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business
principles of risk management

Questions and Answers of Principles Of Risk Management

Why should savings institutions with little or no equity capital seek to take more risk than well-capitalized savings institutions? LO.1
How do adjustable-rate mortgages help savings institutions? LO.1
Are savings institutions likely to be more or less exposed to interest rate risk than are banks? Explain your answer. LO.1
What has the trend in ROA and ROE been in the commercial banking industry over the last decade? LO.1
What are the major regulations that have affected the operations of U.S. commercial banks? LO.1
Describe the responsibilities of the three federal regulatory agencies in the United States. LO.1
What are the major sources of funding for commercial banks? LO.1
What are the major assets held by commercial banks? LO.1
Describe the global challenges facing U.S. Fls in the early 2000s. LO.1
What were the causes of the financial crisis? LO.1
What are the fastest-growing Fls in the United States? LO.1
Is the share of bank and thrift assets growing as a proportion of total Fl assets in the United States? LO.1
What six major types of regulation do Fls face? LO.1
Define the concept of net regulatory burden. LO.1
Why should more regulation be imposed on Fls than on other types of private corporations? LO.1
What is the link between asset diversification and the liquidity of deposit contracts? LO.1
What are primary securities and secondary securities? LO.1
What are two major differences between brokers (such as security brokers) and deposi- tory institutions (such as commercial banks)? LO.1
What are the three major risks to household savers from direct security purchases? LO.1
Go to the Federal Reserve Board's Web site at www.federal reserve.gov and update Table 11-7 using the following steps. Click on "Economic Research and Data." Click on "Statistical Releases and
Go to the Federal Housing Finance Agency's Web site at www.fhfa.gov and find the most recent data on the percentage of conventional single-family mortgages with adjustable rates using the following
Go to the Federal Reserve Board's Web site at www.federal reserve.gov and update the data in Table 11-1 using the following steps. Click on "Economic Research and Data." Click on "Statistical
Industrial Corporation has an income to sales (profit margin) ratio of .03, a sales to assets (asset utilization) ratio of 1.5, and a debt to asset ratio of .66. What is Industrial's return on
Consider the following company balance sheet and income statement.For this company, calculate the following:a. Current ratio.b. Number of days’ sales in receivables.c. Sales to total assets.d.
How does ratio analysis help to answer questions about the production, man- agement, and marketing capabilities of a prospective borrower? LO.1
What are some of the special risks and considerations when lending to small businesses rather than large businesses? LO.1
Suppose you are a loan officer at Carbondale Local Bank. Joan Doe listed the following information on her mortgage application. Characteristic Annual gross income TDS Relations with Fl Value $45,000
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 risk-free rate is 6 percent and the time to
A firm has assets of $200,000 and total debts of $175,000. With an option pric- ing model, the implied volatility of the firm's assets is estimated at $10,730. Under the KMV method, what is the
A firm is issuing two-year debt in the amount of $200,000. The current market value of the assets is $300,000. The risk-free rate is 4 percent and the standard deviation of the rate of change in the
A bank is planning to make a loan of $5,000,000 to a firm in the steel industry. It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years with a duration of 7.5
What is RAROC? How does this model use the concept of duration to mea- sure the risk exposure of a loan? How is the expected change in the credit risk premium measured? What precisely is ALN in the
The table below shows the dollar amounts of outstanding bonds and corre- sponding default amounts for every year over the past five years. Note that the default figures are in millions, while those
The following is a schedule of historical defaults (yearly and cumulative) expe- rienced by an FI manager on a portfolio of commercial and mortgage loans.Years after Issuance Loan Type 1 Year 2 Years
What is the mortality rate of a bond or loan? What are some of the problems with using a mortality rate approach to determine the probability of default of a given bond issue? LO.1
The bond equivalent yields for U.S. Treasury and A-rated corporate bonds with maturities of 93 and 175 days are given below: 93 Days 175 Days Treasury strip 8.07% 8.11% A-rated corporate Spread 8.42
Calculate the term structure of default probabilities over three years using the following spot rates from the Treasury strip and corporate bond (pure dis- count) yield curves. Be sure to calculate
What is meant by the phrase marginal default probability? How does this term differ from cumulative default probability? How are the two terms related? LO.1
Assume that a one-year Treasury strip is currently yielding 5.5 percent and an AAA-rated discount bond with similar maturity is yielding 8.5 percent.a. If the expected recovery from collateral in the
A bank has made a loan charging a base lending rate of 10 percent. It expects a probability of default of 5 percent. If the loan is defaulted, the bank expects to recover 50 percent of its money
If the rate on one-year T-bills currently is 6 percent, what is the repay- ment probability for each of the following two securities? Assume that if the loan is defaulted, no payments are expected.
Consider the coefficients of Altman's Z score. Can you tell by the size of the coefficients which ratio appears most important in assessing creditworthiness of a loan applicant? Explain. LO.1
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.Cash $ 20
Describe how a linear discriminant analysis model works. Identify and dis- cuss the criticisms which have been made regarding the use of this type of model to make credit risk evaluations. LO.1
Suppose the estimated linear probability model used by an FI to pre- dict business loan applicant default probabilities is PD = .03X + .02X- .05X3+ error, where X is the borrower's debt/equity ratio,
What are the purposes of credit scoring models? How do these models assist an FI manager in better administering credit? LO.1
Why are FIs consistently interested in the expected level of economic activity in the markets in which they operate? Why is monetary policy of the Federal Reserve System important to Fis? LO.1
Why is the degree of collateral as specified in the loan agreement of importance to the lender? If the book value of the collateral is greater than or equal to the amount of the loan, is the credit
Identify and define the borrower-specific and market-specific factors that enter into the credit decision. What is the impact of each type of factor on the risk premium?a. Which of these factors is
What are covenants in a loan agreement? What are the objectives of covenants? How can these covenants be negative? Positive? LO.1
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? A
Why are most retail borrowers charged the same rate of interest, implying the same risk premium or class? What is credit rationing? How is it used to con- trol credit risks with respect to retail and
Metrobank offers one-year loans with a 9 percent stated or base rate, charges a 0.25 percent loan origination fee, imposes a 10 percent compensating balance requirement, and must pay a 6 percent
County Bank offers one-year loans with a stated rate of 9 percent but requires a compensating balance of 10 percent. What is the true cost of this loan to the borrower? How does the cost change if
What are compensating balances? What is the relationship between the amount of compensating balance requirement and the return on the loan to the FI? LO.1
Why are rates on credit cards generally higher than rates on car loans? LO.1
What are the two major classes of consumer loans at U.S. banks? How do revolving loans differ from nonrevolving loans? LO.1
What are the primary characteristics of residential mortgage loans? Why does the ratio of adjustable-rate mortgages to fixed-rate mortgages in the economy vary over an interest rate cycle? When would
Why is commercial lending declining in importance in the United States? What effect does this decline have on overall commercial lending activities? LO.1
How does a spot loan differ from a loan commitment? What are the advan- tages and disadvantages of borrowing through a loan commitment? LO.1
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 float- ing rates, especially for longer-maturity
Why is credit risk analysis an important component of FI risk management? What recent activities by FIs have made the task of credit risk assessment more difficult for both FI managers and
Go to the Web site of the Office of the Comptroller of the Currency at www .occ.treas.gov and update Table 13-6 using the following steps. Click on "Publications." Click on "Qrtrly. Derivative Fact
Go to the FDIC Web site at www.fdic.gov and find the total amount of unused commitments and letters of credit and the notional value of interest rate swaps of FDIC-insured commercial banks for the
Defend the statement that although off-balance-sheet activities expose Fls to several forms of risks, they also can alleviate the risks of FIs. LO.1
Discuss how the failure of an affiliate can affect the holding company or its affiliates even if the affiliates are structured separately. LO.1
What is the difference between a one-bank holding company and a multibank holding company? How does the principle of corporate separateness ensure that a bank is safe from the failure of its
Explain how settlement risk is incurred in the interbank payment mechanism and how it is another form of off-balance-sheet risk. LO.1
The manager of Shakey Bank sends a $2 million funds transfer pay- ment message via CHIPS to the Trust Bank at 10 AM. Trust Bank sends a $2 million funds transfer message via CHIPS to Hope Bank later
What is meant by when-issued trading? Explain how forward purchases of when-issued government T-bills can expose Fls to contingent interest rate risk. LO.1
Explain how the use of derivative contracts such as forwards, futures, swaps, and options creates contingent credit risk for an FI. Why do OTC contracts carry more contingent credit risk than do
A corporation is planning to issue $1 million of 270-day commercial paper for an effective annual yield of 5 percent. The corporation expects to save 30 basis points on the interest rate by using
How do standby letters of credit differ from commercial letters of credit? With what other types of FI products do SLCs compete? What types of Fls can issue SLCs? LO.1
A German bank issues a three-month letter of credit on behalf of its customer in Germany, who is planning to import $100,000 worth of goods from the United States. It charges an up-front fee of 100
What is a letter of credit? How is a letter of credit like an insurance contract? LO.1
Do the contingent risks of interest rate, takedown, credit, and aggregate fund- ing tend to increase the insolvency risk of an FI? Why or why not? LO.1
How is an FI exposed to takedown risk and aggregate funding risk? How are these two contingent risks related? LO.1
How is an FI exposed to credit risk when it makes loan commitments? How is credit risk related to interest rate risk? What control measure is available to an FI for the purpose of protecting against
How is an FI exposed to interest rate risk when it makes loan commitments? In what way can an FI control for this risk? How does basis risk affect the implementation of the control for interest rate
Suburb Bank has issued a one-year loan commitment of $10,000,000 for an up-front fee of 50 basis points. The back-end fee on the unused portion of the commitment is 20 basis points. The bank requires
AFI has issued a one-year loan commitment of $2 million for an up-front fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FI requires a
A FI makes a loan commitment of $2.5 million with an up-front fee of 50 basis points and a back-end fee of 25 basis points on the unused portion of the loan. The takedown on the loan is 50 percent
What are the characteristics of a loan commitment that an FI may make to a customer? In what manner and to whom is the commitment an option? What are the various possible pieces of the option
What role does Schedule L play in reporting off-balance-sheet activities? Refer to Table 13-5. What was the annual growth rate over the 18-year period 1992-2009 in the notional value of
What factors explain the growth of off-balance-sheet activities in the 1980s through the early 2000s among U.S. Fls? LO.1
An FI has purchased options on bonds with a notional value of $500 million and has sold options on bonds with a notional value of $400 million. The purchased options have a delta of 0.25 and the sold
Why are contingent assets and liabilities like options? What is meant by the delta of an option? What is meant by the term notional value? LO.1
Contingent Bank has the following balance sheet in market value terms (in millions of dollars). Assets Liabilities and Equity Cash $ 20 Deposits $220 Mortgages 220 Equity 20 Total assets $240 Total
How does one distinguish between an off-balance-sheet asset and an off-balance-sheet liability? LO.1
Classify the following items as (1) on-balance-sheet assets, (2) on-balance- sheet liabilities, (3) off-balance-sheet assets, (4) off-balance-sheet liabilities, or (5) capital account.a. Loan
An FI has a loan portfolio of 10,000 loans of $10,000 each. The loans have a historical average default rate of 4 percent and the severity of loss is 40 cents per dollar.a. Over the next year, what
A five-year fixed-rate loan of $100 million carries a 7 percent annual interest rate. The borrower is rated BB. Based on hypothetical historical data, the probability distribution given below has
From Table 12A–1 , what is the probability of a loan upgrade? A loan downgrade?What is the impact of a rating upgrade or downgrade?How is the discount rate determined after a credit event has
Refer to Appendix 12B for problem 25. Probability New Loan Value plus Forward Rate Spreads at Time t Rating Distribution Coupon $ t 1+% 5,% AAA 0.01% $114.82 1 3.00% 0.72% AA 0.31 114.60 A 1.45
An FI is limited to holding no more than 8 percent of its assets in securities of a single issuer. What is the minimum number of securities it should hold to meet this requirement? What if the
What rules on credit concentrations has the National Association of Insurance Commissioners enacted? How are they related to modern portfolio theory?LO.1
What reasons did the Federal Reserve Board offer for recommending the use of subjective evaluations of credit concentration risk instead of quantitative models? How did this change in 2006?LO.1
Over the last ten years, a bank has experienced the following loan losses on its C&I loans, consumer loans, and total loan portfolio.Year C&I Loans Consumer Loans Total Loans 2012 0.0080 0.0165
Assume that, on average, national banks engaged primarily in mortgage lending have their assets diversified in the following proportions: 60 percent residential, 15 percent commercial, 5 percent
Information concerning the allocation of loan portfolios to different market sectors is given below. Allocation of Loan Portfolios in Different Sectors (%) Sectors Commercial Consumer Real Estate

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