Deck 14: Off-Balance Sheet Activities

Question 1

Derivative securities are normally used by banks to take risks that were previously not possible, as opposed to using them for decreasing risk.

Answer 1

False

Question 2

A contingent claim is the underlying security in a derivative security.

Answer 2

False

Question 3

Financial guarantees are a type of off-balance sheet activity in which commercial banks may engage.

Answer 3

True

Question 4

In a loan guarantee a bank promises to make a loan to firm when they demand funds.

Question 5

SLCs issued by banks require them to pay the beneficiary if the account party defaults on a financial obligation or performance contract.

Question 6

SLCs are often used in connection with the issuance of debt obligations as backup lines of credit.

Question 7

SLCs are NOT considered loans for the purpose of calculating legal lending limits for commercial banks.

Question 8

With respect to SLCs, liquidity risk and funding risk are similar concepts.

Question 9

A material adverse change (MAC) clause prohibits the bank from withdrawing its commitment under certain conditions.

Question 10

A revolving loan commitment is an agreement between a bank and a customer that the bank will entertain a request for a loan from the customer and in most cases the bank will make the loans even though they are not obligated to do so.

Question 11

A commitment fee on a revolving loan commitment is often referred to as a facility fee.

Question 12

Firms face markup risk, which is associated with the premium added on the reference rate (e.g., prime rate) to compensate the bank for risk.

Question 13

The major risk facing banks with loan commitments is that a large number of borrowers will take down their loans simultaneously and the bank may not have sufficient funds to make the loans. This is known as availability risk.

Question 14

Initially, interest rate volatility was the motivation for the growth of loan commitments in the banking industry.

Question 15

NIF stands for note insurance fund.

Question 16

NIFs involve bank guarantees of short-term debt obligations issued by other firms.

Question 17

A NIF organized into a group of 15 or more banks and financial institutions is known as the arranger.

Question 18

Counterparty credit risk is the risk that the counterparty will default on the financial transaction.

Question 19

Settlement risk occurs when one party in a financial transaction pays out funds to the other party before it receives its own cash or assets.

Question 20

Aggregation risk comes about in derivatives deals due to the complex legal uncertainties that can exist.

Question 21

The Chicago Board of Trade is an over-the-counter for derivative securities.

Question 22

Small banks tend to dominate the over-the-counter market for derivatives securities.

Question 23

A currency swap involves the exchange of principal amounts on two different value dates and no exchange of interest payments between those dates.

Question 24

Basis swaps are interest rate swaps in which the interest payments are based on fixed rates and floating rates of interest.

Question 25

Price risk in a swap agreement means that interest rates or exchange rates may change and have an adverse effect on one or more of the participants in the swap agreement.

Question 26

A ceiling agreement between a bank and a firm establishes a minimum lending rat on a loan.

Question 27

An OTC option that combines ceiling and floor mechanics is the interest rate collar.

Question 28

Buying a forward rate agreement is analogous to buying a put and selling a call, where the forward price is equal to the exercise price of the options.

Question 29

When a bank sells loan-backed securities with recourse, it has made an off-balance-sheet commitment.

Question 30

Cash management systems for business concerns are NOT an off-balance-sheet activity of banks.

Question 31

A coupon swap involves the exchange of interest payments on two different floating rates of interest.

Question 32

Banks and securities firms established the International Swaps Dealers Association (ISDA).

Question 33

To implement a ceiling rate on a loan, the firm borrowing the funds should buy an interest rate call option.

Question 34

In floor-ceiling agreements buying a call option in terms of interest rates is the same as buying a put option in terms of prices.

Question 35

Buying a forward rate agreement (FRA) is analogous to buying a call and selling a put option.

Question 36

Securitized home loans are off-balance-sheet assets.

Question 37

When a bank agrees to cover the current obligation of a third party if the third party fails to do so, this is called a:

A) derivative security
B) interest rate swap
C) financial guarantee
D) securitized asset

Question 38

Banks can earn income on standby letters of credit from:

A) fee income
B) interest income
C) a and b
D) none of the above

Question 39

Standby letters of credit are most commonly used as:

A) backup lines of credit
B) credit references
C) start-up capital
D) home mortgages

Question 40

For the purpose of calculating legal lending limits, SLCs are considered:

A) primary capital
B) secondary capital
C) owner's equity
D) loans

Question 41

A bank's promise to make a future loan to a customer under certain conditions is a(n):

A) indenture
B) loan commitment
C) network
D) Euronote

Question 42

A revolving loan commitment differs from a line of credit in that:

A) the bank is obligated to make the loan
B) the bank charges a fee
C) a and b
D) none of the above

Question 43

Revolving loan commitments subject banks to:

A) availability risk
B) interest rate risk
C) a and b
D) none of the above

Question 44

The risk that a large number of borrowers will take down their loans simultaneously is:

A) funding risk
B) interest rate risk
C) commitment risk
D) aggregation risk

Question 45

The motivation for the growth of loan commitments is:

A) stock market crash
B) interest rate volatility
C) S&L bailout
D) all of the above

Question 46

A bank that organizes a note issuance facility is called a(n):

A) originator
B) facilitator
C) opener
D) arranger

Question 47

Institutions that have the right to bid for the short-term notes issued under the note issuance facility are called:

A) tender panels
B) prospectors
C) bid parties
D) none of the above

Question 48

The risk that the price of a derivative security will change is called:

A) liquidity risk
B) settlement risk
C) market risk
D) valuation risk

Question 49

Inadequate internal controls, valuation risk, and regulatory risk are all components of:

A) liquidity risk
B) settlement risk
C) legal risk
D) operating risk

Question 50

The derivative security that accounts for most of the activity in the OTC market is:

A) options
B) swaps
C) futures
D) securitized assets

Question 51

An agreement between two counterparties to exchange cash flows is called a(n):

A) option
B) swap
C) forward contract
D) securitized asset

Question 52

A coupon swap is a type of:

A) interest rate swap
B) currency swap
C) basis swap
D) denomination swap

Question 53

A swap where the two interest payments are based on two different floating rates of interest is called a(n):

A) cross-currency interest rate swap
B) currency swap
C) basis swap
D) maturity swap

Question 54

Which of the following is NOT a risk associated with swaps:

A) market risk
B) funding risk
C) credit risk
D) none of the above - they all are risks associated with swaps

Question 55

Entering into an offsetting swap is a way to control:

A) market risk
B) funding risk
C) credit risk
D) denomination risk

Question 56

Banks and securities firms established the International Swaps Dealers Association to promote:

A) standardization and sound business practices in the swap market
B) the development of swap markets in third world economies
C) reduced volatility in the swap market
D) all of the above

Question 57

An agreement between a bank and its customer that specifies the maximum lending rate on a loan is a(n):

A) interest rate swap
B) ceiling agreement
C) revolving loan commitment
D) stop-out clause

Question 58

A floor agreement is considered "in-the-money" when the:

A) striking price is below the contract price
B) striking price is above the contract price
C) striking price and contract price are the same
D) none of the above

Question 59

An OTC option that combines ceiling and floor mechanics is called a(n):

A) interval option
B) range option
C) straddle
D) interest rate collar

Question 60

The major advantage of forward rate agreements over exchange traded futures contracts is:

A) more flexibility
B) no margin requirements
C) lower monitoring costs
D) a and b

Question 61

Buying a forward rate agreement is analogous to:

A) buying a call and selling a put
B) buying a put and selling a call
C) buying a call and buying a put
D) selling a call and selling a put

Question 62

Using the interest rate futures market to "convert" a floating rate loan to a fixed rate loan is called a(n):

A) lock-in agreement
B) loan swap
C) synthetic loan
D) securitized asset

Question 63

A risk that a bank has with futures contracts but not forward contracts is:

A) market risk
B) liquidity risk
C) basis risk
D) none of the above

Question 64

Packaging of loans into large pools and issuing securities to investors is called:

A) securitization
B) pooling
C) packaging
D) passing-through

Question 65

An example of off-balance sheet trade finance is:

A) commercial letter of credit
B) acceptance participation
C) a and b
D) none of the above

Question 66

Lock boxes are an example of:

A) networking
B) trade finance
C) acceptance participation
D) cash management services

Question 67

Banks can control their risk associated with standby letters of credit by:

A) limiting their amount outstanding
B) diversifying their portfolio of such letters
C) increasing capital
D) all of the above

Question 68

A line of credit is:

A) a formal agreement between a bank and a customer
B) not an obligation for the bank to make loans to a customer
C) a type of security backed by loans
D) a long-term loan contract

Question 69

When evaluating funding risk, it is important to note that certain types of loan
Commitments are irrevocable. According to the Bank for International Settlements,
An example of such a commitment is:

A) asset sale and repurchase agreements
B) outright forward purchases
C) note issuance facilities
D) all of the above

Question 70

In the OTC derivatives market, most of the activity is dominated by:

A) swaps
B) futures
C) options
D) forward agreements

Question 71

Which of the following is NOT a regulator of the derivative markets?

A) Commodity Futures Trading Commission (CFTC)
B) Securities Exchange Commission (SEC)
C) Federal Reserve System (FRS)
D) none of the above; they are ALL regulators in derivatives markets

Question 72

A credit option seeks to:

A) allow two banks to exchange interest and principal payments on portions of their loans.
B) allow a bank to protect itself from a decline in a borrower's credit quality
C) allow a bank the option to make a loan or not
D) all of the above are types of credit options

Question 73

A swap that involves the exchange of loan interest and principal between two banks is a:

A) coupon swap
B) basis swap
C) credit swap
D) none of the above

Question 74

To create a synthetic loan with a fixed rate, a bank with a variable rate loan outstanding can:

A) sell T-bill futures
B) buy T-bill futures
C) buy a credit swap
D) sell a credit swap

Question 75

Loan sales enable banks to:

A) increase diversification
B) lower capital requirements
C) eliminate low-earning assets from their portfolio
D) all of the above

Question 76

Letters of credit:

A) require immediate payment before all paperwork is processed.
B) are based on the bank's creditworthiness, not the buyer's financial strength
C) not specific to the timing of the shipment and storage of goods
D) result in interest income for the bank