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Chapter 05 The Financial Statements of Banks and Their Principal Competitors Multiple Choice Questions

50.

Each of the following falls into the category of bank assets except:

A. loans. B. investment securities. C. demand deposits. D. cash and due from banks. E. other assets.

51.

Banks generate their largest portion of income from:

A. loans. B. short-term investments. C. demand deposits. D. trading account gains & fees. E. certificates of deposits.

52.

Each of the following typically falls into the category of loans except:

A. real estate. B. consumer. C. commercial and industrial (business). D. agricultural. E. municipal.

53.

Which of the following adjustments are made to gross loans and leases to obtain net loans and leases?

A. Loan and lease loss allowance is added to gross loans. B. Unearned income is subtracted from gross interest received. C. Investment income is added to gross interest received. D. Loan and lease loss allowance and unearned income is subtracted from gross loans. E. Loan and lease loss allowance is subtracted from gross loans and investment income is added to gross interest received.

54.

An example of a contra-asset account is:

A. loan and lease loss allowance. B. trading account assets. C. buildings and equipment. D. revenue bonds. E. provision for loan loss.

55.

The noncash expense item on a bank's Report of Income designed to shelter a bank's current earnings from taxes and to help prepare for bad loans is called:

A. short-term debt interest. B. noninterest expense. C. provision for taxes. D. provision for possible loan losses. E. None of the options are correct.

56.

A financial institution's bad-debt reserve, as reported on its balance sheet, is called:

A. unearned income or discount. B. allowance for possible loan losses. C. intangible assets. D. customer liability on acceptances. E. None of the options are correct.

57.

When a bank serves as a security dealer for certain kinds of securities (mainly federal, state, and local government obligations) the value of these securities is usually recorded in what account on a bank's Report of Condition?

A. Investment securities B. Taxable and tax-exempt assets C. Trading account assets D. Secondary reserves E. None of the options are correct.

58.

___________ is calculated by deducting noninterest expense and provision for loan losses from noninterest income.

A. Net profit margin B. Net interest income C. Net income after provision for possible loan losses D. Income or loss before income taxes E. Net noninterest income

59.

The account that is built up by annual noncash expense deductions and is subtracted from Gross Loans on the Report of Condition is:

A. unearned income. B. nonperforming loans. C. allocated loan risk deductions. D. allowance for possible loan losses. E. None of the options are correct.

60.

Nonperforming loans are credits on which any scheduled loan repayments and interest payments are past due for more than:

A. 30 days. B. 60 days. C. 90 days. D. 180 days. E. None of the options are correct.

61.

One-time-only transactions that often involve sale of financial assets or real property pledged as collateral behind a loan and upon which the bank has foreclosed, affect a bank's account known as:

A. allowance for loan losses. B. nonrecurring sales of assets. C. asset gains or losses. D. provision for loan and security losses. E. None of the options are correct.

62.

The use of fixed assets, rather than financial assets, in order to increase the operating earnings is known as:

A. plant and equipment investment. B. financial leverage. C. operating leverage. D. nondeposit capital. E. None of the options are correct.

63.

Banks depend heavily upon borrowed funds supplied by customers with little owners' capital invested. This means that banks make heavy use of:

A. financial leverage. B. capital restructuring. C. operating leverage. D. margin borrowing. E. None of the options are correct.

64.

When a loan is considered uncollectible, the bank's accounting department will write (charge) it off the books by reducing the ______ and the ______ accounts. Which choice below correctly fills in the blanks in the preceding sentence?

A. PLL, gross loans B. ALL, net loans C. ALL, gross loans D. PLL, net loans E. None of the options are correct.

65.

The common banking practice of selling those investment securities that have appreciated in order to reap a capital gain and holding onto those securities whose prices have declined is known as:

A. gains trading. B. performance banking. C. loss control trading. D. selective portfolio management. E. None of the options are correct.

66.

Noninterest revenue sources for a bank are called:

A. commitment fees on loans. B. fee income. C. supplemental income. D. noninterest margin. E. None of the options are correct.

67.

Large U.S. banks must use which of the methods listed below to determine their provision for loan loss expense?

A. Experience method B. Reserve method C. Specific charge-off method D. Historical cost method E. None of the options are correct.

68.

A bank's temporary lending of excess reserves to other banks is labeled on the balance sheet as:

A. fed funds purchased. B. fed funds sold. C. money market deposits. D. securities purchased for resale. E. None of the options are correct.

69.

A bank sells shares of its common stock with a par value of $100 for $200 in the market. Which two accounts on the bank's balance sheet are going to be affected?

A. Retained earnings and surplus accounts B. Subordinated notes and debentures and commons stock outstanding accounts C. Retained earnings and common stock outstanding accounts D. Common stock outstanding and surplus accounts E. Only the common stock outstanding account

70.

Which of the following accounts is also called the bank's primary reserves?

A. Cash and deposits due from banks B. Investment securities C. Trading account securities D. Fed funds sold E. None of the options are correct.

71.

Which of the following assets is the largest asset item on the bank's balance sheet?

A. Securities B. Cash C. Loans and leases D. Bank premises E. None of the options are correct.

72.

What financial-service industry category is second to the banking industry in total financial assets held?

A. Mutual funds B. Thrifts C. Investment banks D. Insurance companies E. Pension funds

73.

Which of the following most accurately describes the principal type(s) of bank noninterest income?

A. Fees from fiduciary transactions B. Fees from deposit transactions C. Fees from securities transactions D. Fees from additional noninterest income E. All of the options are correct.

74.

Fee income arising from fiduciary transactions include all of the following except:

A. fees for checking account maintenance. B. fees for managing and protecting a customer's property. C. fees for recordkeeping for corporate security. D. fees for dispersing interest and dividend payments for a corporation. E. fees for managing corporate and individual retirement plans.

75.

You know the following information about the Miller State Bank:

Given this information, what is the value of this firm's net loans?

A. $250 B. $350 C. $500 D. $50 E. $150

76.

You know the following information about the Miller State Bank:

Given this information, what is the value of this firm's depreciation?

A. $250 B. $30 C. $70 D. $40 E. $110 77.

You know the following information about the Miller State Bank:

Given this information, what is the value of this firm's total liabilities?

A. $390 B. $60 C. $450 D. $500 E. $50

78.

You know the following information about the Miller State Bank:

Given this information, what the value of this firm's undivided profits?

A. $50 B. $5 C. $10 D. $40 E. $450

79.

You know the following information about the Miller State Bank:

Given this information, what is the value of this firm's total liabilities plus equity?

A. $250 B. $450 C. $150 D. $50 E. $500

80.

You know the following information about the Davis National Bank:

Given this information, what is the value of this firm's net interest income? A. $300 B. $150 C. ($50) D. $120 E. $80 81.

You know the following information about the Davis National Bank:

Given this information, what is the value of this firm's net noninterest income? A. $300 B. $150 C. ($150) D. $120 E. $80

82.

You know the following information about the Davis National Bank:

Given this information, what is the value of this firm's net income?

A. $300 B. $150 C. ($50) D. $120 E. $80 83.

You know the following information about the Davis National Bank:

Given this information, what is the value of this firm's increase in undivided profits?

A. $300 B. $150 C. ($50) D. $120 E. $80

CONCEPT QUESTIONS

5-1.

What are the principal accounts that appear on a bank's balance sheet (Report of Condition)?

The principal asset items on a bank's Report of Condition are loans, investments in marketable securities, cash, and miscellaneous assets. The principal liability items are deposits and nondeposit borrowings in the money and capital market. Equity capital supplied by the stockholders rounds out the accumulated sources of funds for a bank. 5-2. Which accounts are most important and which are least important on the asset side of a bank's balance sheet? The principal bank asset items from most important to least important are: Rank Order

Assets

1

Cash and Due from Depository Institutions

2

Investment Securities: a. The Liquid Portion b. The Income-Generating Portion

5-3.

3

Trading Account Assets

4

Federal Funds Sold and Reverse Repurchase Agreements

5

Loans and Leases

6

Unearned Income

7

Nonperforming (Noncurrent) Loans

8

Bank Premises and Fixed Assets

9

Other Real Estate Owned (OREO)

10

Intangible and Miscellaneous Assets

What accounts are most important on the liability side of a balance sheet?

The principal bank liability items from most important to least important are: Rank Order 1

Liabilities and Equity Capital Deposits

2

Nondeposit Borrowings

3

Equity Capital

4

Miscellaneous Liabilities

5-4. What are the essential differences among demand deposits, savings deposits, and time deposits? Demand deposits are regular checking accounts against which a customer can write unlimited checks or make any number of personal withdrawals. Regular checking accounts do not bear interest under current U.S. law and regulation. Savings deposits bear interest (normally, they carry the lowest rate paid on bank deposits) but may be withdrawn at will (though most depository institutions impose a minimum size requirement). Time deposits carry a fixed maturity and the bank may impose a penalty if the customer withdraws funds before the maturity date is reached. The interest rate posted on time deposits is negotiated between the bank and its deposit customer and may be either fixed or floating. A NOW account combines features of a savings account and a checking account, while a money market deposit account (MMDA) encompasses transactional powers similar to a regular checking account (though usually with limitations on the number of checks or drafts that may be written against the account) but also resembles a time deposit with an interest rate fixed for a brief period (such as weekly) but then becomes changeable over longer periods to reflect current market conditions. 5-5.

What are primary reserves and secondary reserves, and what are they supposed to do?

Primary reserves consist of cash, including a bank's vault cash and checkable deposits held with other banks or any other funds such as reserves with the Federal Reserve banks that are accessible immediately to meet demands for liquidity made against the bank. Secondary reserves consist of assets that pay some interest (though usually pay returns that are much lower than earned on other assets, such as loans) but their principal feature is ready marketability. Most secondary reserves are marketable securities such as short term government securities and private securities such as commercial paper. Both primary and secondary reserves are held to keep the bank in readiness to meet demands for cash (liquidity) from whatever source those demands may arise. 5-6. Suppose that a bank holds cash in its vault of $1.4 million, short-term government securities of $12.4 million, privately issued money market instruments of $5.2 million, deposits at the Federal Reserve banks of $20.1 million, cash items in the process of collection of $0.6 million, and deposits placed with other banks of $16.4 million. How much in primary reserves does this bank hold? In secondary reserves?

The bank holds primary reserves of: Vault Cash + Deposits at the Fed + Cash Items in Collection + Deposits With Other Banks = $1.4 mill. + $20.1 mill. + $0.6 mill. + $16.4 mill. = $38.5 million The bank has secondary reserves of: Short-term Government Securities + Private Money Market Instruments = $12.4 mill. + $5.2 mill. = $17.6 million 5-7.

What are off-balance-sheet items and why are they important to some financial firms?

Off-balance-sheet items are usually transactions that generate fee income for a bank (such as standby credit guarantees) or help hedge against risk, (such as financial futures contracts) but do not show up on the balance sheet. They are important as a supplement to income from loans and to help a bank reduce its exposure to interest-rate and other types of risk. 5-9.

What accounts make up the Report of Income (income statement of a bank)?

The Report of Income includes all sources of bank revenue (loan income, investment security income, revenue from deposit service fees, trust fees, and miscellaneous service income) and all bank expenses (including interest on all borrowed funds, salaries, wages, and employee benefits, overhead costs, loan loss expense, taxes, and miscellaneous operating costs.) The difference between operating revenues and expenses (including tax obligations) is referred to as net income. 5-10. In rank order, what are the most important revenue and expense items on a Report of Income? By dollar volume in most recent years the rank order of the revenue and expense items on a bank's Report of Income is: Rank Order

Revenue Items

Expense Items

1

Loan income

Provision for loan and lease losses

2

Security Income

3

Service charges on deposits and other deposit fees Other operating revenues

4

Deposit interest Salaries and employee benefits, premises and equipment expense, and additional noninterest expense

5-11.

For each of the following transactions, which items on a bank’s statement of income and expenses (Report of Income) would be affected?

a.

b.

The bank sets aside funds to be contributed through its monthly payroll to the employee pension plan in the name of all its eligible employees. This would be part of Salaries and Benefits and part of Total noninterest expenses.

c.

The bank posts the amount of interest earned on the savings account of one of its customers. This would be part of Total interest expenses.

d.

Management expects that among a series of real estate loans recently granted the default rate will probably be close to 3 percent. This would be part of Provision for loans and losses to go into reserves for future bad debts.

e.

Mr. and Mrs. Harold Jones just purchased a safety deposit box to hold their stock certificates and wills. This would be part of Additional noninterest income and part of Total noninterest income.

f.

The bank collects $1 million in interest payments from loans it made earlier this year to Intel Composition Corp. This would be part of Total interest income.

g.

Hal Jones’s checking account is charged $30 for two of Hal’s checks that were returned for insufficient funds. This would be part of Service charges on Deposit accounts and then part of Total noninterest income.

h.

The bank earns $5 million in interest on the government securities it has held since the middle of last year. This would be part of Total interest income.

i.

The bank has to pay its $5,000 monthly utility bill today to the local electric company.

This would be part of Premises and equipment expenses and part of Total noninterest expenses. j.

A sale of government securities has just netted the bank a $290,000 capital gain (net of taxes). This would be part of Security gains (losses).

5-12. Which of these account items or entries would normally occur on a bank’s balance sheet (Report of Condition) and which on a bank’s income and expense statement (Report of Income)? Federal funds sold

Deposits due to banks

Addition to undivided profits

Leases of business equipment to customers

Credit card loans

Interest received on credit card loans

Utility expense

Fed funds purchased

Vault cash

Savings deposits

Allowance for loan losses

Provision for loan losses

Depreciation on premises and equipment

Service charges on deposits

Commercial and industrial loans

Undivided profits

Repayments of credit card loans

Mortgage owed on the bank’s buildings

Common stock

Other real estate owned

Interest paid on money market deposits Securities gains or losses

The items which would normally appear on a bank's balance sheet are: Federal funds sold

Deposits due to bank

Credit card loans

Leases of business equipment to customers

Vault cash

Savings deposit

Allowance for loan losses

Undivided profits

Commercial and Industrial Loans

Mortgage owed on the bank’s buildings

Repayments of credit card loans

Other real estate owned

Common stock

Additions to undivided profits

Federal funds purchased

The items which would normally appear on a bank’s income statement are: Interest received on credit card loans

Provision for loan losses

Depreciation on premises and equipment
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