Deck 16: Managing the Investment Portfolio

Question 1

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%

Answer 1

A

Question 2

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

Answer 2

A

Question 3

Mortgage prepayment risk:

A) is greatest for stripped securities.
B) increases as interest rates increase.
C) is eliminated in Z-tranche CMOs.
D) is not impacted by demographic factors.
E) is larger on high-rate mortgages.

Answer 3

E

Question 4

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 5

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 6

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 7

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 8

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 9

GMNA pass-through securities:

A) are issued by the U.S. government.
B) have higher yields that other comparable MBSs.
C) have high liquidity
D) all of the above
E) none of the above.

Question 10

Use the following information for questions
A bank has a planned 2-year investment horizon. It is considering investing $1,000 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? The price at sale after two years will be $1,009.17.

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

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

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.

Question 13

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 14

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 15

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 16

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 17

Use the following information for questions
A bank has a planned 2-year investment horizon. It is considering investing $1,000 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 18

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 19

Most repurchase agreements are secured by:

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

Question 20

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

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

Question 21

Most long-term municipal bonds are serial bonds.

Question 22

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

Question 23

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

Question 24

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 25

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

Question 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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 31

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 32

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

Question 33

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 34

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 35

A bank owns a zero coupon bond with 5 years to maturity and a face value of $10,000. At the current interest rate of 6%, the price of the bond is $7,472.58. 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 36

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

Question 37

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

Question 38

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 39

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

Question 40

Discuss how a basic collateralized mortgage works.

Question 41

What should a bank consider when establishing an investment policy?

Question 42

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

Question 43

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

Question 44

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?

Question 45

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 46

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