commercial banking
A bank wishes to sell $350 million in new 30-day time deposits next month. Today interest rates are 7 percent. However, in the next month interest rates are expected to rise to 7.75 percent. What is the potential loss in profit for the month from this increase in interest rates? (Use a 360 day year)
$0.21875 million
An investor purchases one September T-bond futures contract at 115-110. The settlement price for the contract on next day is 117-225. What is the marked-to-market gain/loss for the investor?
$2,359.38
Suppose a Eurodollar time deposit futures contract whose underlying's duration is 0.5 years and has a current market price of $950,000. Market interest rates are 8.5 percent and are expected to fall to 7.5 percent. What is the expected change in this futures contract's market price as a result of this change in interest rates?
$4,378
A Treasury Bond futures contract is selling in the market for $98,225 and has a duration of 8 years. The same Treasury Bond is selling in the cash market for $98,625 and has a duration of 8.25 years. What is the basis for this futures contract?
$400
The Kromwell Community Bank's asset portfolio has an average duration of 6 years and its liability portfolio has an average duration of 2.5 years. The bank has $500 million in total assets and $450 million in liabilities. The Kromwell Community Bank is thinking about hedging its risk by using a Treasury Bond futures contract whose underlying's duration is 7.5 years and has a price of $98,000. How many futures contracts will it need to hedge its risk?
2,551 contracts
A bond has a face value of $1,000 and coupon payments of $120 annually. This bond matures in three years and is selling in the market for $1,160. Market interest rate is 6 percent. What is this bond's duration?
2.71 years
A bank with a leverage-adjusted duration gap of 2 years and total assets of $100 million uses a futures contract whose underlying's duration is 5 years and has a price of $100,000 to hedge its exposure. The number of contracts needed is:
4,000
The ___________________ view of assets and liabilities held that the amount and types of deposits was primarily determined by customers and hence the key decision a bank needed to make was with the assets
Asset Management
ackson State Bank is worried because many of the loans it has made are home mortgages which can be paid off early by the homeowner. What type of risk would this be an example of?
Call risk
The daily settlement process that credits gains or deducts losses from a futures customer's account is called:
Correct marking-to-market
The __________________ premium on a bond allows the investor to be compensated for their projected loss in purchasing power from the increase in the prices of goods and services in the future.
Inflation Risk
The interest rate on one year Treasury Bonds is 5 percent. The interest rate on five year Treasury Bonds is 7.5 percent. The interest rate on ten year Treasury Bonds is 10 percent. What is true about the yield curve?
It is upward sloping.
Which of the following is a key advantage(s) of issuing standby letters of credit?
Letters of credit generate fee income for the bank. Letters of credit typically reduce the borrower's cost of borrowing. Letters of credit can usually be issued for a relatively low cost. The probability is low that the issuer of the letter of credit will be called upon to pay.
Recent decades have ushered in dramatic changes in banking. The goal of __________________ was simply to gain control of the bank's sources of funds.
Liabilities Management
The __________________ premium on a bond reflects the differences in the ease and ability to sell the bond in the secondary market at a favorable price.
Liquidity risk
The duration of a bond is the weighted average maturity of the future cash flows expected to be received on a bond. Which of the following statements concerning duration is true?
The longer the time to maturity, the greater the duration.
A bank is concerned about excess volatility in its cash flows from some recent business loans it has made. Many of these loans have a fixed rate of interest and the bank's economics department has forecast a sharp increase in interest rates. The bank wants more stable cash flows. Which type of credit derivative contract would you most recommend for this situation?
Total-return swap
A bank seeking to avoid lower than expected yields from loans and security investments is most likely to use:
a long position or buying hedge in futures.
A financial institution that sells a particular futures contract and later purchases the same contract back is executing:
a short hedge
The lesson from the credit crisis of 2007-2009 is that securitized assets and credit swaps:
are complex financial instruments. are difficult to correctly value and measure in terms of risk exposure. are a part of cyclically sensitive markets. possible vehicles to set in motion a financial contagion that cannot be easily stopped without active government intervention.
Current selling price on a futures contract reflects what investors in the market expect cash prices to be:
at the time of delivery.
A significant limitation to financial futures as an interest-rate hedging device is a special form of risk known as ___________ risk. Which of the following terms correctly completes the statement?
basis
_________________________ is the difference in interest rates (or prices) between the cash market and the futures market on an underlying security.
basis
is the phenomenon by which interest rates attached to various assets often change by different amounts and at different speeds than interest rates attached to various liabilities.
basis risk
The buyer of a(n) _________________________ option contract believes that the market price of the underlying security will increase in the future.
call
The interest-rate risk which arises when a borrower has the right to pay off a loan early reducing the lender's expected rate of return is called __________ .
call risk
The net interest margin of a bank is influenced by:
changes in the level of interest rates. changes in the volume of interest-bearing assets and interest-bearing liabilities. changes in interest income from loans and investments. changes in interest expense on deposits and other borrowed funds.
A relatively new type of credit derivative is a CDO which stands for ________________
collateralized debt obligations
The relationship between a change in an asset's price and an asset's change in the yield or interest rate is captured by __________________________.
convexity
A significant limitation to financial futures as an interest-rate hedging device is a special form of risk known as ___________ risk. Which of the following terms correctly completes the statement?
credit
A(n) __________________________ is related to a credit option and is usually aimed at lenders who are able to handle comparatively limited declines in value but want insurance against serious losses.
credit default swap
A(n) _______________ is an over-the-counter agreement offering protection against loss when default occurs on a loan or other debt instrument.
credit derivative
A financial institution plans to issue a group of bonds backed by a pool of automobile loans. However, they fear that the default rate on the automobile loans will rise well above 4 percent of the portfolio—the projected default rate. The financial institution wants to lower the interest payments if the loan default rate rises too high. Which type of credit derivative contract would you most recommend for this situation?
credit linked note
A bank is about to make a $50 million project loan to develop a new oil field and is worried that the petroleum engineer's estimates of the yield on the field are incorrect. The bank wants to protect itself in case the developer cannot repay the loan. Which type of credit derivative contract would you most recommend for this situation?
credit option
A(n) __________________ guards against the losses in the value of a credit asset. It would pay off if the asset declines significantly in value or if it completely turns bad.
credit option
A(n)__________________ rates the securities to be sold from a pool of securitized loans so that investors have a better idea of what the new securities are likely to be worth.
credit rating agency
A bank plans to offer new subordinated notes in the open market next month but knows that its credit rating is being reviewed by a credit rating agency. The bank wants to avoid paying sharply higher credit costs. Which type of credit derivative contract would you most recommend for this situation?
credit risk option
A bank has a limited geographic area of operations. It would like to diversify its loan income with loans in other market areas but does not want to actually make loans in those areas because of its limited experience in those areas. Which type of credit derivative contract would you most recommend for this situation?
credit swap
A(n) _________________________ occurs when two banks agree to exchange a portion or all of the loan repayments of their customers
credit swap
______________ is a measure of interest-rate risk exposure which is the total difference in dollars between those assets and liabilities that can be repriced over a designated time period.
cumulative gap
The __________________________ component of interest rates is the risk premium due to the probability that the borrower will miss some payments or will not repay the loan.
default-risk premium
__________________________ is the difference between the dollar-weighted duration of the asset portfolio and the dollar-weighted duration of the liability portfolio.
duration gap
A buyer of a put option on fixed-income securities is most likely to:
exercise the option if interest rates rise.
A financial institution with a negative gap can reduce the risk of loss due to changing interest rates by:
extending asset maturities. increasing short-term interest-sensitive liabilities. using financial futures or options contracts.
A financial institution is liability sensitive, if its interest-sensitive liabilities are less than its interest-sensitive assets.
false
A hedging tool that provides "one-sided" insurance against interest rate risk is the interest rate option, which, like financial futures contracts, obligates the parties to the contract to either deliver or take delivery of securities.
false
If interest rates fall when a bank is in an asset-sensitive position, its net interest margin will rise.
false
Interest rate caps protect the lender from falling interest rates.
false
Interest-sensitive gap, relative interest-sensitive gap, and the interest-sensitivity ratio will often reach different conclusions as to whether the bank is asset or liability sensitive.
false
Repriceable liabilities include long-term savings and retirement accounts.
false
The short hedge in financial futures contracts is most likely to be used in situations where a bank would suffer losses due to falling interest rates.
false
Virtually all banks in the U.S. use derivative contracts to hedge their risks.
false
A(n) _________________________ is an agreement between a buyer and a seller today which calls for the delivery of a particular security in exchange for cash at some future date for a set price.
financial futures contract
The maturing of the liability management techniques, coupled with more volatile interest rates, gave birth to the __________________ approach, which dominates banking today.
funds management
A bank is __________________ against changes in its net worth if its duration gap is equal to zero.
immunized
A(n)_________________________ protects the holder from rising market interest rates. It sets the maximum interest rate that a lender can charge on a floating-rate loan.
interest rate cap
A(n)_________________________ is where there is both a minimum and a maximum interest rate set on a loan.
interest rate collar
A(n)_________________________ protects the lender from falling interest rates. It is the minimum rate that the borrower must pay on a floating-rate loan.
interest rate floor
A(n)_________________________ is a contract where two parties exchange interest payments in order to save money and hedge against interest rate risks.
interest rate swap
A bank is liability sensitive, if its:
interest-sensitive liabilities exceed its interest-sensitive assets.
A bank that goes short in the futures market:
is obligated to make delivery of the underlying security at the contract price.
A bank has a long-term relationship with a particular business customer. However, recently the bank has become concerned because of a potential deterioration in the customer's income. In addition, regulators have expressed concerns about the bank's capital position. The business customer has asked for a renewal of its $25 million dollar loan with the bank. Which of the following can be used to help this situation?
loan sale
A(n)__________________________ means that the bank has more interest-sensitive liabilities than interest-sensitive assets.
negative interest-sensitive gap (liability sensitive)
________ is interest income from loans and investments less interest expenses on deposits and borrowed funds divided by total earning assets.
net interest margin (nim)
The principal goal of interest rate hedging strategy is to hold fixed a bank's:
net interest margin.
A(n)_________________________ allows the holder the right to either sell securities to another investor (put) or buy securities from another investor (call) at a set price before the expiration date.
option
A(n)_________________________ is the fee a buyer must pay to be able to put securities to, or to call securities away from the option writer.
option premium
One part of interest-rate risk is . This part of interest-rate risk reflects that as interest rates rise, prices of securities tend to fall.
price risk
The buyer of a(n) _________________________ option contract believes that the market price of the underlying security will decline in the future.
put
One part of interest-rate risk is . This part of interest-rate risk reflects that as interest rates fall, any cash flows that are received are invested at a lower interest rate.
reinvestment risk
Interest sensitive assets less interest sensitive liabilities divided by total assets of the bank is known as ________ .
relative interest sensitive gap
Securitization had its origin in the selling of securities backed by _____________.
residential mortgage loans
When a bank sets aside a group of income-earning assets and then sells securities based upon those assets, it is ________________________ those assets.
securitizing
Loans that are to be securitized are passed on to _____________.This helps ensure that if the lender goes bankrupt, it does not affect the credit status of the pooled loans.
special purpose entity
A(n) _________________________ is a contingent claim of the firm that issues it. The issuing firm, in return for a fee, guarantees the repayment of a loan received by its customer or the fulfillment of a contract made by its customer to a third party.
standby credit agreement
Assume that two firms, one considered a high credit risk (HCR) and the other a low credit risk (LCR), are considering an interest rate swap. Each can borrow at the following rates.An interest rate swap would be beneficial to both parties if:
the HCR firm wants to borrow at the fixed rate and the LCR firm wants to borrow at the variable rates
The gain or loss to a bank from the use of a financial futures contract depends upon:
the duration of the underlying security named in the futures contract. the initial futures price. the change expected in interest rates
A bank is concerned about excess volatility in its cash flows from some recent business loans it has made. Many of these loans have a fixed rate of interest and the bank's economics department has forecast a sharp increase in interest rates. The bank wants more stable cash flows. Which type of credit derivative contract would you most recommend for this situation?
total return swap
A(n) _________________________ guarantees the swap parties a specific rate of return on their credit assets. Bank A may agree to pay the total return on the loan to Bank B plus any appreciation in the market value of the loan. In return Bank A will often get LIBOR plus a fixed spread plus any depreciation in the value of the loan.
total return swap
When the FHLMC creates CMOs, they often use different _________________ to issue the securities, which are characterized by the differences in coupon rate, maturity and risk profile.
tranches
Convexity is a direct measure of the price risk of a bond.
true
Duration is the weighted average maturity of a promised stream of future cash flows.
true
Financial securities that are the same in all other ways may have differences in interest rates that reflect the differences in the ease of selling the security in the secondary market at a favorable price.
true
If it has a positive duration gap and interest rates rise, its net worth will decline.
true
Loan sales are generally viewed as a risk-reducing mechanism for the selling financial institution
true
Securitization is designed to turn illiquid loans into liquid assets in the form of securities sold in the open market.
true
The advantage of a credit swap is that it allows each bank in the swap to broaden its market area and spread out its credit risk on its loans.
true
The buyer of a participation loan must watch both the borrower and the seller bank closely.
true
The change in the market price of an asset due to a change in market interest rates is roughly equal to the asset's duration times the relative change in interest rates attached to that particular asset.
true
A financial institution that uses a long hedge is most likely:
trying to avoid lower than expected yields on from loans and securities.
If a bank has a positive interest-sensitive gap, one of the possible management responses would be to:
wait for the interest rates to rise or be stable.
The bank's__________________________ takes into account the idea that the speed (sensitivity) of interest rate changes will differ for different types of assets and liabilities.
weighted interest-sensitive gap
__________________________ is the difference between interest-sensitive assets and interest-sensitive liabilities.
Dollar interest-sensitive gap
__________________ is the weighted average maturity for a stream of future cash flows.
Duration
__________________________ is the coordinated management of both the bank's assets and its liabilities.
Funds Management
