Chapter 10 Test Bank

True/False

1) In the past, excessive competition led to a low rate of innovation within the
banking industry.
(F, easy, section 1)

2) The 6 in the 3-6-3 rule refers to the interest rate on assets.

(T, easy, section 1)

3) Unit banks and national banks comprise all the banks in the United States.
(F, easy, section 1)

4) Unit banks are banks that operate in only one state.

(F, easy, section 1)

5) Unit banks have no branches.

(T, easy, section 1)

6) Unit banks often had local monopolies, meaning they had little incentive to
innovate.
(T, easy, section 1)

7) Banks operating in more than one state used to be illegal.

(T, easy, section 1)

8) Banks chartered by the Federal government are called national banks.

(T, easy, section 1)

9) One of the 3s in the 3-6-3 rule refers to the interest rate on assets.
(F, easy, section 1)

10) The Great Inflation led to a decline in the size of the traditional commercial
bank industry.
(T, easy, section 2)

11) The increase in nominal interest rates during the 1970s led to an increase in the
size of the traditional banking industry.
(F, easy, section 2)

12) Regulation Q (the restriction on interest paid on deposits) was responsible for
the rise in nominal interest rates in the 1970s.
(F, easy, section 2)

13) Loophole mining is a way for banks to get around regulations.

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(T, easy, section 2)

14) SWEEP accounts allow banks to make interest on reserves.

(T, easy, section 3)

15) SWEEP accounts allow deposit rate to adjust with market rates.
(F, easy, section 3)

16) SWEEP accounts are an example of loophole mining.

(T, easy, section 3)

17) Adjustable rate mortgages are a financial innovation appearing in the 1990s.
(F, easy, section 3)

18) Junk bonds are a financial innovation that took business away from traditional
banks.
(T, easy, section 1)

19) The introduction of mutual funds has made reserve requirements largely
ineffective.
(F, easy, section 3)

20) Regulation Q (the restriction on interest paid on deposits) and rising nominal
interest rates during the Great Inflation were responsible for an increase the size of
the mutual fund industry.
(T, medium, section 3)

21) Interest payments from commercial loans are an increasingly important source
of bank profits.
(F, easy, section 2)

22) The Great Inflation eventually led to an increase in bank profits.

(F, easy, section 2)

23) The Herfindahl index is a measure of banking innovation.

(F, easy, section 5)

24) According to the Herfindahl index, the United States has one of the most
concentrated banking industries in the world.
(F, easy, section 5)

25) According to the Herfindahl index, the U.S. banking industry has become
increasingly concentrated in the last few decades.
(T, easy, section 5)

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26) According to the Herfindahl index, the U.S. banking industry is more
concentrated than Canada’s banking industry.
(F, easy, section 5)

27) Commercial banks are the only institutions in the United States that take
transactions deposits.
(F, easy, section 5)

28) The process of bundling loans and selling pieces of the group is known as
securitization.
(T, easy, section 3)

29) Junk bonds are an example of a securitized asset.

(F, easy, section 4)

30) Mortgage backed assets are an example of a securitized asset.

(T, easy, section 4)

31) ARMs allow lenders to pass the default risk on to the borrower.
(F, medium, section 2)

32) Government regulation is relatively permissive in the United States compared to

other countries.
(T, easy, section 3)

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Multiple Choice

1) Unit banks
a) have no branches.
b) have a local monopoly.
c) had little incentive to innovate.
d) all of the above.
(d, easy, section 1)

2) Unit banks
a) have no branches.
b) are highly competitive.
c) are an increasingly common type of financial institution.
d) all of the above.
(a, easy, section 1)

3) Which of the following is an example of disintermediation?

a) money market mutual funds
b) insurance companies
c) interest-only mortgages
d) all of the above
(a, easy, section 3)

4) Which of the following is an example of disintermediation?

a) stock market brokers
b) insurance companies
c) adjustable rate mortgages
d) none of the above
(d, easy, section 3)

5) The Great Inflation affected the banking industry through the following channels.
a) higher nominal interest rates
b) decline in deposits
c) increase in disintermediated borrowing
d) all of the above
(d, easy, section 2)

6) The Great Inflation affected the banking industry through the following channels.
a) lower nominal interest rates
b) decline in deposits
c) decreased competition among banks
d) all of the above
(b, easy, section 2)

7) ARMs
a) force borrowers to assume interest rate risk.

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 b) became more prevalent during the Great Inflation.
c) both of the above.
d) neither of the above.
(c, easy, section 2)

8) ARMs
a) force lenders to assume interest rate risk.
b) became more prevalent during the Great Inflation.
c) both of the above.
d) neither of the above.
(b, medium, section 2)

9) With an ARM, who must take on the interest rate risk?

a) borrower
b) lender
c) both
d) neither
(a, medium, section 2)

10) Bank holding companies allows bankers to circumvent

a) Regulation Q.
b) interstate banking restrictions.
c) reserve requirements.
d) none of the above.
(b, medium, section 3)

11) Technology has helped to make possible which of the following innovations?
a) ATMs
b) credit cards
c) mortgage backed securities
d) all of the above
(d, easy, section 4)

12) Securitization has allowed some banks to concentrate on

a) origination of loans.
b) credit risk.
c) specialized lending.
d) all of the above.
(a, medium, section 4)

13) Which of the following do NOT generate fees for banks?

a) credit cards
b) securitized loans
c) reserves
d) They all generate fees.
(c, easy, section)

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14) Which of the following do NOT generate fees for banks?
a) credit cards
b) securitized loans
c) ATMs
d) They all generate fees.
(d, easy, section)

15) Bank consolidation is potentially a problem because

a) larger banks are harder to regulate.
b) banks are less diversified.
c) banks are less able to innovate.
d) all of the above.
(a, easy, section 5)

16) Bank consolidation is potentially a problem because

a) larger banks are harder to regulate.
b) a failure of a large bank has a big effect on the economy.
c) both of the above.
d) neither of the above.
(c, easy, section 5)

17) Bank consolidation is potentially a problem because

a) it is harder for large banks to implement technological innovations.
b) some consumers may get worse service.
c) banks are less able to innovate.
d) all of the above.
(b, easy, section 5)

18) Bank consolidation is potentially a problem because

a) larger banks tend to be more diversified.
b) larger banks tend to take greater risks.
c) both of the above.
d) neither of the above.
(b, easy, section 5)

19) Bank consolidation is desirable because

a) small banks with little capital are eliminated.
b) banks are more diversified.
c) both of the above.
d) neither of the above.
(c, medium, section 5)

20) Bank consolidation is desirable because

a) banks are able to do specialized lending.
b) banks are more diversified.

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 c) banks are more able to serve small business.
d) all of the above.
(b, medium, section 5)

21) Which of the following is a measure of bank consolidation?

a) Regulation Q
b) Gini coefficient
c) Herfindahl index
d) Quadrini index
(c, easy, section 5)

22) According to the Herfindahl index, the U.S banking industry is _____
concentrated than that of most developed economies.
a) more
b) less
c) equally
d) The Herfindal index is not a measure of concentration.
(b, easy, section 5)

23) The biggest reason for the consolidation of the banking industry in the 1980s
was
a) mergers.
b) bankruptcy.
c) bailouts.
d) all of the above.
(b, easy, section 5)

24) The erosion of Glass-Steagall allowed financial institutions to take advantage of

a) economies of scale.
b) economies of scope.
c) interstate banking.
d) all of the above.
(b, medium, section 5)

25) Regulators do not consider a financial institution to be a bank if it does not

a) take deposits.
b) borrow from the Fed.
c) both of the above.
d) neither of the above.
(a, medium, section 3)

26) Regulators do not consider a financial institution to be a bank if it does not

a) hold bonds.
b) make loans.
c) both of the above.
d) neither of the above.
(b, medium, section 3)
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27) Which of the following changes or innovations does NOT depend on computer
technology?
a) banker’s acceptances
b) ATMs
c) SWEEP accounts
d) They all depend on computer technology.
(a, easy, section 4)

28) Which of the following changes or innovations do NOT depend on computer

technology?
a) SWAPs
b) ATMs
c) SWEEP accounts
d) They all depend on computer technology.
(d, easy, section 4)

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Short Answer

1) What is a unit bank?

A unit bank is a bank without branches.

(easy, section 1)

2) What is a national bank?

A national bank is chartered by the Federal government.

(easy, section 1)

3) Why is commercial paper an example of disintermediation?

Commercial paper are loans between businesses that don’t involve a bank or
financial institution.

(easy, section 2)

4) What regulation do SWEEP accounts circumvent? How do banks benefit?

SWEEP accounts get around the reserve requirement by reducing the

amount of transactions deposits. Banks can now convert those reserves to interest
bearing assets.

(medium, section 3)

5) What type of regulation did holding companies circumvent?

Holding companies got around the ban on interstate banking.

(medium, section 3)

6) Why does the lack of a prepayment clause matter to the interest rate risk involved
in taking a fixed rate mortgage?

Without the clause, if interest rates fall, the homeowner can refinance the
loan at the lower rate, so there is less interest rate risk.

(medium, section 2)

7) How did a lack of competition among banks give rise to mutual funds?

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 The lack of competition meant that banks paid low interest rates on deposits,
so consumers had incentive to seek out institutions such as mutual funds that paid
higher returns.

(medium, section 1)

8) Explain how a lack of competition gave rise to the commercial paper market.

The lack of competition among banks meant they could charge high interest
rates for business loans, which gave firms incentive to lend to each other at lower
rates.

(medium, section 1)

9) What is the advantage of online banking for banks?

Online banking has lower costs.

(easy, section 3)

10) The Erosion of Glass-Steagall has allowed financial institutions to take

advantage of economies of scale or scope. Explain.

Financial institutions can now engage in multiple areas such as insurance

and brokering while taking deposits like a traditional bank, primarily taking
advantage of economies of scope.

(difficult, section 5)

11) Why would larger banks be less risky?

Large banks can have more diversified assets (and liabilities).

(easy, section 5)

12) Why would larger banks be a problem for regulators?

Larger banks might be considered too big to fail, so they have incentive to
take excessive risks.

(medium, section 5)

13) A small bank in a rural community proposes to merge with a large national
bank. Give one reason customers of the small bank might object to the proposal.
Give a reason they might be in favor.

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 Customers might object to the merger since the bank might lose its expertise
in dealing with local industries and be more susceptible to macroeconomic risks.
They might be in favor because of access to a broader range of services and services
nationwide as well as greater security against failure with a larger diversified bank.

(medium, section 5)

14) Why have some argued that securitization has increased risk across the whole
economy, increasing the severity of the recession in 2009?

Loans are no longer held by a single bank. Now many financial institutions
have exposure to many more loans, so defaults have a broader impact.

(difficult, section 5)

15) Explain how the combination of Regulation Q and the high inflation of the
1970s led to an increase in the use of mutual funds and junk bonds.

High inflation pushed up nominal rates and Regulation Q prevented paying

higher rates on deposits. Hence, depositors turned to mutual funds to get market
interest rates. The lack of funds available in traditional banks led firms to raise
funds through their own bond issues.

(medium, section 2)

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