Question:

(a) Briefly define capital risk and explain how a negative leverage-adjusted duration gap can contribute to an adverse impact on capital. (4 marks)

(b) List and briefly discuss three main functions of bank capital (6 marks)

(c) Sao Paolo Bank (BBB rated) has the following balance sheet (in millions of dollars) with the counterparty credit ratings and risk weights in parentheses. Answering parts (i) through (v).

Assets

Liabilities and equity

Cash

$10

Deposits

$194

Government bonds (rated AA, 0% risk weight)

20

Subordinated debt (>10 years)

1

Interbank deposits, 2-month (rated AA+, 20% risk-weight)

25

Non-Cumulative irredeemable preference shares

5

Corporate loans (rated A-, 50% risk weight)

80

Ordinary shares

4

Fixed assets (100% risk weight)

70

Retained earnings

1

Total assets

205

Total liabilities and equity

$205

In addition, the bank engages in the following off-balance activities:

$40 million in performance-related standby letters of credit to BBB rated corporations (SLCs) (100% risk weight)

$100 million in three-year forward FX contracts that are currently out of the money by $2 million

$200 million in four-year interest rate swaps that are currently out of the money by $2 million

$200 million in exchange-traded currency futures that are currently in the money by $1 million.

All derivatives are written on B rated counterparties (150% risk weight).

Credit conversion factors follow:

Performance-related SLoC

50%

Trade-related dLoC

20%

? 1 year loan commitment

20%

> 1 year loan commitment

50%

1-5 year foreign exchange contracts

5%

1-5 year interest rate swaps

0.5%

5-10 year interest rate swaps

1.5%

1-5 year equity contracts

8%

i. What are the risk-adjusted on-balance-sheet assets of the bank as defined under the Basel III Accord? (2 marks)

ii. What are the risk-adjusted off-balance-sheet assets of the bank as defined under the Basel Accord and the total credit risk-adjusted assets? (3 marks)

iii. What is the Common Equity Tier 1, Total Tier 1 capital and Total capital? (1 mark)

iv. Using the minimum required capital amounts, does the bank have enough capital to meet the regulatory capital requirements? (3 marks)

v. What minimum common equity Tier, Total Tier 1 or Total capital does it need to meet the requirement? (1 mark)

Part 2

6 Which of the following is NOT one of the "sizes" of banking for businesses discussed in this course? Multinational Banking Commercial Banking OOOO Business Banking Corporate BankingWhich of the following services are offered at no cost to private banking clients? Tax Planning Estate and Trust Administration OOOO Investment Management Cash ManagementQUESTION 5 An annuity provides protection against the risk of living too long, often called excessive longevity. True False QUESTION 6 Variable annuities contain the following fees and expenses, except Investment management charge Administrative charge Bonus charge Mortality and expense risk charge Surrender chargeYour company. Solid State Gizmo. Inc. (538) has just been spun off by its parent rm, Octopus Industries. into a separate rm. 586's pension fund, currently amounting to $250 million of assets. has also been spun off. SSG's board of directors has asked you to study proposals from a number of investment management rms, each offering to manage the pension fund. You are to give the board a report discussing the different styles of management that are available and making recommendations about which firms should be seriously considered and how SSG should instruct them to manage the pension fund if they' are hired. Carefully dgcug the following (Use no more than 250 words for the discussion of each sub-question): i. What is "active" investment management? ii. Hovr would you judge if one active manager is better than another