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principles of risk management

Questions and Answers of Principles Of Risk Management

What is capital forbearance? How does a policy of forbearance potentially increase the costs of financial distress to the insurance fund as well as the stockholders? LO.1
What four factors were provided by FDICIA as guidelines to assist the FDIC in the establishment of risk-based deposit insurance premiums? What happened to the level of deposit insurance premiums in
How is the provision of deposit insurance by the FDIC similar to the FDIC's writing a put option on the assets of a DI that buys the insurance? What two factors drive the premium of the option? LO.1
What are some ways of imposing stockholder discipline to prevent stockhold- ers from engaging in excessive risk taking? LO.1
What are three suggested ways a deposit insurance contract could be struc- tured to reduce moral hazard behavior? LO.1
How does a risk-based insurance program solve the moral hazard problem of excessive risk taking by Fls? Is an actuarially fair premium for deposit insur- ance always consistent with a competitive
What is moral hazard? How did the fixed-rate deposit insurance program of the FDIC contribute to the moral hazard problem of the savings association industry? What other changes in the savings
Contrast the two views on, or reasons why, depository institution insurance funds can become insolvent. LO.1
What major changes did the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 make to the FDIC and the FSLIC? LO.1
How does federal deposit insurance help mitigate the problem of bank runs? What other elements of the safety net are available to DIs in the United States? LO.1
What is a contagious run? What are some of the potentially serious adverse social welfare effects of a contagious run? Do all types of Fls face the same risk of contagious runs? LO.1
What are the primary methods that insurance companies can use to reduce their exposure to liquidity risk? LO.1
What trends have been observed between 1960 and 2009 in regard to liquid- ity and liability structures of commercial banks? What changes have occurred in the management of assets that may cause the
What does a low fed funds rate indicate about the level of DI reserves? Why does the fed funds rate have higher-than-normal variability around the last two days in the reserve maintenance
What characteristics of fed funds may constrain a DI's ability to use fed funds to expand its liquidity quickly? LO.1
Why do wholesale CDs have minimal withdrawal risk to the issuing FI? LO.1
How does the cost of MMMFs differ from the cost of MMDAs? How is the spread useful in managing the withdrawal risk of MMDAS? LO.1
How does the cash balance, or liquidity, of an FI determine the types of repur- chase agreements into which it will enter? LO.1
How is the withdrawal risk different for federal funds and repurchase agreements? LO.1
What is the relationship between funding cost and funding or withdrawal risk? LO.1
Under CRA, when is the uncertainty about the reserve requirement resolved? Discuss the feasibility of making large reserve adjustments during this period of complete information. LO.1
What is the "weekend game"? Contrast the DI's ability and incentive to play the weekend game under LRA as opposed to CRA. LO.1
In July 1998 the lagged reserve accounting (LRA) system replaced a contem- poraneous reserve accounting (CRA) system as the method of reserve calcula- tion for Dls.a. Contrast a contemporaneous
City Bank has estimated that its average daily demand deposit balance over the recent 14-day reserve computation period was $225 million. The average daily balance with the Fed over the 14-day
Define the reserve computation period, the reserve maintenance period, and the lagged reserve accounting system. LO.1
Rank these financial assets according to their liquidity: cash, corporate bonds, NYSE-traded stocks, and T-bills. LO.1
How do liquid asset reserve requirements enhance the implementation of monetary policy? How are reserve requirements a tax on DIs? LO.1
What concerns motivate regulators to require DIs to hold minimum amounts of liquid assets? LO.1
Consider the assets (in millions) of two banks, A and B. Both banks are funded by $120 million in deposits and $20 million in equity. Which bank has the stronger liquidity position? Which bank
How is an FI's liability and liquidity risk management problem related to the maturity of its assets relative to its liabilities? LO.1
What are the benefits and costs to an FI of holding large amounts of liquid assets? Why are Treasury securities considered good examples of liquid assets? LO.1
A mutual fund has the following assets in its portfolio: $40 million in fixed-income securities and $40 million in stocks at current market values. In the event of a liquidity crisis, the fund can
How is the liquidity problem faced by investment funds different from that faced by Dls and insurance companies? How does the liquidity risk of an open-end mutual fund compare with that of a
What are the levels of defense against liquidity risk for a life insurance com- pany? How does liquidity risk for a property-casualty insurer differ from that for a life insurance company? LO.1
What government safeguards are in place to reduce liquidity risk for DIs? LO.1
What is a bank run? What are some possible withdrawal shocks that could initiate a bank run? What feature of the demand deposit contract provides deposit withdrawal momentum that can result in a bank
How can an FI's liquidity plan help reduce the effects of liquidity shortages? What are the components of a liquidity plan? LO.1
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 $10 million in T-bills, a $5 million line of credit to borrow in the repo market, and $5 million in excess cash reserves (above reserve require- ments) with the Fed. The DI currently has
Define each of the following four measures of liquidity risk. Explain how each measure would be implemented and utilized by a DI.a. Sources and uses of liquidity.b. Peer group ratio comparisons.c.
What are two ways a DI can offset the effects of asset-side liquidity risk such as the drawing down of a loan commitment? 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? LO.1
How is a DI's distribution pattern of net deposit drains affected by the following?a. The holiday season.b. Summer vacations.c. A severe economic recession.d. Double-digit inflation. LO.1
The probability distribution of the net deposit drains of a DI has been esti- mated to have a mean of 2 percent and a standard deviation of 1 percent. Is this DI increasing or decreasing in size?
What are core deposits? What role do core deposits play in predicting the probability distribution of net deposit drains? LO.1
What are the two reasons liquidity risk arises? How does liquidity risk aris- ing from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance
How does the degree of liquidity risk differ for different types of financial institutions? LO.1
What actions has the BIS taken to protect depository institutions from insol- vency due to operational risk? LO.1
How has technology altered the competition risk of Fls? LO.1
What are usury ceilings? How does technology create regulatory risk? LO.1
What has been the impact of rapid technological improvements in the elec- tronic payment systems on crime and fraud risk? LO.1
Why do Fls in the United States face a higher degree of international tech- nology risk than do the FIs in other countries, especially some European countries? LO.1
How does Regulation F of the 1991 FDICIA reduce the problem of daylight overdraft risk? LO.1
What is a daylight overdraft? How do an FI's overdraft risks incurred during the day differ for each of the two competing electronic payment systems, Fed- wire and CHIPS? What provision has been
What are the differences between the Fedwire and CHIPS payment systems? LO.1
Why does the United States lag behind most other industrialized countries in the proportion of annual electronic noncash transactions per capita? What factors probably will be important in causing
What are some of the conclusions of empirical studies on economies of scale and scope? How important is the impact of cost reductions on total average costs? What are X-inefficiencies? What role do
What is the difference between the production approach and the intermedia- tion approach to estimating cost functions of Fls? LO.1
What are diseconomies of scope? How could diseconomies of scope occur? LO.1
A commercial bank with assets of $2 billion and costs of $200 million has acquired an investment banking firm subsidiary with assets of $40 million and expenses of $15 million. After the acquisition,
Buy Bank had $130 million in assets and $20 million in expenses before the acquisition of Sell Bank, which had assets of $50 million and expenses of $10 million. After the merger, the bank had $180
What information on the operating costs of Fls is provided by the measure- ment of economies of scope? What implications do economies of scope have for regulators? LO.1
What are diseconomies of scale? What are the risks of large-scale technologi- cal investments, especially to large FIs? Why are small Fls willing to outsource production to large Fls against which
What information on the operating costs of FIs does the measurement of econ- omies of scale provide? If economies of scale exist, what implications do they have for regulators? LO.1
Distinguish between economies of scale and economies of scope. LO.1
Identify and discuss three benefits of technology in generating revenue for Fls. LO.1
City Bank upgrades its computer equipment every five years to keep up with changes in technology. Its next upgrade is two years from today and is budgeted to cost $1 million. Management is
The operations department of a major FI is planning to reorganize several of its back-office functions. Its current operating expense is $1.5 million, of which $1 million is for staff expenses. The
What are some of the risks inherent in being the first to introduce a financial innovation? LO.1
Compare the effects of technology on an FI's wholesale operations with the effects of technology on an FI's retail operations. Give some specific examples. LO.1
Table 16-1 shows data on earnings, expenses, and assets for all insured banks. Calculate the annual growth rates in the various income, expense, earnings, and asset categories from 1991 to 2008. If
Explain how technological improvements can increase an FI's interest and noninterest income and reduce interest and noninterest expenses. Use some specific examples. LO.1
Go to the World Bank Web site at www.worldbank.org and find the amount of banks loans currently outstanding in Brazil using the following steps. Click on "Data and Research." Under "Data Programs,"
Go to the Heritage Foundation Web site at www.heritage.org/index and find the most recent Economic Freedom Index for the United States using the fol- lowing steps. Click on "Explore the data." This
What are the risks to an investing company participating in a debt-for-equity swap? LO.1
Identify and describe the three market segments of the secondary market for LDC debt. The following questions and problems are based on material presented in Appen- dix 15A. LO.1
Who are the primary sellers of LDC debt? Who are the buyers? Why are FIs often both sellers and buyers of LDC debt in the secondary markets? LO.1
What are the benefits and costs of rescheduling to the following?a. A borrower.b. A lender. LO.1
What is systematic risk in terms of sovereign risk? Which of the variables often used in statistical models tend to have high systematic risk? Which variables tend to have low systematic risk? LO.1
How do price and quantity risks affect the variability of a country's export revenue? LO.1
What shortcomings are introduced by using traditional CRA models and tech- niques? In each case, what adjustments are made in the estimation techniques to compensate for the problems? LO.1
Countries A and B have exports of $2 billion and $6 billion, respectively. The total interest and amortization on foreign loans for both countries are $1 billion and $2 billion, respectively.a. What
An FI manager has calculated the following values and weights to assess the credit risk and likelihood of having to reschedule a loan. From the Z-score calculated from these weights and values, is
What types of variables normally are used in a CRA Z-score model? Define the following ratios and explain how each is interpreted in assessing the prob- ability of rescheduling.a. Debt service
What three country risk assessment models are available to investors? How is each model compiled? LO.1
Identify and explain at least four reasons that rescheduling debt in the form of loans is easier than rescheduling debt in the form of bonds. LO.1
What is the difference between debt rescheduling and debt repudiation? LO.1
What risks are incurred in making loans to borrowers based in foreign coun- tries? Explain. LO.1
Go to the FDIC Web site at www.fdic.gov and find the most recent values for foreign exchange trading revenue at J.P. Morgan Chase and Citigroup using the following steps. Click on "Analysts." Click
Go to the Web site of the U.S. Treasury at www.ustreas.gov and update Table 14-3 using the following steps. Click on "Bureaus." Click on "Financial Management Service (FMS)." Under "Reports," click
A money market mutual fund manager is looking for some profitable invest- ment opportunities and observes the following one-year interest rates on gov- ernment securities and exchange rates: rus =
An FI has $100,000 of net positions outstanding in British pounds () and -$30,000 in Swiss francs (SF). The standard deviation of the net positions as a result of exchange rate changes is 1 percent
What is economic integration? What impact does the extent of economic inte- gration of international markets have on the investment opportunities for FIs? LO.1
What is the relationship between the real interest rate, the expected inflation rate, and the nominal interest rate on fixed-income securities in any particular country? Refer to Table 14-5. What
Assume that annual interest rates are 8 percent in the United States and 4 per- cent in Japan. An FI can borrow (by issuing CDs) or lend (by purchasing CDs) at these rates. The spot rate is
Explain the concept of interest rate parity. What does this concept imply about the long-run profit opportunities from investing in international markets? What market conditions must prevail for the
Suppose that the current spot exchange rate of U.S. dollars for Australian dol- lars, Suss/As, is .7590 (i.e., 0.759 dollars, or 75.9 cents, can be received for 1 Aus- tralian dollar). The price of
What is the purchasing power parity theorem? LO.1
How does the lack of perfect correlation of economic returns between inter- national financial markets affect the risk-return opportunities for FIs holding multicurrency assets and liabilities? Refer
A bank purchases a six-month, $1 million Eurodollar deposit at an annual interest rate of 6.5 percent. It invests the funds in a six-month Swedish krone AA-rated bond paying 7.5 percent per year. The

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