Question

Which of the following is false regarding bank capital management?

		There is a tradeoff between bank safety and return on equity.
		A high level of capital makes it less likely for a bank to become insolvent.
		There is a high incentive for owners of banks to maintain high levels of capital.
		A high level of capital comes with a low return of equity.

Gap analysis

		is a strategy to make sure that banks stay solvent over large fluctuations of interest rates.
		only takes into consideration rate-sensitive assets and liabilities.
		is used to evaluate the change in the net worth of a bank when interest rate fluctuates.
		says that banks with larger gap have larger change in net worths when interest rate changes.

The value of which of the following assets is the most sensitive towards a change in interest rate?

		A 10-year discount bond.
		A fixed-payment loan with duration 5.3.
		A 5-year fixed payment loan with an annual payment of $5000 and interest rate of 3%.
		A coupon bond with duration 8.6.

Which of the following is false regarding the Federal Deposit Insurance Corporation (FDIC)?

		One of the methods the FDIC deal with failing banks is the payoff method.
		FDIC guarantees up to $250,000 per deposit.
		Purchase and assumption method involve the FDIC taking over the failing bank.
		FDIC is founded to promote financial stability.

Which of the following is not an adverse outcome of government safety nets?

		Asset restructuring.
		Adverse selection.
		Too big to fail.
		Financial consolidation.
		Moral hazard

A financial crisis occurs when an increase in asymmetric information from a disruption in the financial system

		causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently.
		allows for a more efficient use of funds.
		reduces uncertainty in the economy and increases market efficiency.
		increases economic activity.

Answer 1

1. There is a high incentive for owners of banks to maintain high levels of capital. This statement is false because to maintain high levels of capital, the bank needs high amount of funds and these are not only difficult to get but also have cost associated with them.

2. Gap analysis is used to evaluate the change in the net worth of a bank when interest rate fluctuates. (Definition of Gap Analysis)

3. A 10-year discount bond. This is because this security will have a duration of 10 years (maximum duration of all the options)

4. One of the methods the FDIC deal with failing banks is the payoff method. They prefer purchase and assumption method.

5. Financial Consolidation. This is not an adverse effect.

6. causes severe adverse selection and moral hazard problems that make financial markets incapable of channeling funds efficiently. Example is the 2008 crisis.