Question 1

Portfolio risk can be reduced through diversification only if the returns of the loans in the portfolio are negatively correlated.

Accepted Answer

A) True 
 B)False

Question 2

In models that are based on loan loss ratios,a $\beta$ that is found to be less than one for a particular loan sector indicates that

Accepted Answer

A) the loans in that sector will soon be downgraded soon. 
B) the FI should increase its concentration in that loan sector due to the high rates of return. 
C) the loan losses in that sector are systematically lower relative to total loan losses. 
D) the FI should decrease its exposure to that sector because losses are higher than the rest of the portfolio. 
A) the loans in that sector will soon be downgraded soon. 
B) the FI should increase its concentration in that loan sector due to the high rates of return. 
C) the loan losses in that sector are systematically lower relative to total loan losses. 
D) the FI should decrease its exposure to that sector because losses are higher than the rest of the portfolio.

Question 3

Comparing the loan mix of an individual FI to a national benchmark loan mix is useful in determining the extent that the individual FI may differ from an efficient portfolio composition.

Accepted Answer

A) True 
 B)False

Question 4

A regression of sectoral loan losses against total loans losses,both measured as a percentage of total loans,of a bank results in the following beta coefficients for the real estate (RE)and commercial (CL)loan variables: $\beta$RE = 1.2,$\beta$CL = 1.6.The intercept for both regressions is zero.
 The results can be interpreted as

Accepted Answer

A) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the real estate sector,measured as a percentage of total loans,is 1.2 percent. 
B) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the commercial sector,measured as a percentage of total loans,is 3.2 percent. 
C) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the commercial sector,measured as a percentage of total loans,is 6.4 percent. 
D) if the total loan losses of the bank measured as a percentage of total loans is 3 percent,the losses in the commercial sector,measured as a percentage of total loans,is 5.2 percent. 
A) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the real estate sector,measured as a percentage of total loans,is 1.2 percent. 
B) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the commercial sector,measured as a percentage of total loans,is 3.2 percent. 
C) if the total loan losses of the bank measured as a percentage of total loans is 2 percent,the losses in the commercial sector,measured as a percentage of total loans,is 6.4 percent. 
D) if the total loan losses of the bank measured as a percentage of total loans is 3 percent,the losses in the commercial sector,measured as a percentage of total loans,is 5.2 percent.

Question 5

The variance of returns of a portfolio of loans normally is equal to the arithmetic average of the variance of returns of the individual loans.

Accepted Answer

A) True 
 B)False

Question 6

Use the following information to answer questions:
 $\begin{array}{lll}
&\text { National Banks } & \text { Bank A } & \text { Bank B } \
\text { Real Estate Loans } & 60 \text { percent } & 30 \text { percent } & 56 \text { percent } \
\text { Consumer Losts } & 20 \text { percent } & 30 \text { percent } & 28 \text { percent } \
\text { Commercial Loans} & 20 \text { percent } & 10 \text { percent } & 16 \text { percent }
\end{array}$
-What is Bank B's standard deviation of its asset allocation proportions relative to the national banks average? Use the formula in the textbook.

Accepted Answer

A) 14.16 percent. 
B) 33.33 percent. 
C) 5.66 percent. 
D) 3.00 percent. 
A) 14.16 percent. 
B) 33.33 percent. 
C) 5.66 percent. 
D) 3.00 percent.

Question 7

A Hypothetical Rating Migration,or Transition Matrix,reflects all of the following EXCEPT

Accepted Answer

A) rating at which the portfolio ended the year. 
B) transition probabilities. 
C) rating at which the portfolio of loans began the year. 
D) future migration expected in the portfolio. 
A) rating at which the portfolio ended the year. 
B) transition probabilities. 
C) rating at which the portfolio of loans began the year. 
D) future migration expected in the portfolio.

Question 8

In applying the loan loss ratio models,the loss rate "$\beta$" for the whole loan portfolio is

Accepted Answer

A) 0. 
B) 0.5. 
C) 1. 
D) 2. 
A) 0. 
B) 0.5. 
C) 1. 
D) 2.

Question 9

A regression of sectoral loan losses against total loans losses,both measured as a percentage of total loans,of a bank results in the following beta coefficients for the real estate (RE)and commercial (CL)loan variables: $\beta$RE = 1.2,$\beta$CL = 1.6.The intercept for both regressions is zero. The results indicate that for the bank

Accepted Answer

A) the real estate loan losses were systematically lower than the total loan losses. 
B) the real estate loan losses were systematically higher than the total loan losses. 
C) the commercial loan losses are systematically higher than the total loan losses. 
D) the real estate loan losses were systematically lower than the total loan losses and the commercial loan losses are systematically higher than the total loan losses. 
E) both the real estate loan losses and the commercial loan losses are systematically higher than the total loan losses. 
A) the real estate loan losses were systematically lower than the total loan losses. 
B) the real estate loan losses were systematically higher than the total loan losses. 
C) the commercial loan losses are systematically higher than the total loan losses. 
D) the real estate loan losses were systematically lower than the total loan losses and the commercial loan losses are systematically higher than the total loan losses. 
E) both the real estate loan losses and the commercial loan losses are systematically higher than the total loan losses.

Question 10

On loans fully secured by physical,non-real estate loans,the Basel Committee has set a loss given defaults (LGD)rate of

Accepted Answer

A) 15 percent. 
B) 25 percent. 
C) 40 percent. 
D) 45 percent. 
A) 15 percent. 
B) 25 percent. 
C) 40 percent. 
D) 45 percent.

Question 11

Recent Federal Reserve policy for measuring credit concentration risk favors technical models over subjective analysis.

Accepted Answer

A) True 
 B)False

Question 12

Concentration limits are used to either reduce or increase exposure to specific industries.

Accepted Answer

A) True 
 B)False

Question 13

Older loan pools provide very little evidence of credit risk to a particular sector when forming new loans of loans to that sector.

Accepted Answer

A) True 
 B)False

Question 14

The simple model of migration analysis tracks the credit ratings of companies that have borrowed from the FI.

Accepted Answer

A) True 
 B)False

Question 15

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 risk of the loan using the Moody's Analytics model?

Accepted Answer

A) 4.75 percent. 
B) 0.48 percent. 
C) 6.89 percent. 
D) 2.18 percent. 
A) 4.75 percent. 
B) 0.48 percent. 
C) 6.89 percent. 
D) 2.18 percent.

Question 16

In the Moody's Analytics portfolio model,the expected loss on a loan is

Accepted Answer

A) the product of the estimated loss given default and risk-free rate on a security of equivalent maturity. 
B) annual all-in-spread minus the loss given default. 
C) annual all-in-spread minus the expected default frequency. 
D) the product of the expected default frequency and the estimated loss given default. 
A) the product of the estimated loss given default and risk-free rate on a security of equivalent maturity. 
B) annual all-in-spread minus the loss given default. 
C) annual all-in-spread minus the expected default frequency. 
D) the product of the expected default frequency and the estimated loss given default.

Question 17

In the Moody's Analytics portfolio model,the risk of a loan measures

Accepted Answer

A) the product of the estimated loss given default and risk-free rate on a security of equivalent maturity. 
B) annual all-in-spread minus the loss given default. 
C) annual all-in-spread minus the expected default frequency. 
D) the product of the expected default frequency and the estimated loss given default. 
E) the volatility of the loan's default rate around its expected value times the amount lost given default. 
A) the product of the estimated loss given default and risk-free rate on a security of equivalent maturity. 
B) annual all-in-spread minus the loss given default. 
C) annual all-in-spread minus the expected default frequency. 
D) the product of the expected default frequency and the estimated loss given default. 
E) the volatility of the loan's default rate around its expected value times the amount lost given default.

Question 18

As part of measuring unobservable default risk between borrowers,the Moody's Analytics model decomposes asset returns into

Accepted Answer

A) credit risk and market risk. 
B) systematic risk and unsystematic risk. 
C) market risk and sovereign risk. 
D) regional risk and maturity risk. 
A) credit risk and market risk. 
B) systematic risk and unsystematic risk. 
C) market risk and sovereign risk. 
D) regional risk and maturity risk.

Question 19

Using migration analysis,a loan officer tracks credit rating agencies as well as their own internal models to help determine appropriate amounts to lend to certain sectors or classes.

Accepted Answer

A) True 
 B)False

Question 20

Any model that seeks to estimate an efficient frontier for loans,and thus the optimal proportions in which to hold loans made to different borrowers,needs to determine and measure the

Accepted Answer

A) expected return on each loan to a borrower. 
B) risk of each loan made to a borrower. 
C) correlation of default risks between loans made to borrowers. 
D) expected return of the entire loan portfolio. 
E) All of the options. 
A) expected return on each loan to a borrower. 
B) risk of each loan made to a borrower. 
C) correlation of default risks between loans made to borrowers. 
D) expected return of the entire loan portfolio. 
E) All of the options.

Exam 11: Credit Risk: Loan Portfolio and Concentration Risk

Portfolio risk can be reduced through diversification only if the returns of the loans in the portfolio are negatively correlated.

In models that are based on loan loss ratios,a β\betaβ that is found to be less than one for a particular loan sector indicates that

Comparing the loan mix of an individual FI to a national benchmark loan mix is useful in determining the extent that the individual FI may differ from an efficient portfolio composition.

The variance of returns of a portfolio of loans normally is equal to the arithmetic average of the variance of returns of the individual loans.

A Hypothetical Rating Migration,or Transition Matrix,reflects all of the following EXCEPT

In applying the loan loss ratio models,the loss rate " β\betaβ " for the whole loan portfolio is

On loans fully secured by physical,non-real estate loans,the Basel Committee has set a loss given defaults (LGD)rate of

Recent Federal Reserve policy for measuring credit concentration risk favors technical models over subjective analysis.

Concentration limits are used to either reduce or increase exposure to specific industries.

Older loan pools provide very little evidence of credit risk to a particular sector when forming new loans of loans to that sector.

The simple model of migration analysis tracks the credit ratings of companies that have borrowed from the FI.

In the Moody's Analytics portfolio model,the expected loss on a loan is

In the Moody's Analytics portfolio model,the risk of a loan measures

As part of measuring unobservable default risk between borrowers,the Moody's Analytics model decomposes asset returns into

Using migration analysis,a loan officer tracks credit rating agencies as well as their own internal models to help determine appropriate amounts to lend to certain sectors or classes.

Any model that seeks to estimate an efficient frontier for loans,and thus the optimal proportions in which to hold loans made to different borrowers,needs to determine and measure the

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Firms and Investment Banks

Financial Services: Mutual Fund and Hedge Fund Companies

Financial Services: Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

Filters

In models that are based on loan loss ratios,a $\beta$ that is found to be less than one for a particular loan sector indicates that

In applying the loan loss ratio models,the loss rate " $\beta$ " for the whole loan portfolio is