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financial institutions management

Questions and Answers of Financial Institutions Management

Two bonds are available for purchase in the financial markets. The first bond is a two-year, $1,000 bond that pays an annual coupon of 10 percent. The second bond is a two-year, $1,000 zero-coupon
Consider three Treasury bonds, each of which has a 10 percent semiannual coupon and trades at par.a. Calculate the duration for a bond that has a maturity of four years, three years, and two years.b.
Maximum Pension Fund is attempting to manage one of the bond portfolios under its management. The fund has identified three bonds that have five-year maturities and trade at a yield to maturity of 9
An insurance company is analyzing three bonds and is using duration as the measure of interest rate risk. All three bonds trade at a yield to maturity of 10 percent, have $10,000 par values, and have
If an FI uses only duration to immunize its portfolio, what three factors affect changes in the net worth of the FI when interest rates change?
The balance sheet for Gotbucks Bank Inc. (GBI) is presented below ($ millions).a. What is the duration of the fixed-rate loan portfolio of Gotbucks Bank?b. If the duration of the floating-rate loans
Hands Insurance Company issued a $90 million, one-year note at 8 percent annual interest (paying one coupon at the end of the year) or with an 8 percent yield. The proceeds, plus $10 million in
Refer again to the financial institutions in problem 26.a. What is the change in the value of the firm’s assets for a relative upward shift in the entire yield curve of 0.5 percent?b. What is the
A financial institution has an investment horizon of 2 years 9.33 months(or 2.777 years). The institution has converted all assets into a portfolio of 8 percent, $1,000 three-year bonds that are
Consider a $1,000 bond with a fixed-rate 10 percent annual coupon rate and a maturity (N) of 10 years. The bond currently is trading at a yield to maturity(YTM) of 10 percent.a. Complete the
Estimate the convexity for each of the following three bonds, all of which trade at a yield to maturity of 8 percent and have face values of $1,000.A seven-year, zero-coupon bond.A seven-year, 10
What are some of the credit quality problems faced by FIs over the last three decades?
What are some of the newer, nontraditional activities that create credit risk for today’s FIs?
What are the four major types of loans made by U.S. commercial banks? What are the basic distinguishing characteristics of each type of loan?
Will more ARMs be originated in high- or low-interest rate environments? Explain your answer.
Referring to Figure 10–4, explain why credit card loan rates are much higher than car loan rates. 0.0% 02/1972 03/1973. 04/1974 5.0% 10.0% 05/1975 06/1976- 07/1977 08/1978 09/1979. 10/1980- 11/1981
Calculate the promised return (k) on a loan if the base rate is 13 percent, the risk premium is 2 percent, the compensating balance requirement is 5 percent, fees are½ percent, and reserve
What is the expected return on this loan if the probability of default is 5 percent? (10.42%)
Can an FI’s expected return on its loan portfolio increase if it cuts its loan rates?
What might happen to the expected return on a wholesale loan if an FI eliminates its fees and compensating balances in a low-interest rate environment?
Is it more costly for an FI manager to assess the default risk exposure of a publicly traded company or a small, single-proprietor firm? Explain your answer.
How do loan covenants help protect an FI against default risk?
Make a list of key borrower characteristics you would assess before making a mortgage loan.
How should the risk premium on a loan be affected if there is a reduction in a borrower’s leverage?
Suppose an estimated linear probability model looked as follows: Z = 0.03X1 +0.01X2 + error, where X 1 = Debt-to-equity ratio X 2 = Total assets-to-working capital ratio Suppose, for a prospective
Suppose X3 = 0.5 in Example 10–3. Show how this would change the default risk classification of the borrower. (Z = 3.95)
What are two problems in using discriminant analysis to evaluate credit risk?
What is the difference between the marginal default probability and the cumulative default probability?
How should the posting of collateral by a borrower affect the risk premium on a loan?
In Table 10–7, the cumulative default probability over three years for CCC-rated corporate bonds is 33.75 percent.Check this calculation using the individual year MMRs. TABLE 10-7 Mortality Rates
Why would any FI manager buy loans that have a cumulative default probability of 33.75 percent? Explain your answer.
Describe the basic concept behind RAROC models.
Which is the only credit risk model discussed in this section that is really forward looking?
What is the link between the implied volatility of a firm’s assets and its expected default frequency?
Differentiate between a secured loan and an unsecured loan. Who bears most of the risk in a fixed-rate loan? Why would FI managers prefer to charge floating rates, especially for longer-maturity
Why is commercial lending declining in importance in the United States? What effect does this decline have on overall commercial lending activities?
Why are rates on credit cards generally higher than rates on car loans?
What are compensating balances? What is the relationship between the amount of compensating balance requirement and the return on the loan to the FI?
Suppose that a bank does the following:a. Sets a loan rate on a prospective loan at 8 percent (where BR = 5% and ϕ = 3%).b. Charges a 1 ⁄ 10 percent (or 0.10 percent) loan origination fee to the
Why could a lender’s expected return be lower when the risk premium is increased on a loan? In addition to the risk premium, how can a lender increase the expected return on a wholesale loan?
What are covenants in a loan agreement? What are the objectives of covenants?
Suppose the estimated linear probability model used by an FI to predict business loan applicant default probabilities is PD = 0.03X1 + 0.02X2 – 0.05X3 + error, where X1 is the borrower’s
Suppose that the financial ratios of a potential borrowing firm take the following values:Working capital/Total assets ratio (X1) = 0.75 Retained earnings/Total assets ratio (X2) = 0.10 Earnings
MNO Inc., a publicly traded manufacturing firm in the United States, has provided the following financial information in its application for a loan. All numbers are in thousands of dollars.Also
Carman County Bank (CCB) has a $5 million face value outstanding adjustable-rate loan to a company that has a leverage ratio of 80 percent. The current riskfree rate is 6 percent and the time to
Go to the Federal Reserve Board’s website at www.federalreserve.gov and update the data in Table 10–1 using the following steps. Click on “Data.” Click on “Assets and Liabilities of
Go to the Federal Reserve Board’s website at www.federalreserve.gov and update the data in Table 10-2 using the following steps. Click on “Data.” Click on “Assets and Liabilities of
Go to the FRED database website from the Federal Reserve Bank of St. Louis at http://fred.stlouisfed.org and update the data for Figure 10-4 using the following steps. Type “48-month auto loan”
In Example 11–1, what would the concentration limit be if the loss rate on bad loans is 25 cents on the dollar? (60 percent) EXAMPLE 11-1 Calculating Concentration Limits for a Loan Portfolio
In Example 11–1, what would the concentration limit be if the maximum loss (as a percent of capital) is 10 percent instead of 15 percent? (25 percent) EXAMPLE 11-1 Calculating Concentration Limits
What is the main point in using MPT for loan portfolio risk?
Why would an FI not always choose to operate with a minimum risk portfolio?
How does Moody’s Analytics measure the return on a loan?
If EDF = 0.1 percent and LGD = 50 percent, what is the unexpected loss (σi) on the loan? (1.58 percent)
How does Moody’s Analytics calculate loan default correlations?
Suppose the returns on different loans are independent. Would there be any gains from loan portfolio diversification?
How would you find the minimum risk loan portfolio in a modern portfolio theory framework?
Should FI managers select the minimum risk loan portfolio? Why or why not?
Explain the reasoning behind the Federal Reserve’s 1994 decision to rely more on a subjective rather than a quantitative approach to measuring credit concentration risk. Is that view valid today?
How do loan portfolio risks differ from individual loan risks?
An FI has set a maximum loss of 2 percent of total capital as a basis for setting concentration limits on loans to individual firms. If it has set a concentration limit of 25 percent of capital to a
Suppose that an FI holds two loans with the following characteristics: Loani X R +2 1 0.55 0.45 10 07 8% 8.55% 73.1025% P12=0.24 9.15 83.7225 012= 18.7758
The Bank of Tinytown has two $20,000 loans with the following characteristics:Loan A has an expected return of 10 percent and a standard deviation of returns of 10 percent. The expected return and
Suppose that an FI holds two loans with the following characteristics.Calculate the return and risk on the two-asset portfolio using Moody’s Analytics RiskFrontier. Annual Spread between Loan Rate
CountrySide Bank uses Moody’s Analytics RiskFrontier to evaluate the riskreturn characteristics of the loans in its portfolio. A specific $10 million loan earns 2 percent per year in fees and the
Suppose that an FI holds two loans with the following characteristics.The return on loan 1 is R1 = 6.25%, the risk on loan 2 is σ2 = 1.8233%, and the return of the portfolio is Rp = 4.555%.
What databases are available that contain loan information at the national and regional levels? How can they be used to analyze credit concentration risk?
Information concerning the allocation of loan portfolios to different market sectors is given below.Bank A and Bank B would like to estimate how much their portfolios deviate from the national
From Table 11A–1, what is the probability of a loan upgrade? A loan downgrade?a. What is the impact of a rating upgrade or downgrade?b. How is the discount rate determined after a credit event has
What are the sources of liquidity risk?
Why is cash more liquid than loans for an FI?
List two benefits and two costs of using (a) purchased liquidity management and(b) stored liquidity management to meet a deposit drain.
What are the three major sources of DI liquidity? What are the two major uses?
What are the measures of liquidity risk used by FIs?
What is likely to be a life insurance company’s first source of liquidity when premium income is insufficient?
Can a life insurance company be subjected to a run? If so, why?
What is the greatest cause of liquidity exposure faced by property–casualty insurers?
Is the liquidity risk of property–casualty insurers in general more or less than that of life insurers?
What would be the impact on their liquidity needs if DIs offered deposit contracts of an open-end mutual fund type rather than the traditional all-or-nothing demand deposit contract?
How do the incentives of mutual fund investors to engage in runs compare with the incentives of DI depositors?
What are the two reasons that liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance
The probability distribution of the net deposit drains of a DI has been estimated to have a mean of 2 percent and a standard deviation of 1 percent. Is this DI increasing or decreasing in size?
AllStarBank has the following balance sheet (in millions):AllStarBank’s largest customer decides to exercise a $15 million loan commitment.How will the new balance sheet appear if AllStar uses the
Define each of the following four measures of liquidity risk. Explain how each measure would be implemented and utilized by a DI.a. Financing gap and financing requirement.b. Sources and uses of
Plainbank has $10 million in cash and equivalents, $30 million in loans, and $15 million in core deposits.a. Calculate the financing gap.b. What is the financing requirement?c. How can the financing
A DI has the following assets in its portfolio: $10 million in cash reserves with the Fed, $25 million in T-bills, and $65 million in mortgage loans. If the DI has to liquidate the assets today, it
Central Bank has the following balance sheet (in millions of dollars).Cash inflows over the next 30 days from the bank’s performing assets are $7.5 million. Calculate the LCR for Central Bank.
WallsFarther Bank has the following balance sheet (in millions of dollars).Cash inflows over the next 30 days from the bank’s performing assets are $5.5 million. Calculate the LCR for WallsFarther
The following is the balance sheet of a DI (in millions):The asset–liability management committee has estimated that the loans, whose average interest rate is 6 percent and whose average life is
How is the liquidity problem faced by investment funds different from that faced by DIs and insurance companies? How does the liquidity risk of an openend mutual fund compare with that of a
Go to JPMorgan Chase’s website (www.jpmorganchase.com), download its latest 10Q report and find its sources of liquidity. How have the sources of liquidity changed since June 2021?
What is the difference between a spot and a forward foreign exchange market transaction?
How is the net foreign currency exposure of an FI measured?
If a bank is long in British pounds (£), does it gain or lose if the dollar appreciates in value against the pound?
A bank has £10 million in assets and £7 million in liabilities. It has also bought£52 million in foreign currency trading. What is its net exposure in pounds? (£55 million)
What are the four major FX trading activities?
In which trades do FIs normally act as agents and in which trades as principals?
What is the source of most profits or losses on foreign exchange trading? What foreign currency activities provide a secondary source of revenue?
The cost of one-year U.S. dollar CDs is 8 percent, one-year U.S. dollar loans yield 10 percent, and U.K. pound loans yield 15 percent. The dollar/pound spot exchange rate is $1.50/£1 and the
What are two ways an FI manager can control FX exposure?

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