Question 1

Bank A has a loan to deposit ratio of 75%, core deposits equal 62% of total assets and borrowed funds are 5% of assets. Bank B has a loan to deposit ratio of 82%. Core deposits are 55% of assets and borrowed funds are 20% of assets. Which bank has more liquidity risk? Ceteris paribus, which bank will probably be more profitable when interest rates are low and the economy is growing?

Accepted Answer

Bank B has more liquidity risk due to a higher loan to deposit ratio and a higher percentage of borrowed funds. However, this also suggests Bank B might be more profitable in a low interest rate, growing economy due to higher interest income from loans and potentially higher leverage.

Question 2

ABC Bank has $39 million invested in T-Bonds with a 16-year duration, $39 million in 6 month maturity T-Bills, and $75 million invested in consumer loans with a 3 year duration. Based only on this data, what is the duration of the bank's asset portfolio in years?

Accepted Answer

The answer of ABC Bank has $39 million invested in...

Question 3

A ______ eliminates the effects of extreme movements in interest rates, allowing the bank's cash flows to fluctuate within a specified range.

Accepted Answer

A collar is a combination of a cap and a floor that serves to limit the range of interest rate movements, ensuring that the bank's cash flows fluctuate within a predetermined range.

Question 4

A bank has a negative $GAP. If interest rates fall the bank's overall NII will

Accepted Answer

When a bank has a negative GAP, it means that its interest-sensitive liabilities exceed its interest-sensitive assets. If interest rates fall, the interest expense on liabilities will decrease more than the interest income on assets, leading to an increase in the bank's Net Interest Income (NII).

Question 5

Which of the following results in a net liquidity drain?

Accepted Answer

The answer of Which of the following results in a...

Question 6

Refer to the information below for questions 
Formosa International Bank (FIB) (mill$)
 $\begin{array}{ll}
\text { Funds borrowed } & \$ 6,300 \
\text { Maximum amount FIB can still borrow } & \$ 8,600 \
\text { Cash-type assets } & \$ 4,700 \
\text { Excess cash reserves } & \$ 100 \
\text { Federal Reserve borrowings } & \$ 200
\end{array}$ 
-What are Formosa International Bank's total sources of future liquidity?

Accepted Answer

Total sources of future liquidity include the maximum amount FIB can still borrow ($8,600), cash-type assets ($4,700), and excess cash reserves ($100). Adding these together gives $8,600 + $4,700 + $100 = $13,400. Federal Reserve borrowings are a current liability, not a source of future liquidity.

Question 7

Refer to the information below for questions 
Formosa Independence Bank has the following balance sheet:
 
-If all interest rates on the two sides of balance sheet decline by 65 basis points, when other things are equal, what is the change in net interest income for Formosa Independence Bank over the year?

Accepted Answer

The answer of Refer to the information below for questions...

Question 8

Refer to the information below for questions 
Formosa International Bank (FIB) (mill$)
 $\begin{array}{ll}
\text { Funds borrowed } & \$ 6,300 \
\text { Maximum amount FIB can still borrow } & \$ 8,600 \
\text { Cash-type assets } & \$ 4,700 \
\text { Excess cash reserves } & \$ 100 \
\text { Federal Reserve borrowings } & \$ 200
\end{array}$ 
-What are Formosa International Bank's total current uses of liquidity?

Accepted Answer

Total current uses of liquidity = Funds borrowed + Federal Reserve borrowings = $6,300 + $200 = $6,500

Question 9

A difference payment refers to

Accepted Answer

A difference payment specifically refers to the net amount that is owed between the parties involved in a swap on the payment date. This amount is determined based on the difference between the obligations of the two parties under the terms of the swap agreement.

Question 10

Macrohedging is the use of risk-management instruments such as futures and options to reduce the interest rate risk of the overall bank portfolio.

Accepted Answer

Macrohedging involves using derivatives like futures and options to manage the interest rate risk across the entire portfolio of a bank, rather than targeting specific individual exposures.

Question 11

The number of futures contracts that a bank will need in order to fully hedge the bank's overall interest rate risk exposure and protect the bank's net worth depends upon (among other factors): I. The relative duration of bank assets and liabilities.
II) The duration of the underlying security named in the futures contract.
III) The price of the futures contract.
IV) The debt to asset ratio.

Accepted Answer

The answer of The number of futures contracts that a...

Question 12

Interest rate collars do which one of the following?

Accepted Answer

Interest rate collars are financial instruments that are used to hedge against interest rate fluctuations. They do this by setting both a ceiling (upper limit) and a floor (lower limit) on interest rates, thereby limiting the movement of a bank's liability costs to remain within a specified range. This helps in managing the risk associated with interest rate volatility.

Question 13

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

Accepted Answer

The answer of Which one of the following is a...

Question 14

Refer to the information below for questions 
Formosa Independence Bank has the following balance sheet:
 
-The bank's one-year gap between assets and liabilities is (Mill $)

Accepted Answer

The answer of Refer to the information below for questions...

Question 15

Duration GAP is a conceptually superior method to assess the interest rate risk of a financial institution than $GAP.

Accepted Answer

Duration GAP takes into account the timing and cash flow of assets and liabilities, providing a more comprehensive measure of interest rate risk compared to the simple dollar GAP, which only considers the difference in the value of assets and liabilities.

Question 16

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

Accepted Answer

Long term assets funded by short term liabilities create the most liquidity risk because the assets cannot be quickly converted into cash to meet the short-term obligations. This mismatch in the maturity profiles of assets and liabilities can lead to a liquidity shortfall.

Question 17

A bank that has made 30 year adjustable rate mortgages that reprice in 6 months that are funded with one year CDs will have a positive $GAP over a 1 year period and a negative Duration Gap all else equal.

Accepted Answer

A positive $GAP occurs when rate-sensitive assets exceed rate-sensitive liabilities over a given period. Since the mortgages reprice in 6 months and CDs in 1 year, the bank has more rate-sensitive assets than liabilities within 1 year. A negative Duration Gap indicates that the duration of liabilities is longer than the duration of assets, which is consistent with the scenario where assets reprice sooner than liabilities.

Question 18

Refer to the information below for questions 
Formosa International Bank (FIB) (mill$)
 $\begin{array}{ll}
\text { Funds borrowed } & \$ 6,300 \
\text { Maximum amount FIB can still borrow } & \$ 8,600 \
\text { Cash-type assets } & \$ 4,700 \
\text { Excess cash reserves } & \$ 100 \
\text { Federal Reserve borrowings } & \$ 200
\end{array}$ 
-What is Formosa International Bank's total net liquidity?

Accepted Answer

The answer of Refer to the information below for questions...

Question 19

Which one of the following alternatives is an appropriate way to deal with deposit withdrawals that utilizes asset management of liquidity?

Accepted Answer

Selling the bank's holdings of T-bills is an example of using asset management to handle liquidity needs. This involves converting assets (in this case, T-bills) into cash to meet withdrawal demands without having to seek external funding or investments.

Question 20

Although caps, floors, and collars can be created by buying and selling options on financial futures, this strategy is difficult because

Accepted Answer

Exchange-traded options with sufficiently long maturities may not exist, are often illiquid, or can be too expensive, making it difficult to create caps, floors, and collars by buying and selling options on financial futures.

Quiz 20: Risk Management in Financial Institutions

ABC Bank has $39 million invested in T-Bonds with a 16-year duration, $39 million in 6 month maturity T-Bills, and $75 million invested in consumer loans with a 3 year duration. Based only on this data, what is the duration of the bank's asset portfolio in years?

A ______ eliminates the effects of extreme movements in interest rates, allowing the bank's cash flows to fluctuate within a specified range.

A bank has a negative $GAP. If interest rates fall the bank's overall NII will

Which of the following results in a net liquidity drain?

A difference payment refers to

Macrohedging is the use of risk-management instruments such as futures and options to reduce the interest rate risk of the overall bank portfolio.

Interest rate collars do which one of the following?

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

Refer to the information below for questions Formosa Independence Bank has the following balance sheet: -The bank's one-year gap between assets and liabilities is (Mill $)

Duration GAP is a conceptually superior method to assess the interest rate risk of a financial institution than $GAP.

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

A bank that has made 30 year adjustable rate mortgages that reprice in 6 months that are funded with one year CDs will have a positive $GAP over a 1 year period and a negative Duration Gap all else equal.

Which one of the following alternatives is an appropriate way to deal with deposit withdrawals that utilizes asset management of liquidity?

Although caps, floors, and collars can be created by buying and selling options on financial futures, this strategy is difficult because