Chapter 4 Risks of financial institutions PDF

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Chapter 4 Risks of financial institutions_Student: ____________________________________________________________________________1.If an FI is long-funded it means that the:A. maturity of assets equals the maturity of liabilities B. bank holds more long-term assets than short-term assets C. maturity o...

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Chapter 4 Risks of financial institutions Student: ___________________________________________________________________________

1.! If an FI is long-funded it means that the:

! A.! maturity of assets equals the maturity of liabilities B.! bank holds more long-term assets than short-term assets C.! maturity of liabilities is less than the maturity of assets D.! maturity of liabilities is longer than the maturity of its assets !

2.! An FI that invests $100 million into corporate bonds is exposed to the following risks:

! A.! credit and interest rate risk B.! liquidity and technology risk C.! solvency and technology risk D.! off-balance-sheet and interest rate risk !

3.! An FI that holds more short-term assets relative to long-term liabilities is:

! A.! exposed to refinancing risk B.! exposed to restructuring risk C.! exposed to reinvestment risk D.! not exposed to any risks !

4.! An example of refinancing risk is a case in which an FI:

! A.! funds two-year maturity assets with one-year maturity liabilities B.! funds one-year maturity assets with two-year maturity liabilities C.! funds two-year maturity assets with two-year maturity liabilities D.! None of the listed options are correct. !

5.! A decrease in interest rates means that the discount rate on cash flows is:

! A.! decreased and thus the market value of an FI's assets and liabilities decreases. B.! increased and thus the market value of an FI's assets and liabilities decreases.

C.! increased and thus the market value of an FI's assets and liabilities increases. D.! decreased and thus the market value of an FI's assets and liabilities increases. !

6.! An increase in interest rates means that the discount rate on cash flows is:

! A.! decreased and thus the market value of an FI's assets and liabilities decreases B.! increased and thus the market value of an FI's assets and liabilities decreases C.! increased and thus the market value of an FI's assets and liabilities increases D.! decreased and thus the market value of an FI's assets and liabilities increases !

7.! Market risk is defined as the risk:

! A.! incurred by granting loans to companies that do not hold a large market share B.! incurred in the trading of assets and liabilities due to changes in interest rates, exchange rates and other asset prices C.! that a sudden surge in liability withdrawals may require FIs to liquidate assets at less than fair market prices D.! that an FI loses market share !

8.! The market risk of an FI increases with:

! A.! increasing volatility of asset prices B.! increasingly large unhedged short positions in bonds, equities and other commodities C.! increasingly large unhedged long positions in bonds, equities and other commodities D.! All of the listed options are correct. !

9.! Why are depository institutions and life insurance companies more exposed to credit risk than, for instance, money market managed funds and general insurance companies?

! A.! Because the average maturities of their assets are longer than those of money market managed funds/general insurance companies. B.! Because the average maturities of their assets are shorter than those of money market managed funds/general insurance companies. C.! They are not exposed to more risk. D.! Because they are not specialised in credit risk management. !

10.! Non-performing loans are defined as loans that:

! A.! are either in default or close to being in default and are at least 90 days in arrears B.! have been written off and loans that are at least 80 days in arrears C.! are either in default or close to being in default and are at least 60 days in arrears

D.! have been written off and loans that are at least 60 days in arrears !

11.! What does systematic credit risk mean?

! A.! The risk of default of the borrowing firm that arises from the borrowing firm's specific projects. B.! The risk of default associated with microeconomic conditions affecting some borrowers. C.! The risk of default associated with general macroeconomic conditions affecting all borrowers. D.! The risk of default associated with general macroeconomic conditions affecting some borrowers. !

12.! The major difference between firm-specific credit risk and systematic credit risk is that:

! A.! FIs can diversify systematic credit risk, while firm-specific credit risk cannot be diversified. B.! FIs can diversify firm-specific credit risk, while systematic credit risk cannot be diversified. C.! None of the listed options are correct, as FIs can diversify both types of credit risk. D.! None of the listed options are correct, as FIs cannot diversify either type of credit risk. !

13.! can be reduced by diversification.

! A.! Firm-specific credit risk B.! Systematic credit risk C.! Firm-specific and systematic credit risks D.! None of the listed options are correct. !

14.! A high-quality loan book for Australian banks during the global financial crisis (GFC) meant that:

! A.! their non-performing loans as a percentage of their total domestic loan portfolio fell during the GFC B.! their non-performing loans as a percentage of their total domestic loan portfolio increased above 2 per cent during the GFC C.! Australian banks' profitability fell and Australian FIs were severely impacted by the GFC D.! Australian banks' profitability was maintained and Australian FIs were not severely impacted by the GFC !

15.! Which of the following are typical off-balance-sheet activities?

! A.! letters of credit B.! loan commitments C.! forward contracts, swaps and other derivative securities D.! All of the listed options are correct. !

16.! What are the major objectives of technological expansion?

! A.! To lower operating costs, increase profits and capture new markets. B.! To stabilise operating costs, increase profits and capture new markets. C.! To lower operating costs, stabilise profits and capture new markets. D.! To lower operating costs, increase profits and stabilise the existing market share. !

17.! What type of risk focuses upon future contingencies?

! A.! liquidity risk B.! interest rate risk C.! credit risk D.! off-balance-sheet risk !

18.! Which of the following is a suitable description of the term 'economies of scope'?

! A.! the use of several inputs to produce one common output B.! the ability to generate cost savings by producing more than one output with the same inputs C.! the ability to lower average operating costs by expanding its output of financial services D.! the ability to lower average operating costs by lowering its output of financial services !

19.! Which of the following is a suitable description of the term 'economies of scale'?

! A.! the use of several inputs to produce one common output B.! the ability to generate cost savings by producing more than one output with the same inputs C.! the ability to lower average operating costs by expanding its output of financial services D.! the ability to lower average operating costs by lowering its output of financial services !

20.! Which of the following are typical operational risk sources?

! A.! employee fraud B.! back-office failures C.! general technological glitches D.! All of the listed options are correct. !

21.! In which of the following situations is an Australian FI exposed to a depreciation of the euro against the Australian dollar?

! A.! The FI holds !00 million in assets and !70 million in liabilities.

B.! The FI holds !100 million in assets and !100 million in liabilities.

C.! The FI holds 70 million in assets and !100 million in liabilities.

D.! The FI does not hold any assets or liabilities in euros, but considers doing so in the future.

!

22.! An Australian FI that invests !50 million in three-year maturity loans and partially funds these loans with !30 million one-year deposits is exposed to the following risks.

! A.!A depreciation of the euro against the Australian dollar plus credit risk plus refinancing risk, such as increasing interest rates in the Eurozone. B.!An appreciation of the euro against the Australian dollar plus credit risk plus refinancing risk, such as increasing interest rates in the Eurozone. C.!A depreciation of the euro against the Australian dollar plus credit risk plus reinvestment risk, such as decreasing interest rates in the Eurozone. D.!A depreciation of the euro against the Australian dollar reinvestment risk, such as increasing interest rates in the Eurozone. !

23.! Sovereign risk refers to the risk that repayments from:

! A.! local borrowers are interrupted because of interference from foreign governments B.! foreign borrowers are interrupted because of interference from local governments C.! foreign borrowers are interrupted because of interference from foreign governments D.! None of the listed options are correct. !

24.! Which of the following is an effective measure for claimholders if a foreign government prohibits repayment of debt obligations to an international lender?

! A.! The claimholder can recover its outstanding debt through local courts. B.! The claimholder can recover its outstanding debt through international courts C.! The claimholder cannot do anything. D.! The claimholder has limited recourse through normal legal channels but may exert leverage if it has control over future loans or supply of funds.

!

25.! Unanticipated diseconomies of scale and scope are a result of:

! A.! technology risk B.! interest rate risk C.! foreign exchange risk D.! credit risk !

26.! 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.! off-balance-sheet risk !

27.! Politically motivated limitations on payments of foreign currency may expose the FI to:

! A.! sovereign or country risk B.! interest rate risk C.! credit risk D.! foreign exchange risk !

28.! The risk that a debt security's price will fall, subjecting the investor to a capital loss is:

! A.! credit risk B.! political risk C.! currency risk D.! market risk !

29.! The risk that interest income will increase at a slower rate than interest expense is:

! A.! credit risk B.! political risk C.! currency risk D.! interest rate risk !

30.!

The risk that borrowers are unable to repay their loans on time is called:

! A.! credit risk B.! sovereign risk C.! currency risk D.! liquidity risk !

31.! A letter of credit is:

! A.! a credit guarantee issued by an FI's customer to pay a predetermined amount of money to the FI at a future point in time B.! an on-balance-sheet transaction for the issuing FI C.! a credit guarantee issued by an FI on which payment is contingent on some future event occurring D.! None of the listed options are correct. !

32.! A bank has liabilities of $4 million with an average maturity of two years paying interest rates of 4 per cent annually. It has assets of $5 million with an average maturity of five years earning interest rates of 6 per cent annually. To what risk is the bank exposed?

! A.! reinvestment risk B.! refinancing risk C.! interest rate risk D.! refinancing risk and interest rate risk !

33.! Matching the foreign currency book protects the FI from:

! A.! sovereign country risk B.! interest rate risk C.! liquidity risk D.! foreign exchange risk !

34.! An FI that finances a German euro loan with US dollar deposits is exposed to:

! A.! technology risk B.! interest rate risk C.! credit risk D.! foreign exchange risk !

35.! An example of a discrete risk is sudden changes in:

! A.! the interest rate B.! banking regulations C.! foreign exchange rates D.! commodity prices !

36.! Event risks such as earthquakes, fraud and theft:

! A.! do not have an impact on an FI's performance B.! are easy to measure and to predict C.! form a normal cost of doing business for FIs D.! may have a significant and negative impact on an FI's performance but are difficult to measure and to predict !

37.! During periods of high and volatile inflation, an FI's:

! A.! interest rate risk exposure and credit risk exposure tends to decrease B.! interest rate risk exposure and credit risk exposure tends to increase C.! interest rate risk exposure and credit risk exposure tends to be unaffected D.! None of the listed options are correct. !

38.! An FI with a low level of leverage, such as a high level of capitalisation:

! A.! is generally less profitable B.! is better able to withstand losses C.! has improved ability to remain solvent D.! All of the listed options are correct. !

39.! Credit risk puts both the principal loaned and expected interest payments at risk. As a result, FIs issue financial claims that have a risk–return profile with:

! A.!high probability of fixed upside return B.!high probability of large downside risk C.!low probability of large downside risk D.!both high probability of fixed upside return and low probability of large downside risk !

40.! The collapse of the US bank IndyMac Bank was an example of:

! A.! market risk B.! operational risk C.! insolvency risk

D.! insolvency and liquidity risk !

41.! Technological risk:

! A.! can only lead to an FI's short-term distress B.! refers to the scenario that technological investments produce the anticipated cost savings C.! can result in major losses and the long-term viability of the FI D.! refers to the scenario that technological investments do not produce the anticipated savings, and can cause major losses and impact on the viability of the FI !

42.! The Bank for International Settlements:

! A.! defines operational risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and systems or from external events B.! does not include technology risk in its categorisation of operational risk C.! is the principal organisation of central banks in the minor economies of the world D.! All of the listed options are correct. !

43.! 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, securitised 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 !

44.! Which function of an FI involves buying primary securities and issuing secondary securities?

! A.! brokerage B.! asset transformation C.! investment research D.! trading !

45.! 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.! currency risk D.! liquidity risk !

46.! 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 !

47.! The increased opportunity for a bank to securitise 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 !

48.! 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 twoyear maturity. B.! An FI issues $10 million of liabilities of two-year maturity to finance the purchase of $10 million of assets with a twoyear maturity. C.! An FI issues $10 million of liabilities of three-year maturity to finance the purchase of $10 million of assets with a twoyear maturity. D.! An FI matches the maturity of its assets and liabilities. !

49.! 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 !

50.! The major source of risk exposure resulting from issuance of standby letters of credit is:

! A.! interest rate risk B.! credit risk

C.! foreign exchange risk D.! off-balance-sheet risk !

51.! The positive difference between an FI's contingent liabilities and contingent assets represents:

! A.! an additional obligation, or claim, on the FI's net worth B.! an additional profit for the FI C.! an increase in assets D.! None of the listed options are correct. !

52.! The potential exercise of unanticipated contingencies can result in:

! A.! technology risk B.! interest rate ris. C.! credit risk D.! off-balance-sheet risk !

53.! Matching the foreign currency book does not protect the FI from:

! A.! sovereign country risk B.! interest rate risk C.! liquidity risk D.! foreign exchange risk !

54.! A small local bank failed because of 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.! insolvency risk !

55.! Interest rate risk is the risk incurred by an FI when the maturities of its assets and liabilities are mismatched.

! True!!!!False !

56.!

An FI that only operates domestically is never exposed to foreign exchange rate risk.

! True!!!!False !

57.! An FI that matches the maturities of its assets and liabilities is perfectly hedged against interest rate risk.

! True!!!!False !

58.! A short-funded FI is exposed to increasing interest rates.

! True!!!!False !

59.! When analysing an FI's performance, it is not important to consider its off-balance-sheet activities as they have no current or future impact on the FI's financial standing.

! True!!!!False !

60.! Firm-specific credit risk can be reduced by diversification.

! True!!!!False !

61.! Systematic credit risk can be reduced by diversification.

! True!!!!False !

62.! Credit risk refers to the possibility that promised cash flows on financial claims such as loans and securities are not paid in full.

! True!!!!False !

63.! Economies of scope imply an FI's ability to lower its average cost by expanding its output of financial services.

!

True!!!!False !

64.! Technological failure, employee fraud and employee errors are all sources of operational risk.

! True!!!!False !

65.! An Australian FI that holds a net short asset position in $US is exposed to foreign exchange rate risk if the $US appreciates against the $A over the investment period.

!

True!!!!False !

66.! A 'fire-sale' means that an FI increases its liquidity position by selling part of its assets at the assets' fair market values.

!

True!!!!False !

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