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financial markets institutions

Questions and Answers of Financial Markets Institutions

Technically speaking, convexity can be viewed as the rate of change of the bond’s value with respect to any interest rate change, whereas duration measures the change in a bond’s value with
For simplicity, we assume that the interest rate changes are the same for both assets and liabilities. This assumption is standard in Macauley duration analysis (see Chapter 3). LO.1
In what follows, we use the Δ (change) notation instead of d (derivative notation) to recognize that interest rate changes tend to be discrete rather then infinitesimally small. For example, in
An alternative version of the gap ratio is defined as rate-sensitive assets divided by ratesensitive liabilities. A gap ratio greater than 1 indicates that there are more rate sensitive assets than
The Federal Reserve’s repricing report has traditionally viewed transaction accounts and passbook savings accounts as rate-insensitive liabilities, as we have done in this example.However, with the
We are assuming that the assets are noncallable over the year and that there will be no prepayments (runoffs, see below) on the mortgages within a year. LO.1
For example, a 30-year bond purchased 10 years ago when rates were 13 percent would be reported as having the same book (accounting) value as when rates were 7 percent.Using market values, capital
In Chapter 23, we examine how derivative securities can be used to hedge interest rate risk. LO.1
Calculate the spread between the prime rate and CD rate since 2016. How has the spread changed over the last several years? LO.1
How have prime rates and CD rates changed since 2016, as reported in Figure 22–1? LO.1
Use the following balance sheet information to answer this question.(LG 22-3)Balance Sheet (dollars in thousands) and Duration(in years)Duration Amount T-bills 0.5 $ 90 T-notes 0.9 55 T-bonds 4.393
Consider the following. (LG 22-3)a. Calculate the leverage-adjusted duration gap of an FI that has assets of $1 million invested in 30-year, 10 percent semiannual coupon Treasury bonds selling at par
Consider the following balance sheet for Watchover Savings Inc. (in millions): (LG 22-1)a. What is Watchover’s expected net interest income at year-end?b. What will be the net interest income at
Claims also may arise in long-tail lines when a contingency takes place during the policy period but a claim is not lodged until many years later. As mentioned in Chapter 15, the claims regarding
Life insurers also provide a considerable amount of loan commitments, especially in the commercial property area. As a result, they face asset-side loan commitment liquidity risk in a similar fashion
A surrender value is usually some proportion or percentage less than 100 percent of the face value of the insurance contract. The surrender value continues to grow as funds invested in the policy
We assume no deposit insurance exists that guarantees payment of deposits or no discount window borrowing is available to fund a temporary need for funds. The presence of deposit insurance and the
“Monitoring Tools for Intraday Liquidity Management,” Bank for International Settlements, April 2013. www.bis.org. LO.1
“International Framework for Liquidity Risk Measurement, Standards and Monitoring,”Bank for International Settlements, December 2009. www.bis.org LO.1
DIs could hold highly liquid interest-bearing assets such as T-bills, but they are still less liquid than cash, and immediate liquidation may result in some small capital value losses and transaction
Currently, the Fed requires a minimum 3 percent cash reserve on the first $110.2 million and 10 percent on the rest of a DIʼs demand deposit and transaction account holdings. The$110.2 million
However, the rates paid are normally slow to adjust to changes in market interest rates and lie below purchased fund rates. LO.1
Accounts with this type of put option include demand deposits, NOW accounts (interestbearing checking accounts with minimum balance requirements), and money market accounts (interest-bearing checking
Calculate the percentage change in each rate since 2016, as reported in Figure 21–1. Which rate has increased or decreased more? Why? LO.1
Using information in this file, update Figure 21–1. LO.1
BancTwo has the following balance sheet (in millions of dollars):(LG21-3) LO.1
FirstBank has the following balance sheet (in millions of dollars):(LG21-3)Calculate the NSFR for FirstBank. LO.1
WallsFarther Bank has the following balance sheet (in millions of dollars): (LG 21-3)Cash inflows over the next 30 days from the FI’s performing assets are$5.5 million. Calculate the LCR for
Central Bank has the following balance sheet (in millions of dollars):(LG 21-3)Cash inflows over the next 30 days from the FI’s performing assets are$7.5 million. Calculate the LCR for Central
An investment fund has $1 million in cash and $9 million invested in securities. It currently has 1 million shares outstanding. (LG 21-7)a. What is the NAV of this fund?b. Assume that some of the
A DI has the following assets in its portfolio: $20 million in cash reserves with the Fed, $20 million in T-bills, and $50 million in mortgage loans. If it needs to dispose of its assets at short
The Acme Corporation has been acquired by the Conglomerate Corporation. To help finance the takeover, Conglomerate is going to liquidate the overfunded portion of Acme’s pension fund. The assets
The Plainbank has $10 million in cash and equivalents, $30 million in loans, and $15 million in core deposits. Calculate (a) the financing gap and (b) the financing requirement. (LG 21-3) LO.1
Consider the balance sheet for the DI listed below:The DI is expecting a $15 million net deposit drain. Show the DI’s balance sheet under these two conditions: (LG 21-2)a. The DI purchases
The AllStar Bank has the following balance sheet:Its largest customer decides to exercise a $15 million loan commitment. Show how the new balance sheet changes if AllStar uses(a) stored liquidity
How is the liquidity problem faced by investment funds different from the liquidity problem faced by DIs and insurance companies? (LG 21-7) LO.1
What is the greatest cause of liquidity exposure that property–casualty insurers face? (LG 21-6) LO.1
Why does deposit insurance deter bank runs? (LG 21-5)page 652 LO.1
Describe the unprecedented steps the Federal Reserve took with respect to the discount window operations during the financial crisis.(LG 21-5) LO.1
What are the several components of a DI’s liquidity plan? How can such a plan help a DI reduce liquidity shortages? (LG 21-4) LO.1
Define each of the following four measures of liquidity risk. Explain how each measure would be implemented and utilized by a DI. (LG 21-3)a. Financing gap and financing requirement.b. Sources and
What are two ways a DI can offset the effects of asset-side liquidity risk, such as the drawing down of a loan commitment? (LG 21-2) LO.1
What are two ways a DI can offset the liquidity effects of a net deposit drain of funds? How do the two methods differ? What are the operational benefits and costs of each method? (LG 21-2) LO.1
How is a DI’s distribution pattern of net deposit drains affected by the following? (LG 21-1)a. The holiday season.b. Summer vacations.c. A severe economic recession.d. Double-digit inflation. LO.1
How is asset-side liquidity risk likely to be related to liability-side liquidity risk? (LG 21-2) LO.1
What are core deposits? What role do core deposits play in predicting the probability distribution of net deposit drains? (LG 21-2) LO.1
The probability distribution of the net deposit drain of a DI has been estimated to have a mean of 2 percent. (LG 21-2)a. Is this DI increasing or decreasing in size? Explain.b. If a DI has a net
Why would a DI be forced to sell assets at fire-sale prices? (LG 21-1) LO.1
How does the degree of liquidity risk differ for different types of financial institutions? (LG 21-1) LO.1
For more on RAROC, see A. Saunders and L. Allen, Credit Risk Measurement: New Approaches to Value at Risk and Other Paradigms, 2nd ed. (New York: John Wiley & Sons, 2002). LO.1
The extreme loss rate is usually calculated by taking the average annual loss rate over some historical period and estimating the annual standard deviation of loan loss rates around that mean. If the
This formula ignores present value aspects that could easily be incorporated. For example, fees are earned in up-front undiscounted dollars, while interest payments and risk premiums are normally
They also create a more stable supply of deposits and, thus, mitigate liquidity problems. LO.1
The Moody’s Analytics database contains 30 years of information on over 6,000 public and 220,000 private company default events for a total of 60,000 public and 2.8 million private companies,
See KMV Corporation, Credit Monitor (San Francisco: KMV Corporation, 1994). LO.1
R. C. Merton, “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates,”Journal of Finance 29 (1974), pp. 449–70; F. Black and M. Scholes, “The Pricing of Options and Corporate
Working capital is Current assets – Current liabilities. LO.1
E. I. Altman, “Managing the Commercial Lending Process,” in Handbook of Banking Strategy, ed. R. C. Aspinwall and R. A. Eisenbeis (New York: John Wiley & Sons, 1985), pp.473–510. See also
Market value ratios such as the growth rate in the share price, price-earnings ratio, and dividend yield are also valuable indicators if they are available. For a mid-market corporation, however,
Sinking funds are required periodic payments into a fund that is used to retire the principal amounts on bonds outstanding (see Chapter 6). LO.1
Another version adds to the denominator investments for replacing equipment that is needed for the applicant to remain in business. LO.1
For example, those credit-scoring systems based on a statistical technique called discriminant analysis are also referred to as discriminant analysis models. Discriminant analysis places borrowers
The numerator of the GDS is often increased to include home heating and homeowners’association and other fees. When the GDS ratio is used for consumer credit, rent is substituted for mortgage
Often called “points” (see Chapter 7). LO.1
That is, the risk of a portfolio of loans is less than the sum of individual risks of each loan because individual loans’ risks are not perfectly correlated with each other. The lower the degree of
Compare the nonperformance rate of C&I loans with real estate and credit card loans. Which has changed the most since 2016? LO.1
How has the nonperformance rate changed since 2016? LO.1
A bank has two loans of equal size outstanding, A and B, and the bank has identified the returns they would earn in two different states of nature, 1 and 2, representing default and no default,
Metrobank offers one-year loans with a 9 percent stated rate, charges a¼ percent loan origination fee, imposes a 10 percent compensating balance requirement, and must pay a 6 percent reserve
Countrybank offers one-year loans with a stated rate of 10 percent but requires a compensating balance of 10 percent. What is the true cost of this loan to the borrower? (LG 20-6)page 631 LO.1
Suppose that the financial ratios of a potential borrowing firm took the following values: X1 = Net working capital/Total assets = 0.10, X2 =Retained earnings/Total assets = 0.20, X3 = Earnings
Industrial Corporation has a net income-to-sales (profit margin) ratio of 0.03, a sales-to-assets (asset utilization) ratio of 1.5, and a debt-toasset ratio of 0.66. What is Industrial’s return on
Calculate the following ratios for Lake of Egypt Marina Inc. as of year-end 2019. (LG 20-4)Lake of Egypt Marina Inc. Industrya. Current ratio 2.0 timesb. Quick ratio 1.2 timesc. Days sales in
In Problem 6, how might we determine whether these ratios reflect a well-managed, creditworthy company? (LG 20-4)Use the following financial statements for Lake of Egypt Marina to answer Problem 8.
Consider the following company’s balance sheet and income statement. (LG 20-4)Income Statement Sales (all on credit) $200,000 Cost of goods sold 130,000 Gross margin 70,000 Selling and
Use the balance sheet and income statement below to construct a statement of cash flows for 2019 for Clancy’s Dog Biscuit Corp. (LG 20-4)Clancy’s Dog Biscuit Corporation Income Statement for
In 2018, Webb Sports Shop had cash flows from investing activities of$2,567,000 and cash flows from financing activities of $3,459,000.page 629 The balance in the firm’s cash account was $950,000
Suppose you are a loan officer at Carbondale Local Bank. Joan Doe listed the following information on her mortgage application: (LG 20-2, LG 20-3)Characteristic Value Annual gross income $45,000 TDS
Explain how modern portfolio theory can be applied to lower the credit risk of an FI’s portfolio. (LG 20-6) LO.1
How does loan portfolio risk differ from individual loan risk? (LG 20-6) LO.1
What are compensating balances? What is the relationship between the amount of compensating balance requirement and the return on the loan to the FI? (LG20-6)The following questions are related to
Why could a lender’s expected return be lower when the risk premium is increased on a loan? (LG 20-6) LO.1
Why is an FI’s bargaining strength weaker when dealing with large corporate borrowers than mid-market business borrowers? (LG20-5) LO.1
What are conditions precedent? (LG20-4) LO.1
Why should a credit officer be concerned if a mid-market business borrower’s liquidity ratios differ from the industry norm? (LG 20-4) LO.1
How does ratio analysis help answer questions about the production, management, and marketing capabilities of a prospective borrower?(LG 20-4) LO.1
Why must an account officer be well versed in the FI’s credit policy before talking to potential mid-market business borrowers? (LG 20-4) LO.1
What are some of the special risks and considerations when lending to small businesses rather than large businesses? (LG 20-4, LG 20-5) LO.1
In what ways does the credit analysis of a mid-market borrower differ from that of a small-business borrower? (LG 20-4) LO.1
How does an FI evaluate its credit risks with respect to consumer and small-business loans? (LG 20-3) LO.1
What are the purposes of credit-scoring models? How do these models assist an FI manager to better administer credit? (LG 20-3) LO.1
What are the primary considerations used by FIs to evaluate mortgage loans? (LG 20-2) LO.1
Why is credit risk analysis an important component of FI risk management? (LG 20-1) LO.1
We look at the analysis of borrower (credit) risk in Chapter 20. LO.1
The Federal Home Loan Bank System, established in 1932, consists of 12 regional Federal Home Loan Banks (set up similar to the Federal Reserve Bank system) that borrow funds in the national capital
Finance companies do, of course, have market participants observing their work and monitoring their activities. LO.1
Failure to meet the 65 percent QTL test results in the loss of certain tax advantages and the ability to obtain Federal Home Loan Bank advances (loans). LO.1
In contrast, a bank is defined as an institution that both accepts deposits and makes loans. LO.1
The major enterprises are GNMA, FNMA, and FHLMC. LO.1
The term savings association has replaced S&L to capture the change in the structure of the industry. In 1978, the Federal Home Loan Bank Board (FHLBB), at the time the main regulator of savings

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