Deck 16: Managing the Investment Portfolio

Question 1

Which of the following classes of securities are carried at market value on the balance sheet?

A)Held-to-maturity
B)Available-for-sale
C)Trading
D)all of the above
E)b.and c.only

Answer 1

E

Question 2

All of the following are capital market instruments except:

A)Treasury bonds.
B)Government National Mortgage Association (Ginnie Mae) bonds.
C)mortgage backed securities.
D)Treasury notes.
E)bankers acceptances.

Answer 2

E

Question 3

Dollar-denominated deposits issued by branches of foreign banks in the United States are known as:

A)Asian bonds.
B)Eurodollar bonds.
C)Foreign bonds.
D)Yankee bonds.
E)Domestic bonds.

Answer 3

D

Question 4

For which of the following classes of securities are unrealized gains and losses included as income?

A)Held-to-maturity
B)Available-for-sale
C)Trading
D)all of the above
E)b.and c.only

Question 5

Which of the following U.S.government agency securities are backed by the full faith and credit of the U.S.Government?

A)Government National Mortgage Association (Ginnie Mae)
B)Student Loan Marketing Association (Sallie Mae)
C)Small Business Administration (SBA)
D)all of the above
E)a.and c.only

Question 6

A bank purchases a new 52-week $1,000,000 face value Treasury bill for $950,000.What is the discount rate on this T-bill (Hint: A 52-week T-bill has an original maturity of 364 days)

A)4.95%
B)5.00%
C)5.06%
D)5.19%
E)5.26%

Question 7

Regulators generally prohibit banks from purchasing ____________ for income purposes.

A)Treasury bills
B)commercial paper
C)common stock
D)repurchase agreements
E)bankers' acceptances

Question 8

All of the following are money market instruments except:

A)Treasury bills.
B)Eurodollar deposits.
C)commercial paper.
D)Treasury bonds.
E)bankers acceptances.

Question 9

Which of the following U.S.government agencies can borrow directly from the U.S.Treasury?

A)Government National Mortgage Association (Ginnie Mae)
B)Student Loan Marketing Association (Sallie Mae)
C)Small Business Administration (SBA)
D)all of the above
E)a.and c.only

Question 10

Eurodollar:

A)deposits are dollar-denominated deposits issued outside the United States.
B)markets are less regulated than U.S.security markets.
C)rates generally are lower than comparable U.S.CD rates.
D)all of the above
E)a.and b.only

Question 11

All of the following are basic functions of a bank's trading activities except:

A)offering investment advice to customers.
B)maintaining an inventory of securities for possible sale to investors.
C)speculating on short-term interest rate movements.
D)All of the above are basic functions of a bank's trading activities.
E)None of the above are basic functions of a bank's trading activities.

Question 12

Which of the following is true of Treasury bills?

A)Interest on Treasury bills is exempt from state income taxes.
B)Interest on Treasury bills is exempt from federal income taxes.
C)Treasury bills pay a lower pretax yield than comparable corporate securities.
D)All of the above are true.
E)a.and c.only

Question 13

Most repurchase agreements are secured by:

A)municipal securities.
B)commercial paper.
C)Treasury securities.
D)discount window loans.
E)cash.

Question 14

Which of the following is not an objective of a bank's investment portfolio?

A)Meeting capital requirements
B)Maintaining liquidity
C)Diversifying credit risk
D)Managing interest rate exposure
E)Preserving capital

Question 15

For which of the following classes of securities are unrealized gains and losses included as a component of capital?

A)Held-to-maturity
B)Available-for-sale
C)Trading
D)all of the above
E)a.and c.only

Question 16

In general, commercial paper:

A)is rated by the various rating agencies.
B)has a maturity of 270 days or less.
C)sells at a premium to face value.
D)all of the above
E)a.and b.only

Question 17

A short-term interest-bearing time draft created by a high-quality bank is called:

A)commercial paper.
B)a bankers acceptance.
C)a Eurodollar deposit.
D)a reverse repurchase agreement.
E)a negotiable CD.

Question 18

Which of the following classes of securities are recorded at amortized cost on the balance sheet?

A)Held-to-maturity
B)Available-for-sale
C)Trading
D)all of the above
E)a.and b.only

Question 19

Interest on bonds issued by the ____________ are not exempt from state and local taxes.

A)Farm Credit System
B)Federal Home Loan Banks
C)Government National Mortgage Association (Ginnie Mae)
D)United States Postal Service
E)Student Loan Marketing Association (Sallie Mae)

Question 20

The underlying mortgages in Ginnie Mae mortgage pools include:

A)Federal Housing Association (FHA) mortgages.
B)Veterans Administration (VA) mortgages.
C)privately issued mortgages.
D)all of the above
E)a.and b.only

Question 21

Use the following information for questions
A bank has a planned 2-year investment horizon.It is considering investing in a 2-year bond that pays 6% annually versus investing in a 4-year bond that pays 6.5% annually and then selling it after two years.The annual coupon payments can be reinvested at 4%.
What will be the realized compound yield if the bank invests in the 2-year security and holds it until maturity?

A)4.00%
B)5.48%
C)5.94%
D)6.01%
E)6.85%

Question 22

As market rates rise, prepayment speed _______, while modified duration _________.

A)slows, lengthens
B)slows, shortens
C)accelerates, lengthens
D)accelerates, shortens
E)accelerates, is unaffected

Question 23

Which of the following is/are true?

A)For rate increases, the estimated price based on duration will be below the actual price.
B)For rate increases, the estimated price based on duration will be above the actual price.
C)For rate decreases, the estimated price based on duration will be below the actual price.
D)a.and c.
E)b.and c.

Question 24

Long-term interest rates tend to be higher than short-term interest rates:

A)at the bottom of the business cycle.
B)at the end of an expansionary period.
C)at the beginning of a contractionary period.
D)at the peak of the business cycle.
E)during periods of rapid deflation.

Question 25

Which of the following is not true regarding prepayments?

A)The greater the prepayments, the shorter the security's duration.
B)Prepayments are relatively low during the first two years of a mortgage.
C)Mortgages to older people tend to have more prepayments than mortgages to younger people.
D)Prepayments increase as interest rates fall.
E)all of the above are true

Question 26

The yield curve tends to be inverted:

A)at the trough of the business cycle.
B)during periods of rapid inflation.
C)at the end of a contractionary period.
D)at the peak of the business cycle.
E)at the beginning of an expansionary period.

Question 27

Mortgage prepayment risk:

A)is greatest for stripped securities.
B)increases as interest rates increase.
C)is eliminated in Z-tranche CMOs.
D)is eliminated by buying stripped mortgage backed securities that mature when the bank needs the funds.
E)is larger on high-rate mortgages.

Question 28

A bank owns a zero coupon bond with 5 years to maturity and a face value of $10,000.If interest rates increase from 6% to 7%, what is the approximate change in price, using Macaulay's duration?

A)$343
B)$352
C)-$343
D)-$352
E)not enough information is given to answer the question.

Question 29

A portfolio is equally invested in securities with 1-, 2-, and 3-years to maturity.Each year as the 1-year securities mature, the funds are reinvested in 3-year securities.This is an example of which investment strategy?

A)Barbell maturity strategy
B)Riding the yield curve
C)Laddered maturity strategy
D)Timing maturity strategy
E)Cycle maturity strategy

Question 30

A bond that has positive convexity:

A)is more price sensitive when rates fall then when rates rise.
B)is more price sensitive when rates rise then when rates fall.
C)has a negative duration.
D)has a duration greater than maturity.
E)a.and d.

Question 31

Which passive investment strategy differentiates between bonds that have been purchased for liquidity versus income purposes?

A)Barbell maturity strategy
B)Riding the yield curve
C)Laddered maturity strategy
D)Timing maturity strategy
E)Cycle maturity strategy

Question 32

Which of the following is considered an active investment strategy?

A)Barbell maturity strategy
B)Riding the yield curve
C)Laddered maturity strategy
D)Interest maturity strategy
E)Risk maturity strategy

Question 33

Use the following information for questions
A bank has a planned 2-year investment horizon.It is considering investing in a 2-year bond that pays 6% annually versus investing in a 4-year bond that pays 6.5% annually and then selling it after two years.The annual coupon payments can be reinvested at 4%.
What will be the realized compound yield if the bank invests in the 4-year security and sells it at the end of two years, assuming interest rates remain unchanged?

A)4.00%
B)5.48%
C)5.94%
D)6.01%
E)6.85%

Question 34

Which of the following is not true regarding collateralized mortgage obligations (CMOs)?

A)Interest earned on CMOs is exempt from state income taxes.
B)CMO yields are generally higher than comparable Treasury yields.
C)CMOs exhibit little default risk.
D)All of the above are true.
E)Only a.and c.are true.

Question 35

Municipal bonds whose primary source of repayment are the revenues from the underlying financed project are known as:

A)general obligation bonds.
B)credit free bonds.
C)revenue bonds.
D)exempt bonds.
E)liquidity bonds.

Question 36

A security might exhibit negative convexity because:

A)its duration is greater than its maturity.
B)it has a fixed interest rate below current market rates.
C)a bank has a negative GAP.
D)it has embedded options.
E)markets are not efficient.

Question 37

If the Federal reserve is easing monetary policy at the end of a recession, you would expect the yield curve to be:

A)upward sloping.
B)flat.
C)inverted.
D)humped.
E)none of the above

Question 38

If the economy is entering into a recessionary period, you would expect the yield curve to be:

A)upward sloping.
B)flat.
C)inverted.
D)humped.
E)none of the above

Question 39

In the above question, what is the approximate pricing error when using Macaulay's duration?

A)$8
B)$10
C)$12
D)$14
E)$16

Question 40

Riding the yield curve:

A)is risk-free.
B)generally involves buying securities with a longer maturity than the intended holding period.
C)can only be accomplished with stripped Treasury securities.
D)all of the above
E)a.and c.only

Question 41

Under a passive investment strategy, secondary reserves are invested in short-term securities.

Question 42

What should a bank consider when establishing an investment policy?

Question 43

The static spread is:

A)the difference between the yield on a zero coupon bond and the yield on a coupon bond.
B)the difference between a fixed-rate yield and a floating-rate yield.
C)the difference between the yield on new Treasury bills versus new Treasury bonds.
D)the difference between expected inflation and the current Treasury bill rate.
E)the difference between the yield on a security with options and the yield on a maturity-matched zero coupon Treasury security.

Question 44

Securities with embedded options:

A)often have higher yields than comparable Treasury securities.
B)generally have no prepayment risk.
C)are always free of default risk.
D)all of the above.
E)a.and b.only

Question 45

When loan demand is weak, banks should keep investments short-term.

Question 46

Fixed-rate mortgages and adjustable-rate mortgages prepay at different rates.

Question 47

The yield curve is generally inverted at the top of the business cycle.

Question 48

Most long-term municipal bonds are serial bonds.

Question 49

A security's bid price will be greater than its ask price.

Question 50

Discuss the liquidity risk of investing in the municipal securities market.

Question 51

What are STRIPS and what do banks find advantageous about them?

Question 52

An investor can invest in either a tax-exempt security that pays 5% or a taxable corporate security of comparable risk and maturity that pays 8%.At what marginal tax rate will the investor be indifferent between these two securities?

A)25.0%
B)32.5%
C)37.5%
D)57.5%
E)62.5%

Question 53

In general, banks are less willing to sell securities when the market value is greater than the book value.

Question 54

Bank managers are often reluctant to sell securities when the market value falls below the book value.Why? Is this behavior in the long-term best interest of the bank? Why or why not?

Question 55

Which of the following would not be considered a bank qualified municipal security?

A)A Hays County general obligation bond to modernize the county fire department.
B)A Lubbock County general obligation bond to build a new sewer plant.
C)A City of San Marcos general obligation bond to pay for street repairs.
D)A City of El Paso general obligation bond to pay for a new city jail.
E)A State of Texas bond to finance road repairs.

Question 56

The security activities of large banks and small banks are fundamentally different.

Question 57

On an unadjusted basis, yields on municipal securities are greater than the yields on corporate securities, everything else the same.

Question 58

Discuss how a basic collateralized mortgage works.

Question 59

Banks can effectively improve their portfolios by:

A)shortening maturities when yields are expected to fall.
B)obtaining less call protection when rates are expected to fall.
C)reducing diversification when the economy is slowing down.
D)increasing bond quality when quality yield spreads are low.
E)all of the above

Question 60

If interest rates fall, a callable bond at par has the potential for large increases in price.

Question 61

Why are banks reluctant to sell securities after interest rates have risen? Is this behavior in the best interest of the bank's stockholders?

Question 62

What is the fundamental difference between an active versus passive investment strategy? Why might a bank choose one over the other?

Question 63

How did the Tax Reform Act of 1986 impact the demand for municipal securities?

Question 64

Explain the difference between a bond's duration and a bond's convexity.

Question 65

When loan demand is weak, a bank will often lengthen the maturity of their investment portfolio.Why does this often cause problems for the bank?