Question 1

The risk premium,or spread,between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

Accepted Answer

A) True 
 B)False

Question 2

In terms of rating agencies such as S&P,investment grade companies are those whose bond ratings are grade B or above.

Accepted Answer

A) True 
 B)False

Question 3

The amount of leverage of a borrower and the probability of default are positively related,but only after some minimum level of debt.

Accepted Answer

A) True 
 B)False

Question 4

Suppose that debt-equity ratio (D/E)and the sales-asset ratio (S/A)were two factors influencing the past default behavior of borrowers.Based on past default (repayment)experience,the linear probability model is estimated as: PDi = 0.5(D/Ei)+ 0.1(S/Ai).If a prospective borrower has a debt-equity ratio of 0.4 and sales-asset ratio of 1.8,the expected probability of default is

Accepted Answer

A) 0.02. 
B) 0.35. 
C) 0.38. 
D) 0.62. 
A) 0.02. 
B) 0.35. 
C) 0.38. 
D) 0.62.

Question 5

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

Accepted Answer

A) True 
 B)False

Question 6

Which of the following observations is true of a spot loan?

Accepted Answer

A) It involves a maximum size and a maximum period of time over which the borrower can withdraw funds. 
B) It involves immediate withdrawal of the entire loan amount by the borrower. 
C) It is an unsecured short-term debt instrument issued by corporations. 
D) It is a nonbank loan substitute. 
A) It involves a maximum size and a maximum period of time over which the borrower can withdraw funds. 
B) It involves immediate withdrawal of the entire loan amount by the borrower. 
C) It is an unsecured short-term debt instrument issued by corporations. 
D) It is a nonbank loan substitute.

Question 7

The payoff function of a loan to a debt holder is similar to writing a call option on the value of the borrower's assets with the face value of the debt as the exercise price.

Accepted Answer

A) True 
 B)False

Question 8

Confidence Bank has made a loan to Risky Corporation.The loan terms include a default risk-free borrowing rate of 8 percent,a risk premium of 3 percent,an origination fee of 0.1875 percent,and a 9 percent compensating balance requirement.Required reserves at the Fed are 6 percent.What is the expected or promised gross return on the loan?

Accepted Answer

A) 11.19 percent. 
B) 11.90 percent. 
C) 12.29 percent. 
D) 12.02 percent. 
E) 12.22 percent. 
A) 11.19 percent. 
B) 11.90 percent. 
C) 12.29 percent. 
D) 12.02 percent. 
E) 12.22 percent.

Question 9

Onyx Corporation has a $200,000 loan that will mature in one year.The risk free interest rate is 6 percent.The standard deviation in the rate of change in the underlying asset's value is 12 percent,and the leverage ratio for Onyx is 0.8 (80 percent).The value for N(h1)is 0.02743,and the value for N(h2)is 0.96406. What is the current market value of the loan?

Accepted Answer

A) $160,000. 
B) $189,932. 
C) $200,000. 
D) $188,352. 
A) $160,000. 
B) $189,932. 
C) $200,000. 
D) $188,352.

Question 10

What is the most important factor determining bankruptcy,according to the Altman Z-score model?

Accepted Answer

A) Working capital to assets ratio. 
B) Retained earnings to assets ratio. 
C) Earnings before interest and taxes to assets ratio. 
D) Market value of equity to book value of long-term debt ratio. 
A) Working capital to assets ratio. 
B) Retained earnings to assets ratio. 
C) Earnings before interest and taxes to assets ratio. 
D) Market value of equity to book value of long-term debt ratio.

Question 11

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract?

Accepted Answer

A) Liquidity risk. 
B) Interest rate risk. 
C) Sovereign risk. 
D) Default risk. 
A) Liquidity risk. 
B) Interest rate risk. 
C) Sovereign risk. 
D) Default risk.

Question 12

Residential mortgages are a relatively small component of bank real estate loan portfolios.

Accepted Answer

A) True 
 B)False

Question 13

Which of the following statements involving the promised return on a loan is NOT true?

Accepted Answer

A) Credit risk may be the most important factor affecting the return on a loan. 
B) Compensating balances reduce the effective cost of loans for the borrower because the deposit interest rate is typically greater than the loan rate. 
C) Compensating balances represents the portion of the loan that must be kept on deposit at the bank. 
D) Compensating balance requirements provide an additional source of return for the lending institution. 
A) Credit risk may be the most important factor affecting the return on a loan. 
B) Compensating balances reduce the effective cost of loans for the borrower because the deposit interest rate is typically greater than the loan rate. 
C) Compensating balances represents the portion of the loan that must be kept on deposit at the bank. 
D) Compensating balance requirements provide an additional source of return for the lending institution.

Question 14

What is the essential idea behind Risk-adjusted return on capital (RAROC)models?

Accepted Answer

A) Evaluating the actual or contractually promised annual ROA on a loan. 
B) Analyzing historic or past default risk experience. 
C) Balancing expected interest and fee income less the cost of funds against the loan's expected risk. 
D) Extracting expected default rates from the current term structure of interest rates. 
A) Evaluating the actual or contractually promised annual ROA on a loan. 
B) Analyzing historic or past default risk experience. 
C) Balancing expected interest and fee income less the cost of funds against the loan's expected risk. 
D) Extracting expected default rates from the current term structure of interest rates.

Question 15

Discriminant models often ignore hard-to-quantify factors in the credit decision.

Accepted Answer

A) True 
 B)False

Question 16

Which of the following is not a characteristic of a loan commitment?

Accepted Answer

A) The maximum amount of the loan is negotiated at the time of the loan agreement. 
B) The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. 
C) Floating-rate loans transfer the interest rate risk to the borrower. 
D) The time period for which the loan is available is negotiated at the time of the loan agreement. 
A) The maximum amount of the loan is negotiated at the time of the loan agreement. 
B) The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. 
C) Floating-rate loans transfer the interest rate risk to the borrower. 
D) The time period for which the loan is available is negotiated at the time of the loan agreement.

Question 17

Usury ceilings are maximum interest rates imposed by federal legislation that FIs are allowed to charge on consumer and mortgage debt.

Accepted Answer

A) True 
 B)False

Question 18

Generally,at the retail level,an FI controls credit risks solely by using a range of interest rates or prices and not by credit rationing.

Accepted Answer

A) True 
 B)False

Question 19

A loan commitment is an agreement involving the amount of loan available and the amount of time during which the loan can be initiated.

Accepted Answer

A) True 
 B)False

Question 20

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower?

Accepted Answer

A) Mortality rates. 
B) RAROC. 
C) Implicit contracts. 
D) Covenants. 
A) Mortality rates. 
B) RAROC. 
C) Implicit contracts. 
D) Covenants.

Exam 10: Credit Risk: Individual Loan Risk

The risk premium,or spread,between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

In terms of rating agencies such as S&P,investment grade companies are those whose bond ratings are grade B or above.

The amount of leverage of a borrower and the probability of default are positively related,but only after some minimum level of debt.

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

Which of the following observations is true of a spot loan?

The payoff function of a loan to a debt holder is similar to writing a call option on the value of the borrower's assets with the face value of the debt as the exercise price.

What is the most important factor determining bankruptcy,according to the Altman Z-score model?

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract?

Residential mortgages are a relatively small component of bank real estate loan portfolios.

Which of the following statements involving the promised return on a loan is NOT true?

What is the essential idea behind Risk-adjusted return on capital (RAROC)models?

Discriminant models often ignore hard-to-quantify factors in the credit decision.

Which of the following is not a characteristic of a loan commitment?

Usury ceilings are maximum interest rates imposed by federal legislation that FIs are allowed to charge on consumer and mortgage debt.

Generally,at the retail level,an FI controls credit risks solely by using a range of interest rates or prices and not by credit rationing.

A loan commitment is an agreement involving the amount of loan available and the amount of time during which the loan can be initiated.

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower?

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: Loan Portfolio and Concentration 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