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Questions and Answers
What is check float?
What is check float?
What does the term 'interchange' refer to in the context of electronic payments?
What does the term 'interchange' refer to in the context of electronic payments?
How do debit cards typically function?
How do debit cards typically function?
What is a potential disadvantage of debit cards for teenagers?
What is a potential disadvantage of debit cards for teenagers?
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Which of the following does not affect the risk-free rate?
Which of the following does not affect the risk-free rate?
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What type of investment is a Certificate of Deposit (CD)?
What type of investment is a Certificate of Deposit (CD)?
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Which scenario is likely to increase the term structure of interest rates?
Which scenario is likely to increase the term structure of interest rates?
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What does the risk premium represent in financial contexts?
What does the risk premium represent in financial contexts?
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What is a characteristic of a certificate of deposit?
What is a characteristic of a certificate of deposit?
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Which option best describes the risk-free rate?
Which option best describes the risk-free rate?
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Why might an individual choose to use a safety deposit box?
Why might an individual choose to use a safety deposit box?
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What factor does NOT typically influence the selection of a financial institution?
What factor does NOT typically influence the selection of a financial institution?
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In the context of economic conditions, which statement about interest rates is correct?
In the context of economic conditions, which statement about interest rates is correct?
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What is a common feature of both cashier’s checks and money orders?
What is a common feature of both cashier’s checks and money orders?
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How do fees associated with using ATMs impact customers?
How do fees associated with using ATMs impact customers?
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Which of the following best illustrates a financial instrument that guarantees payment from the institution?
Which of the following best illustrates a financial instrument that guarantees payment from the institution?
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What does the term structure of interest rates describe?
What does the term structure of interest rates describe?
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If the yield curve shifts upward, what is likely implied about economic conditions?
If the yield curve shifts upward, what is likely implied about economic conditions?
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What additional cost do borrowers typically face when obtaining loans?
What additional cost do borrowers typically face when obtaining loans?
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What does a risk premium in interest rates generally reflect?
What does a risk premium in interest rates generally reflect?
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Which of the following is considered a risk-free rate?
Which of the following is considered a risk-free rate?
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Which of the following statements about certificate of deposits (CDs) is true?
Which of the following statements about certificate of deposits (CDs) is true?
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What is typically illustrated by shifts in the yield curve?
What is typically illustrated by shifts in the yield curve?
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Financial institutions primarily profit from:
Financial institutions primarily profit from:
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Study Notes
Chapter 5: Banking and Interest Rates
- Chapter objectives include describing financial institutions, banking services, selecting financial institutions, identifying interest rate components, and explaining interest rate fluctuations.
Types of Financial Institutions
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Depository institutions accept deposits and provide loans
- Commercial banks accept deposits and use funds for commercial and personal loans
- The UAE central bank guarantees deposit amounts.
- Savings institutions (or thrift institutions) accept deposits and give mortgage and personal loans to individuals.
- Credit unions are non-profit depository institutions for members with a shared affiliation.
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Nondepository institutions do not offer federally insured deposits but provide other financial services.
- Finance companies specialize in personal loans to individuals.
- Securities firms facilitate security purchases/sales through investment banking and brokerage services.
- Insurance companies protect individuals/firms from adverse events.
- Investment companies sell shares to individuals and use proceeds to create mutual funds.
- Financial conglomerates offer diverse financial services to individuals/firms (e.g., Bank of America, Citigroup).
- Exhibit 5.1 illustrates how a financial conglomerate serves individuals through its subsidiaries.
Banking Services Offered by Financial Institutions
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Checking services allow fund access through checks.
- Fees may apply if bills or loan payments are late.
- Banks often issue debit cards and provide online banking, including bill pay and account transfers.
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Monitoring accounts includes recording checks and reconciling statements with registers.
- UAE Penal Code (Article 401) outlines penalties for bounced checks.
- Exhibit 5.2 provides a worksheet example to reconcile a bank statement.
- Check float is the time between writing a check and account reduction. UAE banks now often clear checks same day.
- Electronic checking deters fraud as the payee verifies sufficient funds.
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Credit cards (Visa/Mastercard), debit cards, and interchange fees are discussed.
- Debit cards facilitate easy money transfers but may potentially encourage overspending in some cases.
- Additional services include saftey deposit boxes, ATMs, cashier's checks, money orders, and traveler's checks.
Selecting a Financial Institution
- Criteria used often relate to convenience, online banking, deposit rates, insurance, and fees.
Interest Rates on Deposits and Loans
- Interest rates on deposits and loans directly affect cash inflows and outflows.
- Certificates of deposit have minimum investment, interest rate, and maturity specified. UAE central bank issues CDs to banks.
- Risk-free rates are guaranteed returns even when the bank defaults. These returns are about 2.5% in the UAE.
- Risk premium is an additional return beyond the risk-free rate. This is earned from deposits guaranteed by the government.
- Loan rates are typically higher than deposit rates.
- Loan rates are adjusted based on economic conditions and a borrower's credit, with potentially higher rates for borrowers with poor credit history.
- A "twisted perception" of risk premium suggests that investors may pursue risky investments to compensate for low incomes, even though this is often not financially sound for those with lower incomes.
- Comparing loan rates to maturity time frames and risk tolerances may help inform financial choices.
- Term structure of interest rates describes the relationship between debt security maturity, and associated yields. These are often based on U.S. Treasury-issued securities with differing maturities.
- Shifts in yield curve graphs can be found in publications like The Wall Street Journal.
- Financial institutions obtain funds through deposits and provide loans, enabling profit from this spread in rates. The loan rates generally exceed the offered deposit rates.
- Exhibit 5.3 and 5.4 display annualized deposit rates and interest rate comparisons among various maturities, respectively. Exhibit 5.5 traces trends in one-year CD rates and loan rates through time.
Why Interest Rates Change
- Monetary policy is undertaken by the Central Bank to control the money supply, including demand deposits and public currency. Open market operations include the purchase/sale of Treasury securities to adjust the amount of funds at commercial banks. Changes in the supply of money directly alter interest rates.
- Government demand for funds can affect interest rates via changes in government borrowing; a decrease causes a surplus, leading to lower rates.
- Business demand for funds also affects interest rates.
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Description
This quiz focuses on Chapter 5, covering banking and interest rates. It delves into the types of financial institutions, their functions, and the components of interest rates. Test your understanding of depository and nondepository institutions and how interest rates fluctuate.