Deck 7: Risks of Financial Institutions

Question 1

One method of guarding against credit risk is to assess a risk premium based on the estimate of default risk exposure that a borrower carries.

Answer 1

True

Question 2

Financial claims issued by corporations and held by FIs promise a limited or fixed upside return.

Answer 2

True

Question 3

An FI is short-funded when the maturity of its liabilities is less than the maturity of its assets.

Answer 3

True

Question 4

Credit risk only exposes the lender to the uncertainty that interest payments may not be received.

Question 5

Because the economies of the U.S.and other overseas countries have become more integrated, the risks of financial intermediation have decreased.

Question 6

The relationship of a limited or fixed upside return with a high probability and the potential large downside loss with a small probability is an example of an asset's credit risk to an FI.

Question 7

Funding a portion of assets with equity capital means that hedging risk does not require perfect matching of the assets and liabilities.

Question 8

Firm-specific credit risk can be reduced by diversification.

Question 9

Exactly matching the maturities of assets and liabilities will provide a perfect hedge against interest rate risk for an FI.

Question 10

Managerial monitoring efficiency and credit risk management strategies affect the risk of the loan portfolio.

Question 11

Historically credit card loans have had very low rates of default or credit risk when compared to other assets that an FI may hold.

Question 12

Matching the maturities of assets and liabilities supports the asset transformation function of FIs.

Question 13

In the case where a borrower defaults on a loan, the FI may lose only a portion of the principal that was loaned.

Question 14

FIs that make loans or buy bonds with long maturity liabilities are more exposed to interest rate risk than FIs that make loans or buy bonds with short maturity liabilities.

Question 15

FIs that make long-term loans are less exposed to credit risk than if they make short-term loans.

Question 16

If an FI holds long-term assets funded by short-term liabilities when interest rates rise, the market value of assets will fall by a greater amount than the market value of its liabilities.

Question 17

An FI is exposed to reinvestment risk by holding longer-term assets relative to liabilities.

Question 18

Diversification in the loan portfolio of an FI is intended to reduce systematic risk of each of the loans in the portfolio.

Question 19

Credit risk stems from non-repayment or delays in repayment of either principal or interest on FI assets.

Question 20

An FI that has liability maturities longer than asset maturities faces the risk that the return of reinvesting assets could exceed the cost of funding those assets.

Question 21

During a liquidity crisis assets might be sold at a loss because of the rising interest rates caused by financial institutions attempting to raise funds.

Question 22

One cause of liquidity risk occurs when customers of an FI pay down their lines of credit.

Question 23

Direct foreign investment and foreign portfolio investment both can be beneficial to an FI because of imperfectly correlated returns with domestic investments.

Question 24

Foreign exchange risk is that the value of assets and liabilities may change because of changes in the foreign exchange rate between two countries.

Question 25

Returns from domestic and foreign investments may not be perfectly correlated because of different economic infrastructures and growth rates.

Question 26

To ease the demand for immediate cash by customers, and FI can either borrow additional funds or sell assets.

Question 27

Sovereign risk is a different type of credit risk that affects an FI that purchases bonds of foreign corporations and governments.

Question 28

Foreign exchange rate risk occurs because foreign exchange rates are volatile and can impact banks with exposed foreign assets and/or liabilities.

Question 29

An FI is net long in foreign assets if it holds more foreign liabilities than foreign assets.

Question 30

Systematic credit risk can be reduced significantly by diversification.

Question 31

Individuals have an advantage over FIs in that individuals more easily can diversify away some of the credit risk of their asset portfolios.

Question 32

Foreign exchange risk is that the value of assets and liabilities may change because of changes in the level of interest rates.

Question 33

Unanticipated withdrawals by liability holders are a major part of liquidity risk.

Question 34

Foreign exchange risk includes interest rate risk and credit risk as well as changes in the foreign exchange rate between two countries.

Question 35

An FI can hold assets denominated in a foreign country, but it cannot issue foreign liabilities.

Question 36

Sovereign risk involves the inability of a foreign corporation to repay the principal or interest on a loan because of stipulations by the foreign government that is out of the control of the foreign corporation.

Question 37

To be immunized against foreign currency and foreign interest rate risk, an FI should match both the size and maturities of its foreign assets and foreign liabilities.

Question 38

During a liquidity crisis, an FI may have to borrow additional funds at higher rates as the supply of funds becomes restricted.

Question 39

Control of the future supply of funds available to a foreign country is one method to ensure the repayment of an existing debt.

Question 40

For an FI to exactly hedge the foreign investment risk, the foreign currency assets must equal the foreign currency liabilities.

Question 41

Sovereign risk can be effectively controlled through the foreign exchange market.

Question 42

FIs that actively trade assets and liabilities are exposed to market risk.

Question 43

FIs typically are concerned about the value at risk of their trading portfolios.

Question 44

Similar to loans, non-government bonds expose a lender to principal payment default risk.

Question 45

Contingent claims are assets and liabilities that will come into existence at a future time often due to a customer's action...

Question 46

The merger of Citicorp with Travelers Insurance is an example of an attempt to exploit economies of scope.

Question 47

Off-balance-sheet risk occurs because of activities that do not appear on the balance sheet.

Question 48

An off-balance-sheet activity does not appear on the current balance sheet because it does not involve holding a current primary claim or the issuance of a current secondary claim.

Question 49

One objective of technological expansion is to achieve economies of scale at the expense of diseconomies of scope.

Question 50

Bank regulators typically view tradable assets as those held for one month or less.

Question 51

Economies of scope involve the ability to lower the average cost of operations by expanding the output of financial services.

Question 52

Off-balance-sheet activities often affect the shape of a FIs current balance sheet through the creation of contingent claims.

Question 53

Market risk is present whenever an FI takes an open position in an asset and prices change in a direction opposite to that expected.

Question 54

Technology risk is the uncertainty that economies of scale or scope will be realized from the investment in new technologies.

Question 55

Effective use of diversification principles allows an FI to reduce the total default risk in a portfolio.

Question 56

Off-balance sheet activities never have an effect on the value of equity the FI holds.

Question 57

Off-balance-sheet activities have become an important source of fee income, even though losses on these activities can cause a financial institution to fail.

Question 58

The timing of when a contingent claim appears on the balance sheet is up to the FI.

Question 59

An FI is only exposed to market risk in its trading portfolio if interest rates change over time.

Question 60

The more volatile asset prices, the more market risks an FI has when they have an open, or unhedged, position.

Question 61

Regulation limits FI investment in non-investment grade bonds (rated below Baa or non-rated).What kind of risk is this designed to limit?

A)Liquidity risk.
B)Interest rate risk.
C)Credit risk.
D)Foreign exchange rate risk.
E)Off-balance sheet risk.

Question 62

Insolvency risk is a consequence of the other risks to which FI is exposed.

Question 63

FinTech firms do not support models of peer-to-peer mass collaboration, but rather only to existing organizational firm-to-firm collaboration.

Question 64

FinTech firms are facing increased regulatory oversight.A risk event at a FinTech firm can result in losses that are substantially more damaging than at traditional financial institutions.

Question 65

A lower level of equity capital increases the risk of insolvency to a financial institution.

Question 66

The risk that a computer system may malfunction during the processing of data is an example of operational risk.

Question 67

Many of the various risks faced by an FI often are interrelated with each other.

Question 68

FinTech Risk refers to the risk that FinTech firms could disrupt business of financial service firms in the form of lost customers and lost revenue.

Question 69

Insolvency risk is reduced when the leverage of an FI is also reduced.

Question 70

Event risks often cause sudden and unanticipated changes in financial market conditions.

Question 71

Loss of reputation is a type of operational risk to a financial institution.

Question 72

Employee fraud is a type of operational risk to a financial institution.

Question 73

General macroeconomic risks may affect all risks of a financial institution.

Question 74

Credit risk and interest rate risk cannot affect insolvency risk.

Question 75

FinTech firms have large teams of highly-skilled and experienced employees with years of experience in dealing with risk issues.

Question 76

What type of risk focuses upon mismatched asset and liability maturities and durations?

A)Liquidity risk.
B)Interest rate risk.
C)Credit risk.
D)Foreign exchange rate risk.
E)Off-balance sheet risk.

Question 77

The asset transformation function potentially exposes the FI to

A)foreign exchange risk.
B)technology risk.
C)operational risk.
D)trading risk.
E)interest rate risk.

Question 78

FI regulators are not concerned with insolvency risk.

Question 79

Examples of FinTech services can include cryptocurrencies and blockchain.

Question 80

Holding corporate bonds with fixed interest rates involves

A)default risk only.
B)interest rate risk only.
C)liquidity risk and interest rate risk only.
D)default risk and interest rate risk.
E)default and liquidity risk only.