Chapter 15.

The Management of Capital

Fill in the Blank Questions

1 The risk that has to do with banks trading in foreign currencies is called
. ________________________.

exchange risk

2 The risk that has to do with fraud, embezzlement and bank robberies is called
. _________________.

crime risk

3 _________________________ is measured by the par value of the shares of common

. equity outstanding.

Common stock

4 __________________ is the amount in excess of stock's par value paid by the bank's
. shareholders.

Surplus

5 _________________________ are the net earnings of a bank, which have been kept by
. the bank rather than being distributed as dividends to stockholders.

Undivided profits (or retained earnings)

6 Core capital such as common stock and surplus, undivided profits, qualifying
. noncumulative perpetual preferred stock, etc. is referred to as __________________
capital, as defined by the Basel agreement.

Tier 1

7 The international treaty involving representatives from the U.S. and 12 other leading
. industrialized countries to impose common capital requirements on all banks is known
as the ________________________.

Basel Agreement

8 Supplemental capital such as the allowance for loan and lease losses, subordinated debt
. capital instruments, mandatory convertible debt, intermediate-term preferred stock,
 cumulative perpetual preferred stock with unpaid dividends, and equity notes and other
long-term capital instruments that combine both debt and equity features is more
commonly known as ________________________.

Tier 2 capital

9 When the assets items on a bank's balance sheet and each off-balance-sheet
. commitment it has made are multiplied by the appropriate risk-weighting factor, they
are often called ________________________.

risk-weighted assets

10 The fact that a bank may suffer deficiencies in quality control, inefficiencies in
. producing and delivering of services, natural disasters, terrorist acts, weather damage,
aging or faulty computer systems, errors in judgment by management, and
fluctuations in economy that could adversely affect the bank's performance, is known
as _________________________ risk.

operational

11. One defense against risk for a bank is to spread out its credit accounts and deposits
among a wide variety of customers, including large and small business accounts,
different industries, etc. This defense is known as ________________________.

portfolio diversification

12 One defense against risk for a bank is to seek out customers located in different
. communities or in different countries. This defense is known as
________________________.

geographic diversification

13 When all else fails, the ultimate defense against risk in banking is
. ________________________.
 owners' capital (net worth)

14. The largest component of capital among thrift institutions is ____________.

retained earnings

15 The largest component of capital among commercial banks is ___________.

.
surplus

16 ____________ models attempt to measure price or market risk of a portfolio of assets

. and attempt to determine the maximum loss they might sustain over a designated
period of time.

Value at risk (VaR)

17 The latest revision to the Basel accord is known as __________ and will cover
. capital, liquidity, and debt positions of individual international banks and also the
much broader issues associated with controlling global business cycles and financial
system-wide risks.

Basel III

18 ____________ models measure a lender's exposure to defaults or credit downgrades.

.
Credit risk

19 _________________ risk measures are being developed to be used when Basel III
. takes effect.

Systemic

20 At the center of the debate of the Basel Agreement is the ____________,

. headquartered in Basel, Switzerland, which assists central banks in their transactions
with each other and serves as a forum for international financial issues.

Bank for International Settlements (BIS)

21 _____________ represents funds set aside for contingencies, such as legal action
. against the institution, as well as providing a reserve for dividends expected to be paid
but not yet declared, and a sinking fund to retire stock or debt in the future.

Equity reserves

22. _________ are debt securities repayable from the sale of stock.

Equity commitment notes

23. __________ is a hybrid form of debt and equity capital issued to investors.

Trust preferred stock

24 _________ are a type of long-term debt capital whose claims legally follow after the
. claims of depositors.

Subordinated notes and debentures

25 _________ for banks include assets like mortgage servicing rights and purchased
. credit card relationships and such assets can be counted as part of bank capital.

Identifiable intangible assets

True / False Questions

26 In the field of banking, capital refers principally to those funds contributed by a

. bank's owners. TRUE

27. According to the textbook, capital and risk are intimately related to each other. TRUE

28 One fundamental purpose for regulating capital is to limit losses to the government
. and other institutions arising from deposit insurance claims. TRUE

29 Deposit insurance subsidized by government encourages banks to increase their ratios

. of capital to deposits. FALSE
30 Under the terms of Basel I, Tier 2 capital includes undivided profits. FALSE
.

31. Core capital includes the surplus value of common stock. TRUE

32 Under the international capital (Basel) agreement, Tier 2 capital must be raised to a
. minimum of 4 percent of risk-weighted assets. FALSE

33 Off-balance-sheet commitments of banks carry capital requirements under the

. international (Basel) capital standards. TRUE

34 Portfolio diversification refers to seeking out customers located in different

. communities or countries, which presumably will experience different economic
conditions. FALSE

35 Geographic diversification refers to the spreading out credit accounts and deposits
. among a wide variety of customers within a country, including large and small
business accounts, different industries, and households with a variety of sources of
income and collateral. FALSE

36 The last line of defense against bank failure is owner's capital, according to the
. textbook. TRUE

37 Under the FDIC Improvement Act of 1991, a U.S. bank possessing a leverage ratio
. greater than 4 percent would be considered well capitalized. FALSE

38 Under the FDIC Improvement Act of 1991, a bank whose leverage ratio drops to 2
. percent or less is considered to be critically undercapitalized. TRUE

39 Recent research suggests that interest-rate contracts display considerably less risk
. exposure than do foreign-currency contracts. TRUE
40 The Basel Agreement on new capital standards, as drafted in the 1980s, failed to deal
. with market risk. TRUE

41 If the ratio of tangible equity capital to total assets is 2 percent or less, it is subject to
. being placed in conservatorship or receivership unless the institution's principal
regulator and the FDIC determine that it would be in the public interest to allow the
institution to continue under present ownership and management. TRUE

42 According to recent research, bank stock prices usually drop within a week after a
. dividend cut is announced.TRUE

43. Equity notes are considered to be part of Tier 1 capital. FALSE

44 The largest source of thrift capital in terms of dollar volume is common stock (par
. value). FALSE

45 Recently, the daily rate at which robberies have occurred in the U.S. has continued to
. climb. FALSE

46 One of the reasons to regulate the capital position of banks is to limit the risk of bank
. failures, especially large bank failures. TRUE

47 Deposits with the Federal Reserve banks are considered to have moderate credit risk
. and are therefore placed in the 50 percent risk-weight category. FALSE

48. The largest component of capital among banks is retained earnings. FALSE

49 VaR models measure the market risk and indicate the potential for losses on a
. portfolio of assets. TRUE
50 VaR models are most successful in assessing potential risk when the assets are non-
. traded. FALSE

51 Credit risk models measure the market risk of a portfolio whose value may decline
. due to adverse movements in interest rates, stock prices, currency values, or
commodity prices. FALSE

52 One of the key pillars for capital regulation in Basel II was to require banks to hold
. capital against its own estimated risk exposure from operational risk. TRUE

53 Basel II requires each bank to determine its own capital requirements based on its
. own calculated risk exposure. TRUE

54 It is anticipated that Basel III may increase capital requirements for banks. TRUE
.

55 The global financial crisis of 2007-2009 highlighted the importance of taking into
. consideration a bank's exposure to market risk that arise from changes in interest
rates, security prices, and currency. TRUE

56 Smaller banks rely more heavily on internally generated capital than larger
. banks. TRUE

57 A well-capitalized institution has a ratio of capital to risk-weighted assets of at least

. 10 percent and faces no significant regulatory restrictions on its expansion. TRUE

58 Regulatory capital focuses on the market value of equity. FALSE

.
Multiple Choice Questions

59. According to the textbook, the role(s) of capital is to:

A. provide a cushion against failure risk.

B. provide funds needed to charter, organize, and operate a

bank.

C. promote public confidence.

D. support growth and the development of new services.

E. All of the options are correct.

60 The textbook discusses several alternative defenses banks have against risk. These
. defenses include:

A. quality management.

B. portfolio diversification.

C. geographic diversification.

D. deposit insurance.

E. All of the options are correct.

61. Measured by dollar volume, the largest category of capital at U.S. banks is:

A. par value of common stock.

B. subordinated notes and debentures.

C. surplus.

D. undivided profits and capital reserves.

E. None of the options is correct.

62 The fundamental purposes of regulating bank capital cited in the textbook include
. which of the following?

A. To reduce liquid funds held by the banks.

 B. To preserve public confidence in banks.

C. To limit losses to the public arising from insurance claims.

D. To increase the risk taking ability of the banks.

E. To reduce liquid funds held by the banks and to increase the risk taking ability of
the banks.

63 The internal capital growth rate for a bank is a function of which of the following
. factors?

A. Profit margin.

B. Asset utilization.

C. Equity multiplier.

D. Earnings retention ratio.

E. All of the options are correct.

64 Second National Bank is forecasting a return on equity of 15 percent for this year. The
. board of directors wants to maintain its current policy of paying the bank's
stockholders 40 percent of any net earnings the bank will earn. How fast can the
bank's assets grow this year without jeopardizing its ratio of capital to assets?

A. 15 percent

B. 9 percent

C. 8 percent

D. 6 percent

E. None of the options is correct.

65 Possible breakdowns in quality control, inefficiencies in producing and delivering

. financial services, weather damage, aging or faulty computer systems, and errors in
judgment by bank management illustrate what form of risk faced by banks?

A. Credit risk

B. Liquidity risk
 C. Interest-rate risk

D. Operational risk

E. None of the options is correct.

66. The ratio of core capital to average total assets is called the:

A. supplemental capital ratio.

B. leverage ratio.

C. long-term capital ratio.

D. GAAP capital ratio.

E. None of the options is correct.

67 The risk that a customer with whom the bank has entered into a contract with, will fail
. to pay or to perform, forcing the bank to find a replacement contract with another
party that may be less satisfactory is what form of risk listed below?

A. Counterparty risk

B. Interest-rate risk

C. Operating risk

D. Credit risk

E. Liquidity risk

68 In the United States a 'well capitalized' bank must have a ratio of capital to risk-
. weighted assets of at least:

A. 6 percent.

B. 8 percent.

C. 10 percent.

D. 5 percent.

E. None of the options is correct.

69 In the United States a bank to be considered 'adequately capitalized' must have a ratio
. of Tier 1 (or core) capital to risk-weighted assets of at least:

A. 8 percent

B. 6 percent

C. 10 percent

D. 4 percent

E. None of the options is correct.

70. A 'well capitalized' bank in the United States must have a leverage ratio of at least:

A. 4 percent

B. 5 percent

C. 6 percent

D. 8 percent

E. None of the options is correct.

71 A bank has $100 million in assets in the 0 percent risk-weight category, $200 million
. in assets in the 20 percent risk-weight category, $500 million in assets in the 50
percent risk-weight category, and $750 million in assets in the 100 percent risk-
weight category. This bank has $57 million in core (Tier 1) capital. What is this bank's
ratio of Tier 1 capital to risk-weighted assets?

A. 3.68 percent

B. 7.60 percent

C. 18.25 percent

D. 5.48 percent

E. None of the options is correct.

72 A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent, an

. equity multiplier of 12, and a retention ratio of 60 percent. What is this bank's ICGR?
 A. 6.60 percent

B. 3.96 percent

C. 7.20 percent

D. 0.33 percent

E. None of the options is correct.

73 Which of the following would be an example of Tier 1 capital?

.
A. Subordinated debt capital instruments with an original maturity of at least
5 years

B. Allowance for loan and lease losses

C. Minority interest in the equity accounts of consolidated subsidiaries

D. Intermediate-term preferred stock

E. All of the options are correct.

74 Which of the following would be an example of Tier 2 capital?

.
A. Subordinated debt capital instruments

B. Undivided profits

C. Minority interest in the equity accounts of consolidated

subsidiaries

D. Qualifying noncumulative preferred stock

E. All of the options are correct.

75 Which of the following would be an example of crime risk?

.
A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest and principal has been
collected in 2 years.
 D. A bank manager predicts that interest rates will rise. However, interest rates fall
causing the bank 's net income to fall by $250,000.

E. All of the options are examples of crime risk.

76. Which of the following assets fit(s) into the 0 percent risk-weight category?

A. Cash

B. Deposits at the Federal Reserve

C. Treasury Bills

D. GNMA mortgage-backed securities

E. All of the options are assets that fit into the 0 percent risk-weight
category.

77 A bank that is 'well-capitalized':

.
A. faces no significant regulatory restriction on its expansion.

B. cannot accept broker placed deposits without regulatory approval.

C. has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions.

D. will be placed into conservatorship or receivership if its capital level is not

increased within a certain time limit.

E. None of the options is correct.

78 A bank that is 'critically undercapitalized':

.
A. faces no significant regulatory restrictions.

B. can only grant loan to highly leveraged borrowers.

C. cannot avoid seizure in all circumstances.

D. will be placed into conservatorship or receivership if its capital level is not

increased within a certain time limit.

E. None of the options is correct.

79 A bank that is adequately capitalized:
.
A. faces no significant regulatory restrictions.

B. cannot accept broker-placed deposits without regulatory approval.

C. has limits on dividends and management fees it is allowed to pay and limits on the
maximum asset growth rate among other restrictions.

D. will be placed into conservatorship or receivership if its capital level is not

increased within a certain time limit.

E. None of the options is correct.

80. Which of the following is in the 100 percent risk-weight category?

A. Cash

B. General obligation municipal bonds

C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

81 Which of the following is in the 50 percent risk-weight (moderate credit risk)

. category?

A. Cash

B. General obligation municipal bonds

C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

82. Which of the following is in the 20 percent risk-weight (low credit risk) category?

A. Cash

B. General obligation municipal bonds

 C. Residential mortgage loans

D. Credit card loans

E. None of the options is correct.

83 A bank has a ROE of 14 percent and a ROA of 2 percent. What is this bank's equity
. capital to total assets ratio?

A. 7.00 percent

B. 14.29 percent

C. 28.00 percent

D. 16.00 percent

E. None of the options is correct.

84 A bank has $200 million in assets in the 0 percent risk-weight category. It has $400
. million in assets in the 20 percent risk-weight category. It has $1,000 million in assets
in the 50 percent risk-weight category and has $1,000 million in assets in the 100
percent risk-weight category. This bank has $96 million in Tier 1 capital and $48
million in Tier 2 capital. What is this bank's ratio of Tier 1 capital to risk assets?

A. 6.08 percent

B. 3.04 percent

C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

85 A bank has $200 million in assets in the 0 percent risk-weight category. It has $400
. million in assets in the 20 percent risk-weight category. It has $1,000 million in assets
in the 50 percent risk-weight category and has $1,000 million in assets in the 100
percent risk-weight category. This bank has $96 million in Tier 1 capital and $48
million in Tier 2 capital. What is this bank's ratio of Tier 2 capital to risk assets?

A. 6.08 percent

B. 3.04 percent
 C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

86 A bank has $200 million in assets in the 0 percent risk-weight category. It has $400
. million in assets in the 20 percent risk-weight category. It has $1,000 million in assets
in the 50 percent risk-weight category and has $1,000 million in assets in the 100
percent risk-weight category. This bank has $96 million in Tier 1 capital and $48
million in Tier 2 capital. What is this bank's ratio of total capital to risk assets?

A. 6.08 percent

B. 3.04 percent

C. 9.11 percent

D. 5.54 percent

E. None of the options is correct.

87 A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45
. percent and has an equity multiplier of 12. It retains 40 percent of its earnings each
year. What is this bank's internal capital growth rate?

A. 28.35 percent

B. 2.36 percent

C. 11.34 percent

D. 4.80 percent

E. None of the options is correct.

88. The revised Basel I rules imposed capital requirements for market risk on:

A. only the largest banks.

B. only the smallest banks.

C. only moderate size banks.

D. all banks.
 E. no banks.

89 Which of the following is a bank debt that appears to be highly sensitive to the market
. perception of the bank's risk?

A. Deposits

B. Fed funds

C. Repos

D. Subordinated debt capital

E. Preferred stock

90 As per the Basel Committee, a bank's operational risk includes:

. A. employee fraud.

B. accounting errors.

C. computer breakdowns.

D. natural disasters.

E. All of the options are correct.

91 The task of correctly adding up all of the different types of bank risk exposures is
. known as:

A. risk tallying.

B. summing risk.

C. risk aggregation.

D. risk accumulation.

E. risk totality.

92 For a bank with deficient capital ratios, which of the following actions could be
. required by regulators to increase the capital ratios, all else constant?

A. Cut the bank's dividend payment.

 B. Increase the bank's leverage.

C. Reduce the bank's holdings of cash.

D. Increase the bank's growth rate by making additional commercial loans.

E. Reduce the bank's holdings of Treasury securities.

93 Basel II had a different set of capital rules for different banks, and the number of
. categories is:

A. two.

B. three

C. four.

D. five.

E. ten.

94 Which of the following would be an example of exchange risk?

.
A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been

collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall
causing the bank's net income to fall by $250,000.

E. All of the options are examples of exchange risk.

95 Which of the following would be an example of credit risk?

.
A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business, on which no interest or principal has been

collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall
 causing the bank's net income to fall by $250,000.

E. All of the options are examples of credit risk.

96 Which of the following would be an example of interest rate risk?

.
A. A bank manager embezzles $1,000,000 from the bank.

B. A bank that loses $500,000 from trading in foreign currencies.

C. A $1,000,000 loan given to a business on which no interest or principal has been

collected in 2 years.

D. A bank manager predicts interest rates will rise. However, interest rates fall
causing the bank's net income to fall by $250,000.

E. All of the options are examples of interest rate risk.

97 Which of the following would be an example of operational risk?

.
A. A robber steals $250,000 from the bank locker.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of
depositors.

D. A $500,000 loan that the bank has made has been deemed uncollectible.

E. None of the examples are of operational risk.

98 Which of the following would be an example of liquidity risk?

.
A. A bank teller manages to steal $250,000 over a period of several months.

B. An out-of-date computer system causes the bank to lose $750,000.

C. A bank is forced to sell $1,000,000 in loans, at a loss, in order to meet the needs of
depositors.

D. A $500,000 that loan the bank has made has been deemed uncollectible.

E. None of the examples are of liquidity risk.

99 Which of the following would not be an example of operational risk?

.
A. A bank, on the coast of Louisiana, is hit by a hurricane and is flooded for 6 weeks.

B. A bank employee working as a derivatives trader, is also the one who writes the
reports on profits and losses in derivatives trading every day.

C. The banks older computer system breaks down causing a loss of service to
customers for 2 weeks.

D. A bank robber robs a teller at gun point and gets away before police can get to the
bank.

E. All of the examples are of operational risk.

100 The Jennings Bank of Texas, wants to protect itself from credit risk by making large
. loans to corporate customers, by making residential mortgages to families, by
making agriculture loans to farmers and ranchers in the area, by making small
business loans to business along main street and by making automobile loans for the
car dealership across the street from the bank. What defense against risk is this bank
making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners' capital

E. None of the options is correct.

101 The Michelson Bank of Stetson, wants to protect itself from risk. It decides to make
. loans in Florida, Georgia, Texas, and Oklahoma as well as invest in municipal bonds
from California and Oregon. What defense against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners' capital

E. None of the options is correct.

102 The Perdue Bank of Houston, has just hired a new manager who has a reputation of
. anticipating potential problems and acting quickly to prevent those problems so that
the bank stays healthy and profitable. What defense against risk is this bank
making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners' capital

E. None of the options is correct.

103 The Norton Bank of Illinois, has just issued trust preferred stock. What defense
. against risk is this bank making?

A. Portfolio diversification

B. Geographic diversification

C. Quality management

D. Increasing owners' capital

E. None of the options is correct.

104. What type of preferred stock has appeared recently that carry a lower cost?

A. Cumulative preferred stock

B. Noncumulative preferred stock

C. Convertible preferred stock

D. Trust preferred stock

E. None of the options is correct.

105 Even if individual banks are good at forecasting risk using VaR models, there may
. still be problems because losses may occur at several banks at the same time due to
the interdependency of the financial system, magnifying each bank's risk exposure
and possibly causing a major problem for regulators. The book calls this:
 A. systemic risk.

B. operational risk.

C. credit risk.

D. market risk.

E. liquidity risk.

106 There are three pillars of Basel II. One of them is to make market discipline a
. powerful force compelling risky banks to lower their risk exposure. What does Basel
II want to do to make this happen?

A. Require minimum capital requirement based on the bank's own evaluation of its
risk.

B. Require greater public disclosure of each bank's true financial condition.

C. Expand the risks to be evaluated to include credit risk market risk, and
operational risk.

D. Require a supervisory review of each bank's risk evaluation procedures.

E. All of the options are correct.

107 A bank has capital to risk-weighted assets of 11.5%, Tier 1 capital to risk-weighted
. assets of 7.2% and a leverage ratio of 5.8%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

108 A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted
. assets of 5% and a leverage ratio of 4.8%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized
 C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

109 A bank has capital to risk-weighted assets of 9.2%, Tier 1 capital to risk-weighted
. assets of 4.5% and a leverage ratio of 3.7%. What type of bank is this?
A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

110. A bank has capital to risk-weighted assets of 5.5%, Tier 1 capital to risk-weighted
assets of 2.8% and a leverage ratio of 2.6%. What type of bank is this?

A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

111 A bank has capital to risk-weighted assets of 1.8%. What type of bank is this?
.
A. Well capitalized

B. Adequately capitalized

C. Undercapitalized

D. Significantly undercapitalized

E. Critically undercapitalized

112 Which of the following is not a weakness of Basel I risk-based capital standards?
.
A. They ignore interest rate risk

B. They ignore changes in value due to currency value changes

C. They ignore changes in value due to commodity price changes

D. They ignore credit risk

E. They ignore the market value

113. A bank has decided to retain more of their earnings, moving their retention ratio
from 40% to 70%. What way of meeting their capital needs is the bank taking?

A. Changing their dividend policy

B. Issuing common stock

C. Issuing preferred stock

D. Issuing subordinated notes and debentures

E. Selling assets and leasing facilities

114. The First National Bank of Tucson has determined that the value of their property in
Tucson has tripled in the last three years. They decide that they would like to use this
property to raise funds and will rent space from the new owners of the building.
What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

115. The Second National Bank of Lincoln has decided that, to raise funds it is going to
issue new common equity through a pre-emptive rights offering, so that current
owners will not have that ownership diluted. What way of meeting their capital
needs is the bank taking?

A. Issuing common stock

 B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

116. The Third State Bank of Denton has decided to issue stock through a trust company
and borrow the funds from the trust company. This stock pays a fixed dividend and
because of the way the stock has been issued it is tax deductible. What way of
meeting their capital needs in the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

117. The Northwest Bank of Charlotte has decided to issue new securities that have five
years to maturity that have claims to assets that follow the claims of depositors.
What way of meeting their capital needs is the bank taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

118. Why do regulators prefer higher capital requirements?

A. It justifies the existence of regulatory agencies.

B. It protects the deposit insurance fund from serious

losses.
 C. It enhances bank asset quality.

D. It decreases bank profitability.

E. It increases bank leverage.

119. Why do banks generally prefer lower capital requirements?

A. To minimize the impact shareholders have on management

decisions

B. To increase the influence of bank regulators

C. To increase a bank's return on equity

D. To increase depositor protection

E. To maximize operating leverage

120 A bank has issued $5,000,000 in long term debt and since that time interest rates
. have risen so that it will only cost the bank $3,000,000 to buy the long term debt
back. The bank decides to issue $3,000,000 in new stock and use the proceeds to
retire the long term debt. What way of meeting their capital needs is the bank
taking?

A. Issuing common stock

B. Issuing preferred stock

C. Issuing subordinated notes and debentures

D. Selling assets and leasing facilities

E. Swapping stock for debt instruments

121 Which of the following are the reasons for having the government set capital
. standards for financial institutions as opposed to letting the private marketplace set
those standards?

A. To preserve public confidence

B. To remove each bank's unique asset risk exposure

C. To limit losses to the federal government arising from deposit insurance claims
 D. To preserve public confidence and to limit losses to the federal government
arising from deposit insurance claims

E. None of the options is correct.

122. The following are the advantages of Basel II over Basel I except that:

A. it performs supervisory review of each bank's risk-assessment

procedures.

B. it provides for greater sensitivity to arbitrage and financial

innovations.

C. it applies the same minimum capital requirements to all banks.

D. it broadens the types of risk considered.

E. All are advantages of using Basel II.

123 Which of the following is an internal assessment tool that is used by the
. participating banks to ensure that they are prepared for the possibly damaging
impact of ever changing market conditions?

A. Backtesting

B. Risk aggregation

C. Stress testing

D. Systemic testing

E. Damage testing

124. According to the text, Basel II agreement had resulted in less total capital and:

A. less concentration on operating risk.

B. a weaker mix of capital.

C. more retention ratio.

D. less concentration on assets.

E. a weaker leverage ratio.

125 A standby letter of credit, backing the issue of state and local government general
. obligation bonds, is given a credit risk-weight of 20 percent because of its:

A. modest credit risk.

B. zero credit risk.

C. moderate credit risk.

D. low credit risk.

E. highest credit risk.

126 Along with the value at risk model, which is the other model that determines each
. bank's unique market risk exposure and the amount of capital it needs?

A. Internal modeling.

B. Systemic modeling.

C. Credit risk modeling.

D. Borrower credit ratings.

E. Damage testing.

127 ________________________ represent(s) funds set aside for contingencies, such as

. legal action against the institution or a sinking fund to retire stock or debt in the
future.

A. Undivided profits

B. Surplus

C. Preferred stock

D. Common stock

E. Equity reserves

12. Interbank deposits generally carry:

A. low credit risk.

B. high credit risk.

 C. highest credit risk.

D. moderate credit risk.

E. zero credit risk.

129 Under Basel III, more flexible capital standards which includes the "buffer concept"
. means involvement of which two ratios?

A. Base capital and leverage ratio

B. Base capital and buffer ratio

C. Capital and risk-weighted assets ratio

D. Leverage and buffer ratio

E. Risk-weighted assets ratio and buffer ratio