1) For a bank to accept credit risk, it must expect to be paid either interest at a sufficiently large premium above the risk-free rate or an actuarially fair fee. The required credit risk premium or fee depends upon four determinants. Explain these determinants in detail. (1.5 Marks)

2) SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between marketplace participants at the measurement date. Fair Value Accounting is argued to be conceptually and practically preferable to Amortized Cost Accounting for most financial instruments. But there are some arguments that are against fair value accounting. Understanding these arguments are important because they speak directly to the strength and weakness of fair value accounting. You are required to discuss these arguments in detail. (2 Marks)

3) Mortgage banks are exposed to interest rate risk on their mortgage-related asset through prepayment and discounting effects that are not entirely distinct. Discuss the Prepayment and Discounting Effects of Mortgage Banks in detail. (1.5 Marks)

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