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Chapter 10

The Investment Function in Banking and Financial-Services Management

Fill in the Blank Questions

1. A(n) _________________________ is a security issued by the federal government which has lessthan one year to maturity when it is issued.Answer: Treasury bill

2. Debt instruments issued by cities states and other !olitical entities and which are e"em!t fromfederal ta"es are collectively #nown as _________________________ .Answer: munici!al securities

$. The investment maturity strategy which calls for the ban# to have one half of its investment!ortfolio in very short term assets and one half of its investment !ortfolio in long term assets is#nown as the _________________________ .Answer: barbell strategy

%. A(n) _________________________ is a security where the interest !ortion of the security is soldse!arately from the !rinci!al !ortion of the security.Answer: stri!!ed security

&. _________________________ are the way the federal state and local governments guarantee thesafety of their de!osits with ban#s.Answer: 'ledging reuirements

. The most aggressive investment maturity strategy calls for the ban# to continually shift thematurities of its securities in res!onses to changes in interest rates and is called the__________________.Answer: rate e"!ectation strategy

*. _________________________ is the ris# that the ban# will have to sell !art of its investment!ortfolio before their maturity for a ca!ital loss.Answer: +iuidity ris#

,. _________________________ is the ris# that the economy of the mar#et area they service mayta#e a down turn in the future.Answer: -usiness ris#

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. __________________ is the ris# that the com!any whose bonds the financial institutionowns may retire the entire issue of cor!orate bonds in advance of their maturity leaving the ban# with theris# of earnings losses resulting from reinvesting the cash at lower interest rates.

Answer: /all ris#

10. A security issued by the federal government with 1 to 10 years to maturity when it is issued iscalled a(n) _________________________ .Answer: Treasury note

11. A short term debt security issued by maor cor!orations is #nown as __________________.Answer: commercial !a!er

12. The investment maturity strategy which calls for the ban# to have all of their investment assets invery short term maturities is called the _________________________.Answer: frontendloaded !olicy

1$. A money mar#et security which re!resents a ban#3s commitment to !ay a sti!ulated amount ofmoney on a s!ecific future date under s!ecific conditions and which is often used in internationaltrade is #nown as a(n) _________________________.Answer: ban#ers3 acce!tance

1%. A(n) _________________________ is an interestbearing recei!t for the de!osit of funds in aban# for a sti!ulated time !eriod. 4nes that are oriented towards business customers orinstitutions are #nown as umbos.Answer: certificate of de!osit

1&. _________________________ are any securities which reach maturity in under one year.Answer: 5oney mar#et securities

1. _________________________ are any securities whose original maturity e"ceeds one year.Answer: /a!ital mar#et securities

1*. 6ecurities sold by 7annie 5ae 7reddie 5ac and others are #nown as

_________________________.Answer: federal agency securities

1,. /laims against the e"!ected income and !rinci!al generated by a !ool of similarty!e loans are#nown as _________________________.Answer: securiti8ed assets

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1. The long term debt obligations of maor cor!orations are #nown as________________________.

Answer: cor!orate bonds

20. The investment maturity strategy which calls for the ban# to have all of their investment assets in

very long term maturities is #nown as the _________________________.Answer: bac#endloaded !olicy

21. 7inancial 9nstitutions may invest in munici!al bonds issued by smaller local governments. Thesebonds are #nown as ____________ bonds.Answer: ban# ualified

22. 5ar#etable notes and bonds sold by agencies owned by the government or s!onsored by thegovernment are #nown as .Answer: government agency securities

23. A security issued by the federal government with greater than 10 years to maturity when it isissued is called a(n) .Answer: Treasury -ond

24. are time de!osits of fi"ed maturity issued by the worlds largesban#s headuartered in financial centers around the globe. The heart of this mar#et is centered in+ondon.Answer: ;urocurrency de!osits

25. are a ty!e of munici!al bond that are bac#ed by the full faith andcredit of the issuing government.Answer:

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Answer: 're!ayment ris#

29. A lending institution that sells loweryielding securities at a loss in order to reduce current ta"ableincome while simultaneously !urchasing higheryielding new securities in order to boost futurereturns is doing a(n) .Answer: ta" swa!

30. A(n) is a !icture of how mar#et interest rates differ across loanssecurities of varying times to maturity.Answer: yield curve

True/False Questions

T 7 $1. 9nvestments in securities !rovide diversification for a ban#3s assets because most loanscome from the local areas served by a ban#3s offices.

Answer: True

T 7 $2. -an# income from loans is fully ta"able.Answer: True

T 7 $$. 9nvestment securities are e"!ected to >dress u!> a ban#3s balance sheet according to thete"tboo#.

Answer: True

T 7 $%. 9nvestment securities are e"!ected to hel! stabili8e a financial institutions3s income.Answer: True

T 7 $&. A shortterm 94? offered by maor cor!orations that is of short maturity (most of thesel4?s mature in 0 days or less) is #nown as a /54.

Answer: 7alse

T 7 $. 're!ayment ris# on securiti8ed assets generally increases when interest rates rise.Answer: 7alse

T 7 $*. 6tri!!ing a security eliminates !re!ayment ris#.Answer: 7alse

T 7 $,. According to the te"tboo# the dominant security held in ?.6. ban# investment !ortfoliosis state and local government bonds.

Answer: 7alse

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T 7 $. 9nterest income and ca!ital gains from a ban#3s !ortfolio of investment securities is ta"edin the ?nited 6tates as ordinary income.

Answer: True

T 7 %0. ;urocurrency de!osits that some ban#s !urchase as investments generally carry highermar#et yields than domestic time de!osits issued by com!arablesi8e ?.6. ban#s.

Answer: True

T 7 %1. -an#ers3 acce!tances are considered to be among the safest of all money mar#etinstruments.

Answer: True

T 7 %2. An eligible acce!tance is one that can be used as collateral for borrowing from a 7ederal=eserve ban#.

Answer: True

T 7 %$. @hen a ban# irrevocably guarantees a commercial !a!er issue the ban#3s credit ratingsubstitutes for the borrower3s credit rating.

Answer: True

T 7 %%. The !rinci!al ris# ban#s face from investing in structured notes is credit (default) ris#.Answer: 7alse

T 7 %&. The !rinci!al ris# to a financial institution buying /54s is mar#et ris#.Answer: 7alse

T 7 %. 6tri!!ed mortgagebac#ed securities fully !rotect investors from having to reinvest theirincome at lower and lower interest rates.

Answer: 7alse

T 7 %*. 6tri!!ed mortgagebac#ed securities ma#e maturity matching of ban# assets and

liabilities easier to accom!lish than do most other investment securities that ban#s buy.Answer: 7alse

T 7 %,. +ower interest rates increase the !resent value of all !roected cash flows from a loanbac#ed security so that its mar#et value could rise.

Answer: True


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Answer: 7alseMultiple Choice Questions

60. An im!ortant investment security !o!ular with ban#s that must by law mature within one yearfrom the date of issue and which has a high degree of safety and mar#etability is the:

A) Treasury bill-) Treasury note/) 75A noteD) -an#ers3 acce!tance;) ;urodollar /DAnswer: A

61.A ban#3s !romise to !ay the holder a designated amount of money on a designated future date and isoften used in international trade is #nown as a (or an):

A) 'romissory guarantee-) Discount security/) -an#ers3 acce!tanceD) 9n the money o!tion;) Accretion noteAnswer: /

62. 'ools of mortgages !ut together either by a government agency or by a !rivate investmentban#ing cor!oration to raise more loanable funds for the issuer are #nown as a (or an):A) Accretion bond-) 'artici!ation certificate/) /54D) 6tri!!ed security;) /ommercial !a!erAnswer: /

63. 7luctuations in the timing of cash !ayments flowing from an underlying !ool of securiti8ed assetsis referred to as:A) 9ncome ris#-) 're!ayment ris#/) +iuidity ris#

D) /a!ital ris#;) one of the aboveAnswer: -

64. 'rinci!al roles that a financial institution3s investment !ortfolio !lay include which of thefollowingBA) 9ncome stability-)

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/) Cedging interest rate ris#D) -ac#u! liuidity;) All of the aboveAnswer: ;

65. _____________ is the method by which ban#s can !rovide a safeguard for the de!osits ofgovernmental units.A) Cedging-) /ollaterali8ation/) 'ledgingD) 6ecuriti8ation;) @indow dressingAnswer: /

66. The most aggressive investment maturity strategy that calls for the ban# to continually shift thematurities of its securities in res!onse to changes in interest rates and other economic conditionsis theA) -arbell strategy-) =ate e"!ectations a!!roach/) 7rontendloaded !olicyD) +adder a!!roach;) one of the aboveAnswer: -

67.@hich of the following statements is (are) correct regarding durationBA) 9n com!aring two bonds with the same yield to maturity and the same maturity a bond with a

higher cou!on rate will have a longer duration.-) 9n com!aring two loans with the same maturity and the same interest rate a fully amorti8ed

loan will have a shorter duration than a loan with a balloon !ayment./) The duration will always be shorter than the maturity for all debt instruments.D) All of the above;) - and /Answer: -

68.@hich of the following is not one of the /a!ital 5ar#et instruments in which ban#s investBA) ?.6. Treasury notes-) /or!orate notes and bonds

/) ?.6. Treasury bondsD) 5unici!al bonds;) /ommercial !a!erAnswer: ;

69. @hich of the following is true of Treasury billsB

A) 9nterest on Treasury bills is e"em!t from state income ta"es.

B) 9nterest on Treasury bills is e"em!t from federal income ta"es.

C) Treasury bills !ay a lower !reta" yield than com!arable cor!orate securities.

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D) All of the above are true.

E) A and / onlyAnswer: ;

70. 9n recent years security dealers have assembled !ools of federal agency securities whose !rinci!alinterest yield may be !eriodically reset based on what ha!!ens to a stated interest rate or maycarry multi!le cou!on rates that are !eriodically adusted the foregoing describes a:A) 7inancial futures contract-) =evenueantici!ation note/) Eero cou!on instrumentD) 6tructured note;) one of the aboveAnswer: D

71. -an#s are generally not allowed to invest in s!eculative grade bonds. @hat #ind of ris# is thisdesigned to limitB

A) +iuidity ris#-) -usiness ris#/) /redit ris#D) Ta" e"!osure;) 9nterest rate ris#Answer: /

72.A security where the interest !ayments and the !rinci!al !ayments are sold se!arately is called:

A) A Treasury note-) An accretion/) A structured noteD) A stri!!ed security;) one of the aboveAnswer: D

73.@hich of the following is trueB 5ortgage !re!ayment ris#:A) 9s higher on high interest rate mortgages-) 9s felt most dramatically when interest rates rise/) 9s eliminated by the use of mortgage bac#ed securities

D) 9s eliminated by the !urchase of a stri!!ed mortgage obligation;) All of the above are trueAnswer: A

74. A ban# re!laces &year cor!orate bonds with a yield to maturity of .*& !ercent with &yearmunici!al bonds with a yield to maturity of * !ercent. This ban# is in the $& !ercent ta" brac#etand these bonds have the same default ris#. @hat is the most li#ely reason this ban# changed fromthe cor!orate to the munici!al bondsB


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A) +iuidity ris#-) -usiness ris#/) /redit ris#D) Ta" e"!osure;) 9nterest rate ris#Answer: D

75. 6u!!ose a ban# has found ban# ualified munici!al bonds which have a nominal gross rate ofreturn of , !ercent and that it can borrow funds needed for this !urchase at a rate of .2& !ercent.This bond is in the $& !ercent ta" brac#et. @hat is the net afterta" return on this bondBA) &.20 !ercent-) $.& !ercent/) 1.*& !ercentD) 0 !ercent;) one of the aboveAnswer: -

76. An investor can invest in either a ta"e"em!t security that !ays &F or a ta"able cor!orate securityof com!arable ris# and maturity that !ays ,F. At what marginal ta" rate will the investor beindifferent between these two securitiesB

A) 2&.0F

B) $2.&F

C) $*.&F

D) &*.&F

E) 2.&FAnswer: /

77. @hich of the following would not be considered a ban# ualified munici!al securityB

A) A /olumbia /ounty general obligation bond to moderni8e the county fire de!artment.B) A -uc#s /ounty general obligation bond to build a new sewer !lant.

C) A /ity of 6an 5arcos general obligation bond to !ay for street re!airs.

D) A /ity of /hico!ee general obligation bond to !ay for a new city ail.

E) A Treasury bond to finance government debt.Answer: ;

78. A bond has three years to maturity and has a cou!on rate of 1& !ercent. This bond is selling inthe mar#et for G10*2 and has a yield to maturity of 12F. @hat is the duration of this bondBA) $ years-) 1 year/) 1.2 years

D) 2.%& years;) 2.% yearsAnswer: ;

79. A bond has si" years to maturity and has a cou!on rate of *.& !ercent. /ou!on !ayments aremade annually and this bond has a face value of G1000. This bond is selling in the mar#et forG112*. @hat is the yield to maturity on this bondB

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A) *.& !ercent-) & !ercent/) 11.& !ercentD) 2.& !ercent;) one of the aboveAnswer: -

80. A bond has eight years to maturity and a cou!on rate of .& !ercent. /ou!on !ayments are madeannually and this bond has a face value of G1000. This bond is selling in the mar#et for G,2.@hat is the yield to maturity on this bondBA) .& !ercent-) 10 !ercent/) ,.& !ercentD) !ercent;) one of the aboveAnswer: D

81. A bond has eight years to maturity and a cou!on rate of .& !ercent. /ou!on !ayments are madeannually and this bond has a face value of G1000. This bond is selling in the mar#et for G,2. 9fthis bond is sold at the end of four years for G10% what is the holding !eriod return on thisbondBA) .& !ercent-) 12 !ercent/) !ercentD) !ercent;) one of the aboveAnswer: -

82.A security which was created by the Treasury to !rotect against inflation ris# is called a(n):A) /54-) 75A/)

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84. A ban# that is concerned that the economic conditions of the mar#et area they serve may ta#e adownturn with falling demand for loans and higher ban#ru!tcies in the areas is concerned aboutwhich of the following thingsBA) -usiness ris#-) +iuidity ris#

/) Ta" e"!osureD) /redit ris#;) 9nflation ris#Answer: A

85.@hich of the following is a characteristic of Treasury billsBA) They are cou!on instruments-) They are the short term debt instruments issued by maor cor!orations/) They are discount securitiesD) They have more ris# than other money mar#et securities;) All of the above are characteristics of Treasury billsAnswer: /

86. The investment maturity strategy which calls for the ban# to !ut all of their investment assets intovery long term securities is called the:A) 7rontendloaded maturity !olicy-) -ac#endloaded maturity !olicy/) +adder or s!aced maturity !olicyD) -arbell investment !ortfolio strategy;) =ate e"!ectation a!!roachAnswer: -

87. The Lancaster State Bank is thinking about purchasing a corporate bondthat has a yield of 8.5%. This bank has a marginal tax rate of 25%. hat isthe after!tax yield on this bond"#$ .&&%B$ 8.5%'$ (.&)5%*$ 2.25%+$ ,one of the abo-e#nser/ '

88. The 0erson ,ational Bank is thinking about purchasing a municipal bond thathas a yield of 5.5%. This bank has a marginal tax rate of &1%. hat is theafter!tax yield on this bond"#$ ).8(%B$ 5.5%'$ &.85%*$ .(5%+$ ,one of the abo-e

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93. The 0armer ,ational Bank has purchased a bond that has a coupon rate of.5% and a face -alue of 111. 6t has ( years to maturity and is selling inthe market for &1.81. The bond makes annual coupon payments. The0armer ,ational Bank plans on selling this bond at the end of 8 years for1). hat is the holding period return on this bond"#$ )%

B$ 8%'$ .5%*$ (%+$ ,one of the abo-e#nser/ #

94. The 7ohnson ,ational Bank has purchased a bond that has a coupon rate of5.5% and a face -alue of 111. 6t has 3 years to maturity and is selling inthe market for ). The bond makes annual coupon payments. hat is theyield to maturity on this bond"#$ 5.5%B$ 3.1%'$ .5%*$ 8%+$ ,one of the abo-e

95. The 7ohnson ,ational Bank has purchased a bond that has a coupon rate of5.5% and a face -alue of 111. 6t has 3 years to maturity and is selling inthe market for ). The bond makes annual coupon payments. hat is theduration of this bond"

#$ &.&8 yearsB$ &.(8 years'$ 3.11 years*$ 5.51 years+$ ,one of the abo-e#nser/ B

96. The Sheets Sa-ings and Loan #ssociation has purchased a bond that has acoupon rate of ).5% and a face -alue of 111. 6t has 5 years to maturityand is selling in the market for 1(&. The bond makes annual couponpayments. hat is the duration of this bond"

#$ ).51 yearsB$ 5.11 years'$ 3.(5 years*$ 3.&) years+$ ,one of the abo-e#nser/ *

97. The *illinger State Bank has purchased a bond from the 6nterstate

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anufacturing 'ompany that has 5 years to maturity and has a coupon rateof 2.5%. arket interest rates ha-e recently declined to 8% and the*illinger State Bank is orried that the 6nterstate anufacturing 'ompanyill retire the bond and issue ne ones ith a loer coupon rate. hat typeof risk is the *illinger State Bank orried about"#$ 'redit risk

B$ 6nterest!rate risk'$ Business! risk*$ 'all risk+$ 4repayment risk#nser/ +

98. The Terrell State Bank is a small bank located in 9uyman: ;klahoma. #ll oftheir loans are agriculture and small business loans in 9uyman. They ant tobuy a municipal bond from the state of South 'arolina. hat type of risk arethey likely trying to reduce ith this purchase"#$ 'redit riskB$ 6nterest!rate risk'$ Business risk*$ 'all risk+$ 4repayment risk#nser/ '

99. The 'aldell ,ational Bank has purchased a bond that pays a coupon rate of1.5%. They are a little concerned because they belie-e rates ill decreasein the future and they ill not be able to rein-est the coupon payments at thesame rate. hat type of risk are they concerned about"#$ 'redit riskB$ 6nterest rate risk'$ Business risk*$ 'all risk+$ 4repayment risk#nser/ B

100. oody

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#$ 'redit riskB$ 6nterest rate risk'$ Business risk*$ 'all risk+$ 4repayment risk#nser/ +

102. The 'arey State Bank has purchased a bank!?uali@ed municipal bond ith ayield of (%. This bank has had to borro funds to make this purchase at acost of 5.25%. This bank is in the 31% tax bracket. hat is the net after!taxreturn on this bank!?uali@ed municipal bond"#$ (.11%B$ .)5%'$ 2.85%*$ 2.3&%+$ ,one of the abo-e#nser/ *

103. The esson isconsin State Bank has purchased a bank!?uali@ed municipalbond ith a yield of ).5%. This bank had to borro funds to make thispurchase at a cost of (%. This bank is in the 25% tax bracket. hat is thenet after!tax return on this bank!?uali@ed municipal bond"#$ ).5%B$ 2.)%'$ &.1%*$ .5%+$ ,one of the abo-e#nser/ B

104. The 9oodknight 'ompany has issued securities ith 35 days to maturity.hat type of security ha-e they issued"#$ 'ommercial 4aperB$ Banker

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#nser/ +

Test Bank Chapter 11,

chap 10 mcq

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