Chapter 15

The Management of Capital

True/False Questions

T F 26. In the field of banking, capital refers principally to those funds contributed by a bank's
owners.
Answer: True

T F 30. Tier 2 includes undivided profits.

Answer: False

T F 31. Core capital includes the surplus account for stock.

Answer: True

T F 33. Off-balance-sheet commitments of banks carry capital requirements under the

international (Basel) capital requirements.
Answer: True

Multiple Choice Questions

61. Possible breakdowns in quality control, inefficiencies in producing and delivering financial
services, weather damage, aging or faulty computer systems and simple errors in judgment by
bank management illustrate what form of risk faced by banks?
A) Credit risk
B) Liquidity risk
C) Interest-rate risk
D) Operational risk
E) None of the above
Answer: D

62. The ratio of core capital to average assets is called the:

A) Supplemental Capital ratio
B) Leverage ratio
C) Long-term capital ratio
D) GAAP capital ratio
E) None of the above.
Answer: B

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 63. In Egypt well capitalized' bank must have a ratio of capital to risk-weighted assets of at least:
A) 6 percent
B) 8 percent
C) 10 percent.
D) 5 percent.
E) None of the above
Answer: C

64. A "well capitalized" bank in Basel III must have a leverage ratio of at least:
A) 5 percent
B) 3 percent
C) 6 percent
D) 8 percent
E) None of the above
Answer: B

65. A bank has $100 million in assets in the 0 percent risk weight category, $200 million in assets in
the 20 percent risk weight category, $500 million in assets in the 50 percent risk weight category
and $750 million in assets in the 100 percent risk weight category. This bank has $57 million in
core (Tier 1) capital. What is this bank's ratio of Tier 1 capital to risk-weighted assets?
A) 3.68 percent
B) 7.6 percent
C) 18.25 percent
D) 5.48 percent
E) None of the above
Answer: D

66. A bank has a profit margin of 5 percent, an asset utilization ratio of 11 percent , an equity
multiplier of 12 and a retention ratio of 60 percent. What is this bank's ICGR?
A) 6.6 percent
B) 3.96 percent
C) 7.2 percent
D) .33 percent
E) None of the above
Answer: B

67. Which of the following would be an example of Tier 1 capital?

A) Subordinated debt capital instruments with an original maturity of at least 5 years
B) Allowance for loan and lease losses
C) Minority interest in the equity accounts of consolidated subsidiaries
D) Intermediate term preferred stock
E) All of the above
Answer: C

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 68. Which of the following would be an example of Tier 2 capital?
A) Subordinated debt capital instruments with an original maturity of at least 5 years
B) Undivided profits
C) Minority interest in the equity accounts of consolidated subsidiaries
D) Qualifying noncumulative preferred stock
E) All of the above
Answer: A

69. Which of the following is in the 100 percent risk-weight category?

A) Cash
B) General obligation municipal bonds
C) Residential mortgage loans
D) Credit card loans
E) None of the above
Answer: D

70. Which of the following is in the 35 percent risk-weight category?

A) Cash
B) General obligation municipal bonds
C) Residential mortgage loans
D) Credit card loans
E) None of the above
Answer: C

71. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-
weight category and has $1000 million in assets in the 100 percent risk-weight category. This
bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio
of Tier 1 capital to risk assets?
A) 6.08 percent
B) 3.04 percent
C) 9.11 percent
D) 5.54 percent
E) None of the above
Answer: A

72. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-
weight category and has $1000 million in assets in the 100 percent risk-weight category. This
bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio
of Tier 2 capital to risk assets?

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 A) 6.08 percent
B) 3.04 percent
C) 9.11 percent
D) 5.54 percent
E) None of the above
Answer: B

73. A bank has $200 million in assets in the 0 percent risk-weight category. It has $400 million in
assets in the 20 percent risk-weight category. It has $1000 million in assets in the 50 percent risk-
weight category and has $1000 million in assets in the 100 percent risk-weight category. This
bank has $96 million in Tier 1 capital and $48 million in Tier 2 capital. What is this bank's ratio
of total capital to risk assets?
A) 6.08 percent
B) 3.04 percent
C) 9.11 percent
D) 5.54 percent
E) None of the above
Answer: C

74. A bank has a net profit margin of 5.25 percent. It has an asset utilization ratio of 45 percent and
has an equity multiplier of 12. It retains 40 percent of its earnings each year. What is this bank's
internal capital growth rate?
A) 28.35 percent
B) 2.36 percent
C) 11.34 percent
D) 4.8 percent
E) None of the above
Answer: C

75. Bank operational risk includes:

A) Employee fraud
B) Account errors
C) Computer breakdowns
D) Natural disasters
E) All of the above
Answer: E

76. Which of the following would be an example of interest rate risk?

A) A bank manager embezzles $1,000,000 from the bank
B) A bank that loses $500,000 from trading in foreign currencies
C) A $1,000,000 loan to a business on which no interest or principal has been collected in 2
years
D) A bank manager predicts interest rates will rise. However interest rates fall causing the
bank’s net income to fall by $250,000
E) All of the above are examples of interest rate risk?

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 Answer: D

77. Which of the following would be an example of operational risk?

A) A bank teller manages to steal $250,000 over a period of several months
B) An out of date computer system causes the bank to lose $750,000
C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors
D) A $500,000 loan the bank has made has been deemed uncollectable
E) None of the above are examples of operational risk
Answer: B

78. Which of the following would be an example of liquidity risk?

A) A bank teller manages to steal $250,000 over a period of several months
B) An out of date computer system causes the bank to lose $750,000
C) A bank is forced to sell $1,000,000 in loans at a loss in order to meet the needs of depositors
D) A $500,000 loan the bank has made has been deemed uncollectable
E) None of the above are examples of liquidity risk
Answer: C

79. There are three pillars of Basel II. One of them wants to make market discipline a powerful force
compelling risky banks to lower their risk exposure. What does Basel II want to do to make this
happen?
A) Require minimum capital requirement based on the bank’s own evaluation of its risk
B) Require greater public disclosure of each bank’s true financial condition
C) Expand the risks to be evaluated to include credit risk, market risk and operational risk
D) Require supervisory review of each bank’s risk evaluation procedures
E) All of the above
Answer: B

80. A bank has capital to risk weighted assets of 11.5%, Tier 1 capital to risk weighted assets of 7.2%
and a leverage ratio of 5.8%. What type of bank is this?
A) Well capitalized
B) Adequately capitalized
C) Undercapitalized
D) Significantly undercapitalized
E) Critically undercapitalized
Answer: A

81. Which of the following is not a weakness of Basel I risk-based capital standards?
A) They ignore interest rate risk
B) They ignore changes in value due to currency value changes
C) They ignore changes in value due to commodity price changes
D) They ignore credit risk
E) They ignore the market value

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 Answer: D

82. A bank has decided to retain more of their earnings, moving their retention ratio from 40% to
70%. What way of meeting their capital needs is the bank taking?
A) Changing their dividend policy
B) Issuing common stock
C) Issuing preferred stock
D) Issuing subordinated notes and debentures
E) Selling assets and leasing facilities
Answer: A

83. Why do regulators prefer higher capital requirements?

A) It justifies the existence of regulatory agencies
B) It better protects the deposit insurance fund
C) It enhances bank asset quality
D) It decreases bank profitability
E) It increases bank leverage
Answer: B

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