Question 1

What is the risk (standard deviation of returns)on the bank's loan portfolio if loan returns are uncorrelated ($\rho$ = 0)?

Accepted Answer

A) 1.41 percent. 
B) 1.63 percent. 
C) 0.93 percent. 
D) 3.57 percent. 
E) 1.18 percent. 
A) 1.41 percent. 
B) 1.63 percent. 
C) 0.93 percent. 
D) 3.57 percent. 
E) 1.18 percent. E

Question 2

The concentration limit method of managing credit risk concentration involves estimating the minimum loan amount to a single customer as a percent of capital.

Accepted Answer

A) True 
 B)False  False

Question 3

In the use of modern portfolio theory (MPT),the sum of the credit risks of loans under estimates the risk of the whole portfolio.

Accepted Answer

A) True 
 B)False  False

Question 4

If a bank's concentration limit (as a percent of capital)is 20 percent,and its expected recovery from defaulted loans is 50 percent,what is the maximum loss it permits to affect its capital in the event of a default?

Accepted Answer

A) 5 percent. 
B) 10 percent. 
C) 15 percent. 
D) 20 percent. 
A) 5 percent. 
B) 10 percent. 
C) 15 percent. 
D) 20 percent.

Question 5

The all-in-spread (AIS)used in the Moody's Analytics model is the difference between the interest rate on a loan and the prime lending rate at the time the loan was originated.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following observations concerning concentration limits is not true?

Accepted Answer

A) Limits are set by assessing the borrower's current portfolio,its operating unit's business plans,its economists' economic projections,and its strategic plans. 
B) FIs set concentration limits to reduce exposures to certain industries and increase exposures to others. 
C) When two industry groups' performances are highly correlated,an FI may set an aggregate limit of less than the sum of the two individual industry limits. 
D) FIs may set aggregate portfolio limits or combinations of industry and geographic limits. 
E) Bank regulators in recent years have limited loan concentrations to individual borrowers to a maximum of 30 percent of a bank's capital. 
A) Limits are set by assessing the borrower's current portfolio,its operating unit's business plans,its economists' economic projections,and its strategic plans. 
B) FIs set concentration limits to reduce exposures to certain industries and increase exposures to others. 
C) When two industry groups' performances are highly correlated,an FI may set an aggregate limit of less than the sum of the two individual industry limits. 
D) FIs may set aggregate portfolio limits or combinations of industry and geographic limits. 
E) Bank regulators in recent years have limited loan concentrations to individual borrowers to a maximum of 30 percent of a bank's capital.

Question 7

Which of the following methods measure loan concentration risk by tracking credit ratings of firms in particular sectors or ratings class for unusual downgrades?

Accepted Answer

A) Migration analysis. 
B) Concentration limits. 
C) Loan loss ratio-based model. 
D) Moody's Analytics portfolio manager model. 
A) Migration analysis. 
B) Concentration limits. 
C) Loan loss ratio-based model. 
D) Moody's Analytics portfolio manager model.

Question 8

LNW Bank is charging a 12 percent interest rate on a $5,000,000 loan.The bank also charged $100,000 in fees to originate the loan.The bank has a cost of funds of 8 percent.The borrower has a five percent chance of default,and if default occurs,the bank expects to recover 90 percent of the principal and interest. What is the expected return on the loan using the Moody's Analytics model?

Accepted Answer

A) 6.50 percent. 
B) 5.50 percent. 
C) 6.00 percent. 
D) 14.0 percent. 
A) 6.50 percent. 
B) 5.50 percent. 
C) 6.00 percent. 
D) 14.0 percent.

Question 9

General diversification limits established by life and property and casualty insurance regulators are based on the concepts of modern portfolio theory.

Accepted Answer

A) True 
 B)False

Question 10

Compared to modern portfolio theory,Moody's Analytics Portfolio Manager Model does not require loan returns to be normally distributed.

Accepted Answer

A) True 
 B)False

Question 11

Most portfolio managers will accept some level of risk above the minimum risk portfolio if they expect to receive higher returns.

Accepted Answer

A) True 
 B)False

Question 12

A disadvantage to modern portfolio theory (MPT)is that small institutions generally hold significant amounts of regionally specific and illiquid loans.

Accepted Answer

A) True 
 B)False

Question 13

Use the following information to answer questions:
 $\begin{array}{lll}
&\text { National Benchmark } & \text { Bank A } & \text { Bank B } \
\text { Consumer Loans } & 50 \text { percent } & 65 \text { percent } & 35 \text { percent } \
\text { Commercial Loans} & 50 \text { percent } & 35 \text { percent } & 65 \text { percent }
\end{array}$
-Estimate the standard deviation of Bank B's asset allocation proportions relative to the national benchmark.

Accepted Answer

A) 40.44 percent. 
B) 34.32 percent. 
C) 29.89 percent. 
D) 21.21 percent. 
E) 15.00 percent. 
A) 40.44 percent. 
B) 34.32 percent. 
C) 29.89 percent. 
D) 21.21 percent. 
E) 15.00 percent.

Question 14

Loan loss ratio models are based on historical loan loss ratios of specific sectors relative to the historic loan loss ratios of the FI's entire loan portfolio.

Accepted Answer

A) True 
 B)False

Question 15

In the Moody's Analytics model,which of the following is a function of the historical returns of the individual assets.

Accepted Answer

A) The risk of a loan. 
B) The expected default frequency. 
C) The loss given default. 
D) The correlation of default risk. 
A) The risk of a loan. 
B) The expected default frequency. 
C) The loss given default. 
D) The correlation of default risk.

Question 16

The expected return of a portfolio of loans is equal to the weighted average of the expected returns of the individual loans.

Accepted Answer

A) True 
 B)False

Question 17

Kansas Bank has a policy of limiting their loans to any single customer so that the maximum loss as a percent of capital will not exceed 20 percent for both secured and unsecured loans.The limit has been adopted under the assumption that if the unsecured loan is defaulted,there will be no recovery of interest or principal payments.For loans that are secured (collateralized),it is expected that 40 percent of interest and principal will be collected.

Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized)loan is 10 percent (as a percent of capital).If it wishes to keep a concentration limit at 40 percent for secured loans,what is the estimated amount lost per dollar of defaulted secured loan?

Accepted Answer

A) 40 cents. 
B) 35 cents. 
C) 30 cents. 
D) 25 cents. 
A) 40 cents. 
B) 35 cents. 
C) 30 cents. 
D) 25 cents.

Question 18

Matrix Bank has compiled the following migration matrix on consumer loans.Which of the following statements accurately summarizes this data? $\begin{array}{lllll}
&\text { Risk Grade at }\
&\text { End of year }\
&&1 & 2 & 3 & 4 \
\text { Risk grade at }&1&.88 & .08 & 02 & .02\
\text {  beginning of }\
\text { year }\
2 & 10 & 84 & .03 & .02 \
3 & .02 & .09 & .78 & .11
\end{array}$

Accepted Answer

A) Ten percent of grade two loans were upgraded during the year. 
B) Grade one loans have a higher probability of downgrade than grades two or three. 
C) Grade three loans have a higher probability of upgrade than grade two loans. 
D) Grade three loans have a higher probability of downgrade than grade two loans. 
E) All of the options. 
A) Ten percent of grade two loans were upgraded during the year. 
B) Grade one loans have a higher probability of downgrade than grades two or three. 
C) Grade three loans have a higher probability of upgrade than grade two loans. 
D) Grade three loans have a higher probability of downgrade than grade two loans. 
E) All of the options.

Question 19

Which of the following is the legislation that required bank regulators to incorporate credit concentration risk into their evaluation of bank insolvency risk?

Accepted Answer

A) The Bank Holding Company Act (1956). 
B) FDIC Improvement Act (1991). 
C) Depository Institutions Deregulation and Monetary Control Act (1980). 
D) Garn-St.Germain Depository Institutions Act (1982). 
A) The Bank Holding Company Act (1956). 
B) FDIC Improvement Act (1991). 
C) Depository Institutions Deregulation and Monetary Control Act (1980). 
D) Garn-St.Germain Depository Institutions Act (1982).

Question 20

If a bank's concentration limit (as a percentage of capital)is 25.0 percent,and it does not permit a loss of any loan to impact more than 10 percent of its capital,what is the expected recovery on loans that are defaulted?

Accepted Answer

A) 20 percent. 
B) 30 percent. 
C) 40 percent. 
D) 50 percent. 
E) 60 percent. 
A) 20 percent. 
B) 30 percent. 
C) 40 percent. 
D) 50 percent. 
E) 60 percent.

Exam 11: Credit Risk: Loan Portfolio and Concentration Risk

What is the risk (standard deviation of returns)on the bank's loan portfolio if loan returns are uncorrelated ( ρ\rhoρ = 0)?

The concentration limit method of managing credit risk concentration involves estimating the minimum loan amount to a single customer as a percent of capital.

In the use of modern portfolio theory (MPT),the sum of the credit risks of loans under estimates the risk of the whole portfolio.

If a bank's concentration limit (as a percent of capital)is 20 percent,and its expected recovery from defaulted loans is 50 percent,what is the maximum loss it permits to affect its capital in the event of a default?

The all-in-spread (AIS)used in the Moody's Analytics model is the difference between the interest rate on a loan and the prime lending rate at the time the loan was originated.

Which of the following observations concerning concentration limits is not true?

Which of the following methods measure loan concentration risk by tracking credit ratings of firms in particular sectors or ratings class for unusual downgrades?

General diversification limits established by life and property and casualty insurance regulators are based on the concepts of modern portfolio theory.

Compared to modern portfolio theory,Moody's Analytics Portfolio Manager Model does not require loan returns to be normally distributed.

Most portfolio managers will accept some level of risk above the minimum risk portfolio if they expect to receive higher returns.

A disadvantage to modern portfolio theory (MPT)is that small institutions generally hold significant amounts of regionally specific and illiquid loans.

Use the following information to answer questions: National Benchmark Bank A Bank B Consumer Loans 50 percent 65 percent 35 percent Commercial Loans 50 percent 35 percent 65 percent -Estimate the standard deviation of Bank B's asset allocation proportions relative to the national benchmark.

Loan loss ratio models are based on historical loan loss ratios of specific sectors relative to the historic loan loss ratios of the FI's entire loan portfolio.

In the Moody's Analytics model,which of the following is a function of the historical returns of the individual assets.

The expected return of a portfolio of loans is equal to the weighted average of the expected returns of the individual loans.

Matrix Bank has compiled the following migration matrix on consumer loans.Which of the following statements accurately summarizes this data? Risk Grade at End of year 1 2 3 4 Risk grade at 1 .88 .08 02 .02 beginning of year 2 10 84 .03 .02 3 .02 .09 .78 .11

Which of the following is the legislation that required bank regulators to incorporate credit concentration risk into their evaluation of bank insolvency risk?

If a bank's concentration limit (as a percentage of capital)is 25.0 percent,and it does not permit a loss of any loan to impact more than 10 percent of its capital,what is the expected recovery on loans that are defaulted?

Why Are Financial Institutions Special

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Capital Adequacy

Product and Geographic Expansion

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What is the risk (standard deviation of returns)on the bank's loan portfolio if loan returns are uncorrelated ( $\rho$ = 0)?