Question 1

17-80 Which of the following observations concerning the Fed's discount window is true?

Accepted Answer

Primary credit is available to sound depository institutions on a very short-term basis. This means that eligible institutions can borrow from the Fed's discount window to meet their short-term liquidity needs. The other options are incorrect because:
A) The facility is provided to meet banks' temporary liquidity needs.
B) There are only three lending programs offered through the Fed's discount window.
D) Secondary credit is available to depository institutions that are not eligible for primary credit.
E) Eligible institutions for seasonal credit are those that experience predictable seasonal fluctuations in liquidity needs, not necessarily big urban banks.

Question 2

17-68 How does liability management affect profitability?

Accepted Answer

Liability management affects profitability primarily through its impact on the cost of purchased funds, as managing liabilities effectively can reduce funding costs and improve profit margins.

Question 3

17-67 Which intermediation function results in an FI's exposure to liquidity risk?

Accepted Answer

Asset transformation involves taking short-term liabilities and transforming them into longer-term assets. This process exposes FIs to liquidity risk, as they may not have access to sufficient funds to cover their liabilities if there is a sudden increase in withdrawals or a decline in market liquidity.

Question 4

17-64 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 par value 7 percent annual coupon bond? The fund has 10 million shares.

Accepted Answer

A 50 basis point increase in interest rates will decrease the bond's price due to the inverse relationship between interest rates and bond prices. The decrease in the bond's price will lead to a decrease in the net asset value (NAV) of the mutual fund. The decrease per share is calculated by determining the change in the bond's price due to the interest rate increase and dividing it by the number of shares.

Question 5

17-79 In a crisis,which of the following are relatively less likely to withdraw funds quickly from banks and thrifts?

Accepted Answer

The answer of 17-79 In a crisis,which of the following...

Question 6

17-75 What does a high ratio of loans to deposits indicate?

Accepted Answer

A high ratio of loans to deposits indicates that the depository institution (DI) relies heavily on the short-term money market to fund loans.

Question 7

17-76 In terms of liquidity risk measurement,the financing gap is defined as

Accepted Answer

The financing gap is defined as the difference between average loans and average deposits, indicating the amount of funding needed beyond deposits.

Question 8

17-66 The surrender value of an insurance policy is

Accepted Answer

The surrender value of an insurance policy is the amount of money an insurer will pay to the policyholder if the policy is surrendered before maturity. It is typically a portion of the contract's face value, as the insurer has already collected premiums for the time the policy was in effect.

Question 9

17-70 Which of the following is NOT a primary source of liquidity?

Accepted Answer

Capital notes and other long-term financing alternatives are not considered primary sources of liquidity. Primary sources are those that can be easily and quickly accessed to meet a bank's short-term funding needs, such as cash reserves, borrowings in the money market and purchased funds market, and easy-to-sell cash-type assets. Long-term financing alternatives, on the other hand, are typically used to fund longer-term projects and are not considered as readily available for short-term liquidity needs.

Question 10

17-72 What information does the net liquidity statement provide?

Accepted Answer

The answer of 17-72 What information does the net liquidity...

Question 11

17-65 In the event of financial distress,open?ended mutual fund investors

Accepted Answer

In the event of financial distress, mutual fund investors have an incentive to avoid a run since large redemptions can deplete the fund's net asset value. When a fund sells assets to redeem shares, it can disrupt the market for those securities, causing the market value to fall. This, in turn, can lower the net asset value of the fund and ultimately hurt remaining investors. Therefore, it is in the best interest of investors to remain calm and avoid a run on the mutual fund.

Question 12

17-69 When comparing banks and mutual funds,

Accepted Answer

Mutual funds have less liquidity risk than banks because the loss of value is shared among all shareholders on a pro rata basis, reducing the impact on any single investor.

Question 13

17-71 Which of the following is NOT a method of measuring liquidity?

Accepted Answer

The answer of 17-71 Which of the following is NOT...

Question 14

17-74 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

Accepted Answer

To calculate the liquidity index value for the DI's portfolio, we need to calculate the worst-case scenario for the value of the portfolio after one month.

For the T-bills, the worst-case value is $100 per $100 of face value, since the DI can wait until maturity to receive this amount.

For the real estate loans, the worst-case value is $90 per $100 of face value, since if the DI has to liquidate them today, it will only receive this amount.

To find the overall worst-case value of the portfolio, we take a weighted average of these two values, based on the proportion of the portfolio invested in each asset:

Worst-case value = (0.5 x $100) + (0.5 x $90) = $95

This means that if the DI had to liquidate its entire portfolio today, it would receive only $95 per $100 of face value.

To find the liquidity index value, we divide this worst-case value by the current value of the portfolio, which is just the value of the T-bills:

Liquidity index value = $95 / $98 = 0.969

Multiplying by 100 gives a liquidity index value of 97.9, which is closest to answer choice C.

Question 15

17-83 Which of the following is NOT a component of liquidity planning?

Accepted Answer

Liquidity planning does not typically involve calculating the value of assets at fire-sale prices; it focuses more on managing cash flows and ensuring sufficient liquidity to meet obligations.

Question 16

17-81 What are the two major liquidity risk insulation devices available?

Accepted Answer

The two major liquidity risk insulation devices available are deposit insurance, which protects depositors in the event of a bank failure, and the discount window, which allows banks to borrow from the central bank in times of liquidity shortages. The other options listed are various liquidity risk management tools, but do not directly address liquidity risk insulation.

Question 17

17-82 What is the drawback of deposit insurance facility?

Accepted Answer

Deposit insurance can lead to moral hazard, where deposit-taking institutions (DIs) might take on more risk, including increased liquidity risk, because they know deposits are insured.

Question 18

17-77 In terms of liquidity risk measurement,the financing requirement is defined as

Accepted Answer

The financing requirement is the amount of funding needed to satisfy the difference between the financing gap and the amount of liquid assets. The financing gap is the excess rate-sensitive liabilities over rate-sensitive assets. Therefore, Option B is the correct answer as it combines both these factors to calculate the financing requirement. The other options are incorrect as they do not take into account the rate sensitivity of assets and liabilities which is critical in measuring liquidity risk.

Question 19

17-73 Which of the following is a measure of the potential losses an FI could suffer as the result of fire-sale disposal of assets?

Accepted Answer

The liquidity index measures an FI's ability to meet cash outflows without having to sell assets at fire-sale prices. It is a measure of potential losses an FI could suffer as a result of fire-sale disposal of assets. The quick ratio and current ratio are measures of an FI's short-term liquidity, financing gap and financing requirement are measures of an FI's funding needs, and peer group ratio is a comparison of an FI's performance to that of its peers.

Question 20

17-78 In a crisis,which of the following are more likely to withdraw funds quickly from banks and thrifts?

Accepted Answer

The answer of 17-78 In a crisis,which of the following...

Quiz 17: Liquidity Risk