16
True/False Chapter 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
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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
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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
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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
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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
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28. In 2000 and 2001 the top IPO underwriter (by $ volume) was
A) Goldman-Sachs
B) Merrill-Lynch
C) Citigroup SSB
D) J.P. Morgan Chase
E) 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
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32. An investment banker may be unwilling to engage in a firm commitment offer if
A) The issuer is relatively unknown to the public
B) The issuer desires too low an offer price
C) The investment banker is concerned about overall market price volatility
D) Both A and C
E) 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
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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
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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
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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
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14. The first major finance company was
A) General Motors Acceptance
B) Household Finance Corp
C) General Electric Capital Corp
D) First Alliance Company
E) 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
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18. Sales finance companies
A) Specialize in making loans to customers of a specific retailer or manufacturer
B) Specialize in making installments and other loans to whatever consumers are interested
C) Specialize in providing loans to businesses
D) Specialize in international factoring and forfaiting
E) 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
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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
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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
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30. Finance companies in foreign countries
A) Usually take insured deposits
B) Rarely offer loans to individuals
C) Raise most of their capital via issuing commercial paper
D) Are more highly regulated than U.S. finance companies
E) 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.
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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.
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Answer: False Page: 501 Level: Easy
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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
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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
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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
A) III only
B) I and III only
C) II, III and IV only
D) I, III and IV only
E) 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: Page: C 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
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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
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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
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35. The primary regulator of mutual funds is the
A) NASD
B) CFTC
C) NYSE
D) SEC
E) 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.
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Answer: False Page: 514-515 Level: Medium
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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
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13. In general terms, which one of the following plan types is the riskiest for an employee?
A) Fixed income defined contribution plan
B) Variable income defined contribution plan
C) Final pay defined benefit plan
D) Career average defined benefit plan
E) 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)
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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
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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
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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
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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
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30. ERISA established all but which one of the following?
A) Prudent man rule
B) Maximum vesting times
C) Minimum funding requirements
D) Insurance for pension plan participants
E) 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
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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
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8. 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
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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
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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
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22. Liquidity risk arises from
I. Unexpected loan demand
II. Unexpected deposit withdrawals
III. Anticipated drawdown on a credit line
IV. Loan defaults
A) I only
B) II only
C) I, II and IV only
D) III only
E) 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
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26. If an FI could hedge all its risks, the FI's shareholders could expect to earn
A) The industry average return
B) The T-Bill rate
C) The same rate as the S&P 500
D) The appropriate rating corporate bond rate
E) 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
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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
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34. CHIPS and ACH are
A) Potato products of Frito Lay
B) Check clearing systems run by the Federal Reserve
C) Retail payment systems used in Europe
D) International bank regulators
E) 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
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