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financial institutions management

Questions and Answers of Financial Institutions Management

1. Reconsider Tree Row Bank in problem 17 but assume that the cost rate on the liabilities is 6 percent.
1. The following problem refers to material in Appendix 25A.The following information is available on a three-year swap contract. Oneyear maturity zero-coupon discount yields are currently priced at
1. What additional issues should be considered by the bank in choosing between T-bond and T-bill futures contracts?
1. Verify that the change in the futures position will offset the change in the cash balance sheet position for a change in market interest rates of plus 100 basis points and minus 50 basis points.If
1. How many contracts are necessary to fully hedge the bank?
1. What are the realized cash flows expected over the three-year life of the swap?
1. What are the realized cash flows that occur over the three-year life of the swap if d2 4.95 percent and d3 6.1 percent?
1. Tree Row Bank has assets of $150 million, liabilities of $135 million, and equity of $15 million. The asset duration is six years, and the duration of the liabilities is four years. Market
1. What is meant by fully hedging the balance sheet of an FI?
1. Which have higher yields, junk bonds or HLT loans? Explain your answer.
1. What is the meaning of the Treasury bond futures price quote 101–13?
1. Explain the main reason behind the explosion in loan sales in the 1980s.
1. For a given change in interest rates, why is the sensitivity of the price of a Treasury bond futures contract greater than the sensitivity of the price of a Treasury bill futures
1. If the existing interest rate on the liabilities is 6 percent, what will be the effect on net worth of a 1 percent increase in interest rates?
1. What will be the effect on net worth if interest rates increase 100 basis points?
1. How can an FI use its loans to mitigate a liquidity problem?
1. What is the expected change in net worth for Hedge Row Bank if the forecast is accurate?
1. What is the duration gap for Hedge Row Bank?
1. What are the reasons why an FI may choose to hedge selectively its portfolio?Hedge Row Bank has the following balance sheet (in millions):The duration of the assets is six years, and the duration
1. If you purchased the bond at par and sold the futures contract, what would be the net value of your hedge after the increase in interest rates?What are the differences between a microhedge and a
1. If you sold a Treasury bond futures contract at 95 and interest rates rose 50 basis points, what would be the change in the value of your futures position?
1. What is the impact on the Treasury bond price if market interest rates increase 50 basis points?
1. What is the modified duration of this bond?
1. A bank has made a three-year $10 million loan that pays annual interest of 8 percent. The principal is due at the end of the third year.
1. The duration of a 20-year, 8 percent coupon Treasury bond selling at par is 10.292 years. The bond’s interest is paid semiannually, and the bond qualifies for delivery against the Treasury bond
1. The bank is willing to sell this loan with recourse at an interest rate of 8.5 percent. What price should it receive for this loan?
1. In each of the following cases, indicate whether it would be appropriate for an FI to buy or sell a forward contract to hedge the appropriate risk.A commercial bank plans to issue CDs in three
1. The bank has the option to sell this loan without recourse at a discount rate of 8.75 percent. What price should it receive for this loan?
1. Long Bank has assets that consist mostly of 30-year mortgages and liabilities that are short-term time and demand deposits. Will an interest rate futures contract the bank buys add to or subtract
1. Assume that the Treasury bond futures price rises to 97. Mark to market the position.
1. If the bank expects a 0.5 percent probability of default on this loan, is it better to sell this loan with or without recourse? It expects to receive no interest payments or principal if the
1. Assume that the Treasury bond futures price falls to 94. What is the loss or gain?
1. What are some of the key features of short-term loan sales?
1. If an FI purchases this contract, in what kind of hedge is it engaged?
1. What is the FI’s obligation at the time the futures contract is purchased?
1. Suppose an FI purchases a Treasury bond futures contract at 95.
1. An FI holds a 15-year, par value, $10 million bond that is priced at 104 with a yield to maturity of 7 percent. The bond has a duration of eight years, and the FI plans to sell it after two
1. How do these contracts differ from spot contracts?
1. What has been the regulatory result of some of the misuses by FIs of derivative products?
1. What are the difficulties in completing a loan assignment?
1. Who are the buyers of U.S. loans, and why do they participate in this activity?
1. What are derivative contracts? What is the value of derivative contracts to the managers of FIs? Which type of derivative contracts had the highest volume among all U.S. banks as of September 2006?
1. What are some of the practical problems an FI manager may face when using catastrophe futures to hedge losses on insurance lines?
1. What are vulture funds?
1. What are three reasons why the interbank market has been shrinking?
1. Why are credit forwards useful for hedging the credit risk of an FI’s portfolio?
1. What are reasons why a small bank would be interested in participating in a loan syndication?
1. In running a regression of St on ft, the regression equation is St .51 .95 ft and R2 .72. What is the hedge ratio? What is the measure of hedging effectiveness?
1. What is the purpose of a bad bank?
1. Circle an observation in Figure 23–6 that shows futures price changes exceeding spot price changes.
1. What are the reasons why loan sales through a bad bank will be value enhancing?
1. What impact has the 1996 Federal Debt Collection Improvements Act had on the loan sale market?
1. In Example 23–3, how many futures contracts should have been sold using the 20-year bond and 3-month Eurodollar contracts if the basis risk measure br .8?
1. What are factors that may deter the growth of the loan sales market in the future? Discuss.
1. An FI is planning the purchase of a $5 million loan to raise the existing average duration of its assets from 3.5 years to 5 years. It currently has total assets worth $20 million, $5 million in
1. Explain how a naive hedge works.
1. Assuming it uses the cash to purchase the loan, should it purchase the loan if its duration is seven years?
1. What asset duration loans should it purchase to raise its average duration to five years?
1. Go to the FDIC Web site at www.fdic.gov. From there, click on “Investors,” then click on “Closed Loan Sales,” and then click on “Find” to get information on recent real estate loan
1. Go to the Board of Governors of the Federal Reserve Web site at www. federalreserve.gov. Locate the organizational structure of the two largest U.S. commercial bank holding companies using the
1. What are the potential procompetitive effects of allowing banks to enter more fully into securities underwriting? What is the anticompetitive argument or position?
1. In what ways does the current regulatory structure argue against providing additional securities powers to the banking industry? Does this issue just concern banks?
1. Under what circumstances could the existence of deposit insurance provide an advantage to banks in competing with other traditional securities firms?
1. What are some of the legal, institutional, and market conditions that lessen the likelihood that an FI can exploit conflicts of interest from the expansion of commercial banks into other financial
1. What six conflicts of interest have been identified as potential roadblocks to the expansion of banking powers into the financial services area?
1. What role does bank activity diversification play in the ability of a bank to exploit economies of scale and scope? What remains as the limitation to creating potentially greater benefits?
1. What do empirical studies reveal about the effect of activity diversification on the risk of failure of banks?
1. What are two operational strategies to reduce the risk to the safety and soundness of a bank resulting from the failure of a securities affiliate or many other types of financial distress?
1. What are three ways that the failure of a securities affiliate in a holding company organizational form could negatively affect a bank? How has the Fed attempted to prevent a breakdown of the
1. What are the reasons why the upside returns from firm commitment securities offerings are not symmetrical in regard to the downside risk?
1. Instead of taking a chance that only 60 percent of the shares will be sold on the issue date, a bank suggests a price of $95 to the issuing firm. It expects to quote a bid–ask spread of
1. A Section 20 affiliate agrees to underwrite a debt issue for one of its clients. It has suggested a firm commitment offering for issuing 100,000 shares of stock.The bank quotes a bid–ask spread
1. What is the maximum possible underwriter’s fee on both the best-efforts and firm commitment underwriting contracts on an issue of 12 million shares at a bid price of $12.45 and an offer price of
1. How would your answer be affected if it manages to sell the shares only at$5.50 using the firm commitment method? The commission for best efforts is still 50 basis points.
1. What are the fees if it uses the best-efforts method and a commission of 50 basis points is charged?
1. An FI is underwriting the sales of 1 million shares of Ultrasonics, Inc., and is quoting a bid–ask price of $6.00–$6.50.What are the fees earned by the FI if a firm commitment method is used
1. What are the differences in the risk implications of a firm commitment securities offering versus a best-efforts offering?
1. What are the restrictions on the structure of a financial services holding company as specified by the Financial Services Modernization Act of 1999?
1. The Financial Services Modernization Act of 1999 allows banks to own controlling interests in nonfinancial companies. What are the two restrictions on such ownership?
1. How have nonbanks managed to exploit the loophole in the Bank Holding Company Act of 1956 and engage in banking activities? What law closed this loophole? How did insurance companies circumvent
1. What types of insurance products were commercial banks permitted to offer before 1999? How did the Financial Services Modernization Act of 1999 change this?
1. Explain in general terms what impact the Financial Services Modernization Act of 1999 should have on the strategic implementation of Section 20 activities.The Garn-St. Germain Act of 1982 and
1. A Section 20 subsidiary of a major U.S. bank is planning to underwrite corporate securities and expects to generate $5 million in revenues. It currently underwrites U.S. Treasury securities and
1. What restrictions were placed on Section 20 subsidiaries of U.S. commercial banks that made investment banking activities other than those permitted by the Glass-Steagall Act less attractive? How
1. What general prohibition regarding the activities of commercial banking and investment banking did the Glass-Steagall Act impose? What investment banking activities have been permitted for U.S.
1. How does product segmentation reduce the profitability of FIs? How does product segmentation increase the profitability of FIs?
1. In what ways have other FIs taken advantage of the restrictions on product diversification imposed on commercial banks?
1. How does product segmentation reduce the risks of FIs? How does it increase the risks of FIs?
1. What are three potential procompetitive effects cited in support of banks’ expansion into securities activities? What reason is given to support the opposite claim (i.e., that bank expansion
1. In addition to the six potential conflicts of interest discussed in this section, can you think of any additional possible conflicts that might arise if commercial banks were allowed to expand
1. Describe three ways in which the losses of a securities affiliate in a holding company structure could be transmitted to a bank.
1. Explain how firm commitment underwriting of securities is similar to writing put options on assets.
1. What are some of the issues that tend to arise in response to bank expansion into securities, insurance, and commercial activities?
1. How are the product activities of U.S. commercial banks likely to change in the future?
1. How does the range of product activities permitted for U.S. commercial banks compare to that of banks in other major industrialized countries?
1. How has the Financial Services Modernization Act of 1999 opened the doors for the establishment of full-service financial institutions in the United States?
1. How did the provisions of the National Bank Act of 1863 affect the participation of national banks in establishing nonbank subsidiaries?
1. Does a bank that currently specializes in making consumer loans but makes no commercial loans qualify as a nonbank bank?
1. Why do you think that there was a 25 percent rather than a 50 percent maximum ceiling on the revenues earned from the ineligible underwriting activities of a Section 20 subsidiary?
1. What was the rationale for the passage of the Glass-Steagall Act in 1933? What permissible underwriting activities did it identify for commercial banks?

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