Exam 2

B. interest rate risk.

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

B. net short €10 million.

A U.S. bank has €40 million in assets and €50 million in CDs. All other assets and liabilities are in U.S. dollars. This bank is A. net long €10 million. B. net short €10 million. C. neither short nor long in €. D. net long -€10 million. E. net short -€10 million.

C. Operational risk.

A mortgage loan officer is found to have provided false documentation that resulted in a lower interest rate on a loan approved for one of her friends. The loan was subsequently added to a loan pool, securitized and sold. Which of the following risks applies to the false documentation by the employee? A. Market risk. B. Credit risk. C. Operational risk. D. Technological risk. E. Sovereign risk.

C. an increase

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

E. Insolvency risk.

A small local bank failed because a housing market collapse following the departure of the area's largest employer. What type of risk applies to the failure of the institution? A. Firm-specific risk. B. Technological risk. C. Operational risk. D. Sovereign risk. E. Insolvency risk.

E. Greater than 2.99.

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

D. higher duration and more cash flows.

All else equal, as compared to an annual payment fixed income security, a semi-annual payment security has a A. lower duration value and lower market value. B. higher duration but lower price sensitivity. C. lower duration and more cash flows. D. higher duration and more cash flows. E. none of the options.

D. foreign exchange risk.

An FI that finances a euro (€) loan with U.S. dollar ($) deposits is exposed to A. technology risk. B. interest rate risk. C. credit risk. D. foreign exchange risk. E. off-balance-sheet risk.

C. decreases in net interest income and decreases in the market value of equity when interest rates rise.

An FI that finances long-term fixed rate mortgages with short-term deposits is exposed to A. increases in net interest income and decreases in the market value of equity when interest rates fall. B. decreases in net interest income and decreases in the market value of equity when interest rates fall. C. decreases in net interest income and decreases in the market value of equity when interest rates rise. D. increases in net interest income and decreases in the market value of equity when interest rates rise. E. increases in net interest income and increases in the market value of equity when interest rates rise

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

An interest rate increase A. benefits the FI by increasing the market value of the FI's liabilities. B. harms the FI by increasing the market value of the FI's liabilities. C. harms the FI by decreasing the market value of the FI's liabilities. D. benefits the FI by decreasing the market value of the FI's liabilities. E. benefits the FI by decreasing the market value of the FI's assets.

E. Refinancing risk and interest rate 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? A. Reinvestment risk. B. Refinancing risk. C. Interest rate risk. D. Reinvestment risk and interest rate risk. E. Refinancing risk and interest rate risk.

B. $140,000. ($5,000,000 × 0.06) - ($4,000,000 × 0.04) = $300,000 - $160,000 = $140,000

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? A. $300,000. B. $140,000. C. $160,000. D. $280,000. E. $80,000.

A. The repricing model.

Because of its simplicity, smaller depository institutions still use this model as their primary measure of interest rate risk. A. The repricing model. B. The maturity model. C. The duration model. D. The convexity model. E. The option pricing model.

E. The interest rate risk is transferred to the borrower.

From the perspective of an FI, which of the following is an advantage of a floating-rate loan? A. Stable interest payments will be received throughout the loan period. B. The pre-specified interest rate remains in force over the loan contract period no matter what happens to market interest rates. C. The bank can request repayment of a loan at any time in the contract period. D. The default risk is completely eliminated. E. The interest rate risk is transferred to the borrower.

D. default risk and interest rate risk.

Holding corporate bonds with fixed interest rates involves A. default risk only. B. interest rate risk only. C. liquidity risk and interest rate risk only. D. default risk and interest rate risk. E. default and liquidity risk only.

E. -$25,000.

If interest rates decrease 50 basis points for an FI that has a gap of +$5 million, the expected change in net interest income is A. +$2,500. B. +$25,000. C. +$250,000. D. -$250,000. E. -$25,000.

A. -$112,500. (-$15,000,000) × (+0.0075) = -$112,500.

If interest rates increase 75 basis points for an FI that has a gap of -$15 million, the expected change in net interest income is A. -$112,500. B. +$112,500. C. +$1,125,0000. D. -$1,125,0000. E. -$150,000.

A. 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.

If the loans in the bank's portfolio are all negatively correlated, what will be the impact on the bank's credit risk exposure? A. 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. B. 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. C. 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. D. 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. E. There is no impact on the bank's credit risk exposure.

E. 8 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 A. 9 percent. B. 11 percent. C. 18 percent. D. 10 percent. E. 8 percent.

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

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

B. ¥80 million in liabilities.

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

E. probability that a borrower will default in any given year.

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

D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets.

Of the following institutions, which will be subject to refinancing risk within a particular reprice bucket? A. the market value of rate-sensitive liabilities is less than the market value of equity. B. the book value of rate-sensitive assets is greater than the book value of rate-sensitive liabilities. C. the market value of rate-sensitive assets is less than the market value of rate-sensitive liabilities. D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets. E. the book value of rate-sensitive assets is less than the book value of equity.

B. the book value of rate sensitive assets is greater than the book value of rate-sensitive liabilities.

Of the following institutions, which will be subject to reinvestment risk within a particular reprice bucket? A. the market value of rate-sensitive liabilities is less than the market value of equity. B. the book value of rate sensitive assets is greater than the book value of rate-sensitive liabilities. C. the market value of rate-sensitive assets is less than the market value of rate-sensitive liabilities. D. the book value of rate-sensitive liabilities is greater than the book value of rate-sensitive assets. E. the book value of rate-sensitive assets is less than the book value of equity.

A. sovereign country risk.

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

D. on which a borrower can both draw and repay many times over the life of the loan contract.

Revolving loans are credit lines A. that allow the borrower to borrow the repeat credit only after the first loan is repaid. B. that specify a maximum size and a maximum period of time over which the borrower can withdraw funds. C. whose interest rate adjusts with movements in an underlying market index interest rate. D. on which a borrower can both draw and repay many times over the life of the loan contract. E. that include new and used automobile loans, mobile home loans, and fixed-term consumer loans.

D. on which a borrower can both draw and repay many times over the life of the loan contract.

Revolving loans are credit lines A. that allow the borrower to borrow the repeat credit only after the first loan is repaid. B. that specify a maximum size and a maximum period of time over which the borrower can withdraw funds. C. whose interest rate adjusts with movements in an underlying market index interest rate. D. on which a borrower can both draw and repay many times over the life of the loan contract. E. that include new and used automobile loans, mobile home loans, and fixed-term consumer loans.

B. Operational risk and technology risk

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? A. Credit risk and liquidity risk B. Operational risk and technology risk C. Credit risk and market risk D. Technology risk and liquidity risk E. Sovereign risk and credit risk

B. the weighted-average of the liabilities where the weights are determined relative to the total liabilities of the FI.

The average maturity of the liabilities of an FI's balance sheet is equal to A. the weighted-average of the liabilities where the weights are determined relative to the total liabilities and equity of the FI. B. the weighted-average of the liabilities where the weights are determined relative to the total liabilities of the FI. C. the weighted-average of the liabilities where the weights are determined relative to the total assets of the FI. D. the weighted-average of the liabilities where the weights are determined using market values of liabilities. E. None of the options.

C. $15 million. 555 - 540 = $15 million

The cumulative one-year repricing gap (CGAP) for the bank is A. $25 million. B. $-140 million. C. $15 million. D. $-150 million. E. $-15 million look at chart

C. $140,000. Fees = 0.004 × 10,000,000 = $40,000 Spread = 0.01 × 10,000,000 = $100,000 One-year net income on loan = $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? A. $40,000. B. $100,000. C. $140,000. D. $180,000. E. $280,000.

D. total assets.

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

A. .015. CGAP ÷ Total Assets = $15 million ÷ $970 million = 0.015 or 1.546%.

The gap ratio is A. .015. B. -.015. C. .025. D. -.144. E. .154. look at chart

B. Market risk.

The increased opportunity for a bank to securitize loans into liquid and tradable assets is likely to affect which type of risk? A. Sovereign risk. B. Market risk. C. Insolvency risk. D. Technological risk. E. Interest rate risk.

B. Market risk.

The increased opportunity for a bank to securitize loans into liquid and tradable assets is likely to affect which type of risk? A. Sovereign risk. B. Market risk. C. Insolvency risk. D. Technological risk. E. Interest rate risk.

E. off-balance-sheet risk.

The major source of risk exposure resulting from issuance of standby letters of credit is A. technology risk. B. interest rate risk. C. credit risk. D. foreign exchange risk. E. off-balance-sheet risk.

B. market value of assets and the market value of liabilities.

The net worth of a bank is the difference between the A. value of retained earnings and the provision for loan losses. B. market value of assets and the market value of liabilities. C. book value of assets and book value of liabilities. D. rate-sensitive assets and rate-sensitive liabilities. E. None of the options.

E. off-balance-sheet risk.

The potential exercise of unanticipated contingencies can result in A. technology risk. B. interest rate risk. C. credit risk. D. foreign exchange risk. E. off-balance-sheet risk.

D. it does not recognize timing differences in cash flows within the same maturity grouping.

The repricing gap does not accurately measure FI interest rate risk exposure because A. FIs cannot accurately predict the magnitude change in future interest rates. B. FIs cannot accurately predict the direction of change in future interest rates. C. accounting systems are not accurate enough to allow the calculation of precise gap measures. D. it does not recognize timing differences in cash flows within the same maturity grouping. E. equity is omitted.

D. foreign exchange rate risk.

The risk that a German investor who purchases British bonds will lose money when trying to convert bond interest payments made in pounds sterling into euros is called A. liquidity risk. B. interest rate risk. C. credit risk. D. foreign exchange rate risk. E. off-balance-sheet risk.

C. insolvency 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 A. currency risk. B. sovereign risk. C. insolvency risk. D. liquidity risk. E. interest rate risk.

B. reinvestment risk.

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

B. sovereign risk.

The risk that many borrowers in a particular country fail to repay their loans as a result of a recession in that country relates to A. credit risk. B. sovereign risk. C. currency risk. D. liquidity risk. E. interest rate risk.

D. liquidity risk.

The risk that many depositors withdraw their funds from an FI at once is A. credit risk. B. sovereign risk. C. currency risk. D. liquidity risk. E. interest rate risk.

B. assumes that the yield curve reflects the market's current expectations of future short-term interest rates.

The unbiased expectations theory of the term structure of interest rates A. assumes that long-term interest rates are an arithmetic average of short-term rates. B. assumes that the yield curve reflects the market's current expectations of future short-term interest rates. C. recognizes that forward rates are perfect predictors of future interest rates. D. assumes that risk premiums increase uniformly with maturity. E. None of the options.

E. All of the options.

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

C. $555 million. (150 + 130 + 135 + 140) = $555.

Total one-year rate-sensitive assets is A. $540 million. B. $580 million. C. $555 million. D. $415 million. E. $720 million. look at chart

A. $540 million. (140 + 120 + 160 + 120) = $540.

Total one-year rate-sensitive liabilities is A. $540 million. B. $580 million. C. $555 million. D. $415 million. E. $720 million. look at chart

A. 1.59. Z = 1.4(0.40) + 1.09(0.12) + 1.50(0.60) = 0.56 + 0.1308 + 0.90 = 1.59

Using a modified discriminant function similar to Altman's, Burger Bank estimates the following coefficients for its portfolio of loans: Z = 1.4X1 + 1.09X2 + 1.5X3 where X1 = debt to asset ratio; X2 = net income and X3 = dividend payout ratio. What is the Z-score if the debt to asset ratio is 40 percent, net income is 12 percent, and the dividend payout ratio is 60 percent? A. 1.59. B. 1.48. C. 1.36. D. 1.28. E. 1.20.

B. The bank is exposed to interest rate increases and positioned to gain when interest rates decline.

What does Gotbucks Bank's 91-day gap positions reveal about the bank management's interest rate forecasts and the bank's interest rate risk exposure? A. The bank is exposed to interest rate decreases and positioned to gain when interest rates decline. B. The bank is exposed to interest rate increases and positioned to gain when interest rates decline. C. The bank is exposed to interest rate increases and positioned to gain when interest rates increase. D. The bank is exposed to interest rate decreases and positioned to gain when interest rates increase. E. Insufficient information.

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

What is the essential idea behind Risk-adjusted return on capital (RAROC) models? A. Evaluating the actual or contractually promised annual ROA on a loan. B. Analyzing historic or past default risk experience. C. Balancing expected interest and fee income less the cost of funds against the loan's expected risk. D. Extracting expected default rates from the current term structure of interest rates. E. Dividing net interest and fees by the amount lent.

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

What is the least important factor determining bankruptcy, according to the Altman Zscore model? A. Working capital to assets ratio B. Retained earnings to assets ratio C. Earnings before interest and taxes to assets ratio D. Market value of equity to book value of long-term debt ratio E. Sales to assets ratio

C. Earnings before interest and taxes to assets ratio.

What is the most important factor determining bankruptcy, according to the Altman Zscore model? A. Working capital to assets ratio. B. Retained earnings to assets ratio. C. Earnings before interest and taxes to assets ratio. ' D. Market value of equity to book value of long-term debt ratio. E. Sales to assets ratio.

D. 4.60 years.

What is the weighted average maturity of assets? A. 5.50 years. B. 6.40 years. C. 5.00 years. D. 4.60 years. E. 10.0 years. look at graph

C. 1.44 years.

What is the weighted average maturity of liabilities? A. 5.50 years. B. 6.40 years. C. 1.44 years. D. 1.30 years. E. 1.10 years. look at graph

D. Default risk.

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

E. Off-balance sheet risk.

What type of risk focuses upon future contingencies? A. Liquidity risk. B. Interest rate risk. C. Credit risk. D. Foreign exchange rate risk. E. Off-balance sheet risk.

D. Foreign exchange rate risk.

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

C. potentially harmful for those banks that have financed U.S. dollar assets with liabilities

When the U.S. dollar declines against European currencies, it is A. potentially harmful for European banks only. B. potentially harmful for U.S. banks only. C. potentially harmful for those banks that have financed U.S. dollar assets with liabilities denominated in European currencies. D. potentially harmful for those banks that have financed European currency assets with U.S. dollar liabilities. E. irrelevant for global banks.

D. the higher the loan amount, the lower the RAROC.

Which of the following completes the statement: All else equal, the higher the duration of a loan, A. the lower the current level of interest rates, the higher the RAROC. B. the lower the expected change in risk premium, the lower the RAROC. C. the higher the expected change in risk premium, the higher the RAROC. D. the higher the loan amount, the lower the RAROC. E. the lower the loan amount, the lower the RAROC.

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

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

C. Borrowers prefer fixed-rate loans to ARMs during periods of high interest rates.

Which of the following is NOT characteristic of the real estate portfolio for most banks? A. Commercial real estate mortgages have been the fastest growing component of real estate loans. B. Adjustable rate mortgages have rates that are periodically adjusted to some index. C. Borrowers prefer fixed-rate loans to ARMs during periods of high interest rates. D. Residential mortgages are the largest component of the real estate loan portfolio. E. The proportion of ARMs to fixed-rate mortgages can vary considerably over the rate cycle.

C. Borrowers prefer fixed-rate loans to ARMs during periods of high interest rates.

Which of the following is NOT characteristic of the real estate portfolio for most banks? A. Commercial real estate mortgages have been the fastest growing component of real estate loans. B. Adjustable rate mortgages have rates that are periodically adjusted to some index. C. Borrowers prefer fixed-rate loans to ARMs during periods of high interest rates. D. Residential mortgages are the largest component of the real estate loan portfolio. E. The proportion of ARMs to fixed-rate mortgages can vary considerably over the rate cycle.

E. All of the options.

Which of the following is a weakness of the repricing model to measure interest rate risk? A. Potential for overaggregation of assets and liabilities within each maturity bucket. B. It ignores how changes in interest rates affect the market value of assets and liabilities. C. It ignores the reinvestment of loan interest and principal payments that are reinvested at current market rates. D. It fails to recognize off-balance-sheet activities that may be rate-sensitive. E. All of the options.

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

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

A. Insolvency risk.

Which of the following may occur when a sufficient number of borrowers are unable to repay interest and principal on loans, thus causing an FI's equity to approach zero? A. Insolvency risk. B. Sovereign risk. C. Foreign exchange risk. D. Liquidity risk. E. Interest rate risk.

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

Which of the following observations about the repricing model is correct? A. Its information value is limited. B. It accounts for the problem of rate-insensitive asset and liability runoffs and prepayments. C. It accommodates cash flows from off-balance-sheet activities. D. It helps to determine an FI's profit exposure to interest rate changes. E. It considers market value effects of interest rate changes. 51

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

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

D. Covenants.

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

D. Historic default rate experience of a bond or loan.

Which of the following refers to the term "mortality rate"? A. The success rate of new investments. B. A one-period rate of interest expected on a bond issued at some date in the future. C. The probability that a borrower will default in any given year. D. Historic default rate experience of a bond or loan. E. The probability that a borrower will default over a specified multi-year period.

A. An FI issues $10 million of liabilities of one-year maturity to finance the purchase of $10 million of assets with a two-year maturity.

Which of the following situations pose a refinancing risk for an FI? A. An FI issues $10 million of liabilities of one-year maturity to finance the purchase of $10 million of assets with a two-year maturity. B. An FI issues $10 million of liabilities of two-year maturity to finance the purchase of $10 million of assets with a two-year maturity. C. An FI issues $10 million of liabilities of three-year maturity to finance the purchase of $10 million of assets with a two-year maturity. D. An FI matches the maturity of its assets and liabilities. E. All of the options

C. Reinvestment risk.

Which term refers to the risk that interest income will decrease as maturing assets are replaced with new, more current assets? A. Credit risk. B. Refinancing risk. C. Reinvestment risk. D. Liquidity risk. E. Sovereign risk.

C. Refinancing 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? A. Reinvestment risk. B. Credit risk. C. Refinancing risk. D. Liquidity risk. E. Sovereign risk.

A. The unbiased expectations theory.

Which theory of term structure posits that long-term rates are a geometric average of current and expected short-term interest rates? A. The unbiased expectations theory. B. The liquidity premium theory. C. The loanable funds theory. D. The market segmentation theory. E. None of the options.

D. decrease the value of fixed rate liabilities.

With regard to market value risk, rising interest rates A. increase the value of fixed rate liabilities. B. increase the value of fixed rate assets. C. increase the value of variable-rate assets. D. decrease the value of fixed rate liabilities. E. decrease the value of variable-rate assets