University of Sussex

Q6 - If a bank has reserves of $5,000 and demand deposit liabilities of $80,000, and if the reserve requirement is 20 percent, then the bank has actual reserves of

a) $11,000

b) $21,000

c) $20,000

d) $26,000

If a bank has a negative GAP, a decrease in interest rates will cause interest income to decrease, interest expense to decrease, and net interest income to increase. (Assume a parallel shift in the yield curve). This is because, since there are more rate-sensitive liabilities than assets (due to negative GAP), the decrease in interest expense (due to decrease in interest rates) will be greater than the decrease in interest income (due to decrease in interest rates). In other words, the bank will both pay less and earn less due to the decrease in interest rates, but the change will be greater in the expenses, since there are more rate-sensitive liabilities, therefore the net interest income will increase.

Q15 - If a bank has a negative GAP, a decrease in interest rates will cause interest income to ______, interest expense to ______, and net interest income to ______. (Assume a parallel shift in the yield curve)

a) decrease, decrease, increase

b) decrease, decrease, decrease

c) increase, increase, increase

d) increase, decrease, increase

Q3 - If bad credit risks are the ones who most actively seek loans and, therefore, receive them from financial intermediaries, then financial intermediaries face the problem of

a) risk sharing

b) free-riding

c) adverse selection

d) moral hazard

Q4 - An example of the problem of _______ is when a corporation uses the funds raised from selling bonds to fund corporate expansion to pay for Caribbean cruises for all of its employees and their families.

a) moral hazard

b) risk sharing

c) credit risk

d) adverse selection

Q10 - All of the following are operating expenses for a bank EXCEPT

a) salaries and employer benefits

b) service charges on deposit accounts

c) servicing costs of equipment such as computers

d) rent on buildings

Q12 - Solutions to the moral hazard problem include

a) monitoring and enforcement of restrictive covenants

b) greater reliance on equity contracts and less on debt contracts

c) low net worth

d) greater reliance on debt contracts than financial intermediaries

Q15 - If a bank has a negative GAP, a decrease in interest rates will cause interest income to ______, interest expense to ______, and net interest income to ______. (Assume a parallel shift in the yield curve)

a) decrease, decrease, increase

b) decrease, decrease, decrease

c) increase, increase, increase

d) increase, decrease, increase

Q17 - For a bank that has a positive duration gap, an increase in interest rates will cause a(n) ______ in the economic value of assets, that is ______ than the ______ in the economic value of liabilities, and a(n) _______ in the economic value of equity.

a) decrease, less, decrease, increase

b) increase, greater, decrease, increase

c) decrease, greater, decrease, decrease

d) increase, less, increase, decrease

Conditional default probability is defined as “the probability of default conditional on no earlier default.” Hazard rate is defined as “the probability of default over a short period of time conditional on no earlier default.” Why are definitions of “conditional default probability” and “hazard rate” almost identical?