FINA 365 ch 7-10

When does "duration" become a less accurate predictor of expected change in security prices? As interest rate shocks increase in size. As interest rate shocks decrease in size. When maturity distributions of an FI's assets and liabilities are considered. As inflation decreases. When the leverage adjustment is incorporated.

As interest rate shocks increase in size.

Which function of an FI involves buying primary securities and issuing secondary securities? Brokerage. Asset transformation. Investment research. Self-regulator. Trading.

Asset transformation.

Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually.What is the bank's net interest income for the current year? $300,000. $140,000. $160,000. $280,000. $80,000.

$140,000.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.If the fee income on this loan is 0.4 percent and the spread over the cost of funds to the bank is 1 percent, what is the expected income on this loan for the current year? $40,000. $100,000. $140,000. $180,000. $280,000.

$140,000.

What is market value of the one-year CD if all market interest rates increase by 2 percent? $49.065 million. $50.481 million. $49.528 million. $50.971 million. $50.000 million.

$49.065 million.

An FI purchases at par value a $100,000 Treasury bond paying 10 percent interest with a 7.5 year duration. If interest rates rise by 4 percent, calculate the bond's new value.Recall that Treasury bonds pay interest semiannually. Use the duration valuation equation. $28,572 $20,864 $15,000 $22,642 $71,428

$71,428

Consider a one-year maturity, $100,000 face value bond that pays a 6 percent fixed coupon annually.What is the price of the bond if market interest rates are 7 percent? $99,050.15. $99,457.94. $99,249.62. $100,000.00. $99,065.42.

$99,065.42.

Consider a five-year, 8 percent annual coupon bond selling at par of $1,000.Using present value bond valuation techniques, calculate the exact price of the bond after the interest rate increase of 20 basis points. $1,007.94. $992.02. $992.06. $996.01. $1,003.99.

$992.06.

Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually.What is the bank's net interest income in dollars in year 3, after it refinances all of its liabilities at a rate of 6.0 percent? -$60,000. -$140,000. +$140,000. +$60,000. +$800,000.

+$60,000.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.What is the capital (loan) risk of the loan if the current average level of interest rates for this category of bonds is 12 percent? -$550,000. -$1,564,280. -$1,964,280. -$2,000,000. -$2,200,000.

-$1,964,280.

An FI finances a $250,000 2-year fixed-rate loan with a $200,000 1-year fixed-rate CD. Use the repricing model to determine (a) the FI's repricing (or funding) gap using a 1-year maturity bucket, and (b) the impact of a 100 basis point (0.01) decrease in interest rates on the FI's annual net interest income? $0; $0. -$200,000; +$2,000. -$200,000; -$2,000. +$50,000; -$500. -$200,000; -$1,000.

-$200,000; +$2,000.

An FI has financial assets of $800 and equity of $50. If the duration of assets is 1.21 years and the duration of all liabilities is 0.25 years, what is the leverage-adjusted duration gap? 0.9000 years. 0.9600 years. 0.9756 years. 0.8844 years. Cannot be determined.

0.9756 years.

Calculate the duration of a two-year corporate loan paying 6 percent interest annually, selling at par. The $30,000,000 loan is 100 percent amortizing with annual payments. 2 years. 1.89 years. 1.94 years. 1.49 years. 1.73 years.

1.49 years.

What is the duration of an 8 percent annual payment two-year note that currently sells at par? 2 years. 1.75 years. 1.93 years. 1.5 years. 1.97 years.

1.93 years.

What is the duration of a 5-year par value zero coupon bond yielding 10 percent annually? 0.50 years. 2.00 years. 4.40 years. 5.00 years. 4.05 years.

5.00 years.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.What is the estimated risk-adjusted return on capital (RAROC) of this loan. 6.36 percent. 7.00 percent. 7.13 percent. 10.55 percent. 25.45 percent.

7.13 percent.

Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually.What is the maximum interest rate that it can refinance its $4 million liability and still break even on its net interest income in dollars? 6.5 percent. 7.0 percent. 7.5 percent. 8.0 percent. 8.5 percent.

7.5 percent.

If the spot interest rate on a prime-rated one-month CD is 6 percent today and the market rate on a two-month maturity prime-rated CD is 7 percent today, the implied forward rate on a one-month CD to be delivered one month from today is 9 percent. 11 percent. 18 percent. 10 percent. 8 percent.

8 percent.

For an FI investing in risky loans or bonds, the probability is relatively the lowest for which of the following occurrences? Repayment of principal and promised interest in full. Partial default on interest payments. Complete default on interest payments. Partial default of the principal remaining on a loan. Complete default on principal and interest.

Complete default on principal and interest.

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower? Mortality rates. RAROC. Implicit contracts. Covenants. Credit rationing.

Covenants.

Which of the following refers to an FI's ability to generate cost synergies by producing more than one output with the same inputs? Market intermediation. Economies of scope. Break-even point. Economies of scale. Business continuity plan.

Economies of scope.

Which of the following is the major weakness of the linear probability model? The model is based on past data of the borrower. Measurement of the loan risk is difficult. Estimated probabilities of default may lie outside the interval 0 to 1. Neither the market value of a firm's assets nor the volatility of the firm's assets is directly observed. None of these is a weakness of the linear probability model.

Estimated probabilities of default may lie outside the interval 0 to 1.

Which of the following is true of commercial paper? It is a secured long-term debt instrument issued by corporations. It is always issued via an underwriter. It may help a corporation to raise funds often at rates below those banks charge. All corporations can tap the commercial paper market. Total commercial paper outstanding in the US is smaller than total C&I loans.

It may help a corporation to raise funds often at rates below those banks charge.

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract? Liquidity risk. Interest rate risk. Sovereign risk. Default risk. Solvency risk.

Default risk.

Managers can achieve the results of duration matching by using these to hedge interest rate risk. Rate sensitive assets. Rate sensitive liabilities. Coupon bonds. Consol bonds. Derivatives.

Derivatives.

What type of risk focuses upon mismatched currency positions? Liquidity risk. Interest rate risk. Credit risk. Foreign exchange rate risk. Off-balance sheet risk.

Foreign exchange rate risk.

Suppose that the financial ratios of a potential borrowing firm took the following values:X1 = 0.30X2 = 0X3 = -0.30X4 = 0.15X5 = 2.1Altman's discriminant function takes the form:Z = 1.2 X1+ 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5 According to Altman's credit scoring model, this firm should be considered a high default risk firm. an indeterminant default risk firm. a low default risk firm. a lowest risk customer. Either a low default risk firm or a lowest risk customer.

a high default risk firm.

Economically speaking, OBS activities are contractual claims that may or may not occur. if the contingency does occur, the asset or liability is transferred onto the FI's balance sheet. impact the economic value of the equity. if the contingency never occurs, there is virtually no economic meaning to the OBS activity. all of these.

all of these.

A positive gap implies that an increase in interest rates will cause _______ in net interest income. no change a decrease an increase an unpredictable change No change or a increase.

an increase

The liquidity premium theory of the term structure of interest rates assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term. assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium. recognizes that forward rates are perfect predictors of future interest rates. assumes that risk premiums increase uniformly with maturity. None of these.

assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term.

The market segmentation theory of the term structure of interest rates assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term. assumes that the yield curve reflects the market's current expectations of future short-term interest rates. assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets. fails to recognize that forward rates are not perfect predictors of future interest rates. assumes that both investors and borrowers are willing to shift from one maturity sector to another to take advantage of opportunities arising from changing yields.

assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets.

An interest rate increase benefits the FI by increasing the market value of the FI's liabilities. harms the FI by increasing the market value of the FI's liabilities. harms the FI by decreasing the market value of the FI's liabilities. benefits the FI by decreasing the market value of the FI's liabilities. benefits the FI by decreasing the market value of the FI's assets.

benefits the FI by decreasing the market value of the FI's liabilities.

Calculating modified duration involves dividing the value of duration by the change in the market interest rate. dividing the value of duration by 1 plus the interest rate. dividing the value of duration by discounted change in interest rates. multiplying the value of duration by discounted change in interest rates. dividing the value of duration by the curvature effect.

dividing the value of duration by 1 plus the interest rate.

The duration of all floating rate debt instruments is equal to the time to maturity. less than the time to repricing of the instrument. time interval between the purchase of the security and its sale. equal to time to repricing of the instrument. infinity.

equal to time to repricing of the instrument.

The risk that a foreign government may devalue the currency relates to credit risk. sovereign risk. foreign exchange risk. liquidity risk. interest rate risk.

foreign exchange risk.

The risk that an FI may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities is referred to as currency risk. sovereign risk. insolvency risk. liquidity risk. interest rate risk.

insolvency risk.

"Matching the book" or trying to match the maturities of assets and liabilities is intended to protect the FI from liquidity risk. interest rate risk. credit risk. foreign exchange risk. off-balance-sheet risk.

interest rate risk.

The risk that interest income will increase at a slower rate than interest expense is credit risk. political risk. currency risk. interest rate risk. liquidity risk.

interest rate risk.

Immunization of a portfolio implies that changes in _____ will not affect the value of the portfolio. book value of assets maturity market prices interest rates duration

interest rates

Credit rationing by an FI involves restricting the quantity of loans made available to individual borrowers. results from a positive linear relationship between interest rates and expected loan returns. is not used by FIs at the retail level. involves rationing consumer loans using price or interest rate differences. is only relevant to banks.

involves restricting the quantity of loans made available to individual borrowers.

If an FI's repricing gap is less than zero, then it is deficient in its required reserves. it is deficient in its capital ratio requirement. its liability costs are more sensitive to changing market interest rates than are its asset yields. its liability costs are less sensitive to changing market interest rates than are its asset yields. the duration of the FI's liabilities exceeds the duration of FI's assets.

its liability costs are more sensitive to changing market interest rates than are its asset yields.

Interest rate risk management for financial intermediaries deals primarily with controlling the overall size of the institution. controlling the scope of the institution's activities. limiting the geographic spread of the institution's offices. limiting the mismatches on the institution's balance sheet. continuously and carefully complying with all government regulations.

limiting the mismatches on the institution's balance sheet.

Economies of scale refer to an FI's ability to lower its average costs of operations by expanding its output of financial services. generate cost synergies by producing more than one output with the same inputs. understand each risk and its interaction with other risks. finance its assets completely with borrowed funds. moderate the long-tailed downside risk of the return distribution.

lower its average costs of operations by expanding its output of financial services.

As commercial banks move from their traditional banking activities of deposit taking and lending and shift more of their activities to trading, they are more subject to credit risk. market risk. political risk. sovereign risk. liquidity risk.

market risk.

The risk that a debt security's price will fall, subjecting the investor to a potential capital loss is credit risk. market risk. currency risk. liquidity risk. political risk.

market risk.

The gap ratio expresses the reprice gap for a given time period as a percentage of equity. total liabilities. current liabilities. total assets. current assets.

total assets.

This risk of default is associated with general economy-wide or macro conditions affecting all borrowers. Systematic credit risk. Firm-specific credit risk. Refinancing risk. Liquidity risk. Sovereign risk.

Systematic credit risk.

Credit scoring models include all of the following broad types of models EXCEPT Linear discriminant models. Linear probability models. Term structure models. Logit models.

Term structure models.

The yield curve relates rates for different maturities of assets. for U.S. Treasury securities is the most commonly reported yield curve. may change shape over time. which is inverted does not last very long. All of these.

All of these.

What is the essential idea behind RAROC? Evaluating the actual or contractually promised annual ROA on a loan. Analyzing historic or past default risk experience. Balancing expected interest and fee income less the cost of funds against the loan's expected risk. Extracting expected default rates from the current term structure of interest rates. Dividing net interest and fees by the amount lent.

Balancing expected interest and fee income less the cost of funds against the loan's expected risk.

Which of the following would one typically find in the trading portfolio of an FI? Cash, loans, and deposits. Premises and equipment. Relatively illiquid assets. Assets held for long holding periods. Bonds, equities, and derivatives.

Bonds, equities, and derivatives.

How can discriminant analysis be used to make credit decisions? By discriminating between good and bad borrowers. By using statistical analysis to predict the default probabilities. By using statistical analysis to isolate and weight factors to arrive at default risk classification of a commercial borrower. By using statistical analysis to bypass qualitative credit decision making. By updating FI bankruptcy experiences.

By using statistical analysis to isolate and weight factors to arrive at default risk classification of a commercial borrower.

According to Altman's credit scoring model, which of the following Z scores would indicate a low default risk firm? Less than 1. 1. Between 1 and 1.81. Between 1.81 and 2.99. Greater than 2.99.

Greater than 2.99.

Which of the following observations about the repricing model is correct? Its information value is limited. It accounts for the problem of rate-insensitive asset and liability runoffs and prepayments. It accommodates cash flows from off-balance-sheet activities. It helps to determine an FI's profit exposure to interest rate changes. It considers market value effects of interest rate changes.

It helps to determine an FI's profit exposure to interest rate changes.

Which of the following observations is true of a spot loan? It involves a maximum size and a maximum period of time over which the borrower can withdraw funds. It involves immediate withdrawal of the entire loan amount by the borrower. It is an unsecured short-term debt instrument issued by corporations. It is a nonbank loan substitute. It is a line of credit.

It involves immediate withdrawal of the entire loan amount by the borrower.

Which of the following statements does NOT reflect credit decisions at the retail level? Loans to retail customers are more likely to be rationed through interest rates than loan quantity restrictions. Most loan decisions at the retail level tend to be accept or reject decisions. Mortgage loans often are discriminated based on loan to price ratios rather than interest rates. Household borrowers require higher costs of information collection for lenders. Retail loans tend to be smaller than wholesale loans.

Loans to retail customers are more likely to be rationed through interest rates than loan quantity restrictions.

What is the least important factor determining bankruptcy, according to the Altman Z-score model? Working capital to assets ratio Retained earnings to assets ratio Earnings before interest and taxes to assets ratio Market value of equity to book value of long-term debt ratio Sales to assets ratio

Market value of equity to book value of long-term debt ratio

The BIS definition: "the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events," encompasses which of the following risks? Credit risk and liquidity risk Operational risk and technology risk Credit risk and market risk Technology risk and liquidity risk Sovereign risk and credit risk

Operational risk and technology risk

Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually.To what risk is the bank exposed? Reinvestment risk. Refinancing risk. Interest rate risk. Reinvestment risk and Interest rate risk. Refinancing risk and Interest rate risk.

Refinancing risk and Interest rate risk.

Which term refers to the risk that the cost of rolling over or re-borrowing funds will rise above the returns being earned on asset investments? Reinvestment risk. Credit risk. Refinancing risk. Liquidity risk. Sovereign risk.

Refinancing risk.

Which of the following is NOT characteristic of the consumer loans at U.S. banks? Non revolving consumer loans is the largest class of loans. Credit card loans often have default rates between four and eight percent. Usury ceilings affect the rate structure for consumer loans. Consumer loans differ widely with respect to collateral, rates, maturity, and noninterest fees. Revolving consumer loans include new and used automobile loans, mobile home loans, and fixed-term consumer loans.

Revolving consumer loans include new and used automobile loans, mobile home loans, and fixed-term consumer loans.

Which of the following relationships does NOT hold in the pricing of fixed-rate assets given changes in market rate? A decrease in interest rates generally leads to an increase in the value of assets. Longer maturity assets have greater changes in price than shorter maturity assets for given changes in interest rates. The absolute change in price per unit of maturity time for given changes in interest rates decreases over time, although the relative changes actually increase. For a given percentage decrease in interest rates, assets will increase in price more than they will decrease in price for the same, but opposite increase in rates. None of these.

The absolute change in price per unit of maturity time for given changes in interest rates decreases over time, although the relative changes actually increase.

What is spread effect? Periodic cash flow of interest and principal amortization payments on long-term assets that can be reinvested at market rates. The effect that a change in the spread between rates on RSAs and RSLs has on net interest income as interest rates change. The effect of mismatch of asset and liabilities within a maturity bucket. The premium paid to compensate for the future uncertainty in a security's value. The value of an FI to its owners.

The effect that a change in the spread between rates on RSAs and RSLs has on net interest income as interest rates change.

Which of the following is not a characteristic of a loan commitment? The maximum amount of the loan is negotiated at the time of the loan agreement. The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. Floating-rate loans transfer the interest rate risk to the borrower. The time period for which the loan is available is negotiated at the time of the loan agreement. In a floating-rate loan the borrower pays interest rate in force when the loan is actually taken down.

The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down.

If the loans in the bank's portfolio are all negatively correlated, what will be the impact on the bank's credit risk exposure? The loans' negative correlations will decrease the bank's credit risk exposure because lower than expected returns on some loans will be offset by higher than expected returns on other loans. The loans' negative correlations will increase the bank's credit risk exposure because lower than expected returns on some loans will be offset by higher than expected returns on other loans. The loans' negative correlations will increase the bank's credit risk exposure because higher returns on less risky loans will be offset by lower returns on riskier loans. The loans' negative correlations will decrease the bank's credit risk exposure because higher returns on less risky loans will be offset by lower returns on riskier loans. There is no impact on the bank's credit risk exposure.

The loans' negative correlations will decrease the bank's credit risk exposure because lower than expected returns on some loans will be offset by higher than expected returns on other loans.

What does the Moody's Analytics model use as equivalent to holding a call option on the assets of the firm? The value of equity in a firm. Total liabilities of a firm. Net income of a firm. Dividend yield of investments. Short-term debt liabilities of a firm.

The value of equity in a firm.

In making credit decisions, which of the following items is considered a market-specific factor? Whether the reputation of the borrower enhances the credit application. Whether the current debt-equity ratio is sufficiently low to not impact the probability of repayment. Whether the debt can be secured by specific property. Whether the position of the economy in the business cycle phase would affect the probability of borrower default. Whether the volatility of earnings could present a period where the periodic payment of interest and principal would be at risk.

Whether the position of the economy in the business cycle phase would affect the probability of borrower default.

When the assets and liabilities of an FI are not equal in size, efficient hedging of interest rate risk can be achieved by increasing the duration of assets and increasing the duration of equity. issuing more equity and reducing the amount of borrowed funds. not exactly matching the maturities of assets and liabilities. issuing more equity and investing the funds in higher-yielding assets. efficient hedging cannot be achieved without the use of derivative securities.

not exactly matching the maturities of assets and liabilities.

Borrower reputation is important in assessing credit quality because good past payment performance perfectly predicts future behavior. preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment. FIs only lend to customers they know. customers with poor credit histories always default on their loans. a reputation for honesty is important in credit appraisal.

preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment.

Marginal default probability refers to the probability that a borrower will default over a specified multiyear period. marginal increase in the default probability due to a change in credit premium. historic default rate experience of a bond or loan. expected maximum change in the loan rate due to a change in the credit premium. probability that a borrower will default in any given year.

probability that a borrower will default in any given year.

Cumulative default probability refers to probability that a borrower will default over a specified multiyear period. expected maximum change in the loan rate due to a change in the risk factor on the loan. historic default rate experience of a bond or loan. expected maximum change in the loan rate due to a change in the credit premium. probability that a borrower will default in any given year.

probability that a borrower will default over a specified multiyear period.

The risk that an investor will be forced to place earnings from a loan or security into a lower yielding investment is known as liquidity risk. reinvestment risk. credit risk. foreign exchange risk. off-balance-sheet risk.

reinvestment risk.

Politically motivated limitations on payments of foreign currency may expose an FI to sovereign country risk. interest rate risk. credit risk. foreign exchange risk. off-balance-sheet risk.

sovereign country risk.

Immunizing the balance sheet to protect equity holders from the effects of interest rate risk occurs when the maturity gap is zero. the repricing gap is zero. the duration gap is zero. the effect of a change in the level of interest rates on the value of the assets of the FI is exactly offset by the effect of the same change in interest rates on the liabilities of the FI. after-the-fact analysis demonstrates that immunization coincidentally occurred.

the effect of a change in the level of interest rates on the value of the assets of the FI is exactly offset by the effect of the same change in interest rates on the liabilities of the FI.

From the lender's point of view, debt can be evaluated as writing a call option on the borrower's assets with the exercise price equal to the face value of the debt. buying a call option on the borrower's liabilities with the exercise price equal to the market value of the debt. buying a put option on the borrower's assets with the exercise price equal to the face value of the debt. writing a put option on the borrower's assets with the exercise price equal to the face value of the debt. writing a put option on the borrower's liabilities with the exercise price equal to the market value of the debt.

writing a put option on the borrower's assets with the exercise price equal to the face value of the debt.

When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, the cumulative gap will be zero. one. greater than one. a negative value. infinity.

zero.

n which of the following situations would an FI be considered net long in foreign assets if it has ¥100 million in loans? ¥120 million in liabilities. ¥80 million in liabilities. ¥100 million in liabilities. ¥110 million in liabilities. Answers A and D only.

¥80 million in liabilities.