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Liabilities and Balance Sheets of Financial Institutions

1. Consider the following assets and liabilities:

I. Discount loans
II. U.S. government securities
III. Secondary reserves
IV. Small time deposits
V. Commercial loans
VI. Savings accounts

Bank liabilities include:

A. I, IV, and VI only

B. II, III, and V only

C. II, III, and V only

D. I, II, IV, and VI only

E. I, III, and V only

2. Consider the following statement from a bank manager:

"Recent innovations allow us to rely less on checkable deposits and more on nontransactions accounts such as bank CDs. Although such accounts are desirable because they are less liquid from the depositors' point of view, we must draw customers to these accounts by paying higher interest rates. We must raise funds without incurring too much cost in terms of interest paid to our customers."

What type of balance sheet management does this manager describe?

A. Asset management

B. Liability management

C. Liquidity management

D. Capital adequacy management

3. Banks limit their exposure to credit risk by denying loans to some individuals, even when they pay a higher interest rate to compensate the bank for taking on more risk. This is called:

A. Duration analysis

B. Credit rationing

C. Collateral

D. Moral hazard

E. Compensating balances

4. True or False: If a bank expects interest rates to rise in the near future, it can shorten the duration of its liabilities to reduce changes in bank income when the interest rate changes.

5. Banks should proceed with caution when using trading activities to generate additional bank income because:

A. The principal-agent problem arises with risk managers.

B. The practice leads to loss of fee income.

C. The practice typically leads to high bank capital.

D. Potential exists for adverse selection of depositors.

E. The practice interferes with loan sales.

Solution Preview

Solutions included and explanations provided so you can understand the reasoning for the answer.

Banking and the Management of Financial Institutions
1. Consider the following assets and liabilities:

I. Discount loans
II. U.S. government securities
III. Secondary reserves
IV. Small time deposits
V. Commercial loans
VI. Savings accounts

Bank liabilities include:

A. I, IV, and VI only (answer)
B. II, III, and V only
C. II, III, and V only
D. I, II, IV, and VI only
E. I, III, and V only

Reasoning:
Discount loan is a liability that needs to be paid to the Fed. Small time deposits and savings accounts are deposits made by customers and hence serve as liabilities for the bank. Hence, I, IV and VI are only the bank ...

Solution Summary

The solution discusses liabilities and balance sheets of financial institutions.

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