Financial Markets and Institutions
Midterm Exam
Course Introduction
This course provides an in-depth examination of the structure, function, and role of financial markets and institutions within the global economy. Students will explore various types of financial markets including money, capital, and derivative markets and analyze the operations and significance of key financial institutions such as commercial banks, investment firms, insurance companies, and central banks. The course covers the mechanisms of financial intermediation, regulatory frameworks, risk management strategies, and the impact of monetary policy on financial systems. Emphasis is placed on understanding the dynamic interactions between financial institutions, market participants, and the broader economic environment.
Recommended Textbook
Financial Institutions Management 3rd Edition by Lange
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Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) An example of negative externality is the costs faced by small businesses in a one-bank town if the local bank fails.
A)True
B)False
Answer: True
Q2) Why do households prefer to use FIs as intermediaries to invest their surplus funds?
A)Transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information.
B)To receive the benefits of diversification that households may not be able to achieve on their own.
C)The FI can benefit from combining funds and negotiating lower asset prices and transaction costs.
D)All of the listed options are correct.
Answer: D
Q3) FIs play a significant role in the transmission of monetary policy.
A)True
B)False
Answer: True
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3
Chapter 2: The Financial Services Industry: Depository
Institutions
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Sample Questions
Q1) PAIRS provides APRA with a score-card approach to assessing the risk of FI failure and the impact of any failure by detailing the 12 risk elements separately and disclosing the result to the FI being investigated.
A)True
B)False
Answer: False
Q2) Which of the following statements is true?
A)Off-balance-sheet transactions for Australian banks include direct credit substitutes, interest rate derivative contracts and foreign exchange derivative contracts.
B)On-balance-sheet transactions for Australian banks include direct futures and forward contracts.
C)Off-balance-sheet transactions for Australian banks include the commercial loans and term-deposits.
D)All of the listed options are correct.
Answer: A
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Chapter 3: The Financial Services Industry: Other Financial Institutions
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Sample Questions
Q1) Which of the following statements is true?
A)Australian governments have encouraged national savings through superannuation.
B)The government has provided taxation incentives aimed at increasing voluntary contributions to superannuation by both employers and employees.
C)The government has introduced legislative requirements forcing employers to contribute to superannuation on behalf of their employees.
D)All of the listed options are correct.
Answer: D
Q2) Which of the following statements is true with regard to the regulation of money market corporations?
A)Money market corporations are unregulated.
B)APRA is the primary regulator for money market corporations.
C)ASIC is the primary regulator for money market corporations.
D)The ACCC is the primary regulator for money market corporations.
Answer: C
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Page 5
Chapter 4: Risk of Financial Institutions
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Sample Questions
Q1) 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.
Q2) Economies of scope imply an FI's ability to lower its average cost by expanding its output of financial services.
A)True
B)False
Q3) 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 100 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.
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Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Sample Questions
Q1) The repricing model ignores information regarding the distribution of assets and liabilities within maturity buckets.This limitation of the model refers to:
A)market value effect.
B)over-aggregation.
C)runoffs and pre-payments.
D)off-balance sheet activities.
Q2) The repricing gap focuses on the interest income effect.
A)True
B)False
Q3) Which of the following statements is true?
A)Cheque accounts are a type of interest-sensitive asset.
B)Cheque accounts are a type of interest-sensitive liability.
C)There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive asset.
D)There are strong arguments for and against the inclusion of cheque accounts as a type of interest-sensitive liability.
Q4) An FI with a positive repricing gap expects interest rates to decrease.
A)True
B)False
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Chapter 6: Interest Rate Risk Measurement: The Duration
Model
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Sample Questions
Q1) Consider a consol bond with a required yield to maturity of 9 per cent.What is the consol bond's duration (round to two decimals)?
A)Infinite as the bond has no maturity
B)0 years
C)9.33 years
D)12.11 years
Q2) When does 'duration' become a less accurate predictor of expected change in security prices?
A)As interest rate shocks increase in size.
B)As interest rate shocks decrease in size.
C)When maturity distributions of an FI's assets and liabilities are considered.
D)As inflation decreases.
Q3) The duration of an asset or a liability for which there are intervening cash flows between issue and maturity:
A)equals the asset or the liability's maturity.
B)exceeds the asset or the liability's maturity.
C)is smaller than the asset or the liability's maturity.
D)Not enough information to answer this question.
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Chapter 7: Managing Interest Rate Risk Using Off Balance
Sheet Instruments
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Sample Questions
Q1) Which of the following statements is true?
A)In a spot contract the buyer and seller enter into a contract at time 0, the contract is marked-to-market, the seller agrees on a price at time 0 and the bonds is delivered by the seller to the buyer 'at that time'.
B)In a spot contract the buyer and seller agree on a price at time 0 and the bonds is delivered by the seller at a future point in time, e.g.after three months.
C)In a spot contract the buyer and on a daily basis, and the buyer pays the spot price quoted at expiry.
D)None of the listed options are correct.
Q2) An undeliverable futures contract refers to a futures contract in which:
A)there is no physical settlement.
B)there is no mandatory cash settlement.
C)one of the parties is unable to deliver.
D)money has been lost due to a party having chosen an unfavourable hedging strategy.
Q3) Explain the differences between using futures and options contracts to hedge interest rate risk.Use diagrams where possible to support your points.
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Page 9
Chapter 8: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) Besides reducing credit risks, an FI has an incentive to sell loans it originates for all of the following reasons except to:
A)geographically diversify.
B)decrease core deposits.
C)lower reserve requirements.
D)lower capital requirements.
Q2) Which statement is not true with respect to loan sales?
A)Are one way used by FI managers to restructure their balance sheet.
B)Can change the interest rate sensitivity of the FI's balance sheet.
C)Can be used to manage FI's interest rate risk.
D)None of the listed options are correct.
Q3) Collateralised debt obligation (CDO) is:
A)an asset-backed bond issued in multiple classes or tranches.
B)a mortgage issued in multiple classes or tranches.
C)unsecured notes issued in multiple classes or tranches.
D)commercial paper issued with collateral.
Q4) What are four reasons why an FI may prefer the use of either pass-through securities or CMOs to the use of MBBs?
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Page 10
Chapter 9: Market Risk
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Sample Questions
Q1) Which of the following statements is true?
A)Daily earnings at risk are defined as the dollar market value of a position plus the price sensitivity of the position plus the potential adverse move in yield.
B)Daily earnings at risk are defined as the dollar market value of a position multiplied by the price sensitivity of the position multiplied by the potential adverse move in yield.
C)Daily earnings at risk are defined as (the dollar market value of a position plus the price sensitivity of the position) multiplied by the potential adverse move in yield.
D)Daily earnings at risk are defined as the dollar market value of a position divided by (the price sensitivity of the position plus the potential adverse move in yield).
Q2) Reasons why market risk measurement is important include:
A)management information.
B)resource allocation.
C)performance evaluation.
D)All of the listed options are correct.
Q3) Why is market risk measurement important?
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Chapter 10: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) Which of the following statements in relation to Altman's discriminant function is true?
A)The higher the Z score the higher the probability of default.
B)The loan size does not influence the result of the Altman Z score model.
C)The size of the borrower does not influence the result of the Altman Z score model.
D)The Altman Z score model always produces an exact reject or accept decision.
Q2) Explain the major concept of Altman's linear discriminant model.What would you consider to be the major disadvantages of this model?
Q3) Assume that f<sub>1</sub> = 13.50 per cent and c<sub>1</sub> = 17.40 per cent.Which of the following statements is true?
A)The expected default probability of repayment is 96.10 per cent.
B)The expected probability of repayment is 3.32 per cent.
C)The one-year rate expected on corporate securities one year into the future is 13.50 per cent.
D)The current one-year rate on corporate securities is 17.40 per cent.
Q4) Explain the concept of RAROC and the major role RAROC models play in credit risk analysis.
Q5) What are the major ideas behind KMV's Credit Monitor Model?
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
Risk
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Sample Questions
Q1) Loan sales and securitisation are increasingly seen as valuable tools in the management of credit risk.Which of the following are not advantageous to FIs?
A)Loan sales and securitisation allow FIs to better manage their customer relationships.
B)Loan sales and securitisation create moral hazard issues and reduce scrutiny of off-balance sheet activities of FIs.
C)Loan sales and securitisation reduce FIs industry and/or geographical concentration risk.
D)Loan sales and securitisation allow FIs to separate their credit risk exposure from the lending process itself.
Q2) Financial institutions do not use options to hedge credit risk exposures as credit risk is a natural risk that comes with the core activities of the bank, namely lending. A)True
B)False
Q3) Explain the basic concept of loan loss ratio based models.
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13
Chapter 12: Sovereign Risk
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Sample Questions
Q1) Which of the following statements is true in relation to the Economist Intelligence Unit?
A)The Economist Intelligence Unit rates country risk by combined economic and political risk on a maximum of 100 points scale.
B)The Economist Intelligence Unit rates the risk based on the spread in the Euromarket of the required interest rate on a country's debt over the LIBOR.
C)The Economist Intelligence Unit weighs subjective scores allocated by rating officers by the exposure of each bank to the country in question.
D)None of the listed options are correct.
Q2) Which of the following statements is true?
A)The investment ratio is the ratio of a country's total investments to its GDP.
B)The investment ratio is the ratio of a country's real investments to its total foreign currency obligations.
C)The investment ratio is the ratio of a country's total investments to its imports.
D)None of the listed options are correct.
Q3) What are the costs and benefits of rescheduling for the lenders and for the borrowers?
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Page 14
Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Which of the following statements is true?
A)FX trading is becoming increasingly popular globally.
B)FX trading has become redundant due to stable foreign exchange rates.
C)FX trading is a popular tool to generate profits, as there is little risk involved.
D)The number of FX traders has decreased over the years due to merger activities and as a consequence the number of FX transactions has decreased over time.
Q2) Which of the following are common FX trading activities?
A)The purchase and sale of foreign currencies for speculative purposes through forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers (or the FI itself) to take positions in foreign real and financial investments.
C)The purchase and sale of foreign currencies for hedging purposes to offset customer (or FI) exposure in any given currency.
D)All of the listed options are correct.
Q3) Explain how forward contracts can be used to hedge an FI's FX exposures.
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15
Chapter 14: Liquidity Risk
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Sample Questions
Q1) Which of the following statements is true?
A)In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
B)In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
C)In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.
D)In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.
Q2) APRA requires every FI to hold sufficient liquid assets to meet a name crisis situation.
A)True
B)False
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Chapter 15: Liability and Liquidity Management
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Q1) Which of the following procedures does APRA require to be adopted by FIs as part of their liquidity management strategies?
A)Liquidity management policy approved by the board.
B)Procedures for assessing and measuring liquidity.
C)A formal contingency plan for dealing with a liquidity crisis.
D)All of the listed options are correct.
Q2) Graphically show the relationship between funding cost and funding or withdrawal risk.Explain your graph.
Q3) The challenge of liquidity management is to maintain enough liquidity to avoid a crisis but to sacrifice no more earnings than absolutely necessary.
A)True
B)False
Q4) Potential sources of liquidity include investment in:
A)housing loans.
B)new equipment.
C)short-term securities such as treasury notes and bank accepted bills.
D)housing loans and investment in bank accepted bills.
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17
Chapter 16: Off-Balance-Sheet Activities
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Sample Questions
Q1) The 'face value of an OBS item' is also referred to as the notional value.
A)True
B)False
Q2) Assume a bank has bought a call option on bonds with a notional value of $200.Further assume that and that the delta of the option is calculated at 0.45.What is the contingent asset value (round to two decimals)?
A)$200 / 0.45 = $444.44
B)$200 * 0.45 = $90.00
C)($200 / 0.45) / 100 = $4.44
D)($200 * 0.45) / 100 = $0.90
Q3) Which of the following statements is true?
A)For an in-the-money call option the price of the underlying security is below the option's exercise price.
B)For an in-the-money call option the price of the underlying security is equal to the option's exercise price.
C)For an in-the-money call option the price of the underlying security exceeds the option's exercise price.
D)The answer to the question depends on the type of the call option.
Q4) Briefly explain how off-balance-sheet transactions can affect an FI's solvency.
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Chapter 17: Technology and Other Operational Risk
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Sample Questions
Q1) According to KPMG there has been a decline in the number of credit cards on issue, while there was no slow-down in transaction activity.
A)True
B)False
Q2) Some of the most important retail payment product innovations are:
A)ATMs, EFTPOS and online banking.
B)home banking, telephone banking and business-to-business ecommerce.
C)online banking, smart cards and account reconciliation.
D)All of the listed options are correct.
Q3) Diseconomies of scope refers to the:
A)fall in an FI's average costs of production as its output increases.
B)increase in an FI's average costs of production as its output increases.
C)situation in which the costs of joint production of FI services are higher than they would be if they were produced independently.
D)ability of an FI to generate synergistic cost savings through joint use of inputs in producing multiple outputs.
Q4) Inputs such as capital and labour cannot be jointly used by FIs.
A)True
B)False
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Chapter 18: Capital Management and Adequacy
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Q1) Tier 1 capital is used to provide loss absorption on a gone-concern basis and must be subordinated to depositors and general creditors and an original maturity of at least five years.
A)True
B)False
Q2) Common equity Tier 1 is:
A)made up discretionary non-cumulative dividends or coupons that have neither a maturity date nor an incentive to redeem.
B)used to provide loss absorption on a going-concern basis and must be subordinated to depositors and general creditors and an original maturity of at least five years.
C)subordinated to all other types of funding, absorbs losses, has full flexibility of dividend payments and has no maturity date.
D)None of the listed options are correct.
Q3) Credit-risk-adjusted assets are on- and off-balance-sheet assets whose values are adjusted for approximate credit risk.
A)True
B)False
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