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principles of risk management

Questions and Answers of Principles Of Risk Management

How does FHLMC differ from FNMA? How are they the same? LO.1
How does FNMA differ from GNMA? LO.1
What are the primary functions of GNMA? What is timing insurance? LO.1
What has been the effect of securitization on the asset portfolios of financial institutions? LO.1
An FI has purchased a $200 million cap of 9 percent at a premium of 0.65 percent of face value. A $200 million floor of 4 percent is also available at a premium of 0.69 percent of face value.a. If
Do the goals of FIs that utilize the collar in question 34 differ from those that put on the collar in question 35? If so, how? LO.1
36. Contrast the total cash flows associated with the collar position in question 34 against the collar in question LO.1
35. Use the following information to price a three-year collar by purchasing an out-of-the-money cap and writing an in-the-money floor. Assume a binomial options pricing model with an equal
Use the following information to price a three-year collar by purchasing an in-the-money cap and writing an out-of-the-money floor. Assume a binomial options pricing model with an equal probability
Under what balance sheet circumstances would it be desirable to sell a floor to help finance a cap? When would it be desirable to sell a cap to help finance a floor? LO.1
How is buying a cap similar to buying a call option on interest rates? LO.1
What are collars? Under what circumstances would an FI use a collar? LO.1
What are floors? Under what circumstances would the buyer of a floor receive a payoff? LO.1
What are caps? Under what circumstances would the buyer of a cap receive a payoff? LO.1
What is a catastrophe call spread option? How do the cash flows of this option affect the buyer of the option? LO.1
How do the cash flows to the lender for a credit spread call option hedge differ from the cash flows for a digital default option? LO.1
What is a digital default option? LO.1
What is a credit spread call option? LO.1
What is the delta of an option (8)? LO.1
An FI manager writes a call option on a T-bond futures contract with an exer- cise price of 114 at a quoted price of 0-55.a. What type of opportunities or obligations does the manager have?b. In what
Consider Figure 23-13 again. What happens to the option price of the following?a. A call when the exercise price increases.b. A call when the time until expiration increases.c. A put when the
Consider Figure 23-13. What are the prices paid for the following futures option?a. March T-bond calls at $125.00.b. March 10-year T-note puts at $119.00.c. December Eurodollar puts at 98.75%. LO.1
Why are options on interest rate futures contracts preferred to options on cash instruments in hedging interest rate risk? LO.1
In each of the following cases, identify what risk the manager of an FI faces and whether that risk should be hedged by buying a put or a call option.a. A commercial bank plans to issue CDs in three
Consider the following:a. What are the two ways to use call and put options on T-bonds to generate positive cash flows when interest rates decline? Verify your answer with a diagram.b. Under what
What must happen to interest rates for the purchaser of a put option on a bond to make money? How does the writer of the put option make money? LO.1
What is a put option? LO.1
What must happen to interest rates for the purchaser of a call option on a bond to make money? How does the writer of the call option make money? LO.1
What is a call option? LO.1
How does using options differ from using forward or futures contracts? LO.1
What are the difficulties of expanding globally? How can each of these diffi- culties create negative effects on the operating performance of Fls? LO.1
What are the major advantages of international expansion to Fls? Explain how each advantage can affect the operating performance of FIs. LO.1
What were the main features of FBSEA? How did FBSEA encourage coopera- tion with the home country regulator? What was the effect of the FBSEA on the Federal Reserve and on foreign banks? LO.1
What events led to the passage of the Foreign Bank Supervision Enhancement Act (FBSEA) of 1991? What was the main objective of this legislation? LO.1
What was the fundamental philosophical focus of the International Banking Act (IBA) of 1978? LO.1
What factors affected the relative growth of the proportion of U.S. banking assets that were controlled by foreign banks during the 1990s through 2009? LO.1
What is the European Community (EC) Second Banking Directive? What impact has the Second Banking Directive had on the competitive banking environment in Europe? LO.1
What effect have the problems of emerging-market economies in the late 1990s and 2000s had on the global expansion of traditional banking activities by U.S. banks? LO.1
What is the expected impact of the implementation of the Basel II risk-based capital requirements on the international activities of some major U.S. banks? LO.1
Identify and explain the impact of at least four factors that have encouraged global U.S. bank expansion. LO.1
How did the Overseas Direct Investment Control Act of 1964 assist in the growth of global banking activities? How much growth in foreign assets occurred from 1980 to 2009? LO.1
What are some of the benefits for banks engaging in domestic geographic expansion? LO.1
What are some plausible reasons for the percentage of assets of small and inter- mediate sized banks decreasing and the percentage of assets of large banks increasing since 1984? LO.1
What factors other than market concentration does the Justice Department consider in determining the acceptability of a merger? LO.1
City Bank currently has a 60 percent market share in banking services, fol- lowed by NationsBank with 20 percent and State Bank with 20 percent.a. What is the concentration ratio as measured by the
What is the Herfindahl-Hirschman Index? How is it calculated and interpreted? LO.1
What are the three revenue synergies that may be obtained by an FI from domestic geographic expansion? LO.1
How did the development of the nonbank bank competitive strategy further clarify the meaning of the term activities closely related to banking? In a more gen- eral sense, how has this strategy
How did the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allow for full interstate banking? What are the expected profit performance effects of interstate
What is an interstate banking pact? LO.1
LO.1 In what way did the Garn-St. Germain Act and FIRREA provide incentives for the expansion of interstate branching? LO.1
How are insurance companies able to offer services in states beyond their state of incorporation? LO.1
How do limitations on domestic geographic diversification affect an FI's profitability? LO.1
In what ways does the current regulatory structure argue against providing additional securities powers to the banking industry? Does this issue just con- cern banks? LO.1
Under what circumstances could the existence of deposit insurance provide an advantage to banks in competing with other traditional securities firms? LO.1
What six conflicts of interest have been identified as potential roadblocks to the expansion of banking powers into the financial services area? LO.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 creat- ing potentially greater benefits? LO.1
The Financial Services Modernization Act of 1999 allows banks to own con- trolling interests in nonfinancial companies. What are the two restrictions on such ownership? LO.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? How have nonbanks managed to exploit the
Explain in general terms what impact the Financial Services Moderniza- tion Act of 1999 should have on the strategic implementation of Section 20 activities. LO.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 did
What general prohibition regarding the activities of commercial banking and investment banking did the Glass-Steagall Act impose? LO.1
How does product segmentation reduce the profitability and risk of Fls? How does it increase the profitability and risk of Fls? LO.1
How do the risk categories in the risk-based capital model for property-casualty insurance companies differ from those for life insurance companies? What are the assumed relationships between the
A life insurance company has estimated the following capital requirements for each of the risk classes: asset risk (C1) = $5 million, insurance risk (C2) = $4 mil- lion, interest rate risk (C3) = $1
Identify and discuss the problems in the risk-based capital approach to mea- suring capital adequacy. LO.1
How does the risk-based capital measure attempt to compensate for the limi- tations of the static leverage ratio? LO.1
Explain how off-balance-sheet market contracts, or derivative instruments, differ from contingent guaranty contracts.a. What is counterparty credit risk?b. Why do exchange-traded derivative security
Explain the process of calculating risk-adjusted off-balance-sheet contingent guaranty contracts.a. What is the basis for differentiating the credit equivalent amounts of con- tingent guaranty
Explain the process of calculating credit risk-adjusted on-balance-sheet assets.a. What assets are included in the five categories of credit risk exposure under Basel II?b. What are the appropriate
What components are used in the calculation of credit risk-adjusted assets? LO.1
What are the definitional differences between Tier I and Tier II capital? LO.1
Identify the five zones of capital adequacy and explain the mandatory regula- tory actions corresponding to each zone. LO.1
What is the total risk-based capital ratio? LO.1
What is the major feature in the estimation of credit risk under Basel II capital requirements? LO.1
What is the Basel Agreement? LO.1
Identify and discuss the weaknesses of the leverage ratio as a measure of capi- tal adequacy. LO.1
What is the significance of prompt corrective action as specified by the FDICIA legislation? LO.1
How is the leverage ratio for a DI defined? LO.1
What are the arguments for and against the use of market value accounting for Dls? LO.1
Why is the market value of equity a better measure of an FI's ability to absorb losses than book value of equity? LO.1
What are the differences between the economic definition of capital and the book value definition of capital?a. How does economic value accounting recognize the adverse effects of credit risk?b. How
Why are regulators concerned with the levels of capital held by an FI compared with those held by a nonfinancial institution? LO.1
Identify and briefly discuss the importance of the five functions of an FI's capital. LO.1
Go to the Federal Reserve Board's Web site at www.federal reserve.gov and click on "Economic Research and Data." Click on "Statistical Releases and Historical Data." Under "Interest Rates," click on
Go to the FDIC Web site at www.fdic.gov. Click on "Analysts." Click on "FDIC Quarterly Banking Profile." Click on "Quarterly Banking Profile." Click on "Deposit Insurance Fund Trends." Click on
Under the Federal Deposit Insurance Reform Act of 2005, how is a Category I deposit insurance premium determined? LO.1
What changes did the Federal Deposit Insurance Reform Act of 2005 make to the deposit insurance assessment scheme for DIs? LO.1
What was the purpose of the establishment of the Pension Benefit Guaranty Corporation (PBGC)?a. How does the PBGC differ from the FDIC in its ability to control risk?b. How were the 1994 Retirement
How do insurance guaranty funds differ from deposit insurance? What impact do these differences have on the incentive for insurance policyholders to engage in a contagious run on an insurance
Why is access to the discount window of the Fed less of a deterrent to DI runs than deposit insurance? LO.1
How does the Federal Reserve's discount window serve as an alternative to deposit insurance as a lender of last resort facility to financial institutions? What changes occurred in 2008 that expanded
In what ways did FDICIA enhance the regulatory discipline to help reduce moral hazard behavior? What has the operational impact of these directives been? LO.1
A commercial bank has $150 million in assets at book value. The insured and uninsured deposits are valued at $75 million and $50 million, respectively, and the book value of equity is $25 million. As
What is the primary goal of the FDIC in employing the LCR strategy?a. How is the insured depositor transfer method implemented in the process of failure resolution?b. Why does this method of failure
What are some of the essential features of the FDICIA of 1991 with regard to the resolution of failing Dis?a. What is the least-cost resolution (LCR) strategy?b. When can the systemic risk exemption
What is the too-big-to-fail doctrine? What factors caused regulators to act in a way that caused this doctrine to evolve? LO.1
What changes did the Federal Deposit Insurance Reform Act of 2005 make to the deposit insurance cap? LO.1
Why did the fixed-rate deposit insurance system fail to induce insured and uninsured depositors to impose discipline on risky Dls in the United States in the 1980s?a. How is it possible to structure
Under what conditions may the implementation of minimum capital guide- lines, either risk-based or non-risk-based, fail to impose stockholder discipline as desired by regulators? LO.1

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