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Questions and Answers
What is the primary asset for commercial banks?
What is the primary asset for commercial banks?
Which type of financial intermediary primarily uses deposits to fund mortgages?
Which type of financial intermediary primarily uses deposits to fund mortgages?
What primary liability do life insurance companies rely on?
What primary liability do life insurance companies rely on?
Which of the following is a primary asset for fire and casualty insurance companies?
Which of the following is a primary asset for fire and casualty insurance companies?
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What institution primarily utilizes premiums from policies as its source of funds?
What institution primarily utilizes premiums from policies as its source of funds?
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What is one of the main tools to address the problem of adverse selection?
What is one of the main tools to address the problem of adverse selection?
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Which financial intermediation method relates to moral hazard issues in equity contracts?
Which financial intermediation method relates to moral hazard issues in equity contracts?
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What plays a central role in the banking system's structure, according to the content?
What plays a central role in the banking system's structure, according to the content?
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Which of the following best describes a method to handle moral hazard in debt contracts?
Which of the following best describes a method to handle moral hazard in debt contracts?
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Which element is critical for understanding the regulation of the banking sector?
Which element is critical for understanding the regulation of the banking sector?
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How do banks primarily manage their liquidity?
How do banks primarily manage their liquidity?
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Which factor significantly influenced the role of banks in the money supply process?
Which factor significantly influenced the role of banks in the money supply process?
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What is a common approach to increase information in financial markets?
What is a common approach to increase information in financial markets?
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How can credit risk in an asset portfolio be lowered?
How can credit risk in an asset portfolio be lowered?
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What is a primary objective of credit rationing?
What is a primary objective of credit rationing?
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Which of the following is NOT a strategy to manage credit risk?
Which of the following is NOT a strategy to manage credit risk?
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In gap analysis, what does a negative GAP indicate?
In gap analysis, what does a negative GAP indicate?
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What does establishing loan commitments help with?
What does establishing loan commitments help with?
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What effect does an increase in interest rates have on costs of liabilities in the context provided?
What effect does an increase in interest rates have on costs of liabilities in the context provided?
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Which of the following describes a benefit of specializing in lending?
Which of the following describes a benefit of specializing in lending?
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In the example provided, what is the total amount of rate-sensitive assets?
In the example provided, what is the total amount of rate-sensitive assets?
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What does duration analysis primarily measure?
What does duration analysis primarily measure?
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How does an increase in duration of liabilities impact a bank's capital?
How does an increase in duration of liabilities impact a bank's capital?
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What is the relationship between the maturity of an asset or liability and its market value change due to interest rate changes?
What is the relationship between the maturity of an asset or liability and its market value change due to interest rate changes?
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What is the expected percentage change in the market value of assets if the duration is 4 years and the interest rate changes by -3%?
What is the expected percentage change in the market value of assets if the duration is 4 years and the interest rate changes by -3%?
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Which strategy is NOT recommended for managing interest-rate risk?
Which strategy is NOT recommended for managing interest-rate risk?
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What is the primary goal of liability management in banks?
What is the primary goal of liability management in banks?
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If a bank has assets worth € 100 million and a liability decline of € 9 million, what is the effect on bank capital if the asset value remains unchanged?
If a bank has assets worth € 100 million and a liability decline of € 9 million, what is the effect on bank capital if the asset value remains unchanged?
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Which of the following derivatives is commonly used to manage interest-rate risk?
Which of the following derivatives is commonly used to manage interest-rate risk?
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What happens to the reserves after a deposit outflow of €10 million occurs in a bank with no excess reserves?
What happens to the reserves after a deposit outflow of €10 million occurs in a bank with no excess reserves?
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Which option is NOT a basic action the bank can take to address a reserve shortfall?
Which option is NOT a basic action the bank can take to address a reserve shortfall?
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What is the primary risk of maintaining insufficient reserves in a bank?
What is the primary risk of maintaining insufficient reserves in a bank?
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How does maintaining a healthy level of liquidity reduce the risk of bank runs?
How does maintaining a healthy level of liquidity reduce the risk of bank runs?
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Which of the following describes a challenge in asset management for banks?
Which of the following describes a challenge in asset management for banks?
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What impact do large excess reserves have on a bank's lending capability?
What impact do large excess reserves have on a bank's lending capability?
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How does selling securities help a bank restore its liquidity?
How does selling securities help a bank restore its liquidity?
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What is a potential drawback of holding large excess reserves?
What is a potential drawback of holding large excess reserves?
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Study Notes
Primary Assets and Liabilities of Financial Intermediaries
- Financial intermediaries play a central role in the US financial system by bridging savers and borrowers.
- Depository institutions, like banks, rely primarily on deposits as liabilities to fund assets such as loans and securities.
- Commercial banks provide business and consumer loans and hold government and municipal bonds as their primary assets.
- Savings and loan associations and mutual savings banks predominantly issue mortgages as their key assets.
- Credit unions focus on consumer loans as their major asset while relying heavily on member deposits.
- Life insurance companies obtain funding from policy premiums, investing primarily in corporate bonds and mortgages.
- Fire and casualty insurance companies also collect premiums and invest in municipal bonds, corporate bonds, and stocks.
Asymmetric Information Problems
- Adverse selection arises when private information affects the market, mitigated through information production and government regulation.
- Financial intermediation helps reduce adverse selection by helping allocate and manage risks between parties.
- Moral hazard, particularly in equity contracts, can escalate through inadequate monitoring; government regulation aims to enhance information accuracy.
- For debt contracts, monitoring, collateral, and net worth are crucial in managing risks associated with moral hazard.
Banking Structure and Regulation
- Understanding the balance sheets of banks and their asset and liability management is vital to comprehend their liquidity management.
- Regulation of the banking sector is critical to prevent crises, as seen in the Global Financial Crisis of 2007-2008.
Liquidity Management
- Banks may face liquidity shortages following significant deposit outflows, highlighting the need for effective liquidity strategies.
- Four key liquidity management options include borrowing from other banks, selling securities, borrowing from the central bank, and calling in or selling loans.
Asset Management Challenges
- Banks must identify borrowers who offer high interest with low risk, purchase high-return securities, mitigate credit risk, and satisfy liquidity needs.
- Diversification is essential in asset management to balance risk and returns.
Managing Credit Risk
- Techniques for managing credit risk include rigorous screening, monitoring contracts, developing relationships with borrowers, and offering loan commitments.
- Credit rationing is employed to encourage prudent use of funds, requiring borrowers to contribute a portion of private funds.
Interest-Rate Risk Management
- Interest-rate risk involves the sensitivity of bank profits to changes in interest rates, assessed through gap analysis and duration analysis.
- Gap analysis evaluates the impact of interest rate changes on profits by comparing rate-sensitive assets and liabilities.
- Duration analysis measures how the value of assets and liabilities shifts with interest rate fluctuations, affecting bank capital.
Interest-Rate Risk Strategies
- Banks mitigate interest-rate risks by aligning the maturities and sensitivities of their assets and liabilities.
- Financial derivatives, such as interest-rate swaps and futures, can be employed to alleviate potential risks.
Liability Management
- Modern banks increasingly utilize various funding sources, such as interbank borrowing and certificates of deposit, in addition to traditional deposits.
- The primary goal of liability management is to minimize funding costs, necessitating a coordinated approach to asset and liability management (ALM).
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Description
This quiz covers the primary assets and liabilities of financial intermediaries in the United States, specifically focusing on depository institutions and commercial banks. Understand the sources of funds such as deposits and the uses including various types of loans and securities. Test your knowledge on the fundamental roles these institutions play in the economy.
