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financial institutions management

Questions and Answers of Financial Institutions Management

A Swiss bank issues a $100 million, three-year eurodollar CD at a fixed annual rate of 7 percent. The proceeds of the CD are lent to a Swiss company for three years at a fixed rate of 9 percent. The
Use the following information to construct a swap of asset cash flows for the bank in problem
The bank is a price taker in both the fixed-rate market at 9 percent and the rate-sensitive market at the T-bill rate plus 1.5 percent. A securities dealer has a large portfolio of rate-sensitive
Consider the following currency swap of coupon interest on the following assets:5 percent (annual coupon) fixed-rate US$1 million bond 5 percent (annual coupon) fixed-rate bond denominated in Swiss
Consider the following fixed-floating-rate currency swap of assets: 5 percent(annual coupon) fixed-rate US$1 million bond and floating-rate SFr1.5 million bond set at LIBOR annually. Currently LIBOR
What role did the swap market play in the financial crisis of 2008–2009?The following problem refers to material in Appendix 25A.
Which loans should have the highest yields: (a) loans sold with recourse or (b) loans sold without recourse?
Which have higher yields, junk bonds or leveraged loans? Explain your answer.
Describe the two basic types of loan sale contracts by which loans can be transferred between seller and buyer.
Explain the main reason behind the growth in loan sales in the 1980s and the early 2000s.
What institutions are the major buyers in the traditional U.S. domestic loan sales market? What institutions are the major sellers in this market?
What are some of the economic and regulatory reasons why FIs choose to sell loans?
How can an FI use its loans to mitigate a liquidity problem?
What are some of the factors that are likely to deter the growth of the loan sales market in the future?
What are some specific legal concerns that have hampered the growth of the loan sales market?
What are some of the factors that are likely to encourage loan sales growth in the future?
Why have the FASB and the SEC advocated that financial services firms replace book value accounting with market value accounting?
What is the difference between a life insurance contract and an annuity contract?
Describe the different forms of ordinary life insurance.
Why do life insurance companies invest in long-term assets?
What is the major source of life insurance underwriting risk?
Who are the main regulators of the life insurance industry?
Why is traditional life insurance in decline?
Why do PC insurers hold more capital and reserves than do life insurers?
Why are life insurers’ assets, on average, longer in maturity than those of PC insurers?
Describe the main lines of insurance offered by PC insurers.
What are the components of the combined ratio?
How does the operating ratio differ from the combined ratio?
Why does the combined ratio tend to behave cyclically?
What is refinancing risk?
Why does a rise in the level of interest rates adversely affect the market value of both assets and liabilities?
Explain the concept of maturity matching.
Why does credit risk exist for FIs?
How does diversification affect an FI’s credit risk exposure?
Why might an FI face a sudden liquidity crisis?
What circumstances might lead an FI to liquidate assets at fire-sale prices?
Explain why the returns on domestic and foreign portfolio investments are not, in general, perfectly correlated.
A U.S. bank is net long in European assets. If the euro appreciates against the dollar, will the bank gain or lose?
Can an FI be subject to sovereign risk if it lends only to the highest-quality foreign corporations?
What is one major way an FI can discipline a country that threatens not to repay its loans?
What is market, or trading, risk?
What modern conditions have led to an increase in this particular type of risk for FIs?
Why are letter of credit guarantees an off-balance-sheet item?
Why are FIs motivated to pursue off-balance-sheet business? What are the risks?
How is operational risk related to technology risk?
How does technological expansion help an FI better exploit economies of scale and economies of scope? When might technology risk interfere with these goals?
When does insolvency risk occur?
How is insolvency risk related to the other risks discussed in this chapter?
What is refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the
The sales literature of a mutual fund claims that the fund has no risk exposure since it invests exclusively in federal government securities which are free of default risk. Is this claim true?
A financial institution has the following market value balance sheet structure:Assets Liabilities and Equity Cash $ 1,000 Certificate of deposit $ 10,000 Bond 10,000 Equity 1,000 Total assets 11,000
Corporate bonds usually pay interest semiannually. If an FI decided to change from semiannual to annual interest payments, how would this affect the bond’s interest rate risk?
Consider again the two bonds in problem 11.If the investment goal is to leave the assets untouched until maturity, such as for a child’s education or for one’s retirement, which of the two bonds
A bank invested \($50\) million in a two-year asset paying 10 percent interest per year and simultaneously issued a \($50\) million, one-year liability paying 8 percent interest per year. The
Consider the simple FI balance sheet below ($ millions).Before the Withdrawal Assets Liabilities/Equity Cash assets $ 20 Deposits $ 150 Nonliquid assets 155 Equity 25 175 175 Suppose that depositors
Assume that a bank has assets located in London that are worth £150 million on which it earns an average of 8 percent per year. The bank has £100 million in liabilities on which it pays an average
Six months ago, Qualitybank issued a \($100\) million, one-year maturity CD denominated in euros. On the same date, \($60\) million was invested in a €-denominated loan and \($40\) million was
What is the difference between technology risk and operational risk? How can produce reputational risk increase operational risk?
How does risk of digital disruption and fintech differ from technology risk?
Characterize the risk exposure(s) of the following FI transactions by choosing one or more of the risk types listed below:a. Interest rate riskb. Credit riskc. Off-balance-sheet riskd. Technology
How is the Federal Reserve’s monetary policy linked to the degree of interest rate uncertainty faced by FIs?
How has financial market integration affected interest rate movements?
Summarize the case for and against the inclusion of demand deposits as a ratesensitive liability.
How can FIs change the size and the direction of their repricing gap?
Why is it useful to express the repricing gap in terms of a percentage of assets?What specific information does this provide?
What are four major weaknesses of the repricing model?
What does runoff mean?
How do monetary policy actions made by the Federal Reserve impact interest rates?
What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important in using the repricing model?
Which of the following is an appropriate change to make on a bank’s balance sheet when GAP is negative, spread is expected to remain unchanged, and interest rates are expected to rise?a. Replace
Consider the following balance sheet for MMC Bancorp ($ millions):a. Calculate the value of MMC’s rate-sensitive assets, rate-sensitive liabilities, and repricing gap over the next year.b.
Which of the following assets or liabilities fit the one-year rate or repricing sensitivity test?3-month U.S. Treasury bills 1-year U.S. Treasury notes 20-year U.S. Treasury bonds 20-year
Consider the following balance sheet for WatchoverU Savings Inc. (in millions):a. What is WatchoverU’s expected net interest income for the year?b. What will expected net interest income be at
Use the following information about a hypothetical government security dealer named M. P. Jorgan. Market yields are in parentheses and amounts are in millions.a. What is the repricing gap if the
A bank has the following balance sheet:Suppose interest rates rise such that the average yield on rate-sensitive assets increases by 45 basis points and the average yield on rate-sensitive
A bank has the following balance sheet:Suppose interest rates fall such that the average yield on rate-sensitive assets decreases by 15 basis points and the average yield on rate-sensitive
What are some of the weaknesses of the repricing model? How have large banks solved the problem of choosing the optimal time period for repricing?What is runoff cash flow, and how does this amount
An insurance company has invested in the following fixed-income securities:(a) $10,000,000 of 5-year Treasury notes paying 5 percent interest and selling at par value, (b) $5,800,000 of 10-year bonds
EDF Bank has a very simple balance sheet. Assets consist of a two-year,$1 million loan that pays an interest rate of London Interbank Offer Rate (LIBOR)plus 4 percent annually. The loan is funded
What are the weaknesses of the maturity gap model?The following questions and problems are based on material in Appendix 8B to the chapter.
Suppose that the current one-year rate (one-year spot rate) and expected oneyear T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively)are as follows:1 R 1 = 6% E ( 2 r 1
Based on economists’ forecasts and analysis, one-year Treasury bill rates and liquidity premiums for the next four years are expected to be as follows:1 R 1 = 5.65%E ( 2 r 1 ) = 6.75% L 2 = 0.05%E
You note the following yield curve in The Wall Street Journal. According to the unbiased expectations hypothesis, what is the one-year forward rate for the period beginning two years from today, 2
Why is duration considered a more complete measure of an asset’s or liability’s interest rate sensitivity than maturity?
When is the duration of an asset equal to its maturity?
What does the denominator of the duration equation measure?
What does the numerator of the duration equation measure?
Calculate the duration of a one-year, 8 percent coupon, 10 percent yield bond that pays coupons quarterly.
What is the duration of a zero-coupon bond?
What feature is unique about a consol bond compared with other bonds?
Which has the longer duration: a 30-year, 8 percent, zero-coupon or discount bond or an 8 percent infinite maturity consol bond?
What is the relationship between duration and yield to maturity on a financial security?
Do high-coupon bonds have high or low durations?
What is the relation between the duration of a bond and the interest elasticity of a bond?
How would the formula in equation (6) have to be modified to take into account quarterly coupon payments and monthly coupon payments?
Refer to the example of the insurer in Examples 9–6 through 9–8. Suppose rates fell to 6 percent. Would the FI’s portfolio still be immunized? What if rates rose to 10 percent?
How is the overall duration gap for an FI calculated?
How can a manager use information on an FI’s duration gap to restructure, and thereby immunize, the balance sheet against interest rate risk?
Suppose DA = 3 years, DL = 6 years, k = 0.8, and A = $100 million. What is the effect on owners’ net worth if ΔR/(1 + R) rises 1 percent? (ΔE = $1,800,000)
Is immunizing a bank’s net worth the same as immunizing its net worth-to-assets ratio? If not, why not?

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