Deck 14: Interest Rate Risk

Question 1

Techniques to manage interest rate exposure include:

A) diversifying between short-term and long-term debt issues.
B) monitoring and adjusting the maturity structure of assets and liabilities.
C) financing short-term and long-term debt through both intermediated and direct finance.
D) all of the given answers.

Answer 1

D

Question 2

In relation to interest rate risk,reinvestment rate risk refers to the risk:

A) associated with a shortfall in interest payments.
B) of reinvesting in riskier assets.
C) of reinvesting in bonds of low investment grade.
D) of reinvesting at unknown interest rates.

Answer 2

D

Question 3

The interest rate risk of a bond is the:

A) risk related to the possibility of default by the bond's issuer.
B) risk that arises from the uncertainty of the bond's return, caused by the change in interest rates.
C) unsystematic risk caused by factors relating solely to the bond.
D) risk caused by foreign exchange changes.

Answer 3

B

Question 4

If a bond investor's holding period is longer than the term to maturity of a bond,the investor is exposed to:

A) interest rate risk.
B) reinvestment risk.
C) yield-to-maturity risk.
D) systematic risk.

Question 5

Large fluctuations in interest rates:

A) have led to substantial capital gains and losses for owners of securities.
B) have increased the need for companies to manage their interest-rate exposure.
C) increase the demand for derivative products.
D) mean all of the given choices are correct.

Question 6

Interest rate risk occurs when:

A) investors buy bond portfolios.
B) a firm has a short-term floating rate loan.
C) a company has issued a fixed interest bond.
D) all of the given answers are correct.

Question 7

When a change in interest rate influences the future actions of market participants,this is called _____ interest rate risk.

A) basis
B) direct
C) indirect
D) reinvestment

Question 8

When there are pricing differentials between markets as a result of interest rate changes or expectations,this is called _____ interest rate risk.

A) basis
B) direct
C) indirect
D) reinvestment

Question 9

According to the text,two forms of interest rate risk are:

A) price risk and default risk.
B) reinvestment risk and systematic risk.
C) credit risk and price risk.
D) price risk and reinvestment risk.

Question 10

Over the lifetime of a bond,the coupons received by the holder of the bond are exposed to:

A) financial risk.
B) liquidity risk.
C) price risk.
D) reinvestment risk.

Question 11

The sensitivity of future cash flows and the value of assets and liabilities to movements in interest rates is called:

A) financial risk.
B) business risk.
C) interest rate risk.
D) liability risk.

Question 12

If a bank increases interest rates on its loans for its customers and then they seek new loans from other banks this interest rate exposure is called _____ interest rate risk.

A) direct
B) indirect
C) basis
D) reinvestment

Question 13

If a company has a three-year loan from a bank at 7% per annum,and interest rate dropped to 5% near the end of the term,the bank is exposed to:

A) interest rate risk.
B) reinvestment risk.
C) yield-to-maturity risk.
D) systematic risk.

Question 14

When a change in interest rate affects the value of assets,liabilities and future cash flows,this is called _____ interest rate risk.

A) basis
B) direct
C) indirect
D) reinvestment

Question 15

If the current yields on three-year corporate bonds are 7% per annum and on the same day the yield in the futures market for comparable bonds is 6.50% per annum,the interest rate difference is due to:

A) business risk.
B) basis risk.
C) credit risk.
D) financial risk.

Question 16

If a company has issued a fixed-interest bond to investors and then later interest rates fall on comparable securities,the value of the existing fixed-interest bond:

A) will increase.
B) will decrease.
C) will be unaffected.
D) depends only on the credit risk of the issuer.

Question 17

When there is an upward sloping yield curve and interest rates are forecast to increase a firm decides to restructure its outstanding debt to longer term then in the short-term the company:

A) faces an immediate decrease in its costs of funds.
B) faces an immediate increase in its costs of funds.
C) is reducing its basis risk.
D) is reducing its business risk.

Question 18

If the maturity of a portfolio of deposits for a bank is longer than its portfolio of term loans,the bank is exposed to:

A) interest rate risk.
B) reinvestment risk.
C) yield-to-maturity risk.
D) systematic risk.

Question 19

The relative proportion of a company's assets and liabilities maturing at different time intervals is:

A) investment structure.
B) maturity structure.
C) term structure of interest rates.
D) the yield curve.

Question 20

When a firm's funding is a mixture of short-term and long-term debt issues,it is carrying out:

A) asset management.
B) liability diversification.
C) securitisation management.
D) asset diversification.

Question 21

In relation to re-pricing gap analysis which of the following is a constraint on the model?

A) The appropriate planning period.
B) The timing of cash flows within a planning period.
C) The assumption of an even interest rate change.
D) All of the given answers.

Question 22

Refer to the following table:
$$\begin{array} { | l | l | c | } \hline { \text { Premier National Bank } } \\\hline & { \text { Assets } } & \text { Liabilities } \\\hline \text { Interest-sensitive } & \$ 60 \text { million } & \$ 90 \text { million } \\\hline \text { Fixed-rate } & \$ 70 \text { million } & \$ 40 \text { million } \\\hline\end{array}$$
If interest rates rise by 500 basis points,bank profits (measured using repricing gap analysis)will:

A) fall by $0.5 million
B) fall by $1.5 million
C) fall by $3 million
D) increase by $1.5 million

Question 23

The procedure of creating marketable debt instruments that are backed by otherwise illiquid assets is known as:

A) homogenisation.
B) securitisation.
C) standardisation.
D) hybridisation.

Question 24

When interest-sensitive assets are financed by interest-sensitive liabilities,changes in interest rates will affect:

A) only interest-sensitive assets.
B) only interest-sensitive liabilities.
C) both interest-sensitive assets and interest-sensitive liabilities.
D) only long-term assets.

Question 25

Which of the following is NOT an interest-sensitive asset for a three-month planning period?

A) Floating rate mortgages
B) Securities with a maturity of less than 30 days
C) Fixed-rate mortgages
D) A 181-day negotiable certificate of deposit

Question 26

If an organisation has _______ interest-sensitive assets than liabilities,a/an _______ in interest rates will increase the organisation's profits.

A) more; reduction
B) more; increase
C) less; increase
D) both [more; reduction] and [less; increase] are correct

Question 27

The analysis that involves measuring an organisation's sensitivity of profits to changes in interest rates,by multiplying the difference in rate-sensitive assets and liabilities by the changes in interest rate,is called:

A) basic duration analysis.
B) repricing gap analysis.
C) interest exposure analysis.
D) gap-exposure analysis.

Question 28

Refer to the following table:
First Nationwide Bank
$$\begin{array}{l}\text { First Nationwide Bank }\\\begin{array} { | l | l | l | } \hline & { \text { Assets } } & \text { Liabilities } \\\hline \text { Interest-sensitive } & \$ 90 \text { million } & \$ 80 \text { million } \\\hline \text { Fixed-rate } & \$ 60 \text { million } & \$ 40 \text { million } \\\hline\end{array}\end{array}$$
First Nationwide bank has a repricing gap of:

A) -10
B) +10
C) +20
D) 0

Question 29

When a financial institution matches its interest rate-sensitive assets with its interest-sensitive liabilities:

A) all assets have the same maturity.
B) all liabilities have the same maturity.
C) it typically earns no profit.
D) interest rate risk is neutralised.

Question 30

If a bank expects interest rates to fall,then it will want to:

A) achieve a positive ARBL.
B) achieve a negative ARBL.
C) lower the rate on its loans before it lowers the rates on its deposits.
D) increase the rates on its loans before it lowers the rates on its deposits.

Question 31

If an organisation has more interest-sensitive assets than liabilities,a _______ in interest rates will _______ the organisation's profits.

A) rise; increase
B) rise; decrease
C) fall; increase
D) fall; not affect

Question 32

Which of the following is NOT an interest-sensitive asset for a six-month planning period?

A) Floating rate mortgages
B) Securities with a maturity of less than 90 days
C) Fixed-rate mortgages
D) A 181-day negotiable certificate of deposit

Question 33

The acronym ARBL used in risk management stands for:

A) assets repackaged by means of their liquidity.
B) assets repriced before liquidity.
C) assets repriced before liabilities.
D) acceptance risk balanced limits.

Question 34

An interest-sensitive asset or liability must:

A) have a maturity of less than 90 days.
B) have a rate that shifts in the opposite direction to market changes.
C) have a rate that changes as market conditions alter during the organisation's specified planning period.
D) always be an asset issued for a short-term period.

Question 35

Refer to the following table:
Premier National Bank
$$\begin{array} { | l | l | l | } \hline { \text { Premier National Bank } } \\\hline & { \text { Assets } } & \text { Liabilities } \\\hline \text { Interest-sensitive } & \$ 60 \text { million } & \$ 90 \text { million } \\\hline \text { Fixed-rate } & \$ 70 \text { million } & \$ 40 \text { million } \\\hline\end{array}$$
Premier National bank has a repricing gap of:

A) -30
B) +30
C) +60
D) 0

Question 36

The difference between interest-sensitive assets and interest-sensitive liabilities is termed the:

A) interest-sensitivity index.
B) rate-risk index.
C) gap.
D) duration.

Question 37

The bundling of mortgages into a saleable security (usually for large institutional investors)is called:

A) disintermediation.
B) futures bundling.
C) hedge packaging.
D) securitisation.

Question 38

If interest rates are forecast to rise and a company has achieved a positive ARBL this means:

A) it is disadvantaged if interest rates rise.
B) it can benefit in the short-term if interest rates increase.
C) its profits may be adversely affected.
D) it has a negative impact on its profit margins.

Question 39

If an organisation has more interest-sensitive liabilities than assets,a _______ in interest rates will _______ the organisation's profits.

A) rise; increase
B) rise; decrease
C) fall; increase
D) fall; not affect

Question 40

Which of the following is an interest-sensitive asset for a three-month planning period?

A) A six-month Eurodollar time deposit
B) A 20-year mortgage
C) A floating rate mortgage due for adjustment in four months
D) A Treasury bond with less than 30 days to maturity

Question 41

Calculate the duration of a five-year bond with face value $1000,fixed coupon of 8% per annum,with current market yields of 9%.

A) 4.13 years
B) 4.30 years
C) 4.72 years
D) 5.00 years

Question 42

The measure that takes into account the timing and present values of cash flows associated with financial assets or liabilities is:

A) convexity.
B) duration.
C) novation.
D) ARBL.

Question 43

Everything else being equal,the _______ the time to maturity on a fixed-interest security,the _______ sensitive it is to changes in interest rates.

A) longer; less
B) longer; more
C) shorter; more
D) shorter; extra

Question 44

If an organisation has a repricing gap equal to a negative $30 million,a 500 basis point increase in interest rates will cause profits to:

A) rise by $15 million.
B) rise by $1.5 million.
C) fall by $15 million.
D) fall by $1.5 million.

Question 45

If a financial organisation has a positive repricing gap,what happens if managers do not take action when interest rates decline?

A) Interest-sensitive liability costs stabilise
B) Interest-sensitive assets returns decline
C) The rate differential on the repricing gap remains unaffected
D) Expected pre-tax profits will not change, as the cost of interest-sensitive liabilities will decrease

Question 46

If an organisation has a repricing gap equal to a positive $20 million,a 500 basis point drop in interest rates will cause profits to:

A) rise by $1.0 million.
B) rise by $10 million.
C) fall by $1.0 million.
D) fall by $10 million.

Question 47

Refer to the following table:
$$\begin{array}{l}\text { First Nationwide Bank }\\\begin{array} { | l | l | l | } \hline & { \text { Assets } } & { \text { Liabilities } } \\\hline \text { Interest-sensitive } & \$ 90 \text { million } & \$ 80 \text { million } \\\hline \text { Fixed-rate } & \$ 60 \text { million } & \$ 40 \text { million } \\\hline\end{array}\end{array}$$
If interest rates rise by 500 basis points,bank profits (measured using repricing gap analysis)will:

A) fall by $0.5 million.
B) fall by $1.5 million.
C) increase by $0.5 million.
D) increase by $1.5 million.

Question 48

If an organisation has a repricing gap equal to a positive $20 million,a 500 basis point increase in interest rates will cause profits to:

A) rise by $1.0 million.
B) rise by $10 million.
C) fall by $1.0 million.
D) fall by $10 million.

Question 49

Duration analysis involves comparing the average duration of an organisation's _______ with the average duration of its _______.

A) loan portfolio; non-deposit liabilities
B) loan portfolio; deposit liabilities
C) securities portfolio; non-deposit liabilities
D) assets; liabilities

Question 50

A three-year bond with a current yield of 10% per annum and a duration of 2.76 years,when compared with a four-year bond with a current yield of 12% per annum and duration of 3.43 years,will _______ when interest rates rise.

A) have a greater fall in price
B) have a smaller fall in price
C) have the greater interest rate exposure
D) not alter in price

Question 51

When interest rates move from 9 to 10% per annum for a three-year bond paying a 9% per annum coupon,the:

A) coupon rate becomes higher than the current market yield
B) present value of the bond becomes higher than the face value
C) current yield becomes higher than the coupon rate
D) current price of the bond will increase

Question 52

The duration of securities can be used to estimate their sensitivity to:

A) default risk.
B) holding period yields.
C) interest rate risk.
D) reinvestment risk.

Question 53

The duration of a bond is related to:

A) yield to maturity.
B) coupon rate.
C) time to maturity.
D) all of the given choices.

Question 54

The duration of a 10-year,10% per annum coupon bond,when the interest rate is 10%,is 6.76 years.What happens to the price of the bond if interest rates fall to 8% per annum? The price:

A) rises by 20%.
B) rises by 12.3%.
C) falls by 20%.
D) falls by 12.3%.

Question 55

The duration of a four-year zero coupon bond is:

A) larger than four.
B) smaller than four.
C) equal to four.
D) equal to that of a four-year 5% coupon bond.

Question 56

In order to compare the risk properties of two bonds with different coupons and maturities a bond fund manager may use:

A) repricing gap analysis.
B) duration analysis.
C) technical analysis.
D) liability analysis.

Question 57

If a financial organisation has a repricing gap equal to a negative $30 million,a 500 basis point drop in interest rates will cause profits to:

A) rise by $15 million.
B) rise by $1.5 million.
C) fall by $15 million.
D) fall by $1.5 million.

Question 58

The duration of a coupon bond is:

A) greater than the maturity of the bond.
B) equal to the maturity of the bond.
C) decreases when its maturity of the bond increases.
D) a measure of the length of time it takes to repay the cost of the bond.

Question 59

Which of the following statements about duration is incorrect?

A) Duration is superior to time to maturity as a measure of price sensitivity to interest rate changes.
B) Holding other things constant, the duration of a bond increases with time to maturity.
C) Given time to maturity and yield to maturity, the duration of a bond is higher when the coupon rate is lower.
D) Given time to maturity, the duration of a zero coupon bond decreases with yield to maturity.

Question 60

All things being equal,the duration of a bond is positively correlated with the bond's:

A) yield to maturity.
B) coupon rate.
C) time to maturity.
D) all of the given answers.

Question 61

In general,all other factors held constant,the longer the time to maturity of bonds,the smaller the rate of the change of value will be.This property of coupon bonds is often referred to as:

A) duration.
B) coupon effect.
C) convexity.
D) yield effect.

Question 62

Which of the following duration analysis is incorrect?

A) Duration can be used to calculate the dollar value impact of an interest rate change on the value of a security.
B) The duration of a portfolio is the weighted duration of each asset or liability in the portfolio.
C) A longer term bond with a higher duration than a short-term bond is faced with higher interest rate risk.
D) Duration analysis assumes that yield curves are normal or upward sloping.

Question 63

Two basic strategies for reducing the effects of interest rate risk include using hedging strategies and:

A) buying financial futures contracts.
B) selling options on futures.
C) forecasting interest rates.
D) financing long term.

Question 64

Which of the following is a technique that an institution with rate-sensitive liabilities could perform in order to reduce interest rate risk?

A) Using an interest-rate swap
B) Making more short-term loans
C) Issuing long-term certificates of deposit
D) All of the given answers

Question 65

Which of the following is NOT an internal method of interest rate risk management?

A) Changing the timing of cash flows
B) Changing the structure of the balance sheet to minimise exposure
C) Using forward rate agreements
D) Imposing a financial penalty for early repayment of a loan

Question 66

If a fall in interest rates causes a bank's market value of net worth to rise,the bank must have a:

A) positive duration gap for its portfolio of assets and liabilities.
B) negative duration gap for its portfolio of assets and liabilities.
C) negative gap.
D) positive gap.

Question 67

With a four-year bond of face value $1000 paying an annual coupon of 6%,if current market yields of 6% change to 7%:

A) its duration will increase.
B) the duration price formula will underestimate the change in price.
C) the duration price formula will overestimate the change in price.
D) its duration will decrease.

Question 68

As part of risk management when a company changes the timing of its cash outflows to minimise the effect of interest rate changes,this technique is called:

A) an external technique of interest rate management.
B) an internal technique of interest rate management.
C) a repricing gap technique.
D) a duration technique.

Question 69

Because of convexity of the price/yield curve of fixed-interest securities,when interest rates _______,duration will _______ the change in price.

A) fall; overestimate
B) fall; underestimate
C) rise; underestimate
D) rise; not affect

Question 70

If a rise in interest rates causes a bank's market value of net worth to rise,the bank must have a:

A) positive duration gap for its portfolio of assets and liabilities.
B) negative duration gap for its portfolio of assets and liabilities.
C) negative gap.
D) positive gap.

Question 71

For a given bond,the curvature of the price-yield curve is termed:

A) modified duration.
B) immunisation.
C) sensitivity.
D) convexity.

Question 72

If a bank has a duration gap of two years,a rise in interest rates from 5 to 8% per annum will lead to a/an:

A) increase of 5.71% in the market value of its net worth.
B) fall of 5.71% in the market value of its net worth.
C) increase of 5.71% in net interest income.
D) fall of 5.71% in net interest income.

Question 73

One problem with duration gap analysis is that it:

A) is calculated assuming that the yield curve does not change.
B) is calculated assuming the yield curve is flat.
C) does not measure the sensitivity of net worth to interest rate changes.
D) does not measure the sensitivity of income to interest rate changes.

Question 74

If a bank has a duration gap of two years,a fall in interest rates from 5% to 8% per annum will lead to a/an:

A) increase of 5.71% in the market value of its net worth.
B) fall of 5.71% in the market value of its net worth.
C) increase of 5.71% in net interest income.
D) fall of 5.71% in net interest income.

Question 75

When the duration of a portfolio's assets matches the duration of its liabilities,adjusted for leverage,it is:

A) exposed to interest rate risk.
B) immunised against interest rate risk.
C) protected against default risk.
D) exposed to credit risk only.

Question 76

Because of convexity of the price/yield curve of fixed-interest securities,when interest rates _______,duration will _______ the change in price.

A) rise; underestimate
B) rise; overestimate
C) fall; overestimate
D) fall; not affect

Question 77

Which of the following is NOT an external method of interest rate risk management?

A) Using an interest rate swap
B) Using financial futures
C) Using an off-balance-sheet strategy, such as a forward rate agreement
D) Having fixed-interest assets financed by fixed-interest liabilities and equity

Question 78

When a firm decides to lower its debt-to-equity ratio and implement a strategy to sell excess assets and buy back some outstanding debt issues,it is:

A) carrying out asset and liability repricing.
B) reducing its exposure to interest rate risk.
C) carrying out external interest rate management.
D) improving its working capital management.

Question 79

Which of the following statements about the limitations of duration analysis is incorrect?

A) It assumes that the term structure of interest rates changes by an equal number of basis points.
B) It assumes that the yield curve is always upward-sloping.
C) Duration needs to be regularly recalculated as interest rates change.
D) The pricing of fixed-interest securities displays convexity.

Question 80

Which of the following is a technique that an institution with rate-sensitive assets could perform in order to reduce interest rate risk?

A) Buy short-term Treasury bills
B) Issuing long-term certificates of deposit
C) Purchasing longer term assets
D) None of the given choices