Deck 12: Liquidity Risk

Question 1

During the financial crisis of 2008, there were large deposit inflows to the banking system.

Answer 1

True

Question 2

Mutual funds tend to have less exposure to liquidity risk than banks and thrifts.

Answer 2

True

Question 3

Because cash reserves at the Federal Reserve do not earn interest, DIs do not hold any excess cash reserves beyond the minimum requirements.

Answer 3

False

Question 4

An expected net deposit drain on any given day means that deposit withdrawals are less than deposit inflows.

Question 5

Demand deposits pose a liquidity risk for FIs because funds may be withdrawn at any time.

Question 6

When liquidity risk problems occur at a DI, they often threaten the solvency of the institution.

Question 7

Managing asset-side liquidity risk can involve either purchased liquidity management or stored liquidity management.

Question 8

An FI's most liquid asset is cash.

Question 9

Asset-side liquidity risk may be a result of OBS lending commitments.

Question 10

Liquid funds can be obtained by a DI through unlimited borrowing in the money or purchased funds markets.

Question 11

Core deposits represent a relatively short-term source of funds.

Question 12

The liquidity index should be a number that is either greater than one or less than zero.

Question 13

A bank must be ready to pay out all demand deposit liabilities on any given day.

Question 14

Banks with relatively high loan commitments face less liquidity risk exposure than banks with a low level of loan commitments.

Question 15

During the financial crisis of 2008, liquidity problems were avoided as banks continued to provide lending to each other.

Question 16

Purchased liquidity risk management usually involves purchased funds such as fed funds, repurchase agreements and CDs.

Question 17

Bank runs occur because customers know that banks will be forced to liquidate assets at fire-sale prices.

Question 18

Depository institutions generally rely on each other for cash and to meet their daily liquidity needs.

Question 19

Purchased liquidity management carries the potential risk of significant increases in the cost of funds during periods of high interest rate volatility.

Question 20

Liquidity risk for an FI includes the possibility of an unexpected inflow of funds.

Question 21

In terms of liquidity risk measurement, the financing gap is defined as rate sensitive assets minus rate sensitive liabilities.

Question 22

Insurance companies have had to deal with liability runs by policyholders.

Question 23

In the event of a bank run, depositor claims on the bank are satisfied on a pro rata basis.

Question 24

Liquidity planning primarily is designed to assist management in dealing with relatively predictable events.

Question 25

In general, money center banks are exposed to less liquidity risk than smaller, regional banks.

Question 26

When computing the liquidity coverage ratio, high-quality liquid assets are divided into two levels.

Question 27

The Fed discount window maintains three lending programs to assist DIs in managing liquidity problems.

Question 28

The net stable funds ratio (NSFR) is a longer-term measure than the liquidity coverage ratio (LCR).

Question 29

Abnormally large and unexpected deposit withdrawals can occur because of concerns by depositors about a bank's solvency relative to other banks.

Question 30

Deposit insurance is the only deterrent to bank runs, contagious runs, and bank panics.

Question 31

A problem exists with the net stable funds ratio (NSFR) in that it does not include off-balance-sheet activities.

Question 32

The future liquidity position of a DI cannot be forecasted.

Question 33

The cost of stored liquidity management is the interest that must be paid on the stored funds.

Question 34

The assets of PC insurers are relatively short term and more liquid than those of life insurance companies.

Question 35

For life insurance companies, the distribution of premium income minus policyholder liquidations is unpredictable.

Question 36

The greater the difference between fair market prices and fire-sale prices for assets, the less liquid the DI's portfolio of assets.

Question 37

Even with liquidity planning, net deposit withdrawals and/or the exercise of loan commitments can pose significant liquidity problems for banks.

Question 38

A contagious run, or bank panic, differs from a run on a bank in that a contagious run involves loss of faith in the entire banking system as opposed to just one bank.

Question 39

Surrender value is the amount of cash a life insurance policy holder can receive by turning in the policy before it expires or matures.

Question 40

As of 2012, banks must report their The Liquidity Coverage Ratio (LCR) to the FDIC rather than to the Federal Reserve.

Question 41

Net asset value is the current value of a mutual fund's assets divided by the number of shares outstanding.

Question 42

A disadvantage of using purchased liquidity management to manage a FI's liquidity risk is

A)the resulting shrinkage of the FI's balance sheet.
B)the relatively high cost of purchased liabilities.
C)the accessibility of international money markets.
D)tax considerations.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 43

A bank's net deposit drain

A)is negative if deposits exceed withdrawals.
B)is positive if deposits exceed withdrawals.
C)decreases during holiday and vacation periods.
D)in unaffected by holiday and vacation periods.
E)fluctuates unpredictably on any given day.

Question 44

Which of the following statements is NOT true?

A)Stored liquidity management involves liquidation of assets.
B)Traditionally DIs have stored cash reserves at the Federal Reserve and in their vaults to overcome liquidity risk.
C)When the DI uses its cash as the liquidity adjustment mechanism, both sides of its balance sheet contract.
D)DIs hold cash reserves in excess of the minimum required to meet liquidity drains.
E)A DI sustains no cost under stored liquidity risk management.

Question 45

Open-end mutual funds issue a fixed number of shares as liabilities.

Question 46

Hedge funds are not susceptible to liquidity risk or a liquidity crisis.

Question 47

Why have purchased liquidity management techniques become very popular in spite of its limitations?

A)Because it insulates the assets of an FI from normal drains on liability liquidity.
B)Because funds can be easily raised in the eventuality of a liquidity crunch.
C)Because of decrease in the cost of funds during periods of high interest rate volatility.
D)Because the funds are covered by deposit insurance.
E)Because the adjustment to the deposit drain occurs on the liability side of the balance sheet.

Question 48

A disadvantage of using stored liquidity management to manage a FI's liquidity risk is

A)the resulting shrinkage of the FI's balance sheet.
B)the high cost of purchased liabilities.
C)the accessibility of international money markets.
D)tax considerations.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 49

Liquidation of a mutual fund causes assets to be liquidated and funds received to the dispersed to shareholders on a first come, first served basis.

Question 50

Which of the following is a condition for a DI to be growing?

A)Net positive drain on deposits.
B)Peak of the net deposit drain probability distribution should lie at a point to the right of zero.
C)Average deposit drain such that new deposit funds more than offset deposit withdrawals.
D)The liability side of its balance sheet is decreasing.
E)Unused loan commitments is increasing.

Question 51

Liquidity risk for a life insurance company only occurs when asset returns do not provide sufficient cash flows to meet policyholder liquidations.

Question 52

When banks use stored liquidity management, they

A)must pay interest on the funds that are stored.
B)store the funds at the U.S.Treasury.
C)necessarily increase the asset side of the balance sheet.
D)may shrink the balance sheet if cash is used as the liquidity adjustment mechanism.
E)threaten the capital position of the institution.

Question 53

Which of the following observations is NOT true?

A)Traditionally, DI managers have relied on purchased liquidity management as the primary mechanism of liquidity management.
B)Today, many DIs rely on purchased liquidity management to deal with the risk of cash shortfalls.
C)The largest banks with access to the money market and other nondeposit markets for funds rely on purchased liquidity management to deal with the risk of cash shortfalls.
D)Purchased liquidity management and stored liquidity management are ways of managing a drain on deposits.
E)None of the above.

Question 54

It is impossible for money market mutual fund share prices to fall below $1.00.

Question 55

Government securities represent the reserve asset fund for life insurance companies.

Question 56

What is a fire-sale price?

A)Market value of an asset.
B)Price received for an asset that has to be liquidated immediately.
C)Maximum price that will be received on sale of an asset irrespective of the time of sale.
D)Replacement value of an asset.
E)Book value of an asset.

Question 57

If purchased liquidity is used by a DI to fund an exercised loan commitment

A)the balance sheet will decrease by the amount of the new loan.
B)only the asset side of the balance sheet will increase.
C)the balance sheet will increase by the amount of the new loan.
D)only the liability side of the balance sheet will increase.
E)there will be no effect on the balance sheet.

Question 58

Which of the following is NOT a potential causes of liquidity risk for a DI?

A)A decrease in the DI's stock price caused by market factors.
B)An increase in requests to fund large amounts of loan commitments.
C)A decrease in the availability of short-term borrowed funds.
D)An increase in requests by depositors to withdrawal large amounts of deposits.
E)A decrease in asset prices of securities held in the investment portfolio.

Question 59

Which type of financial intermediary is more highly exposed to liquidity risk?

A)Property-casualty insurance companies.
B)Life insurance companies.
C)Mutual funds.
D)Depository institutions.
E)Pension funds.

Question 60

Which of the following balance sheet entries is not a tool used in purchased liquidity management?

A)Bonds.
B)Federal fund.
C)Demand deposit.
D)Repurchase agreement.
E)Subordinated note.

Question 61

In the event of financial distress, open-ended mutual fund investors

A)have an incentive to cash in their shares quickly since they are paid on a first come, first served basis.
B)have an incentive to avoid a run since that will deplete the fund net asset value.
C)have an incentive to cash in their shares quickly since that will increase the fund's net asset value.
D)will switch into low risk bank deposits.
E)have an incentive to avoid a run since the Federal Reserve guarantees mutual fund holdings.

Question 62

What is the impact of a 50 basis point increase in interest rates on the net asset value of an open-end bond mutual fund holding a seven year, $100 million face value 7 percent annual coupon bond selling at par? The fund has 10 million shares.

A)An increase of $0.24 per share.
B)A decrease of $0.265 per share.
C)An increase of $0.05 per share.
D)A decrease of $0.05 per share.
E)An increase of $0.265 per sharE.

Question 63

What is the asset adjustment to a bank's balance sheet if the bank sold a five-year, 7 percent annual coupon $100,000 bond acquired at par, but now yielding 8 percent? The bond was not in the mark-to-market portfolio.

A)A $96,007 reduction in assets.
B)A $96,007 increase in assets.
C)A $100,000 reduction in assets.
D)A $100,000 increase in assets.
E)A $100,000 increase in liabilities.

Question 64

An open-end bond mutual fund is holding a three-year, $1 million face value 5 percent annual coupon bond selling at par. What is the impact on the total asset value of the fund of a 1 percent decrease in interest rates?

A)A decrease of $10,000.
B)An increase of $10,000.
C)A decrease of $26,730.
D)An increase of $27,751.
E)The answer depends upon the number of mutual funds shares outstanding.

Question 65

In a crisis, which of the following are more likely to withdraw funds quickly from banks and thrifts?

A)Correspondent banks.
B)Small business corporations.
C)Individual depositors.
D)Mutual funds.
E)Foreign depositors.

Question 66

In a crisis, which of the following are relatively less likely to withdraw funds quickly from banks and thrifts?

A)Correspondent banks.
B)Small business corporations.
C)Individual depositors.
D)Mutual funds.
E)Pension funds.

Question 67

In terms of liquidity risk measurement, the financing requirement is defined as

A)total deposits minus core deposits.
B)financing gap plus liquid assets.
C)rate sensitive assets minus rate sensitive liabilities.
D)total assets minus total liabilities.
E)average loans minus average deposits.

Question 68

How does purchased liquidity management affect profitability?

A)By its impact on the interest rate sensitivity of assets.
B)By its impact on the interest rate sensitivity of liabilities.
C)By determining the default risk of investment securities.
D)By its impact on the cost of purchased funds.
E)By enhancing the liquidity of assets held.

Question 69

For a DI, what does a high ratio of loans to deposits indicate?

A)DI relies heavily on the short-term money market to fund loans.
B)High degree of loan commitments.
C)DI has large amounts of asset-side liquidity.
D)Liquidity concerns are at a bare minimum for the FI.
E)DI relies heavily on core deposits to fund loans.

Question 70

The surrender value of an insurance policy is

A)its promised payoff.
B)normally a portion of the contract's face value.
C)its value upon bankruptcy.
D)the value of the junk bonds in the insurance company's portfolio.
E)its holdup value.

Question 71

In terms of liquidity risk measurement, the financing gap is defined as

A)total deposits minus core deposits.
B)financing requirement plus liquid assets.
C)rate sensitive assets minus rate sensitive liabilities.
D)total assets minus total liabilities.
E)average loans minus average deposits.

Question 72

Which intermediation function results in an FI's exposure to liquidity risk?

A)Information production.
B)Asset transformation.
C)Conduit for monetary policy.
D)Lender of last resort.
E)Brokering between funds deficit units and funds surplus units.

Question 73

A DI has two assets: 50 percent in one-month Treasury bills and 50 percent in real estate loans. If the DI must liquidate its T-bills today, it receives $98 per $100 of face value; if it can wait to liquidate them on maturity (in one month's time), it will receive $100 per $100 of face value. If the DI has to liquidate its real estate loans today, it receives $90 per $100 of face value liquidation at the end of one month will produce $92 per $100 of face value. The one-month liquidity index value for this DI's asset portfolio is

A).973.
B).940.
C).979.
D)1.06.
E)1.10.

Question 74

Which of the following is NOT a primary source of liquidity?

A)Excess cash reserves over and above regulatory reserve requirements.
B)Borrowings in the money market.
C)Borrowings in the purchased funds market.
D)Capital notes and other long-term financing alternatives.
E)Cash-type assets that can be sold with little price risk and low transaction costs.

Question 75

Which of the following observations concerning the Fed's discount window is true?

A)The facility is provided to meet DIs' permanent liquidity needs.
B)Four lending programs are offered through the Fed's discount window.
C)Primary credit is available to sound depository institutions on a very short-term basis.
D)Secondary credit is available only to depository institutions that are eligible for primary credit.
E)Eligible institutions for seasonal credit are big banks located in urban areas.

Question 76

Which of the following is NOT used as a method of measuring liquidity risk?

A)Liquidity coverage ratio.
B)Liquidity index.
C)Financing gap and financing requirement.
D)Peer group ratio comparison.
E)Current ratio.

Question 77

Which of the following is a measure of the potential losses an FI could suffer as the result of fire-sale disposal of assets?

A)Quick ratio.
B)Liquidity index.
C)Financing gap and financing requirement.
D)Peer group ratio.
E)Current ratio.

Question 78

When comparing banks and mutual funds,

A)mutual funds have more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
B)mutual funds have less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
C)mutual funds have more liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.
D)mutual funds have less liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.
E)mutual funds have the same liquidity risk as banks because both shareholders and depositors share the fall in the loss of value on a pro rata basis.

Question 79

If stored liquidity is used by a DI to fund an exercised loan commitment

A)the balance sheet will decrease by the amount of the new loan.
B)only the asset side of the balance sheet will increase.
C)the balance sheet will increase by the amount of the new loan.
D)only the liability side of the balance sheet will increase.
E)there will be no effect on the balance sheet.

Question 80

What information does the net liquidity statement provide?

A)A long-term focus on liquidity.
B)Sources and uses of liquidity.
C)Net asset value.
D)Liquidity index information.
E)Peer group ratio comparison.