial futures contract
d.	margin call

       2.    Interest rate futures are not available on

a.	Treasury bonds.
b.	Treasury notes.
c.	Eurodollar CDs.
d.	the S&P 500 index.

       3.    ____ take positions in futures to reduce their exposure to future movements in interest rates or stock prices.

a.	Hedgers
b.	Day traders
c.	Position traders
d.	None of the above

       4.    ____ trade futures contracts for their own account.

a.	Commission brokers
b.	Floor brokers
c.	Commission traders
d.	Floor traders

       5.    The initial margin of a futures contract is typically between ____ percent of a futures contract's full value.

a.	0 and 2
b.	5 and 18
c.	25 and 40
d.	45 and 60

       6.    Futures exchanges take buy or sell positions on futures contracts.

a. True

b. False

       7.    If the prices of Treasury bonds ____, the value of an existing Treasury bond futures contract should ____.

a.	increase; be unaffected
b.	decrease; be unaffected
c.	A and B
d.	decrease; decrease
e.	decrease; increase

       8.    Assume that a T-bill futures contract with a face value of $1 million is purchased at a price of $95.00 per $100 face value. At settlement, the price of T-bills is $95.50. What is the difference between the selling and purchase price of the futures contract?

a.	$.50
b.	$50
c.	$500
d.	$5,000
e.	none of the above

       9.    If speculators believe interest rates will ____, they would consider ____ a T-bill futures contract today.

a.	increase; selling
b.	increase; buying
c.	decrease, selling
d.	decrease; purchasing a call option on

    10.    Financial futures contracts on U.S. securities are ____ by non-U.S. financial institutions.

a.	not allowed to be traded
b.	are rarely desired
c.	are commonly traded
d.	A and B

    11.    Assume that speculators had purchased a futures contract at the beginning of the year. If the price of a security represented by a futures contract ____ over the year, then these speculators would likely have purchased the futures contract for ____ than they can sell it for.

a.	increased; more
b.	decreased; less
c.	remains the same; more
d.	increased; less

    12.    Assume that a futures contract on Treasury bonds with a face value of $100,000 is purchased at 93-00. If the same contract is later sold at 94-18, what is the gain, ignoring transactions costs?

a.	$1,180,000
b.	$118
c.	$11,800
d.	$15,625
e.	$1,562.50

    13.    The use of financial leverage

a.	magnifies the positive returns of futures contracts.
b.	magnifies losses of futures contracts.
c.	both A and B
d.	none of the above

    14.    According to the text, when a financial institution sells futures contracts on securities in order to hedge against a change in interest rates, this is referred to as

a.	a long hedge.
b.	a short hedge.
c.	a closed out position.
d.	basis trading.

    15.    A financial institution that maintains some Treasury bond holdings sells Treasury bond futures contracts. If interest rates increase, the market value of the bond holdings will ____ and the position in futures contracts will result in a ____.

a.	increase; gain
b.	increase; loss
c.	decrease; gain
d.	decrease; loss

    16.    The basis is the

a.	difference between the price of a security and the price of a futures contract on the security.
b.	gain or loss from hedging with futures contracts.
c.	difference between a futures contract price and the initial deposit required.
d.	price paid for a futures contract after accounting for transactions costs.
e.	price paid for an option contract.

    17.    The profits of a financial institution with interest-rate sensitive liabilities and interest rate-insensitive assets are ____ with hedging than without hedging if interest rates decrease.

a.	higher
b.	the same
c.	lower
d.	higher or the same

    18.    Assume that a bank obtains most of its funds from large CDs with a one-year maturity. Its assets are in the form of loans with rates that adjust every six months. The bank would be ____ affected if interest rates increase. To partially hedge its position, it could ____ futures contracts.

a.	adversely; purchase
b.	favorably; sell
c.	favorably; purchase
d.	adversely; sell

    19.    According to the text, a futures contract on one financial instrument to protect a position in a different financial instrument is known as

a.	cross-hedging.
b.	ratio hedging.
c.	basis hedging.
d.	liquid hedging.

    20.    The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.

a. True

b. False

    21.    If a futures contract is more volatile than the portfolio value, the amount of principal represented by the futures contracts to hedge the portfolio is ____ the market value of the securities to be hedged.

a.	smaller than
b.	greater than
c.	equal to
d.	B and C are both possible

    22.    In cross-hedging, if the futures contract value is ____ volatile than the portfolio value, hedging will require a ____ amount of principal represented by the futures contracts.

a.	less; greater
b.	more; greater
c.	more; smaller
d.	none of the above

    23.    Municipal Bond Index (MBI) futures

a.	involve a physical exchange of bonds.
b.	are based on a Treasury bond index.
c.	are based on actively traded corporate bonds.
d.	are settled in cash.

    24.    Systemic risk reflects the risk that a particular event could

a.	cause losses at a firm due to inadequate management control.
b.	spread adverse effects among several firms or among financial markets.
c.	cause a loss in value due to market conditions.
d.	have a larger effect on the futures position than on the position being hedged.

    25.    A savings and loan association has long-term fixed-rate mortgages financed by short-term funds. It hedges by selling Treasury bond futures. If interest rates decline, and many mortgages are prepaid

a.	the gain on the futures contracts offsets the loss on the mortgages.
b.	the gain on the mortgages offsets the loss on the futures contracts.
c.	the gain on the futures contracts more than offsets any unfavorable effects on mortgages.
d.	a loss on the futures contracts more than offsets the favorable effect on the mortgage portfolio.

    26.    If a financial institution expects that the market value of its municipal bonds will decline because of economic conditions, it could hedge its position by ____ futures contracts on ____.

a.	purchasing; Treasury bonds
b.	purchasing; the S&P 500 Index
c.	purchasing; a Municipal Bond Index
d.	selling; a Municipal Bond Index

    27.    The net gain or loss on a futures contract for a stock index that is not closed out is based on the difference between the futures price when the initial position was created and the futures price at

a.	the settlement date.
b.	the date at which the futures price reaches its maximum.
c.	the date at which the futures price reaches its minimum.
d.	the date three months beyond the date when the initial position was taken.

    28.    The value of an S&P 500 futures contract is $500 times the index. Assume the futures price on the S&P 500 index is 1612 at the time of purchase. If the index price is $1619 when the position is closed out, the gain is

a.	$700.
b.	$7,000.
c.	$3,190.
d.	$3,120.
e.	$3,500.

    29.    Assume that a stock mutual fund uses stock index futures as it conducts dynamic asset allocation. This means that the mutual fund

a.	liquidates its stocks whenever it expects a market downturn.
b.	maintains a constant buy position in stock index futures.
c.	maintains a constant sell position in stock index futures.
d.	none of the above

    30.    Companies with international trade can hedge ____ by ____ currency futures.

a.	payables; selling
b.	receivables; buying
c.	payables; buying
d.	A and B
e.	B and C

    31.    Assume that corporate bond portfolio managers are concerned about the possibility of many bond defaults resulting from a future recession. A short position in Treasury bond futures ____ an effective hedge against the default risk. A short position in Treasury bill futures ____ an effective hedge against the default risk.

a.	would be; would be
b.	would be; would not be
c.	would not be; would not be
d.	would not be; would be

    32.    Which of the following statements is incorrect with respect to cross-hedging?

a.	Even when the futures contract is highly correlated with the portfolio being hedged, the value of the futures contract may change by a higher or lower percentage than the portfolio's market value.
b.	If the futures contract value is more volatile than the portfolio value, hedging will require a greater amount of principal represented by the futures contracts.
c.	The effectiveness of a cross-hedge depends on the degree of correlation between the market values of the two financial instruments.
d.	If the price of the underlying security of the futures contract moves closely in tandem with the security hedged, the futures contract can provide an effective hedge.
e.	All of the above are correct with respect to cross-hedging.

    33.    ____ risk is the risk that the position being hedged by a futures contract is not affected in the same manner as the instrument underlying the futures contract.

a.	Market
b.	Liquidity
c.	Credit
d.	Basis
e.	None of the above

    34.    Trading restrictions imposed on specific stocks or stock indices are referred to as

a.	index busters.
b.	index options.
c.	circuit breakers.
d.	protective covenants.

    35.    Financial leverage, when used in association with a futures contract, ____ the positive returns and ____ losses.

a.	magnifies; reduces
b.	reduces; magnifies
c.	magnifies; magnifies
d.	reduces; reduces

    36.    Currency futures may be purchased to hedge ____ or to capitalize on the expected ____ of that currency against the dollar.

a.	receivables; appreciation
b.	receivables; depreciation
c.	payables; depreciation
d.	payables; appreciation

    37.    The risk that the position being hedged by a futures position is not affected in the same manner as the instrument underlying the financial futures contract, is referred to as

a.	market risk.
b.	liquidity risk.
c.	default risk.
d.	basis risk.

    38.    Dynamic asset allocation involves the switching between risky and low-risk investments by institutional investors over time in response to changing expectations.

a. True

b. False

    39.    The prices of stock index futures

a.	are always the same as the prices of the stocks representing the index.
b.	are always a little above the prices of the stocks representing the index.
c.	are always a little below the prices of the stocks representing the index.
d.	none of the above

    40.    The actions of numerous institutional investors to sell stock index futures instead of selling stocks to prepare for a market decline would likely cause the index futures price to be

a.	equal to the prevailing stock prices.
b.	below the prevailing stock prices.
c.	above the prevailing stock prices.
d.	negative.

    41.    Speculators in futures contracts that normally close out their futures positions on the same day that the positions were initiated are referred to as

a.	day traders.
b.	hedgers.
c.	closed-end traders.
d.	position traders.

    42.    Speculators in futures contracts that normally maintain the futures position that they initiate for extended periods of time (such as weeks or months) are referred to as

a.	day traders.
b.	hedgers.
c.	closed-end traders.
d.	position traders.

    43.    Which of the following is incorrect regarding organized exchanges trading financial futures contracts?

a.	Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b.	Organized exchanges ensure that the seller of the futures contract always delivers the securities covered by the contract, whether the contract was settled prior to the settlement date or not.
c.	Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d.	The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e.	All of the above are correct.

    44.    Marcia buys an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Marcia's position in the S&P 500 futures contract is ____ percent.

a.	-20
b.	-10
c.	25
d.	20
e.	0

    45.    Laura sells an S&P 500 futures contract with a September settlement date when the index is 1,750. By the settlement date, the S&P 500 index falls to 1,400. The return on Laura's position in the S&P 500 futures contract is ____ percent.

a.	-20
b.	-10
c.	25
d.	20
e.	0

    46.    Assume a corporation is receiving a large amount of funds in the near future. The company plans to use the funds to purchase municipal bonds. Also assume that the company is concerned that interest rates decrease before the purchase date, which would make the municipal bonds more expensive. In order to hedge against this possibility, the company should ____ MBI futures contracts. If interest rates decrease, the futures contract will generate a ____.

a.	sell; loss
b.	purchase; gain
c.	purchase; loss
d.	sell; gain
e.	none of the above

    47.    If there are ____ traders with buy offers than sell offers for a particular contract, the futures price will ____ until this imbalance is removed.

a.	more; decrease
b.	more; rise
c.	fewer; rise
d.	none of the above

    48.    Which of the following statements is incorrect?

a.	Circuit breakers are trading restrictions imposed on specific stocks or stock indexes.
b.	Circuit breakers guarantee that prices will turn upward.
c.	Circuit breakers may be able to prevent large declines in prices that would be attributed to panic selling rather than to fundamental forces.
d.	Circuit breakers may allow investors to determine whether circulating rumors are true.

    49.    ____ risk is the risk of losses as a result of inadequate management or controls.

a.	Basis
b.	Systemic
c.	Operational
d.	Prepayment

    50.    Financial futures contracts on stock indexes are referred to as interest rate futures.

a. True

b. False

    51.    Financial futures contracts are rarely sold over the counter.

a. True

b. False

    52.    Brokers commonly require margin deposits from their customers above those required by the exchanges.

a. True

b. False

    53.    Purchasers of financial futures contracts usually know who the sellers are, and vice versa.

a. True

b. False

    54.    The futures price is mainly a function of the prevailing price of the underlying security plus an expected adjustment in that price by the settlement date.

a. True

b. False

    55.    A financial institution that hedges with interest rate futures is less sensitive to economic events than an institution that does not hedge.

a. True

b. False

    56.    A bond index futures contract allows for the buying, but not the selling, of a bond index for a specified price at a specified date.

a. True

b. False

    57.    Market participants who expect the stock market to perform poorly before the settlement date may consider selling S&P 500 index futures.

a. True

b. False

    58.    Stock index futures cannot be closed out before the settlement date.

a. True

b. False

    59.    The value of a stock index futures contract has little correlation with the value of the underlying stock index.

a. True

b. False

    60.    Since stock index futures prices are primarily driven by movements in the corresponding stock indexes, participants in stock index futures monitor indicators that may signal changes in the stock indexes.

a. True

b. False

    61.    The price of stock index futures may reflect investor expectations about the market more rapidly than stock prices.

a. True

b. False

    62.    Financial futures contracts on U.S. securities are commonly traded by non-U.S. financial institutions that maintain holdings of U.S. securities.

a. True

b. False

    63.    Purchasers of currency futures contracts are required to hold the contract until the settlement date and accept delivery of the foreign currency at that time.

a. True

b. False

    64.    Which of the following statements is incorrect regarding organized futures exchanges?

a.	Organized exchanges establish and enforce rules for the trading of financial futures contracts.
b.	Organized exchanges serve as market makers for futures contracts by taking positions in futures.
c.	Organized exchanges clear, settle, and guarantee all transactions that occur on their exchanges.
d.	The operations of financial futures exchanges are regulated by the Commodity Futures Trading Commission (CFTC).
e.	All of the above are correct.

    65.    Stock index futures are priced ____ than the stock index itself.

a.	higher
b.	lower
c.	either higher or lower
d.	none of the above

    66.    An unexpected ____ in the consumer price index tends to create expectations of ____ interest rates and places ____ pressure on Treasury bond futures prices.

a.	increase; higher; downward
b.	increase; lower; downward
c.	increase; higher; upward
d.	decrease; higher; downward
e.	none of the above

    67.    Bill Baher, a private investor, purchased a futures contract on Treasury bonds at a price of 102-12. Two months later, Baher sells the same futures contract in order to close out the position. At that time, the futures contract specifies 103-15. What is Baher's nominal profit? The par value of the futures contract is $100,000.

a.	$1,030.00; profit
b.	$1,030.00; loss
c.	$1,093.75; profit
d.	$1,093.75; loss
e.	none of the above

    68.    Clarke plans to satisfy cash needs in nine months by selling its Treasury bond holdings for $4 million. However, Clarke is concerned that interest rates might increase over the next three months. To hedge against this possibility, Clarke plans to sell Treasury bond futures. Thus, Clarke sells ____ futures contract for a price of 99-12. Assuming that the actual price of the futures contract declined to 97-20, Clarke would make a ____ of $____ from closing out the futures position.

a.	40; profit; $76,800
b.	40; loss; $76,800
c.	50; profit; $70,000
d.	40; profit; $70,000
e.	none of the above

       1.    A ____ grants the owner the right to purchase a specified financial instrument for a specified price within a specified period of time.

a.	call option
b.	put option
c.	sale of a futures contract
d.	purchase of a futures contract

       2.    A ____ requires a premium above and beyond the price to be paid for the financial instrument.

a.	futures contract
b.	call option
c.	put option
d.	B and C

       3.    A call option is "in the money" when the

a.	market price of the underlying security exceeds the exercise price.
b.	market price of the underlying security equals the exercise price.
c.	market price of the underlying security is less than the exercise price.
d.	premium on the option is less than the exercise price.

       4.    A put option is "out of the money" when the

a.	market price of the security exceeds the exercise price.
b.	market price of the security equals the exercise price.
c.	market price of the security is less than the exercise price.
d.	premium on the option is less than the exercise price.

       5.    When the market price of the underlying security exceeds the exercise price, the

a.	call option is in the money.
b.	put option is in the money.
c.	call option is at the money.
d.	call option is out of the money.

       6.    When the exercise price exceeds the market price of the underlying security, the

a.	call option is in the money.
b.	put option is in the money.
c.	call option is at the money.
d.	put option is out of the money.

       7.    Sellers (writers) of call options can offset their position at any point in time by

a.	selling a put option on the same stock.
b.	buying identical call options.
c.	selling additional call options on the same stock.
d.	all of the above
e.	A and B

       8.    The ____ is the most important exchange for trading options.

a.	New York Stock Exchange (NYSE)
b.	Chicago Board of Options Exchange (CBOE)
c.	Boston Options Exchange
d.	American Stock Exchange

       9.    The Options Clearing Corporation (OCC) serves as a guarantor on option contracts traded in the United States.

a. True

b. False

    10.    ____ execute transactions desired by investors and trade stock options for their own account.

a.	Floor brokers
b.	Discount brokers
c.	Market-makers
d.	none of the above

    11.    A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. The speculator will exercise the option on the expiration date (if it is feasible to do so). What is the speculator's profit per unit?

a.	$1
b.	$5
c.	$2
d.	-$1
e.	-$2

    12.    A speculator buys a call option for $3, with an exercise price of $50. The stock is currently priced at $49, and rises to $55 on the expiration date. What is the stock price at which the speculator would break even?

a.	$50
b.	$58
c.	$52
d.	$53
e.	$49

    13.    A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29, and rises to $32 before the expiration date. What is the maximum profit per unit to the speculator who owned the put option assuming he or she exercises the option at the ideal time?

a.	-$4
b.	-$3
c.	-$2
d.	$2
e.	$3

    14.    A speculator purchases a put option for a premium of $4, with an exercise price of $30. The stock is presently priced at $29, and rises to $32 before the expiration date. What is the stock price at which the speculator would break even?

a.	$26
b.	$34
c.	$28
d.	$29
e.	$32

    15.    The ____, the higher the call option premium, other things being equal.

a.	lower the existing price of the security relative to the exercise price
b.	lower the variability of the security's market price
c.	longer the maturity of the option
d.	A and B

    16.    The ____, the lower the premium on a put option, other things being equal.

a.	higher the existing price of the security relative to the exercise price
b.	greater the variability of the security's market value
c.	longer the maturity of the option
d.	A and B

    17.    The longer the time to maturity, the ____ the call option premium and the ____ the put option premium.

a.	higher; lower
b.	lower; higher
c.	higher; higher
d.	lower; lower

    18.    The greater the volatility of the underlying stock, the ____ the call option premium and the ____ the put option premium.

a.	higher; lower
b.	lower; higher
c.	higher; higher
d.	lower; lower

    19.    The sale of a call option on a stock the seller already owns is referred to as

a.	a covered call.
b.	a naked call.
c.	call on futures.
d.	futures on options.

    20.    Assume a pension fund purchased stock at $53. Call options at a $50 exercise price presently have a $4 premium per share. The pension fund sells a call option on the stock it owns. If the call option is exercised when the price of the stock is $56, what is the gain or loss per share to the pension fund (including its gain from holding the stock as well)?

a.	$4 gain
b.	$6 loss
c.	$2 loss
d.	$1 gain
e.	$0

    21.    Covered call writing ____ the upside potential return and ____ the risk of an investment in stock.

a.	increases; increases
b.	increases; decreases
c.	limits; increases
d.	limits; decreases

    22.    Put options are typically used to hedge

a.	when portfolio managers are mainly concerned with a permanent decline in a stock's value.
b.	when portfolio managers are mainly concerned with a permanent increase in a stock's value.
c.	when portfolio managers are mainly concerned with a temporary decline in a stock's value.
d.	when portfolio managers are mainly concerned with a temporary increase in a stock's value.

    23.    A savings institution has long-term fixed rate mortgages supported by short-term funds. A put option on Treasury bond futures could be used to (ignore the premium paid for the option when you answer this question)

a.	maintain its interest rate spread if interest rates rise, and increase its spread if interest rates fall.
b.	maintain its interest rate spread if interest rates fall, and increase its spread if interest rates rise.
c.	maintain its interest rate spread whether interest rates rise or fall.
d.	increase its interest rate spread whether interest rates rise or fall.

    24.    A speculator purchases a put option on Treasury bond futures with a September delivery date with a strike price of 85-00. The option has a premium of 2-00. Assume that the price of the futures contract decreases to 82-00 on the expiration date and the option is exercised at that point (if it is feasible). What is the net gain?

a.	$1,968.75
b.	$3,750.00
c.	$3,000.00
d.	-$2,000.00
e.	$1,000.00

    25.    Assume an insurance company purchases a call option on an S&P 500 Index futures contract for a premium of 14, with an exercise price of 1800. The value of an S&P 500 futures contract is 250 times the index. If the index on the futures contract increases to 1830, what is the gain on the sale of the futures contract?

a.	$15,000
b.	$7,500
c.	$3,300
d.	$4,000
e.	$1,500

    26.    Corporations involved in international business transactions can ____ to hedge future ____.

a.	sell currency call options; payables
b.	purchase currency put options; receivables
c.	purchase currency call options, receivables
d.	purchase currency put options, payables
e.	A and B

    27.    If a corporation hedges payables with currency call options, it will ____ if the value of the foreign currency is ____ than the exercise price when the payables are due.

a.	exercise the option; greater
b.	exercise the option; less
c.	let the option expire; greater
d.	let the option expire; less
e.	A and D

    28.    Speculators purchase currency ____ on currencies they expect to ____ against the dollar.

a.	call options; weaken
b.	put options; strengthen
c.	futures; weaken
d.	put options; weaken

    29.    Speculators may be willing to write ____ options on foreign currencies they expect to ____ against the dollar.

a.	put; strengthen
b.	put; weaken
c.	call; strengthen
d.	call; weaken
e.	A and D

    30.    European-style stock options

a.	are long-term options (at least one year until expiration at the time they are created).
b.	can be exercised after the expiration date.
c.	can be exercised any time until the expiration date.
d.	none of the above

    31.    A speculator purchased a call option with an exercise price of $31 for a premium of $4. The option was exercised a few days later when the stock price was $34. What was the return to the speculator?

a.	25 percent
b.	-25 percent
c.	-3.2 percent
d.	-2.9 percent

    32.    A speculator purchased a put option with an exercise price of $56 for a premium of $10. The option was exercised a few days later when the stock price was $44. What was the return to the speculator?

a.	-20 percent
b.	120 percent
c.	-100 percent
d.	20 percent

    33.    The premium on an existing call option should ____ when the underlying stock price decreases.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    34.    The premium on an existing put option should ____ when the underlying stock price increases.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    35.    The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    36.    The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    37.    The premium on an existing put option should ____ when there is an increase in the expected short-term volatility of the stock price.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    38.    The premium on an existing call option should ____ when there is a reduction in the expected short-term volatility of the stock price.

a.	be negative
b.	decline
c.	increase
d.	be unaffected
e.	A and B

    39.    When a stock index option is exercised, the cash payment is equal to a specified dollar amount

a.	multiplied by the index level.
b.	multiplied by the exercise price.
c.	multiplied by the difference between the index level and the exercise price.
d.	multiplied by the sum of the index level and the exercise price.

    40.    Long-term equity anticipations (LEAPS) represent

a.	stocks that have a maturity date.
b.	stocks that are converted to bonds once the price reaches a specified level.
c.	stock options with longer terms to expiration than the more traditional stock options.
d.	stock index futures that can have a more distant settlement date than the more typical stock options.

    41.    When stock portfolio managers use dynamic asset allocation by purchasing call options on a stock index, they ____ their exposure to stock market conditions.

a.	reduce
b.	completely eliminate
c.	have no effect on
d.	increase

    42.    When stock portfolio managers use dynamic asset allocation by writing call options on a stock index, they ____ their exposure to stock market conditions.

a.	reduce
b.	completely eliminate
c.	have no effect on
d.	increase

    43.    Options on stock indexes representing non-U.S. stocks are ____; options exchanges have been established ____.

a.	available; in numerous non-U.S. countries
b.	not available; in numerous non-U.S. countries
c.	available; only in the United States
d.	not available; only in the United States

    44.    Which of the following is not a difference between purchasing an option and purchasing a futures contract?

a.	The option requires that a premium be paid in addition to the price of the financial instrument.
b.	Owners of options can choose to let the option expire on the so-called expiration date without exercising it.
c.	The fulfillment of futures contracts is regulated by exchanges, while the fulfillment of options is not.
d.	All of the above are differences between purchasing an option and purchasing a futures contract.

    45.    Marcie purchases a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, Marcie decides to exercise the option and closes out the position by selling an identical futures contract. Marcie's net gain from this strategy is $____.

a.	-2,687.50
b.	2,687.50
c.	2,375.00
d.	7,437.50
e.	none of the above

    46.    Reese Insurance company sold a call option on interest rate futures with an exercise price of 92-10. The premium on the call option is 2-24. Just before the expiration date, the price of Treasury bond futures is 97-14. At this time, the option was exercised as the buyer closed out the position by selling an identical futures contract. Reese's net gain from selling the call option  is $____.

a.	2,687.50
b.	-2,687.50
c.	2,375.00
d.	7,437.50
e.	none of the above

    47.    Vince, a speculator, expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 93-22. Vince exercises the option and closes out the position by purchasing an identical futures contract. Vince's net gain from this speculative strategy is $____.

a.	-406.25
b.	4,718.75
c.	-4,718.75
d.	-812.50
e.	none of the above

    48.    Which of the following is not an assumption underlying the Black-Scholes option-pricing model?

a.	The risk-free rate is known and constant over the life of the option.
b.	The probability distribution of stock prices is lognormal.
c.	The world is risk-neutral.
d.	The variability of a stock's return is constant.
e.	There are no transaction costs involved in trading options.

    49.    Which of the following is not true with respect to market makers?

a.	They benefit from the spread.
b.	They may earn profits when they take positions in options.
c.	They are not subject to the risk of loss on their positions in options.
d.	All of the above are true with respect to market makers.

    50.    Option trading is regulated by the

a.	Options Clearing Corporation.
b.	International Securities Exchange.
c.	Securities and Exchange Commission.
d.	Federal Reserve.

    51.    On an exchange, option trades can be executed

a.	by a floor broker.
b.	electronically.
c.	by a market maker.
d.	all of the above
e.	A and B only

    52.    When investors purchase an option that does not hedge their existing investments, the option can be referred to as "naked."

a. True

b. False

    53.    Backdating implies that CEO (or other executives) reset the date that their options were granted to a different date when the stock price was lower.

a. True

b. False

    54.    The motive for a CEO to backdate options is that it allowed them to exercise the options at a lower exercise price.

a. True

b. False

    55.    Stock options can be used by speculators to benefit from their expectations and by financial institutions to reduce their risk.

a. True

b. False

    56.    The writer of a put option is obligated to provide the specified financial instrument at the price specified by the option contract if the owner exercises the option.

a. True

b. False

    57.    A call option is said to be at the money when the market price of the underlying security exceeds the exercise price.

a. True

b. False

    58.    Market makers can execute stock option transactions for customers and do not trade stock options for their own account.

a. True

b. False

    59.    American-style stock options can be exercised only just before expiration.

a. True

b. False

    60.    An option with a higher exercise price has a higher call option premium and a lower put option premium.

a. True

b. False

    61.    Several call options are available for a given stock, and the risk-return potential will vary among them.

a. True

b. False

    62.    The greater the existing market price of the underlying financial instrument relative to the exercise price, the higher the put option premium, other things being equal.

a. True

b. False

    63.    The longer a call option's time to maturity, the lower the call option premium, other things being equal.

a. True

b. False

    64.    The results with covered call writing are better than without covered call writing when the stock performs poorly and better when the stock performs well.

a. True

b. False

    65.    Put options are more typically used to hedge when portfolio managers are mainly concerned about a temporary decline in a stock's value.

a. True

b. False

    66.    An increase in uncertainty results in a higher implied standard deviation for the stock, which means that the writer of an option requires a higher premium to compensate for the anticipated increase in the stock's volatility.

a. True

b. False

    67.    Speculators who anticipate a sharp increase in stock market prices overall may consider purchasing put options on one of the market indexes.

a. True

b. False

    68.    Speculators who anticipate a decline in interest rates may consider writing a call option on Treasury bond futures.

a. True

b. False

    69.    Speculators sell call options on currencies that they expect to strengthen against the dollar.

a. True

b. False

    70.    Market makers

a.	can execute stock option transactions for their customers.
b.	can trade options for their own account.
c.	are subject to the risk of losses from their positions in options.
d.	benefit from the spread.
e.	all of the above

    71.    ____ of options can close out their positions at any time by ____ an identical option.

a.	Sellers; purchasing
b.	Sellers; selling
c.	Buyers; purchasing
d.	none of the above

    72.    Assuming the same expiration date, an option with a ____ exercise price has a ____ call option premium and a ____ put option premium.

a.	higher; higher; higher
b.	higher; higher; lower
c.	higher; lower; higher
d.	lower; lower; higher
e.	none of the above

    73.    Which of the following statements is least correct regarding corporations involved in international business transactions?

a.	They may purchase currency put options to hedge future receivables denominated in a foreign currency.
b.	They may purchase currency call options to hedge future payables denominated in a foreign currency.
c.	They may purchase currency call options to hedge future receivables denominated in a foreign currency.
d.	They benefit from currency put options if the currency's value declines before the expiration date of the option.

    74.    The ____ is not a factor affecting the call option premium.

a.	market price of the underlying instrument (relative to option's exercise price)
b.	volatility of the underlying instrument
c.	current price of futures contracts on the underlying instrument
d.	time to maturity of the call option

    75.    Speculators who anticipate a decline in interest rates may consider ____ a ____ option on Treasury bond futures.

a.	purchasing; put
b.	selling; call
c.	purchasing; call
d.	none of the above

    76.    Brad expects interest rates to increase and purchases a put option on Treasury bond futures with an exercise price of 95-32. The premium paid for the put option is 2-36. Just prior to the expiration date, the price of the Treasury bond futures contract is valued at 93-22. Brad exercises the option and closes out the position by purchasing an identical futures contract. Brad's net gain from this speculative strategy is $____.

a.	-812.50
b.	4,718.75
c.	-4,718.75
d.	-406.25
e.	none of the above

    77.    Which of the following statements is incorrect?

a.	Some firms allowed their CEOs to backdate options that they were granted to an earlier period when the stock price was lower.
b.	Backdating is completely inconsistent with the idea of granting options to encourage managers to focus on maximizing the stock price.
c.	Firms readily promote their option compensation programs and are more than willing to acknowledge that the options are an expense.
d.	All of the above are correct.

1.   In a swap arrangement, the most common index used for floating-rate payments would be the

A)  coupon rate on existing bonds.

B)  stock dividend rate based on a U.S. stock index.

C)  London Interbank Offer Rate (LIBOR).

D)  Treasury bond yield.

2.   The most likely users of plain vanilla swaps would be

A)  commercial banks that focus on short-term consumer loans.

B)  savings institutions.

C)  manufacturing companies.

D)  municipal governments.

3.   A plain vanilla swap is especially beneficial when interest rates are expected to

A)  rise consistently.

B)  decline consistently.

C)  be stable.

D)  rise and then decline.

4.   The typical financial intermediaries in swap transactions are

A)  savings institutions.

B)  pension funds.

C)  insurance companies.

D)  securities firms.

5.   If a firm negotiates a plain vanilla swap, it will provide ______ payments in exchange for ______ payments.

A)  fixed-rate; floating-rate

B)  floating-rate; fixed rate

C)  stock dividend; fixed-rate

D)  stock dividend; floating rate

6.   A ______ swap allows the party making floating-rate payments to terminate the swap prior to maturity.

A)  zero coupon-for-floating

B)  forward

C)  callable

D)  putable

7.   A(n) ______ allows the party making fixed payments to extend the swap period.

A)  forward

B)  extendible

C)  callable

D)  putable

8.   A(n) ______ swap allows the party making fixed-rate payments to terminate the swap prior to maturity.

A)  forward

B)  extendible

C)  callable

D)  putable

9.   The option on a callable swap would most likely be exercised if interest rates

A)  rise.

B)  fall.

C)  remain constant.

D)  remain somewhat stable.

10. The option on a putable swap would most likely be exercised if interest rates

A)  rise.

B)  fall.

C)  remain constant.

D)  remain somewhat stable.

11. A(n) ______ swap involves an exchange of interest payments over a swap period that does not begin until a specified future point in time.

A)  forward

B)  extendible

C)  callable

D)  putable

12. Assume a financial institution that has rate-sensitive liabilities and rate-insensitive assets.  If interest rates are expected to decline consistently, this institution would benefit by negotiating a(n)

A)  forward swap.

B)  callable swap.

C)  extendible swap.

D)  none of the above

13. Assume a financial institution has rate-sensitive liabilities and rate-sensitive assets.  If this institution negotiates a rate-capped swap, its ______ payments will be capped, and it will ______ an up-front premium in exchange for the cap.

A)  outflow; receive

B)  outflow; pay

C)  inflow; pay

D)  inflow; receive

14. Assume a U.S. savings institution funds its fixed-rate mortgages by attracting short-term deposits.  If it engages in an interest rate swap, but the index on the swap does not move in perfect tandem with its cost of deposits, this reflects

A)  sovereign risk.

B)  basis risk.

C)  credit risk.

D)  none of the above.

15. According to the text, any political aspects that prevent a counterparty on a swap from meeting its payment obligations represent

A)  sovereign risk.

B)  basis risk.

C)  credit risk.

D)  none of the above.

16. An interest rate swap agreement indicates the ______ value, which represents the principal amount to which interest rates are applied to determine the interest payments involved.

A)  vanilla

B)  LIBOR

C)  programmed

D)  notional

17. Financial institutions primarily use interest rate swaps in a way that will ______ exposure to interest rate risk and ______ potential returns.

A)  increase; increase

B)  increase; reduce

C)  reduce; increase

D)  reduce; reduce

18. An advantage of a ______ over other interest rate swaps is that the fixed-rate payer has the flexibility to avoid exchanging future interest payments.

A)  callable swap

B)  putable swap

C)  zero-coupon for floating swap

D)  forward swap

19. The advantage of a rate-capped interest rate swap to a party exchanging fixed payments for floating payments (relative to a plain vanilla swap) is that

A)  there is a minimum limit set on interest rate payments received.

B)  there is a maximum limit set on the interest payments it will provide.

C)  it receives an up-front fee.

D)  none of the above

20. The advantage of a rate-capped interest rate swap (relative to a plain vanilla swap) to a party exchanging floating payments for fixed payments is that

A)  there is a minimum limit set on interest rate payments received.

B)  there is a maximum limit set on the interest payments it will provide.

C)  it receives an up-front fee.

D)  none of the above

21. A plain vanilla swap enables firms to exchange ______ for ______.

A)  fixed rate payments; variable interest rate payments

B)  a high interest rate foreign currency; a low interest rate foreign currency

C)  a low interest rate foreign currency; a high interest rate foreign currency

D)  bonds; stocks that pay dividends

22. An arrangement which enables firms to exchange currencies at periodic intervals is called a

A)  currency swap.

B)  interest rate swap.

C)  swap exchange.

D)  Eurobond swap.

23. When a bank participates in a swap of fixed interest rate payments for floating-rate payments, or a swap of curren­cies, it

A)  can match up two parties but can not take a position in the swap.

B)  can match up two parties or can take a position in the swap.

C)  cannot match up two parties and cannot take a position in the swap.

D)  cannot match up two parties but can take a position in the swap.

24. An equity swap involves the exchange of

A)  preferred stock for common stock.

B)  interest payments for an equity position in the counterparty’s firm.

C)  interest payments for payments linked to the degree of change in a stock index.

D)  interest payments for newly issued stock by financial institutions.

25. A firm is involved in an agreement in which it receives payments in periods when a market interest rate falls below an interest rate level specified in the agreement.  This means that the firm has

A)  purchased an interest rate cap.

B)  sold an interest rate cap.

C)  purchased an interest rate floor.

D)  sold an interest rate floor.

26. A firm is involved in an agreement in which it makes payments in periods when a market interest rate rises above an interest rate level specified in the agreement.  This means that the firm has

A)  purchased an interest rate cap.

B)  sold an interest rate cap.

C)  purchased an interest rate floor.

D)  sold an interest rate floor.

27. A firm is involved in an agreement in which it makes payments in periods when a market interest rate falls below an interest rate level specified in the agreement.  This means that the firm has

A)  purchased an interest rate cap.

B)  sold an interest rate cap.

C)  purchased an interest rate floor.

D)  sold an interest rate floor.

28. A firm is involved in an agreement in which it receives payments in periods when a market interest rate rises above an interest rate level specified in the agreement.  This means that the firm has

A)  purchased an interest rate cap.

B)  sold an interest rate cap.

C)  purchased an interest rate floor.

D)  sold an interest rate floor.

29. An interest rate collar represents the __________ of an interest rate cap and a simultaneous __________ of an interest rate floor.

A)  sale; sale

B)  sale; purchase

C)  purchase; purchase

D)  purchase; sale

30.  Firms A and B have entered into an interest rate swap. On the first payment date, Firm A owes Firm B 12 percent of $10 million, and Firm B owes Firm A 14 percent of $10 million. Most likely, this transaction will be settled in what manner?

A)     Firm A will send Firm B $120,000 and Firm B will send Firm A $140,000.

B)     Firm B will send Firm A $120,000 and Firm A will send Firm B $140,000.

C)     Firm A will send Firm B $20,000.

D)     Firm B will send Firm A $20,000.

E)      none of the above

31.  Financial institutions such as U.S. savings institutions and commercial banks traditionally had fewer interest rate-sensitive ___________ than ____________ and therefore were adversely affected by ____________ interest rates.

A)     assets; liabilities; increasing

B)     liabilities; assets; decreasing

C)     liabilities; assets; increasing

D)     none of the above

32.  The Bank of Moronto has negotiated a plain vanilla swap in which it will exchange fixed payments of 10 percent for floating payments equal to LIBOR plus 0.5 percent at the end of each of the next three years. In the first year, LIBOR is 8 percent; in the second year, 9 percent; in the third year, LIBOR is 7 percent. What is the total net payment the Bank of Moronto makes over the three-year period if the notional principal is $10 million?

A)     -600,000

B)     600,000

C)     450,000

D)     -450,000

E)      none of the above

33.  Hewitt Inc. has entered into an equity swap arrangement that allows it to swap a fixed interest rate of 8 percent in exchange for the rate of appreciation on the Dow Jones Industrial Average each year over a three-year period. The notional principal is $1 million. If the Dow depreciates by 1 percent, Hewitt will

A)     have to make a payment of $70,000.

B)     have to make a payment of $90,000.

C)     receive a payment of $70,000.

D)     receive a payment of $90,000.

E)      none of the above

The following information refers to questions 34 and 35.

Lizard National Bank purchases a three-year interest rate cap for a fee of 2 percent of notional principal valued at $50 million, with an interest rate ceiling of 11 percent and LIBOR as the index representing the market interest rate. Assume that LIBOR is expected to be 9 percent, 12 percent, and 13 percent at the end of each of the next three years, respectively.

34.  The total payments received (or paid) by Lizard, including the initial fee, are $______________.

A)     500,000

B)     -500,000

C)     -1,500,000

D)     1,500,000

E)      none of the above

35.  The dollar amount to be received (or paid) by the seller of the interest rate cap based on the forecast of LIBOR assumed above over the three-year period is $__________.

A)     -500,000

B)     500,000

C)     -1,500,000

D)     1,500,000

E)      none of the above

1.   The Bretton Woods Era was the era

A)  of free‑floating exchange rates.

B)  of floating rates without boundaries, but subject to government intervention.

C)  in which governments maintained exchange rates within 1 percent of a specified rate.

D)  in which exchange rates were maintained within 10 percent of a specified rate.

2.   A system whereby exchange rates are market determined without boundaries but subject to government inter­vention is called

A)  a dirty float.

B)  a free float.

C)  the gold standard.

D)  the Bretton Woods era.

3.   A system whereby one currency is maintained within spec­ified boundaries of another currency or unit of account is a

A)  pegged system.

B)  free float.

C)  dirty float.

D)  managed float.

4.   If the demand for British pounds ______, the pound will ______, other things being equal.

A)  increases; appreciate

B)  decreases; appreciate

C)  increases; depreciate

D)  b and c

5.         Beginning with an equilibrium situation, if European infla­tion suddenly ______ than U.S. inflation, this forced ______ pressure on the value of the euro.

A)  becomes much higher; upward

B)  becomes much higher; downward

C)  becomes much less; upward

D)  becomes much less; downward

E)  b and c

6.   Purchasing Power Parity suggests that the exchange rate will on average change by a percentage that reflects the ______ differential between two countries.

A)  income

B)  interest rate

C)  inflation

D)  tax

7.   If U.S. interest rates suddenly become much higher than European interest rates, the U.S. demand for marks would ______, and the supply of euros to be exchanged for dollars would ______, other factors held constant.

A)  increase; increase

B)  increase; decrease

C)  decrease; increase

D)  decrease; decrease

8.   Assume interest rate parity exists.  If the spot rate on the British pound is $2 and the 1‑year British interest rate is 7 percent, and the 1‑year U.S. interest rate is 11 percent, what is the pound’s forward discount or premium?

A)  3.74 percent premium

B)  3.74 percent discount

C)  3.60 percent premium

D)  3.60 percent discount

9.   When a government influences factors, such as inflation, interest rates, or income, in order to affect currency’s value, this is an example of

A)  direct intervention.

B)  indirect intervention.

C)  a freely floating system.

D)  a pegged system.

10. If the U.S. government imposed trade restrictions on U.S. imports, this would ______ the U.S. demand for foreign currencies, and would place ______ pressure on the values of foreign currencies (with respect to the dollar).

A)  increase; upward

B)  increase, downward

C)  limit; upward

D)  limit; downward

11. If a commercial bank expects the euro to appreciate against the dollar, it may take a ______ position in euros and a ______ position in dollars.

A)  short; short

B)  long; short

C)  short; long

D)  long; long

12. Generally, a ______ home currency can ______ domestic economic growth.

A)  weak; dampen

B)  strong; stimulate

C)  strong; dampen

D)  a and b

13. A ______ home currency can ______ domestic inflation.

A)  strong; increase

B)  weak; decrease

C)  strong; decrease

D)  a and b

14. If the forward rate of a foreign currency ______ the existing spot rate, the forward rate will exhibit a ______.

A)  exceeds; discount

B)  is below; premium

C)  a and b

D)  is below; discount

15. If the spot rate of the British pound is $2, and the 180‑day forward rate is $2.05, what is the annualized premium or discount?

A)  2.5 percent discount

B)  2.5 percent premium

C)  10 percent premium

D)  5 percent discount

E)  5 percent premium

16. Currency futures contracts differ from forward contracts in that they

A)  are an obligation.

B)  are not an obligation.

C)  are standardized.

D)  can specify any amount and maturity date.

17. If the spot rate ______ the exercise price, a currency ______ option would not be exercised.

A)  remains below; call

B)  remains below; put

C)  A and B

D)  remains below; put

18. If a firm planning to hedge receivables is certain of the future direction a spot rate will move, and requires a tailor‑made hedge in terms of amount and maturity date, it should use a

A)  call options contract.

B)  futures contract.

C)  forward contract.

D)  put options contract.

19. Assume that a British pound put option has a premium of $.03 per unit, and an exercise price of $1.60.  The present spot rate is $1.61.  The expected future spot rate on the expiration date is $1.52.  The option will be exercised on this date if at all.  What is the expected per unit net gain (or loss) resulting from purchasing the put option?

A)  $.01 loss

B)  $.09 loss

C)  $.09 gain

D)  $.05 gain

20. The speculative risk of purchasing a ______ is that the foreign currency value ______ over time.

A)  put option; increases

B)  put option; decreases

C)  call option; increases

D)  futures contract; increases

21. Bank A asks $.555 for Swiss francs and Bank’s B and C are willing to pay $.557 for francs.  An institution could capitalize on these differences by engaging in

A)  covered interest arbitrage.

B)  triangular arbitrage.

C)  locational arbitrage.

D)  witching hour arbitrage.

22. According to interest rate parity, if the interest rate in a foreign country is ______ than in the home country, the forward rate of the foreign country will have a ______.

A)  higher; discount

B)  lower; premium

C)  higher; premium

D)  A and B

23.  _______________ serve as financial intermediaries in the foreign exchange market by buying or selling currencies to accommodate customers.

A)     Pension funds

B)     International mutual funds

C)     Insurance companies

D)     Commercial banks

E)      none of the above

24.  In the Wall Street Journal, you observe that the British pound (£) is quoted for $1.65. The Australian dollar (A$) is quoted for $0.60. What is the value of the Australian dollar in British pounds?

A)     A$2.75

B)     A$0.36

C)     £2.75

D)     £0.36

E)      none of the above

25.  The ______________ was not replaced by the euro.

A)     German mark

B)     Finnish markka

C)     Danish krone

D)     Italian lire

E)      All of the above were replaced by the euro.

26.  If European inflation suddenly becomes must higher than U.S. inflation, the U.S. demand for European goods will __________. In addition, the supply of euros to be sold for dollars will __________; both forces will place ____________ pressure on the value of the euro.

A)     increase; decline; upward

B)     increase; decline; downward

C)     decrease; increase; upward

D)     decrease; increase; downward

E)      none of the above

27.  If British interest rates suddenly increase substantially relative to U.S. interest rates, the demand by U.S. investors for British pounds __________, the supply of British pounds to be sold in exchange for dollars _____________, and the British pound will _____________.

A)     increases; decreases; appreciate

B)     increases; decreases; depreciate

C)     decreases; increases; appreciate

D)     decreases; increases; depreciate

E)      none of the above

28.  Assume the following information.

·   Interest rate on borrowed euros is 5 percent annualized.

·   Interest rate on dollars loaned out is 6 percent annualized.

·   Spot rate is 1.10 euros per dollar (one euro = $0.909).

·   Expected spot rate in five days is 1.15 euros per dollar.

·   Fabrizio Bank can borrow 10 million euros.

If Fabrizio Bank attempts to capitalize on the above information, its profit over the five-day period is

A)     2,653,597.22 euros.

B)     455,266.81 euros.

C)     452,426.04 euros.

D)     none of the above.

29.  A country that pegs its exchange rate to another exchange rate does not have complete control over its interest rates.

A)   True

B)    False

30.  In the period following the September 11 attack, the differential between foreign and U.S. interest rates

A)   decreased.

B)    increased.

C)   remained constant.

D)   none of the above

1.   ______ are offered to bank customers who desire to write checks against their account.

A)  Time deposit accounts

B)  CDs

C)  Demand deposit accounts

D)  Money market deposit accounts

2.   Which type of savings account transfers funds to a checking account when checks are written?

A)  ATS

B)  passbook savings

C)  CDs

D)  MMDAs

3.   “Bull market” CDs reward depositors

A)  when interest rates rise.

B)  if the stock market performs well.

C)  when interest rates decline.

D)  when the stock market performs poorly.

4.   A ______ is a time deposit offered by some large banks to corporations, with a specific maturity date, minimum deposit of $100,000 or more, and a secondary market.

A)  retail CD

B)  negotiable CD

C)  bull market CD

D)  bear market CD

5.   Money market deposit accounts differ from conventional time deposits in that they

A)  specify a maturity.

B)  offer limited check writing privileges.

C)  are less liquid.

D)  none of the above

6.   The intent of federal funds transactions is to

A)  correct short‑term fund imbalances experienced by banks.

B)  correct long‑term fund imbalances experienced by banks.

C)  serve as a permanent source of bank capital.

D)  serve as the primary depository source of funds.

7.   For any given bank, federal funds ______ represent a(n) ______.

A)  purchased; asset

B)  sold; liability

C)  purchased; liability

D)  A and B

8.   The federal funds rate is generally ______ the Treasury bill rate.

A)  equal to

B)  between .50 percent and 1.00 percent below

C)  between .25 percent and 1.00 percent above

D)  between 2.00 percent and 2.50 percent above

9.   Short‑term loans directly from the Federal Reserve to commercial banks (as well as some other depository institu­tions) are called

A)  borrowing at the discount window.

B)  federal funds borrowing.

C)  repurchase agreements.

D)  commercial paper sales.

10. When comparing the federal funds rate and the discount rate, which of the following is true?

A)  The discount rate is more volatile.

B)  The federal funds rate is set by the president of the United States.

C)  The discount rate is set by commercial banks.

D)  The federal funds rate is more volatile.

E)  A and B

11. When a bank in need of funds for a few days sells some of its government securities to a corporation with a temporary excess of funds, then buys them back shortly thereafter, this is a

A)  federal funds loan.

B)  discount window loan.

C)  repurchase agreement.

D)  commercial paper transaction.

12. Banks outside the United States that accept dollar‑denominated deposits are called

A)  Eurobanks.

B)  investment banks.

C)  savings banks.

D)  money banks.

13. Subordinated notes and debentures are examples of

A)  primary capital.

B)  secondary capital.

C)  depository sources of funds.

D)  repurchase agreements.

14. All other things equal, when banks issue new stock, they

A)  increase reported earnings per share.

B)  decrease their ability to absorb operating losses.

C)  dilute the ownership of the bank.

D)  A and B

15. As a source of funds, small banks rely more heavily on ______, and larger banks rely more heavily on ______.

A)  time deposits and foreign deposits; savings deposits and short‑term borrowings

B)  savings deposits and short‑term borrowings; foreign deposits and time deposits

C)  savings and time deposits; foreign deposits and short‑term borrowings

D)  foreign deposits and short‑term borrowings; savings and time deposits

16. Cash held ______ represents the major portion of a bank’s required reserves.

A)  at other commercial banks

B)  in a bank’s vault

C)  on deposit at the FOMC

D)  on deposit with the Board of Governors

17. The main use of bank funds is for

A)  loans.

B)  investment securities.

C)  fixed assets.

D)  repurchase agreements.

18. Bank loans designed to support a firm’s ongoing business operations are called

A)  term loans.

B)  working capital loans.

C)  direct lease loans.

D)  revolving credit loans.

19. ______ loans are primarily used to finance the purchase of fixed assets.

A)  Term

B)  Working capital

C)  Informal line of credit

D)  Revolving credit

20. Which of the following is most appropriate for a business that may experience a sudden need for funds but does not know precisely when?

A)  working capital loan

B)  direct lease loan

C)  term loan

D)  informal line of credit

21. Transaction deposits do not include

A)  demand deposits.

B)  NCDs.

C)  NOW accounts.

D)  All of the above are transactions deposits.

22. When comparing Treasury securities and government agency securities,

A)  neither have default risk.

B)  the yield on Treasury securities is higher.

C)  interest income on federal agency securities is exempt from state and local income taxes.

D)  government agency securities are subject to default risk.

23. Money market deposit accounts (MMDAs)

A)  require a maturity of 6 months or longer.

B)  allow a limited number of checks to be written against the account.

C)  pay a higher interest rate than CDs.

D)  none of the above

24. Which of the following accounts does not allow checks (at least a limited amount) to be written?

A)  NOW accounts

B)  money market deposit accounts (MMDAs)

C)  retail CDs

D)  All of the above allow checks to be written.

25. Banks sometimes need funds and sometimes have excess funds available.  Which of the following is commonly a source of bank funds and a use of bank funds?

A)  MMDAs

B)  Federal funds

C)  the discount window

D)  retail CDs

26. When a bank obtains funds through a ______, the provider of the funds receives collateral.

A)  retail CD

B)  NOW account

C)  repurchase agreement

D)  a money market deposit account

27. When banks obtain funds in the Federal funds market, the providers of the funds are

A)  other depository institutions.

B)  nonfinancial corporations.

C)  consumers.

D)  the Federal Reserve.

28. A single loan in the Federal funds market is usually for ______; when a bank sells a single repurchase agreement, the maturity is usually ______.

A)  just a few days; one year or more

B)  several weeks; one year or more

C)  several weeks; just a few days

D)  just a few days; just a few days

29. The interest rate charged on loans between depository institutions is commonly referred to as  the

A)  Federal funds rate.

B)  discount rate.

C)  repo rate.

D)  none of the above

30. The interest rate charged on loans from the Federal Reserve to banks is commonly referred to as the

A)  Federal funds rate.

B)  discount rate.

C)  repo rate.

D)  none of the above

31. The dis­count rate is determined by

A)  the Federal Reserve.

B)  Congress.

C)   the Treasury.

D)   the president of the United States.

32. Bank capital represents funds obtained through ______ and through ______.

A)  issuing stock; offering long‑term CDs

B)  issuing repurchase agreements; issuing bonds

C)  issuing stock; retaining earnings

D)  offering long‑term CDs; issuing bonds

33. Banks sometimes prefer to minimize their amount of capital since

A)  interest payments must be paid by the bank on all capital that is held.

B)  they try to avoid diluting ownership of the bank.

C)  A and B

D)  none of the above

34. When a bank obtains funds through ______, households are not a common provider of the funds.

A)  NOW accounts

B)  retail CDs

C)  passbook savings accounts

D)  NCDs

35. Which of the following is not an off-balance sheet activity?

A)  highly leveraged transactions (HLTs)

B)  standby letters of credit

C)  forward contracts

D)  swap contracts

36.  Which of the following is not true regarding the Financial Services Modernization Act of 1999?

A)     It provided more momentum for the consolidation of financial services.

B)    Financial institutions were finally able to offer a diversified set of financial services without being subjected to stringent constraints on the form or amount of financial services that they could offer.

C)   Banks and other financial service firms were given more freedom to merge, but were forced to divest some of the financial services that they acquired.

D)   Financial institutions no longer had to search for loopholes or monitor their business to ensure that the degree of financial services offered remained within the regulatory constraints that were previously imposed.

E)      All of the above are true.

37.  ____________ are the largest bank source of funds (as a percentage of total liabilities).

A)     Small-denomination time deposits

B)     Money market deposit accounts (MMDAs)

C)     Transaction deposits

D)     Borrowed funds

E)      Savings deposits (including MMDAs)

38.  Which of the following is not true regarding electronic funds transfer (EFT)?

A)   In point-of-sale transactions, EFT increases the number of transactions by check, credit card, and cash.

B)    Banks have developed shared ATM networks to attract deposits without having to construct facilities or hire and train employees.

C)   Through EFT, Social Security payments made by the government can be directly deposited to individual accounts.

D)   Businesses that receive large volumes of cash receipts (such as utilities) use EFT for collection to reduce the processing tasks.

E)      All of the above are true.

39.  __________ CDs allow the issuer to force an early maturity.

A)   Retail

B)    Bull-market

C)   Negotiable

D)   Callable

40.  Following the September 11 attach, banks

A)   had fewer funds available than needed to extend loans.

B)    had more money available than they could use for lending.

C)   experienced a substantial outflow of funds.

D)   none of the above

1.   The opening of a commercial bank in the United States

A)  does not require a charter.

B)  always requires a charter from a state government.

C)  always requires a charter from the federal government.

D)  requires a charter from a state or the federal government.

E)  requires a charter from both the state and federal government.

2.   Commercial banks that are not members of the Federal Reserve System ______ borrow from the Fed, and ______ subject to the Fed’s reserve requirements.

A)  may; are

B)  may; are not

C)  may not; are not

D)  may not; are

3.   All Fed member banks must hold

A)  private insurance on deposits.

B)  FDIC insurance on deposits.

C)  both FDIC and private insurance on deposits.

D)  none of the above

4.   Commercial banks ______ restricted to a maximum percent­age of their capital to loan to a single customer, and ______ allowed to use borrowed or deposited funds to purchase common stock.

A)  are; are

B)  are; are not

C)  are not; are

D)  are not; are not

5.   An “off‑balance‑sheet commitment” that provides the bank’s guarantee on the financial obligations of a borrower to a specific party is a

A)  standby letter of credit.

B)  federal funds agreement.

C)  repurchase agreement.

D)  discount window agreement.

6.   Regulation Q limited

A)  consumer loan interest rates.

B)  “off‑balance‑sheet commitments.”

C)  interest rates on savings deposits.

D)  corporate loan interest rates.

7.     The Glass‑Steagall Act of 1933 prevented

A)  any firm that accepts deposits and is a member of the Fed from underwriting stocks and bonds of corporations.

B)  any firm that accepts deposits and is a member of the Fed from underwriting general obligation bonds of states and municipalities.

C)  any firm that accepts deposits and is a member of the Fed from holding any corporate bonds in its asset portfolio.

D)  state‑chartered banks that are not members of the Fed from offering commercial loans.

8.   Which of the following is not a main deregulatory provision of Depository Institutions Deregulation and Monetary Control Act of 1980?

A)  phase‑out of deposit rate ceilings

B)  allowance of checkable deposits for all depository institutions

C)  new lending flexibility of depository institutions

D)  allowance of interstate banking for depository insti­tu­tions in most states

9.   The Depository Institutions Deregulation and Monetary Control Act of 1980

     A)  allowed S&Ls to offer the same conventional demand deposits that commercial banks offer.

B)  removed all restrictions on commercial loans by S&Ls.

C)  removed all restrictions on consumer loans by S&Ls.

     D)  required the Fed to offer check clearing services to any depository institutions that desire them.

10. The Garn‑St Germain Act of 1982

A)  permitted depository institutions to offer money market deposit accounts.

B)  prevented depository institutions from acquiring problem institutions across geographical boundaries.

C)  required the Fed to explicitly charge depository institutions for its services.

D)  allowed the Fed to provide check clearing to deposi­tory institutions at no charge.

11. Which of the following is not a specific criterion the FDIC uses to monitor banks?

A)  capital adequacy

B)  dollar value of fixed assets

C)  asset quality

D)   earnings

E)    sensitivity to financial market conditions

12. Which of the following is an “off‑balance‑sheet commit­ment?”

A)  long‑term debt

B)  additional paid‑in capital

C)  notes payable

D)  guarantees on interest rate swaps

13. The McFadden Act was applicable to banks

A)  in states where no branching was allowed.

B)  only in limited branching states.

C)  only in statewide branching states.

D)  in all states, regardless of their intrastate branch­ing status.

14. The McFadden Act restricted banks from

A)  branching within a city.

B)  interstate branching.

C)  intrastate banking.

D)  A and C

15. The fee banks pay to the FDIC for deposit insurance is now

A)  a fixed dollar amount for all banks.

B)  a fixed percentage of the bank’s deposit level for all banks.

C)  a fixed percentage of the bank’s loan volume for all banks.

D)  based on the risk of the bank.

16. Generally, the failure of small banks

     A)  causes more widespread concern about the safety of the banking system than the failure of large banks.

B)  causes equal concern about the safety of the banking system as the failure of large banks.

     C)  causes less concern about the safety of the banking system than the failure of large banks.

     D)  Either A or B can be true, depending on the type of business cycle that exists while the failures occur.

17. Bank A has a 5 percent capital ratio and uses most of its bank assets as Treasury securities.  Bank B has an 8 percent capital ratio and uses most of its assets as loans to businesses.  How would Bank A be rated versus Bank B using the capital and asset quality criteria?

A)  Bank A is perceived as safer by both criteria.

B)  Bank B is perceived as safer by both criteria.

     C)  Bank A is perceived as safer according to capital, but more risky according to asset quality.

     D)  Bank B is perceived as safer according to capital, but more risky according to asset quality.

18. The key reason for regulatory examinations (such as CAMELS ratings) is to

A)  rate past performance.

B)  detect problems of a bank in time to correct them.

C)  check for embezzlement.

D)  monitor reserve requirements.

19. When the Continental Illinois Bank problem became widely publicized, the risk premiums of large CDs of other large banks ______.  This implies that depositors’ confidence in large banks ______ influenced by news of a single large bank.

A)  increased; are

B)  increased; are not

C)  decreased; are

D)  decreased; are not

20. Which banking act allowed banks to cross state lines in order to acquire a failing institution?

A)  McFadden Act

B)  Glass‑Steagall Act

C)  DIDMCA

D)  Garn‑St Germain Act

21. Which banking act allowed for the creation of NOW accounts?

A)  McFadden Act

B)  Glass‑Steagall Act

C)  DIDMCA

D)  Garn‑St Germain Act

22. Which banking act prevented interstate banking?

A)  McFadden Act

B)  Glass‑Steagall Act

C)  DIDMCA

D)  Garn‑St Germain Act

23. Which banking act increased FDIC insurance up to $100,000?

A)  McFadden Act

B)  Glass‑Steagall Act

C)  DIDMCA

D)  Garn‑St Germain Act

24. Which banking act phased out deposit rate ceilings?

A)  McFadden Act

B)  Glass‑Steagall Act

C)  DIDMCA

D)  Garn‑St Germain Act

25. The argument that interstate banking would allow banks to grow and more fully achieve a reduction in operating costs per unit of output as output increases is based on

A)  economies of scale.

B)  financial leverage.

C)  diseconomies of scale.

D)  capital adequacy theory.

26. Federal deposit insurance

A)  existed since the 1800s.

B)  was created in 1933.

C)  was created after World War II.

D)  was created in 1960.

27. The specified maximum deposit amount per depositor of a single bank insured by the FDIC is currently ______.

A)  $25,000

B)  $40,000

C)  $50,000

D)  $100,000

28. The moral hazard problem is minimized when deposit insurance premiums are

     A)  zero (not imposed by the FDIC).

B)  the same percentage of assets for all banks.

C)  set at a fixed percentage of assets for large banks, and is zero for small banks.

     D)  set at a percentage of assets that is based on the bank’s risk level.

29.  Which of the following was not a provision of DIDMCA?

A)   the phase-out of deposit rate ceilings

B)    the allowance of checkable deposits for all depository institutions

C)   the permission of depository institutions to offer money market deposit accounts (MMDAs)

D)   new lending flexibility for depository institutions

E)    All of the above were provisions of DIDMCA.

30.  The ____________________ is the fund used to cover insured depositors.

A)   Bank Insurance Fund

B)    Federal Deposit Insurance Corporation (FDIC)

C)   money market mutual fund

D)   growth fund

E)    none of the above

31. ______________ is not a rating criterion used by the FDIC.

A)   Capital adequacy

B)    Off-balance sheet financing

C)   Asset quality

D)   Management

E)    Liquidity

1. Which of the following statements is incorrect?

     A) Managers may be tempted to make decisions that are in their own best interests rather than shareholder interests.

     B) The compensation of bank loan officers may be tied to loan volume, which encourages a loan department to extend loans with a very high concern for risk.

     C) To prevent agency problems, some banks provide stock as compensation to managers.

     D) The underlying goal behind the managerial policies of a bank is to maximize the wealth of the bank’s shareholders.

2.   When cash outflows temporarily exceed cash inflows, banks are most likely to experience:

A)  higher dividend payments.

B)  illiquidity.

C)  a negative duration on its assets.

D)  an excess of capital.

3.   Banks can resolve cash deficiencies by:

A)  creating additional liabilities.

B)  selling assets.

C)  buying back common stock.

D)  increasing dividend payouts.

E)  creating additional liabilities or selling assets.

4. As the secondary market for loans has become active, banks are more able to satisfy their liquidity needs with a _______ proportion of loans while achieving _______ profitability.

     A) higher; higher

     B) lower; lower

     C) higher; lower

     D) lower; higher

5.   If a bank that relies heavily on short-term deposits expects interest rates to consistently decrease over time, it would allocate most of its loans with _______ rates if it desires to maximize its expected returns. It could reduce its exposure to inter­est rate risk by setting _______ rates on its loans.

A)  fixed; fixed

B)  variable; fixed

C)  variable; variable

D)  fixed; variable

6.   During a period of rising interest rates, a bank’s net interest margin will likely _______ if its liabilities are _______ its assets.

A)  increase; more rate‑sensitive than

B)  decrease; more rate‑sensitive than

C)  increase; equally rate‑sensitive as

D)  decrease; equally rate‑sensitive as

7. If a bank expected interest rates to consistently _______ over time, it will consider allocating most funds to rate-_______ assets.

      A)       decrease; sensitive

      B)       decrease; insensitive

      C)       increase; insensitive

      D)       none of these

The following information refers to questions 8 through 10.

Petri Bank had interest revenues of $70 million last year and $30 million in interest expenses. About $300 million of Petri’s $800 million in assets are rate-sensitive, while $600 million of its liabilities are rate-sensitive.

8. Petri Bank’s net interest margin is _______ percent.

      A)       4.0

      B)       3.6

      C)       6.7

      D)       5.0

9.   Petri Bank’s gap is $_______ million.

      A)       –300

      B)       300

      C)       –500

      D)       500

10. Petri Bank’s gap ratio is _______ percent.

      A)       37.5

      B)       50.0

      C)       100.0

      D)       40.0

11. The measure of interest rate risk that uses the differ­ence between rate‑sensitive assets and rate‑sensitive liabil­ities is called:

A)  gap measurement.

B)  duration measurement.

C)  the duration ratio.

D)  the gap ratio.

12. A gap ratio of less than one suggests that:

A)  rate‑sensitive assets exceed rate‑sensitive liabil­ities.

B)  an increase in interest rates would increase the bank’s net interest margin.

C)  rate‑sensitive liabilities exceed rate‑sensitive assets.

D)  a decrease in interest rates would decrease the bank’s net interest margin.

13. The duration of zero-coupon bonds will be _______ the duration of coupon bonds with the same maturity.

A)  lower than

B)  higher than

C)  the same as

D)  higher than or lower than, depending on the size of the coupon payment

14. In general, the duration of zero-coupon securities with short maturities is _______ than the duration of zero-coupon securities with long maturities.

A)  higher than

B)  lower than

C)  equal to

D)  higher than or lower than, depending on the issuer of the securities

15. Other things equal, assets with shorter maturities have _______ durations. Assets that generate more frequent coupon payments have _______ durations.

A)  shorter; longer

B)  shorter; shorter

C)  longer; shorter

D)  longer; longer

16. For most banks, the average duration of assets _______ the average duration of liabilities, so the duration gap is _______.

     A) exceeds; zero

     B) exceeds; negative

     C) exceeds; positive

     D) is less than; negative

17. Other things being equal, assets with _______ maturities and _______ frequent coupon payments have shorter durations.

     A) shorter; more

     B) shorter; less

     C) longer; more

     D) longer; less

18. Which of the following is not a likely method used by a bank to reduce interest rate risk?

     A) maturity matching

     B) using fixed-rate loans

     C) using interest rate futures contracts

     D) using interest rate caps

19. Which of the following financial institutions would be most willing to swap variable‑rate payments for fixed‑rate payments in order to reduce exposure to interest rate risk?

A)  one whose assets and liabilities are equally interest­‑rate sensitive

B)  one whose assets are more interest‑rate sensitive than its liabilities

C)  one whose liabilities are more interest‑rate sensitive than its assets

D)  one whose gap ratio is equal to 1.0

20. A typical bank will attempt to earn a _______ return and maintain credit risk at a _______ level.

     A) maximum; high

     B) maximum; low

     C) reasonable; tolerable

     D) very safe; high

21. Banks generally _______ loans and _______ their purchases of low-risk securities when the economy is weak.

     A) increase; increase

     B) reduce; reduce

     C) increase; reduce

     D) reduce; increase

22. ROE is defined as:

A)  Net profit after taxes ´ .

B)   Equity.

C)    .

D)  Net profit after taxes ´ .

23. The greater the _______, the greater the amount of assets per dollar’s worth of equity.

A)  leverage measure

B)  ratio of equity to debt

C)  capital ratio

D)  proportion of loans to securities in the asset port­folio

24. A bank has a return on assets of 2 percent, $40 million in assets, and $4 million in equity. What is the return on equity?

A)  10 percent

B)  .2 percent

C)  2 percent

D)  20 percent

E)  none of these

25. A bank has the following asset and liability portfolios. What is the gap?

Rate‑Sensitive         Amount                 Rate‑Sensitive                     Amount

      Assets                 (in millions)      Liabilities                     (in millions)

Floating‑rate

  loans                    $4,000              NOW accounts          $1,750

Floating‑rate

  mortgages                                    1,000          MMDAs                           4,500

Short‑term

  Treasury

  securities              1,500              Short‑term CDs               1,000

      $6,500                                              $7,250

A)  $750 million

B)  -$750 million

C)  1.12

D)  .896

E)  none of these

26. A bank has the following asset and liability portfolios. What is the gap ratio?

Rate‑Sensitive         Amount                 Rate‑Sensitive                     Amount

      Assets                 (in millions)      Liabilities                     (in millions)

Floating‑rate

  loans                     $4,000           NOW accounts           $1,750

Floating‑rate

  mortgages                             1,000                MMDAs                           4,500

Short‑term

  Treasury

  securities                                         1,500           Short‑term CDs                   1,000

          $6,500                                                      $7,250

A)  $750 million

B)  -$750 million

C)  1.12

D)  .896

E)  none of these

27. If Bank A has a negative gap and Bank B has a positive gap. Which of the following is true?

A)  Bank A is more favorably affected by rising interest rates.

B)  Bank B is more favorably affected by falling interest rates.

C)  Bank A is adversely affected by falling interest rates.

D)  None of these is true.

28. Which of the following is a measure for banks to assess their exposure to interest rate risk?

A)  capital ratio

B)  leverage measure

C)  duration measurement

D)  none of these

29. If a bank sells CD futures, it _______ the potential adverse effect of rising interest rates and _______ the potential favorable effect of declining interest rates on its inter­est expenses.

A)  reduces; reduces

B)  increases; increases

C)  decreases; increases

D)  increases; decreases

30. Which of the following loan portfolios are best diversified against default risk?

     A)  consumer loans to farmers and commercial loans to farm equipment dealers in a local area

B)  commercial loans to the same industry

C)  commercial loans to various retail stores in the same city

D)  consumer and commercial loans to different industries in different cities

31. Banks can increase their liquidity position by restructur­ing their asset portfolio to contain less _______ and more _______.

A)  excess reserves; Treasury bills

B)  Treasury bonds; corporate bonds

C)  loans; Treasury bills

D)  none of these

32. Banks can reduce their liquidity position by restructur­ing their asset portfolio to contain less _______ and more _______.

A)  Treasury securities; excess reserves

B)  loans; Treasury securities

C)  corporate bonds; Treasury securities

D)  none of these

33. Banks can reduce their default risk by restructuring their asset portfolio to contain less _______ and more _______.

A)  Treasury bonds; corporate bonds

B)  Treasury bonds; municipal bonds

C)  Treasury bonds; commercial loans

D)  none of these

34. Banks can increase their potential interest revenues by restructuring their asset portfolio to contain less _______ and more _______.

A)  Treasury bonds; commercial loans

B)  Treasury bonds; excess reserves

C)  consumer loans; Treasury bills

D)  none of these

35. If a bank desired to maximize its net interest margin, it would best achieve its goal by attempting to obtain most of its funds through _______ and use most of its funds for _______ (assuming that all loans will be repaid).

A)  traditional demand deposits; commercial loans

B)  traditional demand deposits; consumer loans

C)  NOW accounts; consumer loans

D)  NOW accounts; commercial loans

36. A bank that holds a greater percentage of traditional demand deposits and loans will likely incur _______ non­‑interest expenses and have a _______ net interest margin than other banks of the same size (assuming that its loan losses are no higher than those at other banks).

A)  greater; higher

B)  greater; lower

C)  less; higher

D)  less; lower

37. A bank’s net interest margin is commonly defined as:

A)  interest revenues minus interest expenses.

B)  (interest revenues minus interest expenses)/total assets.

C)  (interest revenues minus interest expenses)/total liabilities.

D)  (interest revenues minus interest expenses)/capital.

38. A common method for banks to reduce their default risk is to:

     A)  specialize in loans to just one or a few particular industries in which they have expertise in assessing creditworthiness.

B)  specialize in loans of companies whose earnings patterns are quite similar over time.

C)  do both of these.

D)  do neither of these.

39. International diversification of loans can best reduce the bank’s overall default risk if the countries where loans are given:

A)  are clustered together in a single continent.

B)  have economic cycles that do not move together over time.

C)  both of these.

D)  neither of these.

40. A bank’s net interest margin will likely decline if it has a large amount of:

A)  rate-sensitive assets and no rate-sensitive liabilities.

B)  rate-sensitive liabilities and no rate-sensitive assets.

C)  loans to technology firms.

D)  real estate loans.

41. Banks can reduce their required capital levels by:

A)  increasing their loans.

B)  reducing their loans.

C)  increasing their dividends.

D)  obtaining more deposits.

42. Research on bank mergers has generally found that the acquiring bank’s stock price _______ at the time of the acquisition.

A)  rises moderately

B)  rises substantially

C)  declines or remains unchanged

D)  All of these occur with equal frequency.

43. Bank A has interest revenues of $4 million, interest expenses of $5 million, and assets totaling $20 million. Bank A’s net interest margin is:

A)   $1 million.

B)    –$1 million.

C)   –5 percent.

D)   5 percent.

44.  _______ analysis is not a method used to assess interest rate risk.

A)   Efficiency

B)    Gap

C)   Duration

D)   Regression

The following information refers to questions 45 and 46.

Durango Bank has $2 million in rate-sensitive liabilities and $3 million in rate-sensitive assets.

45.  Durango’s gap is $_______ million, and Durango is probably more concerned about a(n) _______ in interest rates.

A)   –1; increase

B)    –1; decrease

C)   1; increase

D)   1; decrease

E)    none of these

46.  Durango’s gap ratio is _______.

A)   1.5

B)    0.67

C)   $1 million

D)   none of these

47.  _______ is (are) least likely to be used as a method of reducing interest rate risk.

A)   Maturity matching

B)    Using floating-rate loans

C)   Stock options

D)   Using interest rate swaps

E)    Using interest rate caps

48.  Ringo Bank has a profit after taxes of $1.5 million, total assets of $50 million, and shareholder’s equity of $30 million. Ringo’s return on equity (ROE) is _______ percent.

A)   1.8

B)    5.0

C)   3.0

D)   none of these

49. Assume a bank accepts deposits on Australian dollars (A$) and makes some fixed‑rate loans in British pounds. Which of the following would reduce the bank’s profit margin?

A)  the A$ appreciates against the pound

B)  the A$ is stable against the pound

C)  the A$ depreciates against the pound

D)  the British interest rates increase

50. The performance of a bank that continually concentrates in short‑term deposits in euros and adjustable‑rate dollar loans with equal rate‑sensitivity is:

A)  unaffected if European interest rates increase and U.S. rates decrease.

B)  unaffected if U.S. interest rates increase and European interest rates decrease.

C)  adversely affected if European interest rates in­crease and U.S. rates decrease.

D)  adversely affected if U.S. interest rates increase and European rates decrease.

51. If a bank has assets and liabilities in dollars and euros, its exposure to interest rate risk can best be minimized if:

A)  the currency mix of assets is similar to that of liabilities.

B)  the overall rate‑sensitivity of assets and liabilities are similar.

C)  the rate sensitivity of assets and liabilities is matched for each currency.

D)  none of these.

52. The risk of a loss due to closing out a transaction is referred to as _______ risk.

A)   credit

B)    settlement

C)   interest rate

D)   exchange rate

E)    none of these

53. Banks are more liquid as a result of securitization because it allows them to request repayment of the loan principal from the borrower upon demand.

     A) true

     B) false

54. Each bank may have its own classification system of interest-rate sensitivity, because there is no perfect measurement of the gap.

     A) true

     B) false

55. Floating-rate loans cannot completely eliminate interest rate risk; if the cost of funds is changing more frequently than the rate on assets, the bank’s net interest margin is still affected by interest rate fluctuations.

     A) true

     B) false

56. Banks tend to focus their loans in one industry so that they can specialize on one industry and reduce the credit risk of their loan portfolio.

     A) true

     B) false

57. Most loan sales enable the bank originating the loan to continue servicing the loan.

     A) true

     B) false