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Chapter 01 – Why Are Financial Institutions Special? 1-1 Solutions for End-of-Chapter Questions and Problems: Chapter One 1. What are five risks common to all financial institutions? Default or credit risk of assets, interest rate risk caused by maturity mismatches […]

Chapter 10 – Credit Risk: Individual Loan Risk 10-1 Solutions for End-of-Chapter Questions and Problems: Chapter Ten 1. Why is credit risk analysis an important component of FI risk management? What recent activities by FIs have made the task of […]

Chapter 10 – Credit Risk: Individual Loan Risk 10–15 Education. b. What is the implied probability of default on A-rated bonds over the next 93 days? Over 175 days? The probability of repayment of the 93-day A-rated bond is: p(1 […]

Chapter 11 – Credit Risk: Loan Portfolio and Concentration Risk 11-1 Solution for End-of-Chapter Questions and Problems: Chapter Eleven 1. How do loan portfolio risks differ from individual loan risks? Loan portfolio risks refer to the risks of a portfolio […]

Chapter 12 – Liquidity Risk 12-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twelve 1. How does the degree of liquidity risk differ for different types of financial institutions? Due to the nature of their asset and liability contracts, depository […]

Chapter 13 – Foreign Exchange Risk 13-1 Solutions for End-of-Chapter Questions and Problems: Chapter Thirteen 1. What are four FX risks faced by FIs? Four risks include (1) trading in foreign securities, (2) making foreign currency loans, (3) issuing foreign […]

Chapter 13 – Foreign Exchange Risk 13–16 Education. At the end of the year, the FI must pay the pound CD holders their principal and interest, €160 million (1.07) = €171.20 million. If the euro increases to $1.35/€1 over the […]

Chapter 14 – Sovereign Risk 14-1 Solutions for End-of-Chapter Questions and Problems: Chapter Fourteen 1. What risks are incurred in making loans to borrowers based in foreign countries? Explain. When making loans to borrowers in foreign countries, two risks need […]

Chapter 15 – Market Risk 15-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Fifteen 1. What is meant by market risk? Market risk is the risk related to the uncertainty of an FI’s earnings on its trading portfolio. Market […]

Chapter 15 – Market Risk 15–13 Education. 25. Consider the following discrete probability distribution of payoffs for two securities, A and B, held in the trading portfolio of an FI: Probability A Probability B 50.00% $80m 50.00% $80m 49.00 60m […]

Chapter 16 – Off-Balance-Sheet Risk 16-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Sixteen 1. Classify the following items as (1) on-balance-sheet assets, (2) on-balance-sheet liabilities, (3) off-balance-sheet assets, (4) off-balance-sheet liabilities, or (5) capital account. Classification a. Loan […]

Chapter 17 – Technology and Other Operational Risks 17-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Seventeen 1. Explain how technological improvements can increase an FI’s interest and noninterest income and reduce interest and noninterest expenses. Use some specific […]

Chapter 18 – Liability and Liquidity Management 18-1 Solutions for End-of-Chapter Questions and Problems: Chapter Eighteen 1. What are the benefits and costs to an FI of holding large amounts of liquid assets? Why are Treasury securities considered good examples […]

Chapter 19 – Deposit Insurance and Other Liability Guarantees 19-1 Solutions for End-of-Chapter Questions and Problems: Chapter Nineteen 1. What is a contagious run? What are some of the potentially serious adverse social welfare effects of a contagious run? Do […]

Chapter 02 – Financial Services: Depository Institutions 2-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Two 1. What are the differences between community banks, regional banks, and money-center banks? Contrast the business activities, location, and markets of each of […]

Chapter 20 – Capital Adequacy 20-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twenty 1. Identify and briefly discuss the importance of the five functions of an FI’s capital? Capital serves as a primary cushion against operating losses and unexpected […]

Chapter 20 – Capital Adequacy 20–15 Education. commercial paper 100 100 $30 million potential current exposure exposure v. $4 million five-year interest rate swap with no current exposure 5% $0 100 $20,000 w. $6 million two-year currency swap with $500,000 […]

Chapter 21 – Product and Geographic Expansion 21-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twenty One 1. How does product segmentation reduce the profitability and risk of FIs? How does it increase the profitability and risk of FIs? Product […]

Chapter 22 – Futures and Forwards 22-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twenty-Two 1. What are derivative contracts? What is the value of derivative contracts to the managers of FIs? Which type of derivative contracts had the highest […]

Chapter 22 – Futures and Forwards Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. 23. An FI is planning to hedge its $100 million bond instruments with a […]

Chapter 23 – Options, Caps, Floors, and Collars 23-1 Solutions to End-of-Chapter Questions and Problems: Chapter Twenty Three 1. How does using options differ from using forward or futures contracts? Both options and futures contracts are useful in managing risk. […]

Chapter 23 – Options, Caps, Floors, and Collars 23–15 Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of McGraw-Hill Education. BDx x A]x D k – D [ = NLA p […]

Chapter 24 – Swaps 24-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twenty-Four 1. Explain the similarity between a swap and a forward contract. A forward contract requires delivery or taking delivery of some commodity or financial security at a […]

Chapter 24 – Swaps 24–15 d. How can the Swiss bank reduce that risk exposure? The Swiss bank can undertake a short currency hedge if it wants to protect itself against exchange rate risk exposure. e. If the US dollar […]

Chapter 25 – Loan Sales 25-1 Solutions for End-of-Chapter Questions and Problems: Chapter Twenty Five 1. What is the difference between loans sold with recourse and loans sold without recourse from the perspective of both sellers and buyers? Loans sold […]

Chapter 26 – Securitization 26-1 Solutions for End-of-Chapter Questions and Answers: Chapter Twenty-Six 1. What has been the effect of securitization on the asset portfolios of financial institutions? In addition to serving as another mechanism to hedge interest rate exposure […]

Chapter 26 – Securitization 26–14 c. Interest rate movements over time are assumed to change a maximum of 1 percent per year. Both an increase of 1 percent and a decrease of 1 percent in interest rates are equally probable. […]

Chapter 03 – Financial Services: Finance Companies 3-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Three 1. What is the primary function of finance companies? How do finance companies differ from depository institutions? The primary function of finance companies […]

Chapter 04 – Financial Services: Securities Brokerage and Investment Banking 4-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Four 1. Explain how securities firms differ from investment banks. In what ways are they financial intermediaries? Securities firms specialize primarily […]

Chapter 05 – Financial Services: Mutual Funds and Hedge Funds 5-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Five 1. What is a mutual fund? In what sense is it a financial institution? A mutual fund represents a pool […]

Chapter 06 – Financial Services: Insurance 6-1 Solutions for End-of-Chapter Questions and Problems: Chapter Six 1. What is the primary function of an insurance company? How does this function compare with the primary function of a depository institution? The primary […]

Chapter 07 – Risks of Financial Institutions 7-1 Solutions for End-of-Chapter Questions and Problems: Chapter Seven 1. What is the process of asset transformation performed by a financial institution? Why does this process often lead to the creation of interest […]

Chapter 08 – Interest Rate Risk I 8-1 Solutions for End-of-Chapter Questions and Problems: Chapter Eight 1. How do monetary policy actions made by the Federal Reserve impact interest rates? Through its daily open market operations, such as buying and […]

Chapter 08 – Interest Rate Risk I 8-15 Education. The value and average maturity of the liabilities will be: Demand deposits = $100 CDs = $12.60xPVAn=5,i=7% + $210xPVn=5,i=7% = $201.39 Debentures = $8.4xPVAn=20,i=8% + $120xPVn=20,i=8% = $108.22 ML = [0x$100 […]

Chapter 09 – Interest Rate Risk II 9-1 Education. Solutions for End-of-Chapter Questions and Problems: Chapter Nine 1. What is the difference between book value accounting and market value accounting? How do interest rate changes affect the value of bank […]

Chapter 09 – Interest Rate Risk II 9-21 Education. Immunizing the equity from changes in interest rates requires that the DGAP be 0. Thus, (DA– DLk) = 0  DA = DLk, or DA = 1.8975×0.9 = 1.70775 years. 24. […]

Chapter 09 – Interest Rate Risk II 9-32 Education. Price – market Price – duration Amount determined estimation of error At +0.10%: $988.85 $988.74 $0.11 At -0.10%: $1,011.36 $1,011.26 $0.10 At +2.0%: $811.46 $774.80 $36.66 At -2.0%: $1,275.30 $1,225.20 $50.10 […]

In general, maximum levels of losses in the property-casualty industry are more predictable for liability lines than for property lines. Answer: An FI that is short-funded faces the risk that the return of reinvesting assets could exceed the cost of […]

As of December 2012, the number of nationally chartered banks was greater than the number of state chartered banks. Answer: Although life insurance companies also provide health and accident insurance, they underwrite less than 35% of all health insurance policies. […]

Identify the residual class of a CMO that gives the owner the right to any remaining collateral in the trust after all other bond classes have been retired plus any reinvestment income earned by the trust. A. Class A bonds. […]

Both parties in an interest rate swap normally are fully hedged against interest rate risk on the notional amount of the swap. Answer: One way to minimize contingent credit risk is to use derivative products sold on organized exchanges. Answer: […]

Which of the following situations is similar to the externality effect? A. Exercising an adverse material change in conditions clause as a last resort, thereby canceling or repricing a loan commitment. B. Increase in the cost of funds above normal […]

Which of the following observations about the repricing model is correct? A. Its information value is limited. B. It accounts for the problem of rate-insensitive asset and liability runoffs and prepayments. C. It accommodates cash flows from off-balance-sheet activities. D. […]

Finance companies have had no significant downturns in economic performance over the last two decades. Answer: Insurance guarantee funds are administered by federal insurance regulators. Answer: FALSE The cost of insolvency of an FI to the FDIC is offset in […]

Contagious runs on bank deposits are directed at FIs, whether they are failing or healthy. Answer: Worldwide investments in mutual funds have grown at a rate faster than in the United States over the last decade. Answer: TRUE Migration analysis […]

An FI can eliminate its currency risk exposure by matching its foreign currency assets to its foreign currency liabilities. Answer: Futures contracts are the primary security that insurance companies and banks use to hedge interest rate risk prior to originating […]

Forward contracts in FX are typically written for periods exceeding 6 months. Answer: As of January 2012, credit cards used in either a credit or debit function accounted for less than 5 percent of the dollar value of payments made […]

Violation of the interest rate parity theorem would allow arbitrage profits. Answer: As a percent of assets, finance companies currently rely more heavily on commercial paper as a source of financing than in 1977. Answer: FALSE A naked option is […]

A mutual fund objective statement provides general information about the types of securities a mutual fund will hold as assets. Answer: The safety and soundness of a holding company that has both a bank subsidiary and a securities affiliate can […]

The use of the option pricing model to determine the actuarially fair premium for deposit insurance indicates that the cost of the insurance should rely on both the asset quality and level of leverage of the DI. Answer: An angel […]

All off-balance-sheet items will eventually move on to the balance sheet at some point in time. Answer: Under Basel III, banks are allowed to use their internal estimates of borrower creditworthiness to assess credit risk subject to strict disclosure standards. […]

Interest rate risk is part of the loan commitment contingent risk because of the uncertainty of changes in interest rates before the borrower exercises his option to borrow. Answer: An interest-only (IO) mortgage-backed strip is a rare example of a […]

Average daily turnover in the FX market has recently been over $4 trillion. Answer: The extremely high growth of OBS activities since the early 1990s has caused regulators to recognize the potential risk exposure to FIs from their use. Answer: […]

An off-balance-sheet forward position is used to hedge the FI’s on-balance-sheet risk exposure. Answer: In the U.S., cash reserves necessary to meet deposit reserve requirements typically include vault cash and cash deposits at the Federal Reserve Bank. Answer: TRUE Because […]

The advantage to the lender (purchaser) of a Brady bond versus a loan to a foreign country is that U.S. Treasury bonds serve as collateral for Brady bonds. Answer: An FI that sells a loan with recourse retains ownership of […]

An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $76.95 per $100 for the bond. The current yield on a one-year bond of equal risk is 12 percent, and the one-year rate in […]

Liquidity risk for an FI includes the possibility of an unexpected inflow of funds. Answer: During the financial crisis of 2008, there were large deposit inflows to the banking system. Answer: TRUE The buyer of a loan participation benefits because […]

The loss to a buyer of bond put options is limited to the premium paid. Answer: Reciprocal banking pacts allowed the non-state companies to purchase banks as long as the purchase permission went in both directions. Answer: TRUE The Securities […]

A one bank holding company is a parent bank holding company with only one subsidiary involved in banking activities. Answer: During the late 2000’s financial crisis, global stock market return correlations decreased relative to the decade before the crisis. Answer: […]

Which of the following statements is TRUE?A. An increase in interest rates will benefit the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities. B. An increase […]

Prepayment risk means that realized cash flows on pass-through securities may be more than expected cash flows. Answer: The passage of legislation to prevent discrimination in lending is an example of regulation to protect investors. Answer: FALSE The net stable […]

The savings association industry continues to be the primary lender of residential mortgages. Answer: As the economic expansion continued through the 1990s, the demand for finance company loans increased. Answer: TRUE Determining risk-adjusted asset values for OBS market contracts requires […]

Financial institutions are subject to economies of scale in the collection of information. Answer: International expansion by a commercial bank should provide increased access to funding sources. Answer: TRUE Merger premiums tend to be higher for target banks in competitive […]

Chinese walls are barriers within organizations that limit the flow of confidential information between departments of business areas. Answer: Catastrophe futures are designed to hedge extreme losses of natural disasters for property-casualty insurance companies. Answer: TRUE Operational risk has increased […]

The numbers provided are in millions of dollars and reflect market values: What is the weighted average duration of the assets of the FI?A. 7.25 years. B. 7.75 years. C. 8.25 years. D. 8.75 years. E. 9.25 years. Answer: C. […]

Basel III capital ratios will become fully effective in 2016. Answer: Market value at risk (VAR) is defined as the daily earnings at risk (DEAR) times the number of days (N). Answer: FALSE Equipment leasing to customers is a function […]

A digital default option expires unexercised in situations where the loan is paid in accordance with the loan agreement. Answer: Time intermediation involves the investment of small amounts by investors into mutual funds that invest in long-term securities such as […]

Finance companies operate more like nonfinancial, nonregulated companies than any other type of financial institution. Answer: Swaps generally have a shorter maturity than other derivative instruments. Answer: FALSE The emergence of the Euro as a uniform medium of exchange is […]

When liquidity risk problems occur at a DI, they often threaten the solvency of the institution. Answer: As a result of trading and fee assignment abuses by the mutual fund industry, the SEC established new rules regarding fund governance and […]

Hadbucks National Bank current balance sheet appears below. All assets and liabilities are currently priced at par and pay interest annually. What is market value of the ten-year loan if all market interest rates increase by 2 percent? A. $40.000 […]

The export revenue variance (VAREX) should be negatively related to the probability of debt rescheduling. Answer: Returns from domestic and foreign investments may not be perfectly correlated because of different economic infrastructures and growth rates. Answer: TRUE Most portfolio managers […]

As an industry, finance companies have escaped the merger and consolidation activity that has affected nearly every other sector of the financial services industry. Answer: Historically, correspondent banking relationships have been important in the sale of bank loans. Answer: TRUE […]

By regulation, the payments on an annuity contract must stop when the annuity holder dies. Answer: The Clearing House Interbank Payments System (CHIPS) is an international wire transfer system owned by the participating banks in the countries in which it […]

What is the gain or loss on the futures position using T-Bonds (Duration = 9 years, $96 per $100 face value) if the shock to interest rates is 1 percent [i.e. ΔR/(1 + R) = 0.01 and ΔRf/(1 + Rf) […]

The cost of stored liquidity management is the interest that must be paid on the stored funds. Answer: An FI may be insolvent in market value terms even if the book value of equity is positive. Answer: TRUE On-balance-sheet hedging […]

Which of the following describes the process of “netting” in the swap market?A. Stripping out the “interest rate” sensitive element of total return swaps to reduce the net portfolio risk. B. Acting as an intermediary by bringing together two FIs […]

Recent evidence strongly suggests that economies of scope exist for both asset and liability products, but not for off-balance-sheet products. Answer: Calculating the risk of a multi-asset trading portfolio requires the consideration of the correlations of returns between the different […]

In the banking environment, economic and legal firewalls often have been designed to separate the risks of investment bank affiliate activities from commercial banks. Answer: The three government agencies that sponsor the creation of mortgage-backed, pass through securities are: GNMA, […]

Larger coupon payments on a fixed-income asset cause the present value weights of the cash flows to be lower in the duration calculation. Answer: The Insurance Regulatory Information System (IRIS) is a standardized examination system used to measure the profitability […]

Basis risk occurs on a loan commitment because the spread of a pricing index over the cost of funds may vary. Answer: A run on a bank is not necessarily a bad occurrence. Answer: TRUE Retail banking services and products […]

Prior to the financial crisis of 2008, the return on equity for small community banks had been larger than for large money center banks. Answer: GNMA will sponsor any pool of loans regardless of the size of each individual loan […]

An FI can hold assets denominated in a foreign country, but it cannot issue foreign liabilities. Answer: Unexpected increases in inflation cause loss rates to increase more for long-tail risk than for short-tail risks. Answer: TRUE The hedge ratio measures […]

Historically credit card loans have had very low rates of default or credit risk when compared to other assets that an FI may hold. Answer: Sellers of LDC debt in secondary markets include small FIs wishing to disengage themselves from […]