Question

Question 1- Please choose the correct answer inside the bracket and copy it to your answer sheets (12 Marks) a. Given a bank's return on assets, the higher the bank capital, the (higher/lower) the return for the owners of the bank b. Greater flexibility in liability management has allowed banks to (increase/decrease) the proportion of their assets held in loans. C. In the absence of regulation, banks would probably hold too little capital, (increasing/ decreasing) the return on equity. d. If a bank's return on equity remains constant, but the ratio of bank assets to bank capital increases the bank's return on assets must have (increased/decreased). e. Loans are probably the largest/smallest) category of bank assets and earn the (highest/lowest) return of all bank assets. f. A bank failure is more likely to occur when a bank holds (more/less) equity capital g. A bank's off-balance-sheet activities usually increase/decrease) its net income but do not change its assets or liabilities. h. If a bank has more interest-rate sensitive liabilities than interest-rate sensitive assets, an increase in the interest rate will cause profits to (increasel decrease). A bank that cannot meet its loan commitments is experiencing the results of credit/ liquidity) risk. j A bank manager concerned about interest income who expects interest rates to rise and who knows the bank currently has a positive gap should (increase/decrease) rate-sensitive assets and increase/decrease) rate-sensitive liabilities.

Answer 1

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a. Correct Answer: Higher

Explanation: Bank capital is the difference in a bank's assets & its liabilities. Higher bank capital implies higher assets as compared to liabilities which will lead to higher returns for the owners.

b. Correct Answer: Increase

Explanation: Banks would prefer to give out more loans as the loans provide them interest income. These loans are given out from deposits that depositors make with the bank which is the banks' liabilities. Higher flexibility implies higher freedom to banks to give out loans from these deposits.

c. Correct Answer: Increasing

Explanation: Banks would give out more loans, which would increase the interest income thus increasing the return on equity.

d. Correct Answer: Decreased

Explanation: Bank's return on equity = return on the bank's capital. if the ratio of bank capital to bank assets increases, It implies the bank's equity increased. If higher equity does not fetch increased returns & they remain constant, it only implies that the return on assets decreased.

e. Correct Answer: Largest, Highest

Explanation: Bank assets usually comprise of cash, government securities, and interest-earning loans. Out of these, loans comprise the largest portion as they are preferred by banks since they earn the highest interest income as compared to other forms of bank assets.