Commercial Banking FINA 4389'01

1
Commercial Banking(FINA 4389.01)

• Exam 2 Review
• November 13, 2006

2

• You will notice that I decided to leave all the
  previous slides from Exam 1 review (since the
  exam is cumulative). I added the new slides at
  the end.

3
What are the three key functions of bank capital?

• bank capital is a long-term source of funds to
  finance start-up costs and bank expansion.
• it serves as a cushion to absorb unexpected
  operating losses.
• bank capital must be adequate from a regulatory
  standpoint, which is concerned with the safety
  and soundness of the banking system.

4
How does bank regulation differ from bank
supervision?

• Regulation refers to the establishment of rules
  by bank regulators.
• Supervision is concerned with the safety and
  soundness of banks, making sure that the rules
  followed. Supervision also includes compliance
  with existing laws.

5
What are Federal Funds (Fed funds)?

• Short-term, unsecured transfers of immediately
  available funds between depository institutions
  for use in one business day

6
What are the 3 components of bank deregulation?

• Prices (e.g., interest rate paid on deposits)
• Products (e.g., investment banking)
• Geographic location (Interstate banking)

7
What is an interest rate swap? How can it be used
to hedge interest rate risk?

• A swap is an agreement between two parties to
  exchange cash flows. Swaps are used to reduce
  interest rate and currency risk. In an interest
  rate swap, one party usually pays a fixed amount
  (based upon notional principal) and receives a
  floating or variable payment while the other
  party pays floating and receives fixed.

8
Distinguish between the incremental gap and the
cumulative gap.

• The incremental gap measures the difference
  between rate sensitive assets and rate sensitive
  liabilities over increments of the planning
  horizon.
• The cumulative gap measures this difference over
  a more extended period, i.e., it is the sum of
  the incremental gaps.

9
What is meant by a short/long futures contract?
How is each affected by changes in interest rates?

• A short position represents the sale of a futures
  contract / long purchase. Interest rates and
  prices are inversely related, so a short position
  will benefit from an interest rate increase and
  be harmed from an interest rate decrease.

10
What does mark-to-market mean?

• Futures contracts are evaluated daily at their
  market values and gains or losses are added to or
  subtracted from the margin balance each day.

11
As the growth rate of dividends increases, the
market price of bank stock will ..

• increase

12
What usually happens to the price of a buyers
(bidders) stock in a bank merger?

• It declines (overpayment theory)

13
As a rule of thumb, how much is one point
expressed as a percentage ?

• 1

14
The risk associated with not being able to sell a
financial asset quickly without loss of value is
called

• Marketability risk

15
What are derivatives?

• Off balance sheet transactions that result in
  contingent assets or liabilities.

16
Off-balance sheet risk taking involves

• generating fee income by assuming contingent
  liabilities.

17
The second largest use of funds by a commercial
bank is

• investments.

18
Investment securities are held by commercial
banks to produce income in the forms of _______
and ________.

• interest capital gains.

19
Define market share in relation to commercial
banking.

• The proportion of assets, deposits, and loans
  held by a bank in its business region relative to
  other banks.

20
Suppose the bank has a negative dollar gap and
interest rates are expected to rise in the near
future. How could the bank hedge this interest
rate risk using options?

• buying a put option.

21
Why is the US said to have a Dual Banking
System?

• Banks can operate with either a State or a
  National charter.

22
What are the 2 components of return from holding
a stock for a year?

• the dividend yield
• the change in the price of the stock (capital
  gain)

23
Off-balance sheet risk taking involves

• generating fee income by assuming contingent
  liabilities.

24
What is duration?

• Duration refers to the weighted average length of
  time (measured in years) it takes to collect all
  the proceeds from a financial instrument.

25

• The duration of assets is (275 .5 years)
  (645 8 years) / 1,000 5.30 years
• The duration of liabilities is (560 .5
  years) (270 2.5 years) / 830 1.15 years
• The duration gap is 5.30 years (.83 1.15
  years) 4.35 years
• The change in net worth would be -(4.35) (1 /
  1.08) -4.03
• The bank could alter the duration of its assets
  and liabilities. Specifically, it could shorten
  the duration of assets and lengthen the duration
  of liabilities.

26
In loan pricing, how much is one point?

• Approximately 1

27
What is relationship pricing?

• When making a loan, the price (interest rate)
  charged is determined by taking into
  consideration the other business relationships
  that the borrower may have with the bank.

28
In regards to lending, what is the finance charge?

• The finance charge is the difference between the
  amount borrowed and the amount repaid. It
  includes interest, service charges, fess, and
  other items charged to obtain the loan.

29
When borrowing, what is pledging?

• With pledging, the borrower uses receivables as
  collateral, but retains ownership of the
  receivables.

30
Is a credit card money?

• No. (Why not?)

31
If the present 1-year rate is 4 and the expected
1-year rate is 6.25, what is the 2-year rate?

• 5.12

32
Differentiate betweena) the adjusted balance
methodb) Previous balance methodc) Average
daily balance method excluding current
transactions d) Average daily balance method
including current transactions.

• See text, page 302

33
When borrowing, what is factoring?

• With factoring, the borrower uses receivables to
  obtain funding. The accounts receivables are sold
  to a factor, which is a bank or some other type
  of financial institution.

34
What does the Truth in Lending Act require
lenders to do?

• Disclose the APR on all loans.

35
List at least 4 non-traditional types of
mortgages.

• Text, page 292

36
How can a prospective borrower buydown a
mortgage?

• Text, page 290

37
Forget worrying and prepare well.Thats a sure
way to ace the test!!