Question

3a.

A bank is a financial institution whose principal business consists of which of the following?

Accepting deposits and making loans

Buying and selling securities

Trading stock

Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities Accepting deposits and selling securities

b.

What does vault cash earn for commercial banks?

No interest at all

A comparatively high rate of interest

An interest rate equal to the market interest rate as determined by the federal funds rate

A comparatively low rate of interest

c.

Because of ___________ risk, banks may become insolvent if market interest rates ___________

market; increase

liquidity; increase

liquidity; decrease

market; decrease

d.

There is an unexpected increase in market interest rates. We would expect the value of securities held by banks to ___________ and net worth to

decrease; decrease

increase; increase

increase; decrease

decrease; increase

e.

If an asset can serve directly as a means of payment and is convertible to cash without loss of nominal value it is said to be perfectly __________.

liquid

illiquid

solvent

insolvent

Answer 1

3

a.

A bank's principal business consists of mainly accepting deposits and making loans. Through this function, banks earn profit.

So, the correct option is accepting deposits and making loans.

b.

The amount of cash left in the bank's vault earns no profit for the bank unless it is lent to the general public. This cash is known as bank's reserves and earns no interest at all.

So, first option is the correct option.

c.

Becuase of Liquidity Risk, banks may become insolvent if market interest rates increase. Liquidity risk arises when banks cannot raise enough cash to avoid the risk. The increase in the interest rate causes a fall in the bond prices and their value and leads to revenue loss to the bank.

So, option second; liquidity, the increase is correct.

d.

There exists inverse relation between market interest rates and the bonds or securities prices and values.

An unexpected increase in the market interest rates causes expected value of the securities to fall. This would decrease the asset value held by the banks and thereby reduce the net worth.

Hence, option first is correct. Decrease; Decrease

e.

Such assets are called liquid assets if they are directly converted into cash. They are perfectly liquid if they can be converted with no nominal loss.

So, first option is correct. Liquid.