FIN 4324 Mid Term Exam Fall 2016 Material Covered on Exam The Mid Term Exam will be given on Tuesday March 1st Please bring a pencil and a non programmable calculator The exam will cover all material in the following PowerPoint slides Part 1 Introduction A Why Study Commercial Banking Part 2 Bank Financial Statements 2 A Commercial Bank Financial Statements Balance Sheet 2 A 1 Definition of Deposit Broker 2 A 2 Reserve Computation and Reserve Maintenance Periods 2 A 3 Illustration of the Computation of Required Reserves Assigned reading from the textbook include Chapter 1 Introduction pp 10 17 Chapter 11 Commercial Banks Industry Overview pp 36 59 Chapter 12 Commercial Bank Financial Statements and Analysis pp 62 79 Exam Composition The exam has two parts Part 1 is made of 45 multiple choice and True False questions similar in nature to the questions appearing on the quizzes Each objective question is worth 2 points Part 2 of the exam is a computation analysis question similar in nature to Mini Case 1 dealing with the computation of required reserves The breakdown of the objective questions is as follows 2 questions purpose of the Glass Steagall Act o Legally defined a commercial bank as financial institutions that make commercial loans accept demand deposits o Distinguished it from investment banking Views investment banking as too risky for banks a potential source of conflict of interest IB defined as the underwriting issuing and distributing securities o Also called the Banking Act of 1933 created after the stock crash of 1929 in order to restrict the use of bank credit for speculative purposes Except for underwriting of new issues of T bills municipal general obligations bonds private placements of corporate debt and equity securities 1 question FDIC o The Federal Deposit Insurance Corporation was created in 1933 By Banking Act of 1933 to maintain the stability and public confidence of the US financial system It is the federal agency that insures deposits at commercial banks for up to 250 000 o FDIC is also the primary Federal Regulator for State chartered banks that do not elect to 3 questions Definitions of Retail Wholesale and Investment banking join the Federal Reserve o Retail bank Focus on consumer oriented banking activities such as residential and consumer loans mortgages and small time CD s and savings deposits Since people look for convenience they need to have a lot of branches nationwide Ex Suntrust Mainly involved with commercial oriented banking activities such as commercial loans funded large corps or gov t by borrowing funds from other banks through money markets and repos Ex 5 3 Bank Citibank o Wholesale bank o Investment Bank Sometimes called shadow banks perform banking activities designed to help customers raise funds This consists of advising underwriting marketing and distributing financial securities Ex Goldman Sachs Morgan Stanley 1 question shadow banks o Non Commercial Banks such as IBs or other financial companies that do not meet the legal definition of a commercial bank CB They are much less regulated than CBs cannot accept deposits but they may originate loans other than commercial ones and operate in the shadows of the banking business Includes money market funds hedge funds private equity funds securities broker dealers and insurance companies 1 question source of bank profitability o By generating enough interest revenue on bank assets RA loans and investments to cover the the lower interest cost of funds deposits and other borrowed funds RL providing a positive spread RA RL 0 to cover their operating costs and expected losses o Summarized by the bank s rate spread composed of the credit risk liquidity and o Profit Interest Rev on Assets Interest Costs of Funds Operating Costs Expected 1 question definition of a SIFI ROA Profits Assets RA RL OC A EL A o Systematically Important Financial Institution defined as a financial institution whose failure could cause substantial damage to the financial system and the economy too big to fail o During the Obama administrations SIFIs were target of regulatory and regulatory reform including Dodd Frank mandating that they d need to maintain meet higher capital standards develop contingency plans maturity Loss 1 question banks advantage s in financing below investment grade borrowers o Banks are more effective and efficient in using their screening and monitoring expertise to help them select and protect their credit exposures while avoiding asymmetric info This allows banks to fund riskier borrowers at more sustainable funding rates and reduce the rate spreads charged to borrowers 1 question bank certification effect o When a bank makes a new loan to a company capital market investors are led to believe the bank is certifying that the company is a good credit risk and the effect is a 1 positive rise on the company s stock price 3 questions Sources of funding for US publically traded manufacturing firms o The average publicly traded US manufacturing firm obtains approximately 70 of its funding from internal sources such as current profits and retained earnings and 30 comes from external sources such as issues of equities bonds and bank loans o The majority of the external funding 69 utilized by the average publicly traded US manufacturing firm is obtained from bank loans followed by sale of new bonds 29 and sales of new equities 2 1 question the most important source of bank profits and risk o The most important source of profits and risk for banks are loans with an borrowers of an average credit rating between Borrower of Good Quality BB and Borrower of Average Quality BB BB 1 question usefulness of financial statement information o Financial statements can be very useful to describe the current composure of a bank and they are reported at every quarter by a call report These reports contain information about the bank s Profitability Are their revenues covering expenses and earning a profit This is crucial for future growth ability to obtain funds to operate Liquidity Do they have enough cash or assets that can be quickly sold converted to cash with little to no loss in value Banks need to be liquid in order to pay loan deposit withdrawals and other cash disbursements Solvency Banks need to have an adequate quality asset base that exceeds their liabilities and maintain a strong capital base to offset risky investments 1 question income statement o Also called the Report of Income it demonstrates the