Chapter 07 Risk Management for Changing Interest Rates Asset-Liability Management and Duration Techniques PDF

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100 Test Bank , Chapter 7Chapter 7Risk Management for Changing Interest Rates: Asset-Liability Managementand Duration TechniquesFill in the Blank Questions The ___________________ view of assets and liabilities held that the amount and types of deposits was primarily determined by customers and henc...

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Chapter 7 Risk Management for Changing Interest Rates: Asset-Liability Management and Duration Techniques Fill in the Blank Questions 1. 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. Answer: asset management 2. Recent decades have ushered in dramatic changes in banking. The goal of __________________ was simply to gain control of the bank's sources of funds. Answer: liability management 3. The__________________________ is the interest rate that equalizes the current market price of a bond with the present value of the future cash flows. Answer: yield to maturity (YTM) 4. The __________________ risk 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. Answer: inflation 5. The __________________ shows the relationship between the time to maturity and the yield to maturity of a bond. It is usually constructed using treasury securities since they are assumed to have no default risk. Answer: yield curve 6. The __________________ risk premium on a bond reflects the differences in the ease and ability to sell the bond in the secondary market at a favorable price. Answer: liquidity 7. __________________________ are those assets which mature or must be repriced within the planning period. Answer: Interest-sensitive assets 8. __________________________ is the difference between interest-sensitive assets and interestsensitive liabilities. Answer: Dollar interest-sensitive gap

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9. A(n)__________________________ means that the bank has more interest-sensitive liabilities than interest-sensitive assets. Answer: negative interest-sensitive gap (liability sensitive) 10. 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. Answer: weighted interest-sensitive gap

11. __________________________ is the coordinated management of both the bank's assets and its liabilities. Answer: Funds management

12. __________________________ is the risk due to changes in market interest rates which can adversely affect the bank's net interest margin, assets and equity. Answer: Interest rate risk 13. The__________________________ is the rate of return on a financial instrument using a 360 day year relative to the instrument's face value. Answer: bank discount rate 14. 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. Answer: default risk premium 15. __________________ is the weighted average maturity for a stream of future cash flows. It is a direct measure of price risk. Answer: Duration

16. __________________________ is the difference between the dollar-weighted duration of the asset portfolio and the dollar-weighted duration of the liability portfolio. Answer: Duration gap 17. A(n)__________________________ duration gap means that for a parallel increase in all interest rates the market value of net worth will tend to decline. Answer: positive

18. A(n)__________________________ duration gap means that for a parallel increase in all interest rates the market value of net worth will tend to increase. Answer: negative

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19. The __________________ refers to the periodic fluctuations in the scale of economic activity. Answer: business cycle 20. The__________________________ is equal to the duration of each individual type of asset weighted by the dollar amount of each type of asset out of the total dollar amount of assets. Answer: duration of the asset portfolio 21. The__________________________ is equal to the duration of each individual type of liability weighted by the dollar amount of each type of asset out of the total dollar amount of assets. Answer: duration of the liability portfolio 22. A bank is __________________ against changes in its net worth if its duration gap is equal to zero. Answer: immunized (insulated or protected)

23. The relationship between a change in an asset's price and an asset’s change in the yield or interest rate is captured by __________________________. Answer: convexity

24. The change in a financial institution's __________________ is equal to difference in the duration of the assets and liabilities times the change in the interest rate divided by the starting interest rate times the dollar amount of the assets and liabilities. Answer: net worth 25. When a bank has a positive duration gap a parallel increase in the interest rates on the assets and liabilities of the bank will lead to a(n) __________________ in the bank's net worth. Answer: decrease

26. When a bank has a negative duration gap a parallel decrease in the interest rates on the assets and liabilities of the bank will lead to a(n)_________________________ in the bank's net worth. Answer: decrease 27. U.S. banks tend to do better when the yield curve is upward-sloping because they tend to have ____________ maturity gap positions. Answer: positive

28. One government-created giant mortgage banking firms which have subsequently been privatized

is the . Answer: FNMA or Fannie Mae (or FHLMC or Freddie Mac)

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29. 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. Answer: price risk 30. 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 before maturity are invested at a lower interest rate. Answer: reinvestment risk 31. When a borrower has the right to pay off a loan early which reduced the lender’s expected rate of return it is called . Answer: call risk 32. In recent decades, banks have aggressively sought to insulate their assets and liability portfolios and profits from the ravages if interest rate changes. Many banks now conduct their assetliability management strategy with the help of an which often meets daily. Answer: asset-liability committee

33.

is interest income from loans and investments less interest expenses on deposits and borrowed funds divided by total earning assets. Answer: Net interest margin (NIM)

34.

are those liabilities that which mature or must be repriced within the planning period. Answer: Interest-sensitive liabilities

35. Variable rate loans and securities are included as part of banks. Answer: repriceable assets

36. Money market deposits are included as part of Answer: repriceable liabilities

for

for banks.

37. Interest sensitive assets less interest sensitive liabilities divided by total assets of the bank is known as . Answer: relative interest sensitive gap

38. Interest sensitive assets divided by interest sensitive liabilities is known as Answer: Interest sensitivity ratio

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39.

is a measure of interest rate exposure which is the total difference in dollars between those assets and liabilities that can be repriced over a designated time period. Answer: Cumulative gap

40.

is the phenomenon that interest rates attached to various assets often change by different amounts and at different speeds than interest rates attached to various liabilities, Answer: basis risk

True/False Questions T

F 41. Usually the principal goal of asset-liability management is to maximize or at least stabilize a bank's margin or spread. Answer: True

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F 42. Asset management strategy in banking assumes that the amount and kinds of deposits and other borrowed funds a bank attracts are determined largely by its management. Answer: False

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F 43. The ultimate goal of liability management is to gain control over a financial institution's sources of funds. Answer: True

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F 44. If interest rates fall when a bank is in an asset-sensitive position its net interest margin will rise. Answer: False

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F 45. A liability-sensitive bank will experience an increase in its net interest margin if interest rates rise. Answer: False

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F 46. Under the so-called liability management view in banking the key control lever banks possess over the volume and mix of their liabilities is price. Answer: True

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F 47. Under the so-called funds management view bank management's control over assets must be coordinated with its control over liabilities so that asset and liability management are internally consistent. Answer: True

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F 48. Bankers cannot determine the level or trend of market interest rates; instead, they can only react to the level and trend of rates. Answer: True

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F 49. Short-term interest rates tend to rise more slowly than long-term interest rates and to fall more slowly when all interest rates in the market are headed down. Answer: False

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F 50. A financial institution is liability sensitive if its interest-sensitive liabilities are less than its interest-sensitive assets. Answer: False

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F 51. If a bank's interest-sensitive assets and liabilities are equal than its interest revenues from assets and funding costs from liabilities will change at the same rate. Answer: True

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F 52. Banks with a positive cumulative interest-sensitive gap will benefit if interest rates rise, but lose income if interest rates decline. Answer: True

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F 53. Banks with a negative cumulative interest-sensitive gap will benefit if interest rates rise, but lose income if interest rates decline. Answer: False

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F 54. For most banks interest rates paid on liabilities tend to move more slowly than interest rates earned on assets. Answer: False

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F 55. Interest-sensitive gap techniques do not consider the impact of changing interest rates on stockholders equity. Answer: True

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F 56. 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. Answer: False

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F 57. The yield curve is constructed using corporate bonds with different default risks so the bank can determine the risk/return tradeoff for default risk. Answer: False

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F 58. 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. Answer: True

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F 59. Financial institutions face two major kinds of interest rate risk. These risks include price risk and reinvestment risk. Answer: True

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F 60. Interest-sensitive gap and weighted interest-sensitive gap will always reach the same conclusion as to whether a bank is asset sensitive or liability sensitive. Answer: False

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F 61. Weighted interest-sensitive gap is less accurate than interest-sensitive gap in determining the affect of changes in interest rates on net interest margin. Answer: False

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F 62. A bank with a positive duration gap experiencing a rise in interest rates will experience an increase in its net worth. Answer: False

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F 63. A bank with a negative duration gap experiencing a rise in interest rates will experience an increase in its net worth. Answer: True

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F 64. Duration is a direct measure of the reinvestment risk of a bond. Answer: False

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F 65. A bank with a positive duration gap experiencing a decrease in interest rates will experience an increase in its net worth. Answer: True

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F 66. A bank with a negative duration gap experiencing a decrease in interest rates will experience an increase in its net worth. Answer: False

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F 67. Duration is the weighted average maturity of a promised stream of future cash flows. Answer: True

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F 68. Duration is a direct measure of the price risk of a bond. Answer: True

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F 69. A bond with a greater duration will have a smaller price change in percentage terms when interest rates change. Answer: False

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F 70. Long-term interest rates tend to change very little with the cycle of economic activity. Answer: True

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F 71. A bank with a duration gap of zero is immunized against changes in the value of net worth due to changes in interest rates in the market. Answer: True

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F 72. Convexity is the idea that the rate of change of an asset's price varies with the level of interest rates. Answer: True

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F 73. The change in the market price of an asset's price from a change in market interest rates is roughly equal to the asset's duration times the change the interest rate divided by the original interest rate. Answer: True

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F 74. U.S. banks tend to do better when the yield curve is upward-sloping. Answer: True

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F 75. Net interest margin tends to rise for U.S. banks when the yield curve is upward-sloping. Answer: True

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F 76. Financial institutions laden with home mortgages tend be immune to interest-rate risk. Answer: False

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F 77. If a Financial Institution's net interest margin is immune to interest-rate risk then so is its net worth. Answer: False

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Multiple Choice Questions 78. When is interest rate risk for a bank greatest? A) When interest rates are volatile. B) When interest rates are stable. C) When inflation is high. D) When inflation is low. E) When loan defaults are high. Answer: A 79. A bank’s IS GAP is defined as: A) The dollar amount of rate-sensitive assets divided by the dollar amount of rate-sensitive liabilities. B) The dollar amount of earning assets divided by the dollar amount of total liabilities. C) The dollar amount of rate-sensitive assets minus the dollar amount of rate-sensitive liabilities. D) The dollar amount of rate-sensitive liabilities minus the dollar amount of rate-sensitive assets. E) The dollar amount of earning assets times the average liability interest rate. Answer: C

80. According to the textbook, the maturing of the liability management techniques, coupled with more volatile interest rates, gave birth to the __________________ approach which dominates banking today. The term that correctly fills in the blank in the preceding sentence is: A) Liability management B) Asset management C) Risk management D) Funds management E) None of the above. Answer: D

81. The principal goal of interest-rate hedging strategy is to hold fixed a bank's: A) Net interest margin B) Net income before taxes C) Value of loans and securities D) Noninterest spread E) None of the above. Answer: A

82. A bank is asset sensitive if its: A) Loans and securities are affected by changes in interest rates. B) Interest-sensitive assets exceed its interest-sensitive liabilities. C) Interest-sensitive liabilities exceed its interest-sensitive assets. D) Deposits and borrowings are affected by changes in interest rates. E) None of the above. Answer: B

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83. The change in a bank's net income that occurs due to changes in interest rates equals the overall change in market interest rates (in percentage points) times _____________. The choice below that correctly fills in the blank in the preceding sentence is: A) Volume of interest-sensitive assets B) Price risk of the bank's assets C) Price risk of the bank's liabilities D) Size of the bank's cumulative gap E) None of the above. Answer: D

84. A bank with a negative interest-sensitive GAP: A) Has a greater dollar volume of interest-sensitive liabilities than interest-sensitive assets. B) Will generate a higher interest margin if interest rates rise. C) Will generate a higher interest margin if interest rates fall. D) A and B. E) A and C. Answer: E

85. The net interest margin of a bank is influenced by: A) Changes in the level of interest rates. B) Changes in the volume of interest-bearing assets and interest-bearing liabilities. C) Changes in the mix of assets and liabilities in the bank's portfolio. D) All of the above. E) A and B only. Answer: D

86. The discount rate that equalizes the current market value of a loan or security with the expected stream of future income payments from that loan or security is known as the: A) Bank discount rate B) Yield to maturity C) Annual percentage rate (APR) D) Add-on interest rate E) None of the above. Answer: B

87. The interest-rate measure often quoted on short-term loans and money market securities such as U.S. Treasury bills is the: A) Bank discount rate B) Yield to maturity C) Annual percentage rate (APR) D) Add-on interest rate E) None of the above Answer: A

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88. A bank whose interest-sensitive assets total $350 million and its interest-sensitive liabilities amount to $175 million has: A) An asset-sensitive gap of 525 million B) A liability-sensitive gap of $175 million C) An asset-sensitive gap of $175 million D) A liability-sensitive gap of $350 million E) None of the above. Answer: C 89. A bank has a 1-year $1,000,000 loan outstanding, payable in four equal quarterly installments. What dollar amount of the loan would be considered rate sensitive in the 0 – 90 day bucket? A) $0 B) $250,000 C) $500,000 D) $750,000 E) $1,000,000 Answer: B

90. A bank has Federal funds totaling $25 million with an interest rate sensitivity weight of 1.0. This bank also has loans of $105 million and investments of $65 million with interest rate sensitivity weights of 1.40 and 1.15 respectively. This bank also has $135 million in interest-bearing deposits with an interest rate sensitivity weight of .90 and other money market borrowings of $75 million with an interest rate sensitivity weight of 1.0. What is the weighted interest-sensitive gap for this bank? A) $50.25 B) $-15 C) -$50.25 D) $34.25 E) None of the above Answer: A

91. A bond has a face value of $1000 and five years to maturity. This bond has a coupon rate of 13 percent and is selling in the market today for $902. Coupon payments are made annually on this bond. What is the yield to maturity (YTM) for this bond? A) 13% B) 12.75% C) 16% D) 11.45% E) Cannot be calculated from the information given Answer: C

92. A treasury bill currently sells for $9,845, has a face value of $10,000 and has 46 days to maturity. What is the bank discount rate on this security? A) 12.49% B) 12.13% C) 12.30% D) 2%

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E) None of the above Answer: B

93.

The _______________ is determined by the demand and supply for loanable funds in the market. The term that correctly fills in the blank in the preceding sentence is: A) The yield to maturity B) ...