Risk Management in Financial Institutions
Review Questions
Course Introduction
This course examines the principles and practices of risk management within financial institutions, focusing on identifying, measuring, and mitigating various types of financial risks such as credit, market, operational, and liquidity risks. Students will explore key regulatory frameworks, risk assessment tools, and the implementation of effective risk management strategies to safeguard institutional stability. Case studies and real-world scenarios are used to illustrate how banks and other financial firms manage risks in response to economic and regulatory changes, enabling students to develop a comprehensive understanding of the risk management challenges facing the modern financial sector.
Recommended Textbook
Financial Institutions Management A Risk Management Approach 7th Edition by Anthony Saunders
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Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) 1-57 Which of the following is NOT a major function of financial intermediaries?
A)Brokerage services.
B)Asset transformation services.
C)Information production.
D)Management of the nation's money supply.
E)Administration of the payments mechanism.
Answer: D
Q2) 1-29 The ability of savers to transfer wealth between youth and old age and across generations is called maturity intermediation.
A)True
B)False
Answer: False
Q3) 1-82 Which of the following is true of secondary securities?
A)They include equities,bonds,and other debt claims.
B)They are backed by the real assets of corporations issuing them.
C)They are securities that back primary securities.
D)They are securities issued by FIs.
E)They must be placed in a separate account on order for primary securities to be offered.
Answer: C
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Chapter 2: Financial Services: Depository Institutions
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Sample Questions
Q1) 2-34 The primary objective of the 1927 McFadden Act was to restrict interstate bank branching.
A)True
B)False
Answer: True
Q2) 2-66 By late 2009,the number of branches of existing commercial banks in the U.S.approximated ________,which was a (an)_________ from 1985.
A)88,000; increase B)43,000; increase C)68,000; decrease D)103,000; decrease E)72,000; increase
Answer: A
Q3) 2-26 The use of off-balance-sheet activities and instruments will always reduce the risk to a bank.
A)True
B)False
Answer: False
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4
Chapter 3: Financial Services: Insurance
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Q1) 3-26 Insurance guaranty funds involve a permanent fund similar to the FDIC for the purpose of compensating the policyholders of failed insurers.
A)True
B)False
Answer: False
Q2) 3-47 Unlike the banking industry,globalization of financial services is having little or no effect on the insurance industry.
A)True
B)False
Answer: False
Q3) 3-46 The Insurance Regulatory Information System (IRIS)is a standardized exam to measure the profitability of insurance companies.
A)True
B)False
Answer: False
Q4) 3-9 The policyholder can vary the premium payments on an endowment life policy. A)True
B)False Answer: False
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Chapter 4: Financial Services: Securities Brokerage and Investment Banking
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Sample Questions
Q1) 4-50 The largest category of assets for broker-dealers as of the beginning of 2009 was
A)receivables from other broker-dealers.
B)securities purchased under agreement to resell.
C)receivables from customers.
D)exchange membership.
E)long position in securities and commodities.
Q2) 4-21 Agency transactions of market makers are two-way transactions on behalf of customers
A)True
B)False
Q3) 4-85 If the investment bank can sell the shares for $9.75 per share,what is the profit (loss)to the investment banker?
A)Profit of $1,000,000.
B)Loss of $7,500,000.
C)Profit of $7,000,000.
D)Loss of $7,000,000.
E)Loss of $1,000,000.
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Chapter 5: Financial Services: Mutual Funds and Hedge Funds
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Q1) 5-11 One of the goals of mutual funds is to achieve superior diversification through fund and risk pooling compared to what individual investors can achieve.
A)True
B)False
Q2) 5-90 Hedge fund data
A)are self-reported.
B)can be independently tracked.
C)can be obtained from SEC filings.
D)can be obtained from research agencies.
E)All of the above.
Q3) 5-7 Equity mutual funds may contain common stock,but not preferred stock.
A)True
B)False
Q4) 5-96 75 percent of all hedge funds are located in A)Bermuda.
B)Hong Kong.
C)Cayman Islands.
D)Luxembourg.
E)San Marino.
Page 7
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Chapter 6: Financial Services: Finance Companies
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Sample Questions
Q1) 6-17 Finance companies are subject to regulations that restrict the types of products and services they can offer to small business customers.
A)True
B)False
Q2) 6-18 Because finance companies do not accept deposits,they do not have bank regulators providing oversight of their activities.
A)True
B)False
Q3) 6-52 A finance company may be classified as a subprime lender if it
A)charges interest rates below those charged by commercial banks.
B)lends to low-risk customers.
C)lends to high-risk customers.
D)originated from check cashing outlets in the early 1990s.
E)is wholly owned by a parent corporation.
Q4) 6-7 Over the last 30 years finance companies have replaced real estate loans and other assets with increasing amounts of consumer and business loans.
A)True
B)False
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8
Chapter 7: Risks of Financial Institutions
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Q1) 7-79 The risk that borrowers are unable to repay their loans on time is
A)credit risk.
B)sovereign risk.
C)currency risk.
D)liquidity risk.
E)interest rate risk.
Q2) 7-51
Many of the various risks faced by an FI often are interrelated with each other.
A)True
B)False
Q3) 7-87 The U.S.dollar's decline against European currencies 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.
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Chapter 8: Interest Rate Risk I
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Q1) 8-30 The maturity of a portfolio of assets or liabilities is a weighted average of the maturities of the assets or liabilities that comprise that portfolio.
A)True
B)False
Q2) 8-74 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.
Q3) 8-3 The repricing gap model is a book value accounting based model.
A)True
B)False
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Chapter 9: Interest Rate Risk Ii
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Q1) 9-12 Duration of a fixed-rate coupon bond will always be greater than one-half of the maturity.
A)True
B)False
Q2) 9-19 For a given maturity fixed-income asset,duration increases as the promised interest payment declines.
A)True
B)False
Q3) 9-30 Perfect matching of the maturities of the assets and liabilities will always achieve perfect immunization for the equity holders of an FI against interest rate risk.
A)True
B)False
Q4) 9-79 What is the price of the bond if market interest rates are 4 percent?
A)$105,816.44.
B)$105,287.67.
C)$105,242.14.
D)$100,000.00.
E)$106,290.56.
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11
Chapter 10: Market Risk
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Sample Questions
Q1) 10-33 In the BIS framework,vertical offsets are charges that reflect the modified duration and interest rate shocks for each maturity.
A)True
B)False
Q2) 10-62 The general market risk charge in the BIS standardized framework of market risk measurement
A)reflects the product of the modified durations and the interest rate shocks.
B)measures the credit risk quality of the trading portfolio.
C)measures the vertical offsets of the portfolio.
D)measures the decline in liquidity of the portfolio.
E)More than one of the above is correct.
Q3) 10-63 The additional capital charge for basis risk
A)reflects the product of the modified durations and the interest rate shocks.
B)measures the credit risk quality of the trading portfolio.
C)measures the vertical offsets of the portfolio.
D)measures the decline in liquidity of the portfolio.
E)More than one of the above is correct.
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Chapter 11: Credit Risk: Individual Loan Risk
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Q1) 11-99 What is the expected probability of default in year 2 of two-year maturity
B?rated debt?
A)2.83 percent.
B)3.00 percent.
C)4.43 percent.
D)2.68 percent.
E)5.00 percent.
Q2) 11-66 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.
Q3) 11-2 Junk bonds are bonds that are rated less than investment grade by bond-rating agencies.
A)True
B)False
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13
Chapter 12: Credit Risk: Loan Portfolio and Concentration
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Sample Questions
Q1) 12-50 What is Bank B's standard deviation of its asset allocation proportions relative to the national banks average? Use the formula in the textbook.
A)14.16 percent.
B)33.33 percent.
C)5.66 percent.
D)3.00 percent.
E)1.50 percent.
Q2) 12-48 What is the risk (standard deviation of returns)on the bank's loan portfolio if loan returns are uncorrelated (\(\rho\) = 0)?
A)1.41 percent.
B)1.63 percent.
C)0.93 percent.
D)3.57 percent.
E)1.18 percent.
Q3) 12-4 Migration analysis is not appropriate for an FI to use in the analysis of credit risk of consumer loans and credit card portfolios.
A)True
B)False
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Chapter 13: Off-Balance-Sheet Risk
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Q1) 13-19 The extremely high growth of OBS activities since the early 1990s has caused regulators to recognize the potential risk exposure to FIs from their use.
A)True
B)False
Q2) 13-49 To be an affiliate of a holding company,the parent must own at least 50 percent of the shares of the affiliate company.
A)True
B)False
Q3) 13-82 Which of the following ratios do FIs and regulators often use as a simple measure of solvency?
A)Current ratio.
B)Capital to assets.
C)Earnings before interest and taxes to total assets.
D)Quick ratio.
E)Asset turnover ratio.
Q4) 13-14 If an FI enters into a loan commitment,it is essentially entering into a forward contract.
A)True B)False
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Chapter 14: Foreign Exchange Risk
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Q1) 14-73 If the exchange rate had fallen from $1.60/£1 at the beginning of the year to $1.50/£1 at the end of the year when the FI needed to repatriate the principal and interest on the loan.What would be the dollar loan revenues at the end of the year?
A)$6.25 million.
B)$11.6 million.
C)$7.25 million.
D)$6.625 million.
E)$10.875 million.
Q2) 14-95 What must be the forward exchange rate to eliminate the preference for the yen loans?
A)$0.6416/¥.
B)$0.5798/¥.
C)$0.6118/¥.
D)$0.5991/¥.
E)Insufficient information.
Q3) 14-2 To a U.S.trader of foreign currencies,a direct quote indicates U.S.dollars received for each one unit of the foreign currency.
A)True
B)False
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Chapter 15: Sovereign Risk
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Q1) 15-78 Which of the following is the largest segment in the secondary market for sovereign debt?
A)Restructured loans.
B)Brady bonds.
C)Sovereign bonds.
D)Performing loans.
E)Nonperforming loans.
Q2) 15-12 Sometimes banks received criticism because domestic governments take special political steps to reduce the probability that foreign borrowers will default or repudiate their debt contracts,an occurrence that could cause financial harm to the domestic banks.
A)True
B)False
Q3) 15-68 What is the approximate yield on a 20-year 10 percent annual coupon LDC bond selling at 75 cents on the dollar?
A)10 percent..
B)40 percent.
C)14 percent.
D)25 percent.
E)Cannot be determined.
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Chapter 16: Technology and Other Operational Risks
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Q1) 16-99 Moving funds from accounts in several FIs into a few centralized accounts at one FI.
A)Account reconciliation.
B)Assisting small business entries into e-commerce.
C)Check deposit services.
D)Controlled disbursement accounts.
E)Electronic billing.
F)Electronic data interchange.
G)Electronic funds transfer.
H)Electronic initiation of letters of credit.
I)Electronic lockbox.
J)Facilitating business-to-business e-commerce.
K)Funds concentration.
L)Treasury management software.
M)Verifying identities.
N)Wholesale lockbox.
Q2) 16-38 CHIPS guarantees that any wire transfer is final at the time it is made.
A)True
B)False
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Chapter 17: Liquidity Risk
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Q1) 17-84 A liquidity plan will include
A)the size of potential deposit and fund withdrawals.
B)a list of fund providers that are most likely to withdraw funds.
C)the pattern of potential withdrawals.
D)the details and responsibilities of management.
E)All of the above.
Q2) 17-23 Maturity ladder/scenario analysis is a method of measuring liquidity risk and net funding requirements.
A)True
B)False
Q3) 17-21 The greater the difference between fair market prices and fire-sale prices for assets,the less liquid the DI's portfolio of assets.
A)True
B)False
Q4) 17-6 An FI's most liquid asset is cash.
A)True
B)False
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19
Chapter 18: Liability and Liquidity Management
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Q1) 18-74 Requiring minimum reserves to be held at the central bank is the equivalent of A)buffer reserves.
B)a reserve requirement tax.
C)the target reserve ratio.
D)contagious effects of liquidity risk.
E)None of the above.
Q2) 18-11 In most countries,assets used to satisfy the liquid assets ratio may include liquid government securities.
A)True
B)False
Q3) 18-61 Although they are subject to reserve requirements,many DIs have begun to issue medium-term notes because they are a stable source of funds.
A)True
B)False
Q4) 18-50 The negotiable instrument characteristic of large wholesale CDs effectively eliminates the adverse withdrawal risk for the bank.
A)True
B)False
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Page 20
Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) 19-9 After nearly failing,the FDIC's Bank Insurance Fund (BIF)achieved record levels of reserves during the 1990s.
A)True
B)False
Q2) 19-101 If the insured depositor transfer resolution method is utilized,what is the cost to the FDIC of bank failure resolution?
A)$0.
B)-$200 million.
C)$67 million.
D)$133 million.
E)$200 million.
Q3) 19-72 Which of the following refers to mandatory actions that have to be taken by regulators as a DI's capital ratio falls.
A)Capital forbearance.
B)Prompt corrective action.
C)Risk-based deposit insurance.
D)Too-big-to-fail.
E)Regulatory oversight.
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Chapter 20: Capital Adequacy
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Q1) 20-117 In calculating the net capital for a securities firms,which of the following is NOT an adjustment to the book value of net worth?
A)The market value of net worth is calculated on a day-to-day basis.
B)A series of adjustments are made to reflect unrealized profits and losses,subordinated liabilities,deferred taxes,options,and futures.
C)The amount of securities that cannot be publicly sold are subtracted.
D)All assets not readily converted into cash are subtracted.
E)Haircuts to reflect potential market value fluctuations in asset values are deducted.
Q2) 20-55 In determining the risk-adjusted value of the on-balance-sheet credit equivalent amounts of the contingent guaranty contracts,the risk weights are determined by the credit rating of the underlying counterparty of the off-balance-sheet activity.
A)True
B)False
Q3) 20-24 A market to book ratio greater than one indicates that the book value of equity is overstated.
A)True
B)False
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22
Chapter 21: Product and Geographic Expansion
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Q1) 21-43 Research on bank mergers for the decade of the 1990s found that improved performance of the merged bank occurred because of both revenue enhancements and cost reduction.
A)True
B)False
Q2) 21-151 If Bank A acquires Bank B,what is the new Herfindahl Index?
A)60.
B)100.
C)5,800.
D)5,050.
E)6,525.
Q3) 21-39 In order to achieve a more stable revenue stream in a merger,the asset and liability portfolios of the two institutions should have similar credit,interest rate,and liquidity characteristics.
A)True
B)False
Q4) 21-7 Banks have been permitted to acquire existing investment banks since 1997.
A)True
B)False
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Chapter 22: Futures and Forwards
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Q1) 22-109 Based on the estimate of gain or loss in question 108,what is the number of T-bond futures contracts necessary to hedge the balance sheet if the duration of the deliverable bonds is 9 years and the current price of the futures contract is $96 per $100 face value?
A)1,630 contracts.
B)1,475 contracts.
C)1,900 contracts.
D)2,077 contracts.
E)3,225 contracts.
Q2) 22-18 Immunizing the balance sheet against interest rate risk means that gains (losses)from an off-balance-sheet hedge will exactly offset losses (gains)from the balance sheet position.
A)True
B)False
Q3) 22-39 Hedging effectiveness often is measured by the squared correlation between past changes in the spot asset prices and futures prices.
A)True
B)False
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Chapter 23: Options,caps,floors,and Collars
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Q1) 23-98 If rates increase 1 percent,what will be the change in value of the option position?
A)-$1,660,525.
B)+$1,660,525.
C)-$2,430,511.
D)-$765,253.
E)+$2,430,511.
Q2) 23-18 The losses on a purchased put option position when rates fall are limited to the option premium paid.
A)True
B)False
Q3) 23-57 An option that does NOT identifiably hedge an underlying asset is a A)put option.
B)call option.
C)naked option.
D)futures option.
E)credit spread call option.
Q4) 23-42 Buying a floor means buying a put option on interest rates.
A)True
B)False
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Chapter 24: Swaps
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Q1) 24-43 In the derivatives markets,the instrument with the longest potential maturity is A)options. B)futures. C)forwards. D)swaps. E)currencies.
Q2) 24-18 A pure credit swap is similar to buying credit insurance. A)True B)False
Q3) 24-27 A total return credit swap is eliminates interest rate risk as well as credit risk. A)True B)False
Q4) 24-22 At the end of 2009,the world-wide notational value of swap agreements was less than $400 trillion. A)True B)False
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26
Chapter 25: Loan Sales
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Q1) 25-48 Currently,this basic type of loan sale contracts comprises the bulk of loan sales trading.
A)Participations.
B)Originations.
C)Syndications.
D)Assignments.
E)Transfers.
Q2) 25-67 The traditional interbank loan sale market has been shrinking for which of the following reasons?
A)The barriers to nationwide banking have been largely removed through legislation.
B)Concerns about counterparty risk and moral hazard have increased.
C)The traditional correspondent banking relationships are slowly breaking down.
D)All of the above.
E)Only two of the above.
Q3) 25-33 Research has shown that current-year income for an FI is rarely affected by the decision to sell loans from their balance sheet.
A)True
B)False
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Chapter 26: Securitization
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Q1) 26-70 Servicing a pass?through security refers to
A)an FI processing of all payments.
B)an FI provision of clearing services to set up the pass?through.
C)broker/dealer services provided by the FI to the ultimate holders of the pass?through.
D)guarantee by the FI of all principal and interest payments.
E)an FI provision of liquidity services to the ultimate holders of the pass?through.
Q2) 26-91 What amount of demand deposits are needed to fund the mortgage?
A)$5,500,000.
B)$400,000.
C)$5,333,333.
D)$500,000.
E)$5,000,000.
Q3) 26-68 Which is the oldest mortgage-backed security sponsoring agency?
A)GNMA.
B)FNMA.
C)FHA.
D)FMHA.
E)FHLMC.
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