Deck 21: Managing Liquidity Risk on the Balance Sheet

Question 1

Bank A has a loan-to-deposit ratio of 110 percent,core deposits equal 55 percent of total assets,and borrowed funds are 25 percent of assets. Bank B has a loan-to-deposit ratio of 80 percent. Core deposits are 65 percent of assets and borrowed funds are 5 percent of assets. Which bank has more liquidity risk? Ceteris paribus,which bank will probably be more profitable when interest rates are low?

A)Bank A; Bank A
B)Bank A; Bank B
C)Bank B; Bank A
D)Bank B; Bank B
E)You can't tell

Answer 1

A

Question 2

The greater the discount required to sell assets quickly,the higher the value of the bank's liquidity index.

Answer 2

False

Question 3

If a bank meets a net deposit drain by borrowing money in the fed funds market,it is using purchased liquidity.

Answer 3

True

Question 4

A bank meets a deposit withdrawal with one of the following alternatives. Which one of the following is an example of using stored liquidity to meet a deposit withdrawal?

A)Increasing Eurodollar deposits
B)Contacting an investment banker to find new corporate deposits
C)Increasing fed funds borrowed
D)Issuance of a negotiable CD
E)Selling the bank's holdings of T-bills

Question 5

Core deposits include all but which of the following?

A)Retail demand deposits
B)NOW accounts
C)MMDAs
D)Savings accounts
E)Negotiable CDs

Question 6

Repos and fed funds borrowed are examples of stored liquidity.

Question 7

The financing gap is defined as average core deposits minus average borrowed funds.

Question 8

Property and casualty insurers have a greater need for liquidity than life insurers.

Question 9

If a bank's brokered deposits increase $3 million and their savings accounts decrease $1 million,then core deposits decreased.

Question 10

The fear that liquidity problems at one bank may cause depositors to worry about the solvency of other banks is called the disease effect.

Question 11

Closed-end mutual funds have less need to maintain liquid asset holdings than open-end mutual funds.

Question 12

If a bank relies solely on purchased liquidity,the bank will likely

A)maintain large amounts of liquid assets.
B)fund its loan commitments with asset sales.
C)be required to borrow money at short notice.
D)be required to raise equity capital quickly.
E)be forced to liquidate liabilities at fire sale prices.

Question 13

Using stored liquidity to offset a deposit drain will reduce the size of the bank,but using purchased liquidity to offset the drain will not.

Question 14

Which of the following results in a net liquidity drain?

A)Demand deposits increase $100; loans increase $50
B)Demand deposits decrease $100; loan repayments are $150
C)Repurchase agreements increase $100; demand deposits decrease $50
D)Reverse repurchase agreements increase $50; demand deposits decrease $50
E)none of the options

Question 15

Which one of the following situations creates the most liquidity risk?

A)Long-term assets funded by long-term liabilities
B)Short-term assets funded by short-term liabilities
C)Long-term assets funded by short-term liabilities
D)Short-term assets funded by long-term liabilities
E)Long-term liabilities funded by short-term assets

Question 16

A corporation informs the bank that it will immediately draw down the maximum amount on its credit line. This is an example of liability side risk.

Question 17

When money market interest rates are higher than deposit rates,using purchased liquidity to replace deposit drains can reduce a bank's profit margin.

Question 18

A bank's financing gap is calculated as average loans minus average deposits plus liquid assets.

Question 19

Which one of the following is a source of liquidity risk for a bank?

A)Predicted increase in net deposit drain before Christmas
B)Maturation of notes payable
C)Corporation calling in a bond the bank is holding
D)A natural disaster in the bank's community
E)none of the options

Question 20

Relying on purchased liquidity is more risky than relying on stored liquidity.

Question 21

Discount window borrowing is available to
I) banks.
II) thrifts.
III) investment banks.
IV) nonfinancial corporations.

A)I and II only
B)I and III only
C)I,II,and III only
D)II,III,and IV only
E)I,II,III,and IV

Question 22

How does reliance on purchased liquidity rather than core deposits affect a bank?
I) Increases the risk of a liquidity crisis
II) Allows the bank to adjust to deposit drains without affecting bank size
III) Increases overall interest sensitivity of the bank's profits to interest rates

A)I only
B)II only
C)I and II only
D)II and III only
E)I,II,and III

Question 23

A financial intermediary has two assets in its investment portfolio. It has 35 percent of its security portfolio invested in one-month Treasury bills and 65 percent in real estate loans. If it liquidated the bills today,the bank would receive $98 per hundred of face value. If the real estate loans were sold today,they would be worth $85 per 100 of face value. In one month,the real estate loans could be liquidated at $94 per 100 of face value. What is the intermediary's one-month liquidity index?

A)0.93
B)0.92
C)0.91
D)0.90
E)0.89

Question 24

An increasingly positive financing gap can indicate ________________ liquidity risk because it may indicate _______________ deposits and/or rising loan commitments.

A)increasing; increasing
B)decreasing; decreasing
C)increasing; decreasing
D)decreasing; increasing

Question 25

Insurance industry guarantee funds do not eliminate runs on insurers because
I) the funds are not backed by the federal government.
II) the funds lack permanent reserves to back policies.
III) the funds have low maximum annual contribution amounts that limit insurers' liability.

A)I only
B)II only
C)III only
D)I and III only
E)I,II,and III

Question 26

The amount that a policyholder receives when he or she cashes in an insurance policy is called the

A)cash value.
B)surrender value.
C)face value.
D)policy value.
E)fair market value.

Question 27

Explain how liquidity risk can lead to insolvency risk.

Question 28

When calculating the liquidity index,the larger the discount from fair value,the ______________ the liquidity index; and the _________________ the liquidity risk the FI faces.

A)larger; greater
B)smaller; greater
C)larger; lower
D)smaller; lower

Question 29

A bank has $6 million in Treasury bills,$3 million in excess reserves at the Fed,$1 million in vault cash,and an $8 million line of credit on the repo market. The bank has borrowed $6 million in fed funds and $12 million in short-term notes borrowed to finance loans. What is the net liquidity position of the bank and what can you conclude from it?

Question 30

Which of the following statements,if any,is (are)true?
I) Mutual funds never have runs.
II) Funds invested with insurers are as safe as deposits at a bank.
III) Pension funds generally have less liquidity risk than banks.

A)All three are true.
B)Only I is true.
C)Only II and III are true.
D)Only III is true.
E)None are true.

Question 31

You have the following data for a bank (Million $):

Question 32

Runs on insurance firms are more likely to occur than runs on banks even in states with guaranty funds for insurers because these funds generally

A)lack a permanent reserve fund.
B)do not repay insurance policyholders immediately.
C)lack federal government backing.
D)all of the options.

Question 33

A married couple each has an IRA and deposits at a bank. The couple also has one child. If they had the money,what is the total amount of their accounts that could be insured at one bank?

A)$250,000
B)$750,000
C)$1,250,000
D)$1,500,000
E)$2,000,000

Question 34

In the absence of deposit insurance,a deposit is a _______________ to the bank's assets.

A)pro rata claim
B)first come/first serve claim
C)full pay or no pay claim
D)pro rata claim and first come/first serve claim
E)first come/first serve claim and full pay or no pay claim

Question 35

The greater the _________________ ratio,the more liquid is the institution,ceteris paribus.

A)borrowed funds to total assets
B)core deposits to total assets
C)loans to deposits
D)unused commitments to lend to total assets
E)unused commitments to lend to liquid assets

Question 36

The two main reasons why runs on U.S. banks no longer occur are

A)reserve requirements and higher bank liquidity ratios.
B)a required positive financing gap and bank use of purchased liquidity.
C)the FDIC and the discount window.
D)insurance funds operated by individual states and tighter bank regulations.
E)none of the options.

Question 37

Which of the following can create liquidity risk for a life insurer?
I) Unexpectedly high number of policy surrenders
II) Unexpectedly low number of new policies sold
III) Unexpectedly high insurance claims filed by policyholders

A)I only
B)II only
C)I and II only
D)II and III only
E)I,II,and III

Question 38

The BIS recommends that depository institutions do which of the following to realistically measure liquidity risk?
I) Construct a maturity ladder of funding requirements over both the short and long run.
II) Conduct scenario analyses of the bank's implied liquidity position under different bank and economic conditions.
III) Always keep the loan-to-deposit ratio less than one.

A)I only
B)II only
C)I and II only
D)II and III only
E)I,II,and III

Question 39

The BIS maturity ladder approach to managing liquidity includes which of the following?
I) Assessing expected cash inflows and outflows in different time periods.
II) Calculating daily and cumulative funding requirements.
III) Estimating funding requirements under different scenarios.
IV) Minimizing the securities holdings to increase the bank's ROE.

A)I and II only
B)II and III only
C)I,II,and IV only
D)I,II,and III only
E)I,II,III,and IV

Question 40

What are the major sources of liquidity risk for a bank?
For a life insurer?

Question 41

The Fed now operates the discount window differently than it used to. What are the major changes?

Question 42

Why might a bank face abnormal deposit drains?

Question 43

Explain the relationship between each of the following ratios and liquidity risk.

Question 44

We rarely see bank runs since the advent of Federal Deposit Insurance,but runs on life insurers and mutual funds do occur even though claimants have pro rata claims in the event of default. Why do these runs still occur?

Question 45

Describe the major components of a liquidity plan.

Question 46

What are the trade-offs involved between storing liquidity and purchasing liquidity as needed for a bank?

Question 47

Does a positive or a negative financing gap indicate greater liquidity risk?
Explain.