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Chapter 16 True/False Questions

1. For securities firms, income from investment management is more stable than the income from underwriting or trading. Answer: True Page: 457 Level: Medium

2. Full line investment banks act as both broker dealers and securities underwriters. Answer: True Page: 455 Level: Easy

3. A private placement is allowed under SEC Rule 415 to allow large corporations to preregister an upcoming security offering for up to two years in advance. Answer: False Page: 458 Level: Medium

4. Issuers of privately placed securities must still register the issue with the SEC. Answer: False Page: 457 Level: Medium

5. In a best efforts offering the investment banker acts as an agent for the issuer rather than as a principle. Answer: True Page: 459 Level: Easy

6. A market maker buys IBM at $185 for his own account and sells the stock later in the day at $187. He is acting as a broker in this transaction. Answer: False Page: 460-461 Level: Easy

7. Buying large blocks of securities and holding them until the price rises sufficiently to warrant a sale is an example of pure arbitrage. Answer: False Page: 461 Level: Easy

8. An example of a pure arbitrage strategy is to simultaneously buy and sell the same security in two different markets at different prices. Answer: True Page: 461 Level: Easy

9. A stock broker acts as a principle on behalf of the customer. Answer: False Page: 461 Level: Medium

10. Securities firms often provide deposit type services through cash management accounts. Answer: True Page: 462 Level: Easy

11. Program trading is the simultaneous buying and selling of at least $1 million worth of at least 15 stocks. Answer: True Page: 461 Level: Medium

12. The major source of funds for securities firms are repurchase agreements. Answer: True Page: 466-467 Level: Easy

13. Equity capital levels of securities firms are higher than for banks since securities firms cannot offer insured deposits. Answer: False Page: 467 Level: Medium

14. One could argue that decimalization has cut dealer profit margins but may have helped increase broker profits. Answer: True Page: 461 Level: Difficult

15. The Securities Investor Protection Corporation protects investors against losses due to unfavorable market moves of up to $500,000. Answer: False Page: 468 Level: Medium

16. In the recent past, stock research analysts received bonuses for generating allegedly biased research reports that helped to sell new issues underwritten by their firm. Answer: True Page: 463,468 Level: Easy

17. Total dollar value of debt underwriting exceeded total equity underwriting dollar volume in every year from 1990 to 2001. Answer: True Page: 465 Level: Medium

Multiple Choice Questions

18. Full line securities firms engage in all but one of the following A) Trading and brokerage of existing securities B) Corporate restructuring and advice C) Issuing new securities D) Raising money via insured deposits Answer: D Page: 453-454 Level: Easy

19. A best efforts offering is one where A) The underwriter bears the risk of an unsuccessful offering. B) The bid-ask spread is exceptionally high, but the investment banker does their best to sell the issue anyway. C) The investment banker acts as a principle for the issuer. D) The investment banker acts only as a distribution agent. E) The issue can only be privately placed. Answer: D Page: 459 Level: Easy

20. If an underwriter overestimates the demand for a firm's securities in a firm commitment offering the underwriter can A) Sell the shares back to the issuing firm at a discount. B) Lower the bid price to the issuing firm. C) Increase the fees charged to the issuing firm. D) Cancel the issue and refund the fees paid by the issuing firm. E) None of the above Answer: E Page: 459 Level: Medium

21. If an underwriter underestimates the demand for a firm's securities in a firm commitment offering the underwriter can A) Raise the offer price to the public B) Lower the bid price to the issuing firm C) Increase the fees charged to the issuing firm D) Cancel the issue E) None of the above Answer: E Page: 459 Level: Medium

22. Investment firms that pool money from individuals and/or institutions and invest equity funds in startup firms are called A) Top tier bankers B) Section 20 affiliates C) Venture capital firms D) ECNs E) Discount brokerage houses Answer: C Page: 456 Level: Easy

23. You buy French Francs in New York and simultaneously sell them in Frankfurt for a gain. This is an example of A) Position trading B) Program trading C) Pure arbitrage D) Risk arbitrage E) Hedging Answer: C Page: 461 Level: Medium

24. An unregistered issue sold to a few large institutional buyers is an example of a A) Best efforts offering B) Fully underwritten public offering C) Shelf offering D) Private placement E) SEC Rule 415 offering Answer: D Page: 468 Level: Medium

25. An investment banker agrees to a firm commitment offering of 1 million shares of Ace stock. The offer price is set at $45 and the spread is 50 cents per share. If the stock is actually sold to the public at $44 however, what is the investment banker's gain or loss? A) $1,000,000 gain B) $1,000,000 loss C) $500,000 gain D) $500,000 loss E) None of the above Answer: D Page: 459 Level: Medium

26. Day to day trading practices of securities firms currently may be regulated by which of the following? I. NASD II. SEC III. NYSE IV. SIPC A) I only B) II only C) I and II only D) I and III only E) II and IV only Answer: D Page: 468 Level: Medium

27. Firms in the securities industry are required to maintain a minimum capital to asset ratio of _____ A) 2% B) 4% C) 6% D) 8% E) 10% Answer: A Page: 467 Level: Medium

A) B) C) D) E)

28. In 2000 and 2001 the top IPO underwriter (by $ volume) was Goldman-Sachs Merrill-Lynch Citigroup SSB J.P. Morgan Chase UBS Warburg

Answer: B Page: 458 Level: Easy

29. The major result of NSMIA was to A) Reduce state regulatory powers over securities firms B) Establish the SIPC C) Create the NASD D) All of the above E) None of the above Answer: A Page: 467-468 Level: Easy

30. The largest source of funds for a securities firm is A) Short positions in securities and commodities B) Payables to other broker dealers C) Securities sold under repurchase agreement D) Call loans E) Securities purchased under agreements to sell Answer: C Page: 467 Level: Easy

31. _____________ are examples of investment bankers offering traditional commercial banking services. A) Online brokers B) Cash management accounts C) Underwriting corporate debt and equity offers D) Venture capital funds E) Mergers and acquisition services Answer: B Page: 462 Level: Medium

A) B) C) D) E)

32. An investment banker may be unwilling to engage in a firm commitment offer if The issuer is relatively unknown to the public The issuer desires too low an offer price The investment banker is concerned about overall market price volatility Both A and C Both B and C

Answer: D Page: 459 Level: Medium

33. When an underwriter engages in a firm commitment, the underwriter is acting as A) A principle B) An agent C) An asset transformer D) An M&A advisor E) All of the above Answer: A Page: 459 Level: Easy

34. Underwriter spreads will normally be larger on A) A shelf offering than on an IPO B) A best efforts offer than on an IPO C) A best efforts offer than on a seasoned offering D) An IPO than a seasoned offering E) Less risky issues Answer: D Page: 457-459 Level: Easy

35. In July 2002 the U.S. Congress passed the Corporate Governance and Accounting Oversight bill. Among other things, this bill I. Created an independent auditing oversight board run by the SEC II. Increased penalties for corporate wrongdoers III. Eliminated the use of stock options for executive compensation A) I only B) I and II only C) I and III only D) II and III only E) I, II and III Answer: B Page: 468 Level: Medium

36. From 1991 to 2001, foreign investor transactions in U.S. securities ___________ and U.S. investor transactions in foreign securities ______________. A) increased ; increased B) increased ; decreased C) decreased ; increased D) decreased ; decreased E) increased ; stayed the same Answer: A Page: 470 Level: Medium

37. The SEC primarily sets standards to regulate securities firms' A) Program trading and arbitrage strategies B) M&A and cash management activities C) Profitability and holding companies activities D) Trading and underwriting activities E) Corporate advisory and M&A activities Answer: D Page: 467-468 Level: Medium

Chapter 17 True/False Questions

1. Because of the differences in the makeup of their major loan types, finance companies typically have shorter term loans than banks. Answer: True Page: 473 Level: Medium

2. The twenty largest finance companies own about 80% of the industry's assets. Answer: True Page: 475 Level: Easy

3. The first major finance company was formed by Filene's Basement to service the credit needs of its employees. Answer: False Page: 473 Level: Easy

4. An installment loan is one where all the principle is repaid at maturity. Answer: False Page: 473 Level: Easy

5. As of 2000, the largest finance company was General Motors Acceptance Corporation. Answer: False Page: 476 Level: Easy

6. The largest commercial mortgage lender in the U.S. is a finance company. Answer: True Page: 475 Level: Medium

7. Sales finance institutions specialize in loan sales to banks and thrifts. Answer: False Page: 475 Level: Medium

8. Except for certain special promotional deals, finance companies generally charge higher rates for similar loans than do commercial banks. Answer: True Page: 478 Level: Easy

9. It is generally impossible to get a mortgage loan if you have a bankruptcy on your credit record, even from a subprime lender. Answer: False Page: 479 Level: Easy

10. Finance companies are now the largest issuers in the country in the short term banker's acceptance market. Answer: False Page: 480 Level: Medium

Multiple Choice Questions

11. Which of the following are not sources of funds for finance companies? A) Bank loans B) Commercial paper C) Equity D) Deposits E) Neither C) or D) are sources of funds for a finance company Answer: D Page: 473 Level: Easy

12. Finance company loss reserves will typically be _____ percent of assets than/as a bank's loss reserves. A) A higher B) A lower C) An equal Answer: A Page: 480-481 Level: Easy

13. Finance company services include A) Consumer lending B) Business lending C) Mortgage lending D) All of the above E) A. and B. only Answer: D Page: 473 Level: Easy

A) B) C) D) E)

14. The first major finance company was General Motors Acceptance Household Finance Corp General Electric Capital Corp First Alliance Company Metrics Companies

Answer: C Page: 473 Level: Easy

15. A finance company makes a 48 month $15,000 installment loan to a customer. If the annual rate is quoted at 9%, which of the following monthly payments is correct? A) $138.89 B) $373.28 C) $1,371.92 D) $444.21 E) None of the above Answer: B Page: 474 Level: Medium

16. A subprime lender makes a loan to a customer. The customer is given $9000 today and she must then make twelve monthly installment payments of $860 (beginning in one month) to the lender. What rate must be quoted to the customer? A) 21.46% B) 26.05% C) 217.10% D) 32.24% E) 29.40% Answer: B Page: 474 Level: Medium

17. Factoring is A) Equipment leasing B) Servicing mortgage factors C) Purchasing corporate accounts receivables at a discount D) Financing automobile purchases E) Making installment loans to customers Answer: C Page: 475 Level: Medium

A) B) C) D) E)

18. Sales finance companies Specialize in making loans to customers of a specific retailer or manufacturer Specialize in making installments and other loans to whatever consumers are interested Specialize in providing loans to businesses Specialize in international factoring and forfaiting None of the above

Answer: A Page: 475 Level: Easy

19. In recent years the fastest growing area of business at finance companies has been in A) Auto lending B) Unsecured consumer loans C) Mortgages D) Leasing and business lending E) None of the above Answer: D Page: 476-477 Level: Medium

20. A finance company that makes loans to high risk customers is called a A) Subprime leader B) Commercial bank C) Factor D) Warehouse lender E) Supraprime lender Answer: A Page: 478 Level: Easy

21. A lender that loans money and charges usurious interest rates and/or fees with no credit checks is called a(n) A) Ebeneezer B) Greenmailer C) Land shark D) Bird of prey E) Loan shark Answer: E Page: 478 Level: Easy

22. Finance companies enjoy several advantages over banks. These include all but which one of the following? A) Finance companies can offer various types of products and services without regulatory interference. B) Many finance companies have considerable knowledge and expertise about specific industries and products. C) Finance companies can accept riskier customers than banks. D) Finance companies generally have lower overhead than banks. E) Finance companies have lower funds costs than banks. Answer: E Page: 476-477 Level: Medium

23. As compared to banks, the typical finance company loan portfolios I. Have a lower percentage of mortgages II. Are shorter term III. Have higher credit risk A) I only B) II only C) II and III only D) I and III only E) I, II and III Answer: E Page: 476 Level: Medium

24. Which of the following do finance companies use to signal their safety and solvency to users? A) Government insurance B) Substantial equity to asset ratios C) Letters of credit from high quality banks D) A. and B. E) B. and C. Answer: E Page: 483 Level: Medium

25. A captive finance company is one that A) Is owned by a retailer or manufacturer B) Is owned by a bank holding company C) Is owned by it depositors D) Lends only to high risk individuals that cannot obtain loans elsewhere (i.e. captives) E) Is regulated at the Federal level Answer: A Page: 476 Level: Easy

26. A local finance company allows you to give them a postdated check not cashable for two weeks for $100. In return they give you $90 today. What annual rate must be disclosed on this loan? A) 11.11% B) 288.89% C) 1447.73% D) 577.72% E) 29.00% Answer: B Page: None Level: Difficult

27. A loan agreement between Ford Motor Credit and a local Ford dealer is an example of A) Retail motor vehicle loan B) Business equipment loan C) Factoring of receivables D) Depreciation loan E) None of the above Answer: E Page: 479 Level: Medium

28. The largest full service financial institution in the country that includes a finance company is A) Citigroup B) General Electric Capital Services C) General Motors Acceptance Corporation D) American Express E) CIT Group Holdings Answer: A Page: 480 Level: Medium

29. Although finance company growth has generally been positive for the last ten years _______ _________ finance companies have recently been struggling. A) Business and captive B) Consumer and wholesale C) Subprime and electronic D) Mortgage and subprime E) Sales and business Answer: C Page: 481 Level: Medium

A) B) C) D) E)

30. Finance companies in foreign countries Usually take insured deposits Rarely offer loans to individuals Raise most of their capital via issuing commercial paper Are more highly regulated than U.S. finance companies Are usually subsidiaries of local banks and dependent on their parents for capital

Answer: E Page: 484 Level: Medium

Chapter 18 True/False Questions

1. Over the last ten years the number of banks has been declining, but the number of mutual funds has been growing. Answer: True Page: 486 Level: Easy

2. Net new cash flows to money market mutual funds vary inversely with interest rate spreads on money market funds and savings deposits. Answer: False Page: 497 Level: Easy

3. Most of the recent growth of long term mutual funds has occurred because of the bull market of the 1990s. Answer: True Page: 489 Level: Easy

4. As of 2001 total U.S. mutual fund assets exceeded U.S. insurer's assets but were less than commercial bank total assets. Answer: True Page: 488 Level: Medium

5. The shares of a closed end fund with market value of assets of $200 million and 2 million shares outstanding will always trade at a market value of $100 per share. Answer: False Page: 496 Level: Easy

6. If invest $10,000 in a mutual fund with a NAV of $50 per share and a 5.5% load you will receive less than 200 shares in the fund. Answer: False Page: 498 Level: Medium

7. The typical household that owns mutual funds owns no more than 3 mutual funds. Answer: False Page: 491 Level: Medium

8. Each fund's prospectus is required to disclose the fund's beta risk and total risk. Answer: False Page: 494 Level: Medium

9. The market value of a fund's net assets divided by the number of mutual fund shares outstanding is called the NAV of the fund. Answer: True Page: 495 Level: Easy

10. Open end fund shares often trade at a discount or premium relative to NAV. Answer: False Page: 495 Level: Easy

11. Load funds typically provide investors with higher rates of return and offer more services such as check writing, transfers between funds, etc. Answer: False Page: 497-498 Level: Easy

12. A 12 b-1 fee is an implicit load charge. Answer: True Page: 498 Level: Medium

13. Of long term equity funds, municipal funds and growth and income funds are the largest categories. Answer: False Page: 493 Level: Easy

14. A drop in interest rates will usually result in an increase in the number of money market mutual fund shares. Answer: True Page: 500 Level: Medium

15. The Federal Mutual Fund Commission (FMFC) is the primary regulator of the mutual fund industry. Answer: False Page: 501 Level: Easy

Multiple Choice Questions

16. Open end mutual funds guarantee A) Investors a minimum rate of return B) Investors a minimum NAV C) To redeem investor's shares upon demand at current NAV D) To earn the rate promised in the prospectus E) None of the above Answer: C Page: 495 Level: Medium

17. As compared to purchasing a stock, a no load mutual fund investor will usually get A) Commissionless reinvestment opportunities B) Better diversification C) Free switching between funds within the same family D) Lower commissions costs E) All of the above Answer: E Page: 486 Level: Easy

18. Money market mutual funds invest primarily in A) Foreign currencies B) Real estate C) Long term bonds D) IPOs E) None of the above Answer: E Page: 501 Level: Medium

19. In terms of asset size, rank the top three U.S. financial intermediaries from largest to smallest. I. Commercial banks II. State and local government pension funds III. Private pension funds IV. Mutual funds A) I, IV, III B) I, III, II C) IV, I, II D) I, II, IV E) II, III, I Answer: A Page: 488 Level: Medium

20. As the economy weakens, one would expect investment in _________ funds to increase and investment in __________ funds to decrease, ceteris paribus. A) Money market mutual; equity B) Equity; bond C) Municipal bond; money market mutual D) Corporate bond; Municipal bond E) Long term; short term Answer: A Page: 500 Level: Medium

21. Hybrid mutual funds normally invest significant amounts in A) Common stock B) Commercial paper C) Long term bonds D) Treasury bills E) Both A) and C) Answer: E Page: 488-489 Level: Medium

22. During 2001 investment in money market mutual funds _____ and the investment in long term mutual funds ____. A) Decreased; decreased B) Increased; increased C) Increased; decreased D) Decreased; increased E) Stayed the same; increased Answer: B Page: 486 Level: Medium

23. Money market mutual funds (MMMFs) have caused disintermediation at banks. This is because MMMFs A) Allow investors access to higher interest rate money market securities with a relatively small capital investment B) Are less risky than bank deposits C) Are now federally insured, like bank deposits D) Offer guaranteed rates of return E) None of the above Answer: A Page: 489-490 Level: Medium

A) B) C) D) E)

24. The 'profile' of the typical mutual fund owners implies that he or she is a: I. Long term investor II. Generation Xer III. Employed IV. College graduate III only I and III only II, III and IV only I, III and IV only I, II, III and IV

Answer: D Page: 490-491 Level: Easy

25. By type of fund, there are more _____ funds than any other. A) Equity B) Bond C) Taxable money market D) Tax exempt money market E) Hybrid Answer: A Page: 489 Level: Easy

26. The largest proportion of long term mutual fund assets are held by _____ and the largest proportion of money market mutual fund assets are held by _____. A) Bank trusts and estates, the household sector B) The household sector, private pension funds C) The household sector, the household sector D) Private pension funds, nonfinancial corporate business E) Life insurance firms, funding corporations Answer: C Page: 489 Level: Medium

27. The market value of a mutual fund's assets divided by the number of fund shares outstanding is equal to the A) Load charge B) NAV C) Expense ratio D) 12b-1 fee E) Management fee Answer: B Page: 495 Level: Easy

28. Rank the following types of funds from most risky to least risky (variations exist but rank them generally) I. Growth II. Growth and income III. Money market mutual fund IV. Bond fund A) II, I, III, IV B) I, II, IV, III C) I, IV, II, III D) II, III, I, IV E) III, IV, II, I Answer: B Page: 493 Level: Easy

29. You have $5,000 to invest and you are considering investing in Fund A. The fund charges a 5.5% load and an annual expense fee of 1.25% of the average asset value over the year. You believe the fund's rate of return will be 10% per year. If you make the investment what should your investment be worth in one year? A) $5,135.48 B) $5,197.50 C) $5,500.00 D) $5,431.25 E) $5,162.50 Answer: A Page: 498 Level: Difficult Response: Investment amount = $5,000*(1-0.055) = $4,725; FV1:$4,725*1.10 = $5,197.5; Average assets = ($4,725+$5,197.5)/2 = 4,961.25; $4,961.25*0.0125= $62.01; $5,197.5 $62.01=$5,135.48 30. A fund has a NAV of $30 per share but the shares are currently selling for $32. This fund must be A) An open ended fund B) A closed end fund C) A balanced fund D) An aggressive growth fund E) A money market mutual fund Answer: B Page: 496 Level: Medium

31. An open end mutual fund owns 1000 share of Krispy Kreme priced at $40. The fund also owns 2000 shares of Ben & Jerry's priced at $55, and 1000 shares of Pepsi priced at $45. The fund itself has 3000 of its own shares outstanding. What is the NAV of a fund's share? A) $65 B) $55 C) $45 D) $35 E) $25 Answer: A Page: 495 Level: Medium Response: [(1000*40) + (2000*55) + (1000*45)] / 3000 fund shares 32. You have $8,000 to invest in a mutual fund with a NAV = $45. You choose a fund with a 5.5% load, a 1% management fee and a 0.25% 12b-1 fee. Assume that the management and 12b-1 fees are charged on year end assets. The gross annual return on the fund's shares was 12%. What was your net annual rate of return to the nearest basis point? A) 3.26% B) 6.50% C) 6.25% D) 4.52% E) 4.02% Answer: D Page: 497-498 Level: Difficult Response: {{[$8,000*(1-0.055) *1.12] * (1-0.0125)} / $8,000} 1 33. Investors pay load changes to receive A) Higher returns on their investments B) Additional services from funds C) Voting shares of stock D) Advice on which fund to buy E) 12B-1 remunerations Answer: D Page: 497 Level: Medium

34. A money market mutual fund's total assets increase from $100 to $105 when the fund has 100 shares outstanding. Which of the following will happen? A) The fund's NAV will rise from $100 to $105 B) The fund's NAV per share will rise from $1 to $1.05 C) The fund will issue a total of 5 new shares D) The fund's NAV will fall 5% E) The fund will close to new investors Answer: C Page: 500 Level: Medium

A) B) C) D) E)

35. The primary regulator of mutual funds is the NASD CFTC NYSE SEC NSMIA

Answer: D Page: 501 Level: Easy Chapter 19 True/False Questions

1. Of the different types of defined benefit plans, plans using the final pay method will usually produce the biggest retirement benefit to employees. Answer: True Page: 509 Level: Easy

2. A 403(b) plan is designed for self-employed individuals. Answer: False Page: 510 Level: Easy

3. Pension plans administered by the federal government are called insured pension plans. Answer: False Page: 506 Level: Easy

4. Noninsured pension plans are backed by a percentage of the sponsor's assets but do not have separate asset backing. Answer: False Page: 507 Level: Medium

5. The largest amount of pension fund assets are held by uninsured private pension funds. Answer: True Page: 507 Level: Medium

6. Noninsured pension plans generally invest in riskier assets than insured pension plans. Answer: True Page: 507 Level: Medium

7. If you believe that you will be in a much lower tax bracket at retirement than now, you will probably be better off with a Roth IRA than with a traditional IRA.

Answer: False Page: 514-515 Level: Medium

8. Under ERISA, the time period an employee must work before they are eligible to receive pension benefits is called the nontransferability period. Answer: False Page: 520 Level: Easy

9. In a defined contribution plan the retirement benefit is determined solely by the size of the employee and employer contributions. Answer: False Page: 508-509 Level: Medium

10. In terms of assets managed and numbers of plans, defined contribution plans are becoming more predominant and defined benefit plans are declining. Answer: True Page: 510-511 Level: Easy

Multiple Choice Questions

11. The largest amount of pension fund reserves are held by A) The Federal government B) State and local government retirement funds C) Insured pension plans D) Uninsured pension plans Answer: D Page: 507 Level: Medium

12. Private pension funds are funds administered by A) The Federal government B) State and local governments C) Insurance companies D) Banks and mutual funds E) Both C and D Answer: E Page: 509-510 Level: Medium

A) B) C) D) E)

13. In general terms, which one of the following plan types is the riskiest for an employee? Fixed income defined contribution plan Variable income defined contribution plan Final pay defined benefit plan Career average defined benefit plan Overfunded defined benefit plan

Answer: B Page: 509 Level: Medium

14. Over the last 10 years defined contribution plans have grown faster than defined benefit plans in which of the following areas? I. Fund assets II. Number of funds III. Number of plan participants A) I only B) I and II only C) II and III only D) I, II and III E) II only Answer: D Page: 510 Level: Medium

15. Congratulations, you have just been employed! You now have a choice between a flat benefit at retirement equal to $3,000 times your years of service, or a career average formula of 3% of your average salary times your years of service. You expect to work 35 years. At what average salary would you be indifferent between the two alternatives? A) $103,000 B) $102,500 C) $101,850 D) $105,000 E) $100,000 Answer: E Page: 508 Level: Medium Response: ($3000*35) / (0.03*35)

16. At your new job you estimate that your average salary over your working years will be $75,000 per year. How many more years would you have to work to receive as much benefit from a flat benefit of $2,250 times years of service as you would receive from 4% of your average salary times years of service? A) 1.33 times as many years B) 0.75 times as many years C) 1.04 times as many years D) 2.40 times as many years E) 1.50 times as many years Answer: A Page: 508 Level: Difficult Response: (0.04*$75,000) / $2,250 17. An employee who has worked for his firm for 30 years can retire right now and receive a constant annual benefit of $45,000. He has a final pay plan that pays his average salary over his final 5 years times 3% times years of service. He has decided he will keep working five more years only if by doing so, his retirement benefits will grow at 6% per year. How much would his expected average salary (to the nearest dollar) have to be over the next 5 years to keep him working? A) $60,220 B) $57,353 C) $50,010 D) $66,911 E) $53,147 Answer: B Page: 509 Level: Difficult Response: ($45,000*1.065) / (0.03*35) 18. The main advantage of a profit sharing Keogh plan over a money sharing Keogh plan is that profit sharing plans A) Are eligible for PBGC insurance and money sharing plans are not B) Have higher maximum contributions than money sharing plans C) Can have contributions that vary from year to year with profits, while money sharing plan contributions are fixed D) Both A and B are advantages E) None of the above Answer: C Page: 516 Level: Medium

19. A defined benefit pension plan has expected payouts of $15 million per year over the next 25 years. The fund can be expected to earn an average of 6% on its assets. It currently has reserves of $160 million. The fund is __________ by about ___________ million. A) Underfunded ; $31.75 B) Underfunded ; $215 C) Overfunded ; $31.75 D) Overfunded ; $215 Answer: A Page: 508 Level: Medium 20. A highly risk averse investor in a defined contribution plan should choose what type of investment? A) A fixed income fund B) A variable income fund C) An insured pension fund D) A privately managed fund E) None of the above Answer: A Page: 509 Level: Medium 21. A ______ plan does not require the employer to guarantee retirement benefits nor to maintain a minimum level of pension reserves A) Defined benefit B) Insured pension C) Corporate pension D) Uninsured pension E) Defined contribution Answer: E Page: 509 Level: Easy 22. Which of the following statements about 401(k) plans are true? I. They are defined benefit plans II. They allow employer and employee contributions III. Earnings accrue tax free during the employee's working years IV. They allow employee discretion in asset allocation V. They always have minimum guaranteed rates of return A) I, IV and V only B) II, II and V only C) II and III only D) II, III and IV only E) All are true Answer: D Page: 510-512 Level: Medium

23. An employee contributes 8% of his/her salary to their 401(k) plan, and the employer matches with 3%. The employee earns $60,000 per year and is in a 28% tax bracket. If the employee earns 10% on all funds invested, what is his/her annual rate of return? A) 10.00% B) 51.25% C) 110.07% D) 13.75% E) 44.52% Answer: C Page: 513-514 Level: Difficult

24. Employee plus employer contributions to a 401(k) are $15,000 per year. Equity funds are earning 15%, bond funds 8% and money market funds 6%. The employee wants to retire as soon as possible with $1 million in retirement assets. How much more quickly can he retire if he puts all his money in equity than if he puts 1/3 in each? A) 3.3 years B) 9.7 years C) 4.6 years D) 2.4 years E) 12.2 years Answer: C Page: 513-514 Level: Medium

25. Which of the following statements are true about a traditional IRA? I. Subject to an income limit, a single person may contribute up to $3000 per year of pretax income to an IRA II. All withdrawals are tax free III. Earnings on the IRA account are not taxed until withdrawn IV. You must begin withdrawals at age 59 V. Withdrawal(s) can be a lump sum or installments A) I, II, IV B) I, II, IV and V C) I, III and V D) II, IV and V E) III, IV and V Answer: C Page: 514-515 Level: Medium

26. Which of the following are true about a Roth IRA? I. Contributions are tax deductible II. Withdrawals are always taxed III. You must begin withdrawals at age 70 IV. Employers match contributions V. They are only available to individuals earning less than $110,000, or households earning less than $160,000 A) I, II and IV B) II, IV and V C) I, III and IV D) I, III and V E) V only Answer: E Page: 515 Level: Medium

27. A retirement account specifically designed for self-employed persons is a A) Roth IRA B) Traditional IRA C) Keogh D) Penny Benny E) Public Pension plan Answer: C Page: 515-516 Level: Easy

28. Most public pension funds are A) Overfunded B) Underfunded C) Fully funded D) Defined contribution E) Keogh plans Answer: B Page: 519-520 Level: Easy

29. Under ERISA, the maximum time period allowed until an employee is eligible to receive pension benefits is __ years. A) 5 B) 8 C) 10 D) 12 E) 15 Answer: C Page: 520 Level: Easy

A) B) C) D) E)

30. ERISA established all but which one of the following? Prudent man rule Maximum vesting times Minimum funding requirements Insurance for pension plan participants Minimum payouts for defined contribution plans

Answer: E Page: 520-522 Level: Medium

31. The PBGC A) Insures participants of defined benefit plans if plan funds are insufficient to meet contractual pension obligations B) Insures participants of defined contribution plans if investment returns are insufficient to meet expected pension obligations C) Regulates day to day pension fund operations D) Both A and C are correct E) A, B and C are correct Answer: A Page: 520-522 Level: Medium

Chapter 20 True/False Questions

1. The risk that an FI may not have enough capital to offset a sudden decline in the value of its assets is called liquidity risk. Answer: False Page: 527 Level: Medium

2. The risk that an FI may not have enough capital to offset a sudden decline in the value of assets is called insolvency risk. Answer: True Page: 527 Level: Easy

3. A probability distribution of loan returns would exhibit negative skewness. Answer: True Page: 527 Level: Medium

4. Loan charge offs do not lead to insolvency risk because when loans are written off both loans and liabilities are reduced. Answer: False Page: 527-528 Level: Medium

5. Maintaining a diversified loan portfolio helps a bank reduce systematic credit risk. Answer: False Page: 528 Level: Medium

6. Of C&I loans, real estate loans and credit card loans, C&I loans have had the highest net charge off rate in recent years. Answer: False Page: 529 Level: Medium

7. Higher credit card loss rates in the 2000s have led to a reduction in credit card loans extended by commercial banks. Answer: False Page: 528 Level: Medium


A thin market is one where transaction costs are low (thin).

Answer: False Page: 530 Level: Easy

9. A corporation unexpectedly exercises their right to borrow against their bank credit line. This is an example of liability side credit risk. Answer: False Page: 527 Level: Easy

10. A bank that has made floating rate loans funded by longer maturity deposits is at risk from falling interest rates. Answer: True Page: 533 Level: Medium

11. Rising interest rates decrease the value of fixed income assets and increase the value of fixed income liabilities. Answer: False Page: 531-532 Level: Medium

12. Risk generated by FI speculation on interest rate and exchange rate movements is called market risk. Answer: True Page: 533-534 Level: Easy

13. Assets in a bank's trading book tend to be longer term than assets in held in the banking book. Answer: True Page: 534 Level: Easy

14. A contingent liability is an example of an off balance sheet activity. Answer: True Page: 535 Level: Easy

15. Breakdowns of clearing and settlement systems are examples of operational risk. Answer: True Page: 540 Level: Medium

Multiple Choice Questions

16. A bank has total assets of $120 million and $15 million in equity. The managers of the bank realize that $10 million of its $100 million loan portfolio will not be repaid. After the bank charges off the bad loans the bank's equity to asset ratio will be _____. A) 12.5% B) 13.6% C) 16.7% D) 4.2% E) 4.5% Answer: E Page: 527-528 Level: Medium

17. The risk that an unanticipated increase in liability withdrawals may cause an FI to have to sell assets at fire sale prices is an example of A) Credit risk B) Liquidity risk C) Interest rate risk D) Sovereign risk E) Technology risk Answer: B Page: 527 Level: Easy

18. Risk arising from trading activities is termed A) Credit risk B) Liquidity risk C) Interest rate risk D) Sovereign risk E) Market risk Answer: E Page: 533-534 Level: Easy

19. Second Bank now offers web banking services. Last week a computer glitch posted all web deposit transfers to the wrong accounts. This is an example of A) Credit risk B) Liquidity risk C) Stupidity risk D) Technological risk E) Operational risk Answer: E Page: 540 Level: Medium

20. MONDEX spent $50 million to develop the Smart Card, but tests of prototypes in New York and Canadian cities revealed very little consumer interest. This is an example of: A) Credit risk B) Liquidity risk C) Stupidity risk D) Technological risk E) Operational risk Answer: D Page: 540 Level: Medium

21. Rank order the net charge off rates from high to low for the following loan types: I. C&I loans II. Credit card loans III. Real estate loans A) I, II, III B) I, III, II C) II, I, III D) II, III, I E) III, I, II Answer: C Page: 529 Level: Medium

A) B) C) D) E)

22. Liquidity risk arises from I. Unexpected loan demand II. Unexpected deposit withdrawals III. Anticipated drawdown on a credit line IV. Loan defaults I only II only I, II and IV only III only I, II and III only

Answer: C Page: 530 Level: Medium

23. A thrift makes long term fixed rate mortgages funded with short term deposits and then interest rates rise. Which of the following is true? A) Profitability would decline B) Profitability would increase C) The market value of equity increases D) Interest income would fall E) Both B and C would occur Answer: A Page: 531-533 Level: Medium

24. In year one a bank facing reinvestment risk earns 11% on its assets and pays 10% on its liabilities. In year two the bank had a negative profit spread of 100 basis points. Which of the following is true? In year two A) Rates rose 100 Basis points B) Rates rose 200 Basis points C) Rates fell 100 Basis points D) Rates fell 200 Basis points E) None of the above Answer: D Page: 532 Level: Medium

25. Present value uncertainty is the risk that A) The market value of equity will decline if interest rates change. B) Interest income will rise by more than interest expense when rates increase. C) Assets will be insufficient to cover loan losses. D) Bank capital will be insufficient to cover loan losses. E) Real interest rates will exceed nominal rates. Answer: A Page: 533 Level: Medium

A) B) C) D) E)

26. If an FI could hedge all its risks, the FI's shareholders could expect to earn The industry average return The T-Bill rate The same rate as the S&P 500 The appropriate rating corporate bond rate A zero rate of return

Answer: B Page: 533 Level: Easy

27. Which of the following leads to market risk? A) A bank lends money to a corporate borrower B) A FI grants a letter of credit to a customer C) A bank uses a foreign currency forward contract to hedge a foreign currency exposure D) A bank purchases interest rate options in hopes of profiting when rates move E) None of the above Answer: D Page: 533-534 Level: Easy

28. A bank has $5 million in liquid assets and $95 million in nonliquid assets. Large depositors unexpectedly withdraw $9 million in deposits. To cover the withdrawals the bank sells all of its liquid assets at book value but must sell $7 million at less than their book value of their nonliquid assets to raise the additional funds needs. As a result the bank's equity will _____________. A) Remain unchanged B) Fall $3 million C) Fall $4 million D) Fall $7 million E) Rise $5 million Answer: B Page: 530-531 Level: Medium

29. Which of the following would normally be banking book assets rather than trading book assets? A) Capital B) Short position in bonds C) FX forward contracts D) Long term loans E) Options on interest rates Answer: D Page: 534 Level: Easy

30. A bank has on balance sheet assets with a market value of $250 million, and deposits and other borrowings with a market value of $225 million. The bank also has contingent assets currently valued at $50 million and contingent liabilities worth $60 million. Stockholder's net worth should be valued at ______ million. A) $25 B) $15 C) $35 D) $0 E) $300 Answer: B Page: 536 Level: Difficult

31. The is worth euro 1.5 and the euro and the dollar are at parity. Statistical analysis indicates that when the euro rises 1% against the dollar, the pound rises 0.5% against the euro and vice versa. A U.S. bank has assets of 40 million that mature in one year funded with liabilities of euro 75 million due in 6 months. The bank would be hurt by: A) An increase in the value of the euro against the dollar. B) A decrease in the value of the euro against the dollar. C) An increase in euro interest rates relative to pound interest rates. D) An increase in pound interest rates relative to euro interest rates E) Both A & C Answer: E Page: 537 Level: Difficult

32. The U.S. decision to freeze Iranian assets during the Iranian hostage crisis during the Carter Administration is an example of _____ to Iranian FIs. A) Credit risk B) Liquidity risk C) Foreign exchange risk D) Sovereign risk E) Insolvency risk Answer: D Page: 539 Level: Easy

33. The major purpose(s) in investing in technology is/are to A) Lower operating costs B) Keep up with competitors C) Exploit economies of scope D) A and B only E) A, B and C Answer: D Page: 540 Level: Easy

A) B) C) D) E)

34. CHIPS and ACH are Potato products of Frito Lay Check clearing systems run by the Federal Reserve Retail payment systems used in Europe International bank regulators Wholesale electronic payment systems

Answer: E Page: 540 Level: Medium

35. The terrorist attacks on the World Trade Center in 2001 are an example of ______________. A) Regulatory risk B) Liquidity risk C) Credit risk D) Insolvency risk E) Event risk Answer: E Page: 543 Level: Easy