Question 1

Regulators' overall evaluation of the riskiness of a depository institution is measured by the ________.

Accepted Answer

The CAMELS rating system (Capital adequacy, Asset quality, Management, Earnings, Liquidity, and Sensitivity to market risk) is used by regulators to evaluate the overall riskiness of depository institutions. The other options (Basel Accord, CRA rating, Exposure scale, and FFIEC score) either measure specific aspects of the institution's risk or are not used for overall evaluation.

Question 2

CHIPS and ACH are

Accepted Answer

CHIPS (Clearing House Interbank Payments System) and ACH (Automated Clearing House) are both wholesale electronic payment systems used for transferring large sums of money between financial institutions. They are not potato products, check clearing systems run by the Federal Reserve, retail payment systems in Europe, or international bank regulators.

Question 3

Rank order the net charge-off rates from high to low for the following loan types:
I. C&I loans
II. Credit card loans
III. Real estate loans

Accepted Answer

Credit card loans typically have the highest net charge-off rates due to their unsecured nature and higher default risk. C&I (Commercial and Industrial) loans follow, as they can vary widely in risk. Real estate loans generally have the lowest net charge-off rates because they are secured by property, which can be sold to recover losses.

Question 4

A bank has invested in U.S. Treasury investments that mature in two years. They will be held until maturity. The investments are funded with three-year maturity time deposits. The primary risk this bank faces is

Accepted Answer

The answer of A bank has invested in U.S. Treasury...

Question 5

A thrift makes long-term fixed-rate mortgages funded with short-term deposits and then interest rates rise. Which of the following is true?

Accepted Answer

A thrift with long-term fixed-rate mortgages funded with short-term deposits would face a decline in profitability if interest rates rise. This is because the institution would have to pay higher interest rates to retain deposits, while existing low-rate mortgages would cause a decline in interest income. This situation would lead to a decrease in net interest margin, and thus a decline in profitability.

Question 6

A bank has on-balance-sheet assets with a book value of $940 million and a market value of $985 million and on-balance-sheet liabilities with a book value of $900 million and a market value of $930 million. The bank also has off-balance-sheet assets currently valued at $150 million and off-balance-sheet liabilities worth $160 million. Stockholders' net worth should be valued at ________ million.

Accepted Answer

The answer of A bank has on-balance-sheet assets with a...

Question 7

In year one,a bank facing reinvestment risk earns 11 percent on its assets and pays 10 percent on its liabilities. In year two,the bank had a negative profit spread of 100 basis points. Which of the following is true? In year two,

Accepted Answer

A negative profit spread means that the bank's cost of funds (10 percent on liabilities) is higher than its asset yield (unknown in year two, but was 11 percent in year one). The difference is 100 basis points, so if we assume the asset yield remained the same in year two, then rates must have fallen 100 basis points (resulting in a lower asset yield) for the profit spread to be negative. Therefore, the correct answer is D, rates fell 200 basis points (100 basis points for the profit spread plus another 100 basis points for the decrease in asset yield).

Question 8

A bank has book value of $5 million in liquid assets and $95 million in nonliquid assets. Large depositors unexpectedly withdraw $9.5 million in deposits. To cover the withdrawals the bank sells all of its liquid assets at book value. To raise the additional funds needed the bank sells the necessary amount of nonliquid assets at 80 cents per dollar of book value. As a result,the bank's equity will ________.

Accepted Answer

The bank initially covers $5 million of the withdrawals by selling all its liquid assets at book value. The remaining $4.5 million is covered by selling nonliquid assets. Since nonliquid assets are sold at 80 cents per dollar, the bank needs to sell $4.5 million / 0.8 = $5.625 million in book value of nonliquid assets. The loss on this sale is $5.625 million - $4.5 million = $1.125 million. The total equity reduction is the sum of the liquid assets sold ($5 million) and the loss on the sale of nonliquid assets ($1.125 million), totaling $6.125 million. However, since the question asks how much the bank's equity will fall and not the final equity value, the correct calculation should focus on the loss incurred from selling nonliquid assets at a discount. The initial mistake in calculation led to an incorrect explanation. The correct approach is to calculate the loss directly related to selling nonliquid assets at a discount: $4.5 million needed - $3.6 million raised (90% of $4.5 million) = $0.9 million loss, in addition to the $2.7 million loss from selling at 80% value, not accounting for the initial $5 million liquid assets used. This discrepancy indicates a need to reassess the calculation focusing on the direct impact of the discount on nonliquid assets on the bank's equity.

Question 9

In October 2005,the Bankruptcy Reform Act was signed into law. This law primarily

Accepted Answer

The Bankruptcy Reform Act of 2005 made it more difficult for debtors to receive bankruptcy protection by imposing stricter eligibility requirements, such as mandatory credit counseling and means testing, and by limiting the types of debts that can be discharged. This law was intended to reduce bankruptcy abuse and encourage personal responsibility for debt repayment. It applies to individuals, not just corporations or financial institutions. Foreign debtors are not specifically addressed in this law.

Question 10

Repurchase agreements (repos)are used extensively to finance security holdings. In 2007,many investment banks and other financial institutions were unable to roll over their maturing repurchase agreements during the subprime mortgage crisis. This inability to get new repo financing is an example of

Accepted Answer

The inability to roll over maturing repurchase agreements during the subprime mortgage crisis is an example of liquidity risk, which refers to the risk of not being able to meet short-term financial obligations. This is because repos are a common source of short-term funding for financial institutions. Credit risk refers to the risk of borrower default, sovereign risk is the risk associated with a country defaulting on its debt, technological risk is the risk of technology malfunctions, and operational risk is the risk of losses resulting from inadequate or failed internal processes, people, and systems.

Question 11

Which one of the following intermediaries is likely to engage in more asset liability maturity matching?

Accepted Answer

Life insurers are more likely to engage in asset liability maturity matching as their primary business involves providing long-term insurance policies (such as life insurance) and they need to ensure they have sufficient long-term assets to cover potential claims. Banks, savings associations, and savings banks may also engage in some level of maturity matching, but their primary business involves taking deposits and making loans, which can be shorter-term in nature.

Question 12

For most financial institutions,present value uncertainty is the risk that

Accepted Answer

Present value uncertainty is commonly associated with interest rate risk, which is the risk that changes in interest rates can impact the value of assets and liabilities on a bank's balance sheet. Option A reflects this risk, as an increase in interest rates can cause the market value of an asset or liability to decline due to changes in their present value. The other options are not directly related to present value uncertainty.

Question 13

Having longer maturity assets than liabilities causes banks to bear which of the following risks?
I. Interest rate risk
II. Liquidity risk
III. Credit risk

Accepted Answer

Having longer maturity assets than liabilities causes banks to bear interest rate risk and liquidity risk because they may struggle to meet short-term obligations if interest rates rise or if there is a sudden need for cash. It does not necessarily increase credit risk.

Question 14

If a bank is exposed to refinancing risk,its profitability is reduced if interest rates ________ and if it is exposed to reinvestment risk,its profitability is reduced if interest rates ________.

Accepted Answer

Refinancing risk affects a bank negatively when interest rates rise, making it more expensive to refinance debt. Reinvestment risk hurts profitability when interest rates fall, as the returns on reinvested funds decrease.

Question 15

Which of the following would normally be banking book assets rather than trading book assets?

Accepted Answer

Long-term loans are typically held as banking book assets, as they represent long-term investments on the balance sheet. The other options are all examples of trading book assets, which are typically held for shorter periods of time and may be actively traded or hedged in the market.

Question 16

The terrorist attacks on the World Trade Center in 2001 are an example of ________.

Accepted Answer

The terrorist attacks on the World Trade Center in 2001 were an example of event risk, which refers to the possibility that an unforeseen event, such as a terrorist attack or natural disaster, may cause significant losses for an individual or organization.

Question 17

The £ is worth 1.2569 euros and the euro is worth $1.5568. Statistical analysis indicates that when the euro rises 1 percent against the dollar,the pound rises 0.5 percent against the euro and vice versa. A U.S. bank has assets of £40 million that mature in one year funded with liabilities of €55 million due in six months. The bank would be hurt by
I. an increase in the value of the euro against the dollar.
II. a decrease in the value of the euro against the dollar.
III. an increase in euro interest rates relative to pound interest rates.
IV. an increase in pound interest rates relative to euro interest rates.

Accepted Answer

The bank would be hurt by an increase in the value of the euro against the dollar because it would increase the dollar value of its liabilities when converted from euros. It would also be hurt by an increase in euro interest rates relative to pound interest rates because it would increase the cost of its euro-denominated liabilities relative to its pound-denominated assets.

Question 18

A bank invests $250 million to add the ability to provide online bill paying for its customers. Usage of the new service is at about 50 percent of expected usage. This is an example of

Accepted Answer

Technological risk refers to the risk of technology not performing as expected or not being adopted by users as anticipated. In this case, the bank's investment in online bill paying is not being used as much as expected, indicating a technological risk.

Question 19

The Fed allowed nonbank financial institutions to borrow money from the discount window during the mortgage crisis and even allowed nonbanks to swap mortgages for Treasury securities. This was an attempt by the Fed to reduce ________ at institutions.

Accepted Answer

The borrowing from the discount window and the swap of mortgages for Treasury securities were aimed at reducing liquidity risk at financial institutions during the mortgage crisis. The other options are not directly related to the measures taken by the Fed in this context.

Question 20

Argentina has refused to pay loans made to it by foreign institutions three times. This is an example of

Accepted Answer

Argentina's refusal to pay loans made to it by foreign institutions is an example of sovereign risk. Sovereign risk is the risk that a national government will default on its sovereign debt obligations, which includes loans made to the country by foreign institutions. This can occur due to political instability, economic turmoil, or other factors that make it difficult for the government to repay its debts.

Quiz 19: Types of Risks Incurred by Financial Institutions