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Money and Banking Chapter 10
Terms in this set (57)
A bank's primary sources of funds are
deposits, and primary uses of funds are loans, which are summarized in the bank's balance sheet.
is a statement that shows an individual's or a firm's financial position on a particular day.
The typical layout of a balance sheet is based on the following accounting equation:
Assets= Liabilities + shareholders equities
The key commercial banking activities are
taking in deposits from savers and making loans to households and firms.
something of value that an individual or a firm owns; in particular, a financial claim.
something that an individual or a firm owes, particularly a financial claim on an individual or a firm.
the difference between the value of a bank's assets and the
value of its liabilities; also called shareholders' equity.
(or transaction deposits) are accounts against which depositors can write checks.
-liabilities to banks and assets to households and firms.
checkable deposits on which banks do not pay interest.
NOW (negotiable order of withdrawal) accounts
checking accounts that pay interest.
The most important types of nontransaction deposits are
savings accounts, money market deposit accounts (MMDAs), and time deposits, or certificates of deposit (CDs).
Federal deposit insurance
is a government guarantee of deposit account
balances up to $250,000.
include short-term loans in the federal funds market, loans from a bank's foreign branches or other subsidiaries or affiliates, repurchase agreements, and discount loans from the Federal Reserve System.
The federal funds market involves interbank loans borrowed at the ...
federal funds rate.
Bank assets are acquired by banks with the funds they:
receive from depositors
borrow from other institutions
acquire initially from shareholders
retain as profits from operations
bank assets consisting of vault cash plus bank deposits with the Federal Reserve.
cash on hand in a bank (including currency in ATMs and deposits with other banks).
Required reserves are
reserves the Fed requires banks to hold against demand deposit and NOW account balances
Excess reserves are
reserves banks hold above those necessary to meet reserve requirements.
Excess reserves can provide an important source of ____ to banks, and during the financial crisis, bank holdings of excess reserves soared.
liquid assets that banks trade in financial markets.
-Bank holdings of U.S. Treasury securities are also called secondary reserves due to their liquidity,
In the United States, commercial banks cannot invest checkable deposits in corporate bonds or common stock.
The largest category of bank assets; illiquid relative to marketable securities and have greater default risk and higher information costs.
There are three categories of loans:
loans to businesses: commercial and industrial loans
consumer loans: made to households primarily to buy automobiles and other goods
real estate loans: residential and commercial mortgages
"Other" Bank Assets Include:
banks' physical assets (e.g., computer equipment and buildings).
collateral received from borrowers who have defaulted on loans.
A bank's capital represents the funds contributed by
the bank's shareholders through their purchases of stock the bank has issued plus accumulated retained profits.
is an accounting tool used to show changes in balance sheet items.
Net interest margin
the difference between the interest a bank receives on its securities and loans and the interest it pays on deposits and debt, divided by the total value of its earning assets.
bank's profits are commonly expressed in terms of
its return on assets.
Return on assets (ROA) is
the ratio of the value of a bank's after-tax profit to the value of its assets.
Return on equity (ROE)
is the ratio of the value of a bank's after-tax profit to the value of its capital.
is a measure of how much debt an investor assumes in making an investment.
the ratio of the value of a bank's assets to the value of its capital.
The inverse of bank leverage is
the leverage ratio.
is the possibility that a bank may not be able to meet its cash needs by selling assets or raising funds at a reasonable cost.
Banks reduce liquidity risk through strategies of...
asset management and liquidity management.
Asset management involves
lending funds in the federal funds market, usually for one day at a time.
-Bank can also use reverse repurchase agreements: buying Treasury securities while at the same time agreeing to sell the securities back at a later date, often the next morning.
Liability management involves
determining the best mix of borrowings using repurchase agreements or discount loans.
is the risk that borrowers might default on their loans.
By diversifying, banks can...
reduce the credit risk associated with lending too much to a single borrower.
Credit-risk analysis is
the process that bank loan officers use to screen loan applicants.
Banks often use credit-scoring systems to predict whether a borrower is likely to default.
Historically, the high-quality borrowers paid the prime rate.
Today, most banks charge rates that reflect changing market interest rates instead of the prime rate.
Prime rate was formerly the...
interest rate banks charged on six-month loans to high-quality borrowers (now an interest rate banks charge primarily to smaller borrowers).
assets pledged to the bank in the event that the borrower defaults.
Used to reduce adverse selection.
A compensating balance is a required minimum amount that the business taking out the loan must maintain in a checking account with the lending bank.
is the restriction of credit by lenders such that borrowers cannot obtain the funds they desire at the given interest rate.
Banks keep track of whether borrowers are obeying restrictive covenants—
explicit provisions in the loan agreement that prohibit the borrower from engaging in certain activities.
Interest-rate risk is
the effect of a change in market interest rates on a bank's profit or capital.
A rise (fall) in the market interest rate will lower (increase) the present value of a bank's assets and liabilities.
Gap analysis is
an analysis of the gap between the dollar value of a bank's variable-rate assets and the dollar value of its variable-rate liabilities.
Gap analysis is used to calculate the vulnerability of a bank's profits to changes in market interest rates.
Most banks have negative gaps because their liabilities (deposits) are more likely to have variable rates than are their assets (loans and securities).
Duration analysis is
an analysis of how sensitive a bank's capital is to changes in market interest rates.
If a bank has a positive duration gap, then:
the duration of the bank's assets is greater than the duration of the bank's liabilities.
an increase in market interest rates will reduce the value of the bank's assets more than the value of the bank's liabilities, which will decrease the bank's capital.
National bank is
a federally chartered bank.
Dual banking system is
the system in the United States in which banks are chartered by either a state government or the federal government.
Off-balance-sheet activities are
activities that do not affect a bank's balance sheet because they do not increase either the bank's assets or its liabilities.
Standby letter of credit is
a promise by a bank to lend funds, if necessary, to a seller of commercial paper at the time that the commercial paper matures.
Loan commitment is
an agreement by a bank to provide a borrower with a stated amount of funds during some specified period of time.
a financial contract in which a bank agrees to sell the expected future returns from an underlying bank loan to a third party
Banks earn fees from trading in the multibillion-dollar markets for futures, options, and interest-rate swaps.
Bank losses from trading in securities became a concern during the financial crisis of 2007-2009.
The first important development in electronic banking was the spread of automatic teller machines (ATMs).
By the mid-1990s, virtual banks (banks that carry out all their banking activities online) began to appear.
By the mid-2000s, most traditional banks had also begun providing online services.
Check clearing is now done electronically.
Troubled Asset Relief Program (TARP)
a government program under which the U.S. Treasury purchased stock in hundreds of banks to increase the banks' capital.
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Chapter 9-12: Money and Banking
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