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CHAPTER 1: INTRODUCTION TO BANKING List four functions that define a bank Safeguarding, transferring, exchanging and lending of money What three factors in modern banking have changed the industry? Mergers, technology and competition What are ways a bank is like any other business? What are ways it is different from other business? A bank is like any other business because they sell their service to consumers to earn money and they market and manage those service in a competitive field They like any business that much earn profit to survive and a bank is unlike any other business because they not produce goods, they only handle money for people Name three ways you interact with your own bank For each, explain how technology has changed the interaction between the bank and the customer - ATMs: If customers need cash to something, they don’t have to go to the bank, they can withdraw in the ATM - Networked computers: If customers need to transfer money or pay a bill, they can it in the internet with online banking - Smart cards with embedded microchips: Plastic cards are used to pay with noncash Why governments regulate banks? Because they essential to maintaining the economics, they guarantee the safety and stability of the money supply and the country as much as possible What challenges you think the trend toward mergers poses to banks? What skills will these challenges require of those making careers in banking? Opportunities to handle more money efficiently is increasing They require thorough understanding of how the system and its tool work and how money in an increasingly complex economy Name six ways banks safeguard your money Record keeping, indentity theft, enforcement, transfer security, sound business practices, examinations by feral or state bank authorities How does lending stimulate the economy? Depositors: much money Borrowers: Good economic plans (start – ups) So the bank takes money from depositors and give it to the borrowers And start – ups can create the profit So lending stimulate the economy How banks contribute to stability of the society at large while safeguarding the funds of their own customers? The bank takes money from depositors and give it to the borrowers to invest or expand their business, so it can stimulate the economy Sometimes, the bank can invest in property or stocks to make a profit Banks must have the reserve requirement in the central bank to safeguard and guarantee that the bank can cash on hand to cover withdrawals 10 Governments don’t routinely examine the books of many businesses Poor business practices just put them out of business Why should banks be treated any differently? Unlike any other business, banks not produce goods, banks only handle money for people If a firm can’t sell goods, they won’t have money to pay the cost and go bankrupt While, if the bank goes bankrupt, depositors cannot get the money back, it effect on the increasing of the economy 11 In what ways have security issues for banks changed in the last 30 years? 12 Name three sources of bank income What is a bank’s spread? Service fees, ATM fees, creadit card interest The spread is the difference between what a bank pays in interest and what it receives in interest 13 What changes have deregulation and competition brought to modern banking? They have become more customer oriented and are in new areas of financial services (innovative lending and technology related services: ATMs, smart cards, payroll cards, online banking, mobile banking) 14 How does the fact that consumers have many choices for places to put their money affect the banking industry? They have to be more competitive and make smarter investment choices 15 Savings deposits today are smaller by percentage than they once were Why you think some economists feel that this is a risk to the economy? Savings deposits guarantees a stable amount of money to make loans When it is smaller, the banks cannot make loans, so companies who want to expand their business, they cannot access money That is the reason why the economy goes down 16 What reasons might some people have for not taking full advantage of today’s banking services and technology? Nowadays, banks give a lot of services and technology to operate better So customers have a lot of wide range services to use based on their needs.* 17 How might smart – card technology reduce the number of cards in a consumer’s wallet or purse? Smart cards are credit, debit, or other types of cards that have embedded microchips Smart cards are useful for a wide variety of “electronic purse” applications, which allow the card to store a value So the number of cards in a consumer’s wallet is reducing 18 What is a wholesale bank? What is the primary difference between credit unions and other depositor – owned financial institutions? Wholesale bank is the commercial banks that specialize only in business banking Credit unions Depositor – owned financial institutions Members Everyone who want to deposit their money Not – for – profit financial It works for the purpose of making a profit institutions that exist to benefit the members 19 Why is an insurance company considered a financial intermediary? What is the primary difference between depository institutions and most nondepository institutions? Insurance company make money on the policies they sell, which protect against financial loss and build income for late use The policies are not tangible and the protection they offer is financial so the companies are performing a financial service Although insurance comapnies not typically make loans, in some cases the cash value of a policy may be used to secure a loan Private insurance companies try to earn a profit from the permiums beyond the cost of insurance payouts Depository institutions Nondepository institutions Take deposits Don’t take deposits They pay low interest rates and make They perform other financial services loans or invest to make a higher and collect fees for them as their interest rates primary means of business Protected by government Not protected by government 20 Services from depository institutions have become similar since deregulation Why is there any need for different forms of depository institutions? 21 Credit unions are not – for – profit institutions They return profits to members Why wouldn’t everyone place their money only in credit unions? Users of credit unions must be members Membership is usually based on some type of association, such as a common employer, a certain line of work, a geographical region, or even a social or religious affiliation Therefore, being a member of credit unions is very difficult 22 Do you think payday loans and currency exchanges take advantage of those who not have access to other forms of financial services? Why or why not? 23 How does the fact that the government backs many forms of depository institutions affect the confidence of consumers about their deposits? When the government backs many forms of depository institutions, the consumer doubt the ability of these institutions They think banks cannot keep their money safety and use it efficently.* 24 Why are banks called financial intermediaries? They are the middleman between parties The bank takes money from depositors and give it to the borrowers 25 List four functions that banks perform (1) Safeguarding, transferring, exchanging, lending of money 26 Name three trends in recent banking history (2) Mergers, competition, technology 27 List four ways that banks safeguard money (7) Record keeping, identification theft, enforcement, transfer security 28 How banks help expand and maintain the economy? (8) Depositors: much money Borrowers: Good economic plans (start – ups) So the bank takes money from depositors and give it to the borrowers And start – ups can create the profit So lending stimulate the economy 29 Why is a deposit considered a liability for a bank? Because they must pay interest and give it back when it maturity And a bank must give depositors their money if they request it 30 How might investors evaluate a bank’s ROA and ROE ratio? ROA = Net income / total assets ROE = Net income / total equity 31 What has been the effect of competition between banks? The deposit interest and the lending interest* 32 Name five types of technological innovations in banking ATMs, online banking, smart cards, payroll cards, mobile banking 33 Name two types of thrift institutions Mutual savings, savings and loan associations 34 What is a nondepository financial institution? Nondepository financial institution don’t take deposits, they perform other fianancial services and collect fees for them as their primary means of business 35 Why are banks regulated and protected by government? (5) Because they essential to maintaining the economics, they guarantee the safety and stability of the money supply and the country as much as possible 36 What are advantages and disadvantages of mergers in banking? - Advantages: Expand the business, have more customers, reduce costs due to no interest rate competition - Disadvantages: effect on the rights and benefits of shareholders, there is a mixture of style, culture of the work of merging banks 37 How did deregulation ultimately result in more banking services for consumers? 38 Would consumers be better off if all public utilities, including electric and gas companies, were deregulated so that the marketplace could set prices? If the marketplace could set prices, consumers would used the good price More companies will establish and give more discount, gift and competitive price to attract more consumers 39 Consumer debt is higher than ever in the United States What would happen if people suddenly simply stopped borrowing from banks? Money wouldn’t flow, no one would be buying things, banks cannot make a profit to pay the interest of depositors Economy would fail 40 How has the US, mortgage crisis affected both the US economy and the international economy? People lost jobs: Businesses reduce their production scales to affect workers’ wages, so consumers tighten their spending That is the reason why companies can not sell goods and go bankrupt Deflation: Companies can not sell goods so they discount, consumers delay spending to wait deep discounts So the economy is not developing International economy: Debt crisis occurred in Europe, the Asian economy is down, espeacially Japan and South Korea 41 If private, nondepository loan companies charge higher interest than depository institutions backed by government, how they stay in business? They lend to less secure customers that can’t get loans anywhere* CHAPTER 5: DEPOSITS IN BANKS What is a transaction account and why is it a demand deposit? A transaction account is an account that allows transactions to occur without restrictions on the frequency on the volume of transactions It is a demand deposit because they are payable on demand whenever the depositor chooses List three types of time deposit Which of these are exempt from reserve requirement? - Savings accounts: This is exempt from reserve requirement - Money Market Deposit Accounts - Certificates of Deposit Why does the Federal Reserve require reserves for demand deposits but not for time deposit? Because demand deposits that the customers can withdraw anytime they wants So it is high liquidity and this is the reason why Federal Reserve require reserves for demand deposits to guarantee that they can withdraw their money How might competitive pressures have led to different types of checking accounts? Why you think passbook savings accounts have disappeared? Because it is replaced by statement savings accounts, it provides a monthly or quarterly computerized statement deatiling all account activity and it is also the safest places to put money What factors should be considered when contemplating a certificate of deposit? Fixed interest rate or fluctuate rate, maturity date, holder’s name, is it callable or uncallable CD.* What the terms in formula P x R x T = I stand for? P: principal; R: rate; T: time; I: interest Excercise: Simple Interest 5% Compound Interest 5% Time Interest Principal Interest Principal months $250 $10,000 $250.00 $10,250.00 year $250 $10,000 256.30 10,506.30 ½ year $250 $10,000 262.70 10,769.00 years $250 $10,000 269.20 11,038.20 ½ years $250 $10,000 276.00 11,314.20 years $250 $10,000 282.90 11,597.10 Total $1,500 $1,597.10 Assume you put the same $10,000 in a bank account paying percent interest compounded semiannually You’d get back $11,597.10 In effect, that’s a rate of 5.3 percent per year Why is compound interest such a powerful savings tool? It starts over with a new principal every time interest is paid, adding the paid interest to create a higher principal on which interest is paid in the next interval 10 Why financial institutions try to thwart the efforts of rate chasers? Because the people borrow at low interest rate (credit cards) and savings at high interest rate (short – term) to make a profit If it is continue, the bank will go bankrupt 11 Why is it important for consumers to compare interest rates on bank accounts and other interest – bearing instruments? 12 How does the frequency that interest is compounded change the effect of compounded interest rates? It changes the effect because it would make the interest rate rise more frequently than if it didn’t rise at all It would add a higher interest rate on your deposits more frequently 13 Why is APY a more useful measure for comparing interest rates than APR? APY is more useful because it represents the effect of compouding whereas APR is the nominal rate on which interest is calculated per year 14 What is the greatest factor in the flow of deposits? Why economists track and analyze so much data? Economy is the greatest factor in the flow of deposits It is not always easy to predict the results of these transactions, but the best predictor is the past National Assembly set some economic targets, central bank base on it to provide monetary policies, which based on intermediate target 15 How does the Federal Reserve influence the flow of deposits? The Fed influences the flow of deposits by raising or lowering the reserve requirements, they can buy or sell bonds or adjust the discount rate 16 Why is it sometimes hard to predict the flow of deposits in the banking system? Because the economy is the greatest factor in the flow of deposits So when you predict it, the economy have many factors affect to it like: interest rate, inflation, saving, spending… 17 How might political or national events affect the flow of deposits in the banking system? When political or national events apppear, FED can adjust the money supply or discount rate or adjust reserve requirements to control the velocity of circulation So it affects the flow of deposits in the banking system 18 Do you think the government should have more direct control of the economy and thus the flow of deposits? Why or why not? No I don’t think so Because deposit flow is determined by the needs of all businesses, bank and nonbank, moving money around in the banking system When the government control the flow of deposits, the economy cannot grow 19 Give examples of daily economic activities that are more likely to have predictable effects on the flow of deposits If the stock market tanks, the FED could lower interest rates and purchase bonds from banks to temporarily stimulate the economy 20 Why are governing documents necessary? Because it is a legal relationship that offers rights and imposes responsibilities on each party 21 How governing documents and account rules differ? The difference between documents and rules are that documents tell about the account where as rules are the legal steps 22 Why banks supply a separate set of account rules as part of the governing documents for each account? Because state and federal governments require banks to provide this documentation to customers so that questions about account policies and procedures have clear answers These documents protect both the consumer and the bank from misunderstanding and loss 23 Do you think most people carefully read the documents associated with their bank accounts? Why or why not? Yes, I think so Because their money are put into these accounts, so they must read carefully to guarantee that all of the information are correct and they can understand clearly all of the information 24 Why does the government feel it is necessary to require that written copies of documents related to bank accounts be provided to customers? (23 ) Because their money are put into these accounts, so they must read carefully to guarantee that all of the information are correct and they can understand clearly all of the information And to ensure the rights and benefits of depositors 25 In what circumstances might a bank waive a fee it had charged? 26 What is demand deposit? Demand deposit are payable on demand whenever the depositor chooses 27 Name three forms of demand deposits - Checking account - Traveler’s check - Automactic transfer service 28 What is a minimum balance? The minimum balance is the minimum amount that a customer must have in an account in order to get a service 29 Name three types of time deposits (2) - Savings accounts - Money Market Deposit Accounts - Certificates of Deposit 30 Why are savings accounts not subject to the Fed’s reserve requirements? Savings accounts are held for or mature at a specified time So it is less liquidity And it is no reserve requirements 31 Describe a certificate of deposit and its maturity date CDs are certificates issued by banks that guarantee the payment of a fixed interest rate until the maturity date, which is a specified date in the future 32 What the letters in the fomula P x R x T = I represent? (7) P: principal; R: rate; T: time; I: interest 33 Explain the basic idea of compound interest (8) …… 34 What is the difference between APR and APY? - APR: Principal is fixed and the interest cannot add to it - APY: Principal is flexible and the interest can add to it after the term of deposit 35 Whay is the most significant factor influencing the flow of deposits in the United States? (14) Economy is the most significant factor influencing the flow of deposits in the US 36 Name five main types of documents typically supplied with new accounts - Account rules - Deposit rate schedule - Fee schedules - Check hold policies - Disclosure statements 37 Why are transaction accounts the most liquid of all funds? (3) Because demand deposits that the customers can withdraw anytime they wants So it is high liquidity and this is the reason why Federal Reserve require reserves for demand deposits to guarantee that they can withdraw their money 38 What factors should a person consider when choosing an account? - Fees: Customers need to know the fees of this service like: ATM fees, withdrawl fee and monthly fee for keeping this account - Minimum account balance: how much money at least to keep in it at all times - Interest rate: when customers use what they pay interest or what they receive in interest 39 Why is the annual percentage rate an ineffective measure for comparing accounts? (13) APY is more useful because it represents the effect of compouding whereas APR is the nominal rate on which interest is calculated per year 40 Why won’t the Federal Reserve’s monetary policies completely control the flow of deposits in the US banking system? (18 ) FED only can control the money supply by adjust the discount rate, reserve requirements and buy or sell tresury bills While deposit flow is determined by the needs of all businesses, bank and nonbank, moving money around in the banking system 41 Why must banks provide customers with documents such as account rules, and how account rules protect both banks and consumers? (23) Because their money are put into these accounts, so they must read carefully to guarantee that all of the information are correct and they can understand clearly all of the information And to ensure the rights and benefits of depositors Account rules is a legal relationship that offers rights and imposes responsibilities on each party 42 How Federal Reserve regulations protect consumers? (9 chapter 1) Banks must have the reserve requirement in the central bank to safeguard and guarantee that the bank can cash on hand to cover withdrawals If the bank go bankrupt, the central bank can afford to get the money back to the consumers CHAPTER 7: BANK LOANS What is asset transformation? When banks transfrom liabilities (deposit) into assets (loans), asset transformation has occured What is adverse selection? Adverse selection is the concept that the borrowers who are most willing to accept a high interest rate are the same borrowers who are most likely to default on their loans What are three methods of providing overdraft protection? What are the two key ideas of modern portfolio theory? Spread out risk and staggering of maturity dares of securities Explain why people raised concerns about moral hazard when the government intervened to help out Bear Stearns What are the long – term concerns with moral hazard? When the government intervented to help out Bear Stearns, there was a great deal of concern whether other financial companies would continue to engage in high – risk behavior because they knew the government would provide a safety net if they got into trouble Many would argue, to decrease moral hazard, the government should not intervene to rescue firms that engaged in high – risk behavior How banks earn revenue by selling loans? Banks not always keep loans They often sell loans on the secondary market When sold to an intermediary, banks achieve profits from the loans in ways: charging loan origination fees to the borrowers, selling the loan for a slightly higher principal than the original loan What is the advantage of off – balance sheet activities? What is the difference between a secured loan and an unsecured loan? A secured loan is the loan that some item of value backs the loan in case the borrower defaults on the loan While, unsecured loan is a loan backed only by the reputation and creditworthiness of the borrowers What is an open – end loan? Open – end loans are another type of loan with an almost endless variety of applications 10 Why you think consumer loans have so many names and forms? Because the consumer loans based on the consumer’s credit rating and the specific type of loan he or she seeks 11 What is difference between the interest and the finance charge of a loan? The interest is the amount you pay to use the principal While the finance charge of loan is the total dollar amount to be paid for the loan (the finance charge = lending interest + fees) 12 Why might it be important for consumers to understand their credit card agreements? Because the credit cards is known as forms of consumer loans The principal changes as your balance goes up and down, but you are still borrowing and paying interest Late penalties for bills paid after the due date raise the cost of credit cards, and delinquency rates may raise the APR significantly So you need to know the information in your credit card agreement 13 In your opinion, how many credit cards are too many? Explain your reasoning In my opinion, I think one person should have one credit card Because they need to focus the balance in their credit card You must pay all the loans before the due date to get away pay interest 14 What is underwriting? Underwriting is reviewing the loan for soundness to make sure the loan the loan is a prudent use of bank funds 15 What is a consumer reporting agency? Consumer reporting agency is a company that complies and keeps records on consumer payment habits and sells these reports to banks and other companies to use for evaluating creditworthiness 16 Why might underwriting standards vary at different banks? 17 How subprime rates offset the risk associated with borrowers who have less – than – perfect credit? Subprime rates are those higher than normal to offset the increased risk represented by a less – than – perfect borrower 18 How might a stranger having your Social Security number ruin your credit rating? 19 Do any of the categories of personal information on a credit report strike you as being a violation of privacy? Discuss 20 What is it a good idea for consumers to pay more than their minimum balances on open – ended credit accounts? 21 Why consumers become overextended? They take on 2, 3, 4, or more new credit cards, thinking that they will have only a small balance on each without really totaling up the costs They may be able to make minimum payments, but their overall debt load increases 22 Excercises methods of calculate interest: - Sum – of – Dights Method (Rule of 78): $1,000 has 6% interest rate and a $30 loan processing fee For this loan, the total financing charges are $105 ($75 for interest and $30 for loan processing) The total loan cost, comprised of principal, interest and the loan processing fee, is $1,105 Monthly loan payments are $1,105/15 = $73.67 Month of Loan Payment Numerator for Month Denominator for Month Ratio of Payment Applied toward Interest Monthly Loan Payment Amount of Payment Applied to Interest Amount of Payment Applied to Principal 15 120 0.125 $73.67 $9.208 $82.878 14 120 0.117 $73.67 $8.594 $82.264 13 120 0.108 $73.67 $7.981 $81.651 12 120 0.1 $73.67 $7.367 $81.037 11 120 0.092 $73.67 $6.753 $80.423 10 120 0.083 $73.67 $6.139 $79.809 120 0.075 $73.67 $5.525 $79.195 8 120 0.067 $73.67 $4.911 $78.581 120 0.058 $73.67 $4.297 $77.967 10 120 0.05 $73.67 $3.683 $77.353 11 120 0.042 $73.67 $3.069 $76.739 12 120 0.033 $73.67 $2.456 $76.126 13 120 0.025 $73.67 $1.842 $75.512 14 120 0.017 $73.67 $1.228 $74.898 15 120 0.008 $73.67 $0.614 $74.284 - Previous Balance Method: Lend 100 million VND, I = 1%/month P1 = 10 I1 = P2 = 10 I2 = … - Adjusted Balance Method: Lend 100 million VND, I = 1%/month P1 = 10 I1 = 100 x 1% = P2 = 10 I2 = 90 x 1% = 0.9 P3 = 10 I3 = 80 x 1% = 0.8… 23 How can a consumer find the best deals on credit? 24 What factors should consumers consider when choosing a loan? 25 In your opinion, why has there been rapid growth in subprime lending? 26 What danger signals might indicate to a consumer that he or she is becoming overextended? 27 What is the function of a loan policy committee? 28 How loans affect a bank’s income? 29 Why is liquidity risk of considerable importance to a bank’s loan policy? 30 How does market risk affect a bank? 31 What role liquidity, credit, and market risk play when a loan policy committee sets the bank’s lending guidelines? 32 Give three examples of installment loans 33 What is a secured loan? 34 What is moral hazard? 35 What is the difference between the interest rate and the finance charge? 36 Why are credit cards a form of consumer lending? 37 What is a line of credit? 38 List six steps in the credit – granting process 39 What are the three Cs? 40 What is a credit – scoring system? 41 Why are credit investigation sometimes criticized? 42 What five items apper in most credit reports? 43 How does liquidity affect a bank’s income? 44 Compare and contrast liquidity, credit, and market risk 45 Explain the functions of a loan policy committee 46 Should FICO scores be released to consumers? Why or why not? 47 Why banks engage in credit rationing? 48 What factors should a person consider before obtaining a loan? 49 Why is it important to pay every bill on time? 50 Why is having many credit card accounts a risky pratice? 51 Why banks offer overdraft protection? 52 Why are banks required to have loan policies? ... 15 Savings deposits today are smaller by percentage than they once were Why you think some economists feel that this is a risk to the economy? Savings deposits guarantees a stable amount of money... in the banking system 18 Do you think the government should have more direct control of the economy and thus the flow of deposits? Why or why not? No I don’t think so Because deposit flow is... bank from misunderstanding and loss 23 Do you think most people carefully read the documents associated with their bank accounts? Why or why not? Yes, I think so Because their money are put into