Question 1

The duration gap model is a more complete measure of interest rate risk than the repricing model.

Accepted Answer

A) True 
 B)False  True

Question 2

For a bank with a positive duration gap,an increase in interest rates will

Accepted Answer

A) increase the likelihood of insolvency. 
B) decrease the likelihood of insolvency. 
C) not affect the likelihood of insolvency. 
D) result in increased loan trading. 
A) increase the likelihood of insolvency. 
B) decrease the likelihood of insolvency. 
C) not affect the likelihood of insolvency. 
D) result in increased loan trading. A

Question 3

A bank has book value of assets equal to $800 million and market value of assets equal to $1,100 million. The bank has book value of liabilities of $700 million and market value of liabilities equal to $850 million. The bank's market-to-book ratio is

Accepted Answer

A) 2.5. 
B) 2.0. 
C) 1.5. 
D) 1.0. 
E) 0.67. 
A) 2.5. 
B) 2.0. 
C) 1.5. 
D) 1.0. 
E) 0.67. A

Question 4

For large interest rate declines,duration ___________ the increases in the bond's price,and for large interest rate increases,it ____________ the decline in the bond's price.

Accepted Answer

A) underpredicts; overpredicts 
B) overpredicts; underpredicts 
C) underpredicts; underpredicts 
D) overpredicts; overpredicts 
A) underpredicts; overpredicts 
B) overpredicts; underpredicts 
C) underpredicts; underpredicts 
D) overpredicts; overpredicts

Question 5

Weaknesses of the repricing model include the fact that
I. it ignores changes in present values caused by changes in interest rates.
II. it ignores different cash flow sensitivities within a maturity bucket.
III. it fails to account for runoffs and prepayments.

Accepted Answer

A) I only 
B) I and II only 
C) I and III only 
D) II and III only 
E) I,II,and III 
A) I only 
B) I and II only 
C) I and III only 
D) II and III only 
E) I,II,and III

Question 6

The repricing gap fails to consider how the value of fixed income accounts will change when rates change.

Accepted Answer

A) True 
 B)False

Question 7

A bank has a negative duration gap. Which one of the following statements is most correct?

Accepted Answer

A) If all interest rates are projected to increase,to limit a net value decline before rates rise,the bank should increase the amount of short-term loans on the balance sheet. 
B) If all interest rates are projected to increase,to limit a net value decline before rates rise,the bank should increase the amount of short-term bonds issued by the bank. 
C) If all interest rates are projected to decrease,to limit a net value decline before rates fall,the bank should increase the amount of long-term loans on the balance sheet. 
D) If all interest rates are projected to decrease,to limit a net value decline before rates fall,the bank should increase the amount of long-term bonds issued by the bank. 
A) If all interest rates are projected to increase,to limit a net value decline before rates rise,the bank should increase the amount of short-term loans on the balance sheet. 
B) If all interest rates are projected to increase,to limit a net value decline before rates rise,the bank should increase the amount of short-term bonds issued by the bank. 
C) If all interest rates are projected to decrease,to limit a net value decline before rates fall,the bank should increase the amount of long-term loans on the balance sheet. 
D) If all interest rates are projected to decrease,to limit a net value decline before rates fall,the bank should increase the amount of long-term bonds issued by the bank.

Question 8

Convexity arises because a fixed income's price is a nonlinear function of interest rates.

Accepted Answer

A) True 
 B)False

Question 9

A bank has DA = 2.4 years and DL= 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Interest rates are at 6 percent. To get DE to equal zero to protect the equity value in the event of an interest rate change,the bank could

Accepted Answer

A) reduce DA to 1.21 years. 
B) increase DL to 2.44 years. 
C) increase DL to 3.10 years. 
D) reduce DA to zero. 
E) increase DL to 2.76 years. 
A) reduce DA to 1.21 years. 
B) increase DL to 2.44 years. 
C) increase DL to 3.10 years. 
D) reduce DA to zero. 
E) increase DL to 2.76 years.

Question 10

A bank has three assets. It has $75 million invested in consumer loans with a three-year duration,$39 million invested in T-bonds with a 16-year duration,and $39 million in six-month maturity T-bills. What is the duration of the bank's asset portfolio in years?

Accepted Answer

A) 3.95 years 
B) 4.83 years 
C) 6.50 years 
D) 7.38 years 
E) 11.51 years 
A) 3.95 years 
B) 4.83 years 
C) 6.50 years 
D) 7.38 years 
E) 11.51 years

Question 11

Convexity in bond prices is caused by the

Accepted Answer

A) coupon changes on a bond. 
B) change in default probability associated with a yield change. 
C) CGAP effect. 
D) curvature around the bond price yield relationship. 
E) mismatch between the duration of the assets and liabilities. 
A) coupon changes on a bond. 
B) change in default probability associated with a yield change. 
C) CGAP effect. 
D) curvature around the bond price yield relationship. 
E) mismatch between the duration of the assets and liabilities.

Question 12

A bank has a negative repricing gap. This implies that

Accepted Answer

A) some RSAs are financed by fixed-rate liabilities. 
B) some RSLs are financing fixed-rate assets. 
C) some RSAs are financing equity. 
D) the bank has no fixed-rate assets. 
A) some RSAs are financed by fixed-rate liabilities. 
B) some RSLs are financing fixed-rate assets. 
C) some RSAs are financing equity. 
D) the bank has no fixed-rate assets.

Question 13

A bond's price changes 2 percent when interest rates drop. The duration model would predict a price increase of more than 2 percent.

Accepted Answer

A) True 
 B)False

Question 14

A bank is facing a forecast of rising interest rates. How should it set the repricing and duration gap?

Accepted Answer

A) Positive repricing gap and negative duration gap 
B) Negative repricing gap and positive duration gap 
C) Positive repricing gap and positive duration gap 
D) Negative repricing gap and negative duration gap 
A) Positive repricing gap and negative duration gap 
B) Negative repricing gap and positive duration gap 
C) Positive repricing gap and positive duration gap 
D) Negative repricing gap and negative duration gap

Question 15

If a bank has a negative repricing gap,falling interest rates increase profitability.

Accepted Answer

A) True 
 B)False

Question 16

What are three major weaknesses of the repricing model?

Accepted Answer

*It ignores market value effects of chan

Question 17

For a one-year maturity bucket,the repricing model assumes that a nine-month loan is as equally rate-sensitive as a three-month loan.

Accepted Answer

A) True 
 B)False

Question 18

Weaknesses of the duration gap immunization model include all but which of the following?

Accepted Answer

A) Continuously matching the duration of assets and liabilities can be time-consuming and costly. 
B) Duration-based predictions are always incorrect due to convexity. 
C) Duration measurement and management are more complex than the repricing model. 
D) Duration-based immunization strategies require continuous rebalancing of asset and liability durations. 
E) Duration measures only how cash flows change,not the present value of those changes. 
A) Continuously matching the duration of assets and liabilities can be time-consuming and costly. 
B) Duration-based predictions are always incorrect due to convexity. 
C) Duration measurement and management are more complex than the repricing model. 
D) Duration-based immunization strategies require continuous rebalancing of asset and liability durations. 
E) Duration measures only how cash flows change,not the present value of those changes.

Question 19

A bank has a positive repricing gap using a six-month maturity bucket. Which one of the following statements is most correct?

Accepted Answer

A) If all interest rates are projected to increase,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from one-year adjustable rate loans to fed funds loans. 
B) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from one-month reset floating rate loans to three-year fixed-rate loans at current rates. 
C) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from fixed-rate mortgages to adjustable rate mortgages. 
D) If all interest rates are projected to increase,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from three-year to five-year auto loans. 
E) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from their bank to another bank. 
A) If all interest rates are projected to increase,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from one-year adjustable rate loans to fed funds loans. 
B) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from one-month reset floating rate loans to three-year fixed-rate loans at current rates. 
C) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from fixed-rate mortgages to adjustable rate mortgages. 
D) If all interest rates are projected to increase,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from three-year to five-year auto loans. 
E) If all interest rates are projected to decrease,to limit a profit decline when this occurs,the bank could encourage its retail loan customers to switch from their bank to another bank.

Question 20

With a six-month maturity bucket,a nine-month fixed-rate loan would be considered a ________________ asset and a 30-year mortgage with a rate adjustment in three months would be classified as a _______________ asset.

Accepted Answer

A) rate-sensitive; fixed-rate 
B) rate-sensitive; rate-sensitive 
C) fixed-rate; fixed-rate 
D) fixed-rate; rate-sensitive 
E) fixed-rate; nonearning 
A) rate-sensitive; fixed-rate 
B) rate-sensitive; rate-sensitive 
C) fixed-rate; fixed-rate 
D) fixed-rate; rate-sensitive 
E) fixed-rate; nonearning

Exam 22: Managing Interest Rate Risk and Insolvency Risk on the Balance Sheet

The duration gap model is a more complete measure of interest rate risk than the repricing model.

For a bank with a positive duration gap,an increase in interest rates will

A bank has book value of assets equal to $800 million and market value of assets equal to $1,100 million. The bank has book value of liabilities of $700 million and market value of liabilities equal to $850 million. The bank's market-to-book ratio is

For large interest rate declines,duration ___________ the increases in the bond's price,and for large interest rate increases,it ____________ the decline in the bond's price.

Weaknesses of the repricing model include the fact that I. it ignores changes in present values caused by changes in interest rates. II. it ignores different cash flow sensitivities within a maturity bucket. III. it fails to account for runoffs and prepayments.

The repricing gap fails to consider how the value of fixed income accounts will change when rates change.

A bank has a negative duration gap. Which one of the following statements is most correct?

Convexity arises because a fixed income's price is a nonlinear function of interest rates.

A bank has DA = 2.4 years and DL= 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Interest rates are at 6 percent. To get DE to equal zero to protect the equity value in the event of an interest rate change,the bank could

A bank has three assets. It has $75 million invested in consumer loans with a three-year duration,$39 million invested in T-bonds with a 16-year duration,and $39 million in six-month maturity T-bills. What is the duration of the bank's asset portfolio in years?

Convexity in bond prices is caused by the

A bank has a negative repricing gap. This implies that

A bond's price changes 2 percent when interest rates drop. The duration model would predict a price increase of more than 2 percent.

A bank is facing a forecast of rising interest rates. How should it set the repricing and duration gap?

If a bank has a negative repricing gap,falling interest rates increase profitability.

What are three major weaknesses of the repricing model?

For a one-year maturity bucket,the repricing model assumes that a nine-month loan is as equally rate-sensitive as a three-month loan.

Weaknesses of the duration gap immunization model include all but which of the following?

A bank has a positive repricing gap using a six-month maturity bucket. Which one of the following statements is most correct?

With a six-month maturity bucket,a nine-month fixed-rate loan would be considered a ________________ asset and a 30-year mortgage with a rate adjustment in three months would be classified as a _______________ asset.

Introduction

Determinants of Interest Rates

Interest Rates and Security Valuation

The Federal Reserve System, Monetary Policy, and Interest Rates

Money Markets

Bond Markets

Mortgage Markets

Stock Markets

Foreign Exchange Markets

Derivative Securities Markets

Commercial Banks: Industry Overview

Commercial Banks Financial Statements and Analysis

Regulation of Commercial Banks

Other Lending Institutions: Savings Institutions, Credit Unions, and Finance Companies

Insurance Companies

Securities Firms and Investment Banks

Investment Companies

Pension Funds

Types of Risks Incurred by Financial Institutions

Managing Credit Risk on the Balance Sheet

Managing Liquidity Risk on the Balance Sheet

Managing Risk Off the Balance Sheet With Derivative Securities

Managing Risk Off the Balance Sheet With Loan Sales and Securitization

Filters

For large interest rate declines,duration _ the increases in the bond's price,and for large interest rate increases,it __ the decline in the bond's price.

A bank has D_A = 2.4 years and D_L= 0.9 years. The bank has total equity of $82 million and total assets of $850 million. Interest rates are at 6 percent. To get D_E to equal zero to protect the equity value in the event of an interest rate change,the bank could

With a six-month maturity bucket,a nine-month fixed-rate loan would be considered a __ asset and a 30-year mortgage with a rate adjustment in three months would be classified as a _ asset.