Banking Banking Fundamentals 5 — Questions and Answers
Question 1: What is 'moral hazard' in the context of banking?
- The ethical obligation bankers have to disclose conflicts of interest
- The tendency for entities to take on more risk when protected from the consequences of that risk (Correct answer)
- A risk created when bank employees act unethically toward customers
- The hazard posed by hiring staff without adequate background checks
Correct answer: The tendency for entities to take on more risk when protected from the consequences of that risk
Moral hazard occurs when deposit insurance or government bailout expectations cause banks to take excessive risks because losses will be partially borne by others.
Question 2: What is an 'adjustable-rate mortgage (ARM)'?
- A mortgage with a fixed payment but variable amortization schedule
- A mortgage where the interest rate changes periodically based on a benchmark index (Correct answer)
- A mortgage where the borrower can adjust the monthly payment amount freely
- A government-backed mortgage with rates adjusted annually by HUD
Correct answer: A mortgage where the interest rate changes periodically based on a benchmark index
An ARM has an interest rate that adjusts at set intervals based on a reference rate like SOFR, meaning monthly payments can rise or fall over time.
Question 3: What is 'check kiting'?
- The practice of sending checks to customers via express mail to speed processing
- A form of bank fraud that exploits float by drawing on funds from checks not yet cleared (Correct answer)
- Endorsing a check over to a third party by writing on the back
- Depositing multiple checks from the same payer into different accounts
Correct answer: A form of bank fraud that exploits float by drawing on funds from checks not yet cleared
Check kiting is fraud where someone uses the float time between depositing and clearing to artificially inflate account balances across multiple banks.
Question 4: What is a 'money market account (MMA)'?
- An account used exclusively for trading money market mutual fund shares
- A deposit account that typically offers higher interest than a savings account and may allow limited check writing (Correct answer)
- A brokerage account where only Treasury bills and commercial paper can be held
- A checking account linked to the federal funds market rate
Correct answer: A deposit account that typically offers higher interest than a savings account and may allow limited check writing
A money market account is a bank deposit product combining features of savings and checking accounts, offering competitive interest rates with limited transaction capabilities.
Question 5: What does 'underwriting' mean in banking?
- Writing loan terms on the back of a promissory note
- The process of evaluating and assuming the risk of a loan or securities issuance (Correct answer)
- The practice of guaranteeing minimum deposit returns to bank customers
- Drafting legal documentation for mortgage agreements
Correct answer: The process of evaluating and assuming the risk of a loan or securities issuance
Underwriting is the risk assessment process by which a bank evaluates a borrower's creditworthiness or a security's risk before committing to lend money or issue the security.
Question 6: What is the 'discount window' in U.S. banking?
- A teller window dedicated to processing customer discounts and promotions
- A Federal Reserve lending facility that allows eligible banks to borrow funds short-term (Correct answer)
- A period when the Fed reduces interest rates to stimulate the economy
- A discount brokerage service offered through commercial banks
Correct answer: A Federal Reserve lending facility that allows eligible banks to borrow funds short-term
The discount window is the Federal Reserve's lending facility where banks can borrow short-term funds, typically overnight, to meet reserve requirements or liquidity needs.
Question 7: What is 'amortization' in the context of a bank loan?
- The process of calculating a borrower's credit score over time
- The gradual repayment of a loan through scheduled payments that cover both principal and interest (Correct answer)
- A penalty assessed when a borrower pays off a loan too early
- The accounting method for depreciating bank-owned real estate assets
Correct answer: The gradual repayment of a loan through scheduled payments that cover both principal and interest
Amortization is the process of systematically reducing loan principal through regular payments, with each payment covering interest first and the remainder reducing the balance.
Banking Banking Fundamentals 5
What is 'moral hazard' in the context of banking?