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(econ333)[2001](f)final~masze^_10250.pdf
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Final Exam
Economics 333
Money and Banking
Wednesday, December 19, 2001
Instructions Answer each of the questions below. Questions 1 and 2 are short answer questions. Put the answers to these questions on, respectively, pages 1 and 2 of your blue book. There is an underlined space following short answer questions 3C14 and multiple-choice questions 15-17 on the exam. For those questions, put your final answer in that space and circle it. Though you may use the remainder of the blue book for calculations, do not write the answers to those questions in the bluebook.
Short Answer
1.
10 Points In one paragraph or less, explain why bank owners would prefer a high ROA and a high asset-to-equity ratio? Why might depositors prefer strategies that lead to low ROA and low asset to equity ratios?
Bank owners inject their own capital into a bank in order to achieve high returns on their investment. Banks earn income by taking deposits and making loans. The income that they earn per dollar of loans and other assets is the Return on Assets (ROA). The return that they earn on their investment is the income that they earn on their investment or the banks capital. This is the product of ROA multiplied by the asset to equity ratio. Thus, a high ROA and a high asset to equity ratio implies a high return on equity and good returns for the bank owners. However, some strategies that banks can use to increase the return on assets expose them to risk. If the banks make many risky loans, they may earn high returns but expose themselves to default risk. If the banks hold a high percentage of their assets in illiquid loans rather than reserves they can also increase their average asset returns but expose themselves to liquidity risk. Since depositors earns fixed interest rates, they might prefer that banks earn safe returns rather than high returns. Bank owners can increase their returns on equity, by increasing their leverage. That is if banks borrow to finance loans and inject relatively little of their own money, they will earn high profits for each dollar invested. However, any loan losses come out of bank capital. A low amount of bank capital per loans increases the possibility will be so high that banks will be unable to repay depositors in full.
2.
5 Points In six sentences or less, describe the difference between U.K. style universal banking and continental style universal banking. Which style is prevalent in Hong Kong? Which style is currently prevalent in the US and Japan? Under universal banking, a commercial bank is part of a larger financial entity that engages in investment banking, insurance, owning shares and other activities. Under continental style banking, all of these activities are undertaken as one legal entity with the risks fully shared across businesses. Under UK style banking, a holding company owns majority stakes in financial com