Practice Questions #2

Identifications:

I.
Define and explain the significance of each of the terms given below.

Asymmetric Information
Moral Hazard
Adverse Selection
Secured Debt
Unsecured Debt
Financial Intermediaries
Mutual Fund
The Lemons Problem
Free Rider Problem
Net Worth
Venture Capital
Incentive Compatible
Collateral
Cash Flow
Bank Panic
Debt Deflation
Time Deposits
Required Reserve Ratio
Reserves
Excess Reserves
Loan Loss Reserves
Secondary Reserves
Capital Adequacy Management
Money Center Banks
Return on Assets
Return on Equity
Equity Multiplier
Screening
Compensating Balances
Gap Analysis
Duration Analysis
Loan Sale
Financial Engineering
Disintermediation
Eurodollars
NOW
Sweep Account
Glass-Steagall
Dual Banking System
Bank Holding Companies
Loophole Mining
Nonbank Banks
Super-regional Banks
Universal Banking
The Common Bond Controversy
Junk Bonds
GNMA
Thrifts
Z-bonds
IBFs
Payoff method of FDIC
Off-balance Sheet Activities
Call Reports
McFadden Act
FDICIA
CEBA
FIRREA
DIDMCA

II True/False/Uncertain

Read each statement below and decide whether you think it is true, false, or you are uncertain. Explain your position in a paragraph

1. Moral hazard and adverse selection are the same phenomena.
2. Financial markets in the U.S. are not very regulated.
3. Indirect finance is more important than direct finance as a source of funding for industries.
4. Venture capital firms create moral hazard.
5. Recession aggravates the moral hazard problem.
6. Bank loans are bank liabilities.
7. The discount rate and the federal funds rate are the same.
8. Lower bank capital always leads to higher returns to the owners of banks.
9. If a bank has more interest rate sensitive assets than liabilities, a decline in interest rates will increase bank profits.
10. Increasing reserves for banks leads to higher profits.
11. FDIC made sure that there was no financial crisis in the USA.
12. Preponderance of banks in the U.S. is due to the intense competition in the banking sector.
13. U.S., U.K., Canada and Australia have universal banking.
14. Since 1980s, the share of non-interest income in total bank income has been decreasing in the U.S.
15. Rising profits for commercial banks since mid 1980s have given rise to the moral hazard problem in the U.S.
16. Basel Accord has stipulated that capital adequacy ratio should be 12%.
17. Increase in competition amongst banks always aggravates the moral hazard problem.
18. Central Bank has been in existence in the U.S. since the passing of the National Bank Act of 1863.
19. Regulatory forbearance prevented crisis in the Savings and Loan (S&L) industry.
20. Glass-Steagall Act of 1933 has been abolished.

III Essays

1. Analyze the following statement.

" Asymmetric information, adverse selection and moral hazard can go a long way in explaining sources of funds for non-financial businesses in the U.S ."

2. Compared to other developed countries, the U.S.has too many banks. Why do you think the United States has evolved with so many banks while the European countries and Japan have a relatively smaller number of large banks?

3. What kind of asset management, liability management, capital adequacy management, and risk-management techniques should banks adopt to maximize returns while incurring a reasonable amount of risk?

4. Discuss the reasons behind the decline in traditional banking and consolidation of the banking sector in the United States since the 1980s.

5. Invoking arguments using the ideas implicit in the principal-agent problem, explain the reasons behind the U.S banking crisis in the 1980s. What remedial measures have been undertaken since then to ensure that such crises are not repeated?