Question 1

A criticism of the Basel I risk-based capital ratio is

Accepted Answer

A) the incorporation of off-balance-sheet risk exposures. 
B) the application of a similar capital requirement across major banks in international banking centers across the world. 
C) the more systematic accounting of credit risk differences. 
D) the lack of appropriate consideration of the portfolio diversification effects of credit risk. 
E) Answers B and C only. 
A) the incorporation of off-balance-sheet risk exposures. 
B) the application of a similar capital requirement across major banks in international banking centers across the world. 
C) the more systematic accounting of credit risk differences. 
D) the lack of appropriate consideration of the portfolio diversification effects of credit risk. 
E) Answers B and C only.

Question 2

$$\begin{array} { l l l l } 
\text { Securities (at par) } & \$ 250 & \text { Deposits } & \$ 975 \
\text { Loans (at par) } & \$ 760 & \text { Capital } & \$ 35
\end{array}$$
-If problem loans reduce the market value of the loan portfolio by 25 percent, what is the market value of capital?

Accepted Answer

A) $35 million. 
B) -$155 million. 
C) $7 million. 
D) -$7 million. 
E) $0. 
A) $35 million. 
B) -$155 million. 
C) $7 million. 
D) -$7 million. 
E) $0.

Question 3

Under Basel II (2006), regulatory minimum capital requirements for credit, market, and operational risks are covered in the first pillar of the regulation.

Accepted Answer

A) True 
 B)False

Question 4

The difference between the market value of assets and liabilities is the definition of the

Accepted Answer

A) accounting value of capital. 
B) regulatory value of capital. 
C) economic value of capital. 
D) book value of net worth. 
E) adjusted book value of net worth. 
A) accounting value of capital. 
B) regulatory value of capital. 
C) economic value of capital. 
D) book value of net worth. 
E) adjusted book value of net worth.

Question 5

In the life insurance model, morbidity risk differs from mortality risk by the circumstances surrounding the actual death event.

Accepted Answer

A) True 
 B)False

Question 6

Sigma Bank has the following balance sheet in millions of dollars. Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns). Values are in millions of dollars. Refer to table 20-8 for appropriate risk weights $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { l-4 family } \
( 80 \% - 90 \% \text { LTV) }
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$ 10 \
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10)
$40 million direct-credit substitute standby letters of credit issued to a U.S. corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
-What is the minimum total capital (Tier I + Tier II) required to be adequately capitalized for the off-balance sheet derivative contracts (both interest rate swaps and foreign exchange forwards) under Basel II?

Accepted Answer

A) $0.24 million. 
B) $0.36 million. 
C) $0.72 million. 
D) $0.60 million. 
E) $0.48 million. 
A) $0.24 million. 
B) $0.36 million. 
C) $0.72 million. 
D) $0.60 million. 
E) $0.48 million.

Question 7

The current exposure component of the credit equivalent amount of OBS derivative items reflects

Accepted Answer

A) the probability of an adverse price movement in contracts. 
B) the cost of replacing a contract if a counterparty defaults today. 
C) the probability today of a counterparty contract default in the future. 
D) the maximum price loss for any given position. 
E) future volatility of the underlying. 
A) the probability of an adverse price movement in contracts. 
B) the cost of replacing a contract if a counterparty defaults today. 
C) the probability today of a counterparty contract default in the future. 
D) the maximum price loss for any given position. 
E) future volatility of the underlying.

Question 8

In calculating the net capital for a securities firms, which of the following is NOT an adjustment to the book value of net worth?

Accepted Answer

A) The market value of net worth is calculated on a day-to-day basis. 
B) A series of adjustments are made to reflect unrealized profits and losses, subordinated liabilities, deferred taxes, options, and futures. 
C) The amount of securities that cannot be publicly sold are subtracted. 
D) All assets not readily converted into cash are subtracted. 
E) Haircuts to reflect potential market value fluctuations in asset values are deducted. 
A) The market value of net worth is calculated on a day-to-day basis. 
B) A series of adjustments are made to reflect unrealized profits and losses, subordinated liabilities, deferred taxes, options, and futures. 
C) The amount of securities that cannot be publicly sold are subtracted. 
D) All assets not readily converted into cash are subtracted. 
E) Haircuts to reflect potential market value fluctuations in asset values are deducted.

Question 9

$\begin{array}{c}
\begin{array}{lll}
 \text {Cash and Treasury securities}\
 \text {Fed Funds Sold}\
 \text {Residential Mortgages 1-4 family}\
 \text {Commercial Loans}
\end{array}
\begin{array}{lll}
 \text { \$ 100 million}\
  \text {\$ 100 million}\
 \text { \$ 200  million}\
 \text {\$ 600  million}
\end{array}
\end{array}$
 Note: The residential mortgages all have a loan-to-value of between 60 and 80 percent.
-What is the amount of risk-adjusted assets?

Accepted Answer

A) $1,000 million. 
B) $720 million. 
C) $900 million. 
D) $600 million. 
E) $700 million. 
A) $1,000 million. 
B) $720 million. 
C) $900 million. 
D) $600 million. 
E) $700 million.

Question 10

The capital requirements for broker-dealers include a net worth market value to assets ratio of at least 2 percent.

Accepted Answer

A) True 
 B)False

Question 11

Under Basel II (2006), operational risk can be measured by four different approaches.

Accepted Answer

A) True 
 B)False

Question 12

The determination of risk-adjusted on-balance-sheet assets under Basel III requires the segregation of assets into nine categories of credit risk exposure.

Accepted Answer

A) True 
 B)False

Question 13

Calculation of the "add-on" to the risk-based capital ratio to measure operational risk

Accepted Answer

A) may be done using the Basic Indicator Approach. 
B) may be done using the Standardized Approach. 
C) may be done using the Advanced Measurement Approach. 
D) All of the above. 
E) Answers A and B only. 
A) may be done using the Basic Indicator Approach. 
B) may be done using the Standardized Approach. 
C) may be done using the Advanced Measurement Approach. 
D) All of the above. 
E) Answers A and B only.

Question 14

Sigma Bank has the following balance sheet in millions of dollars. Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns). Values are in millions of dollars. Refer to table 20-8 for appropriate risk weights $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { l-4 family } \
( 80 \% - 90 \% \text { LTV) }
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$ 10 \
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10)
$40 million direct-credit substitute standby letters of credit issued to a U.S. corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
-What is the minimum required Tier I and Total risk-based capital for the on-balance-sheet assets in order for the DI to be adequately capitalized?

Accepted Answer

A) $8 million; $8 million. 
B) $16.87 million; $16.87 million. 
C) $17.22 million; $22.96 million. 
D) $22.96 million; $28.70 million. 
E) $10.8 million; $8 million. 
A) $8 million; $8 million. 
B) $16.87 million; $16.87 million. 
C) $17.22 million; $22.96 million. 
D) $22.96 million; $28.70 million. 
E) $10.8 million; $8 million.

Question 15

Except in cases of extreme credit risk shocks or interest rate risk shocks, the book value of equity is equal to the economic or market value of equity.

Accepted Answer

A) True 
 B)False

Question 16

Basel III capital ratios were enacted due to Basel II weaknesses exposed during the financial crisis of 2008-20009.

Accepted Answer

A) True 
 B)False

Question 17

The FASB set its guidelines to allow for the valuation of assets to be based on

Accepted Answer

A) prices at the discretion of the DI's management. 
B) book values rather than market values. 
C) market values that existed when the assets were last marked to market. 
D) prices that would be received as part of a forced liquidation. 
E) prices that would be received in an orderly market. 
A) prices at the discretion of the DI's management. 
B) book values rather than market values. 
C) market values that existed when the assets were last marked to market. 
D) prices that would be received as part of a forced liquidation. 
E) prices that would be received in an orderly market.

Question 18

One function of bank capital is to protect uninsured depositors, bondholders, and creditors in the event of insolvency and liquidation.

Accepted Answer

A) True 
 B)False

Question 19

The book value of equity is seldom equal to the market value of equity.

Accepted Answer

A) True 
 B)False

Question 20

The economic definition of the value of an FI's equity is the book value of assets minus the market value of liabilities.

Accepted Answer

A) True 
 B)False

Exam 20: Capital Adequacy

A criticism of the Basel I risk-based capital ratio is

Securities (at par) \ 250 Deposits \ 975 Loans (at par) \ 760 Capital \ 35 -If problem loans reduce the market value of the loan portfolio by 25 percent, what is the market value of capital?

Under Basel II (2006), regulatory minimum capital requirements for credit, market, and operational risks are covered in the first pillar of the regulation.

The difference between the market value of assets and liabilities is the definition of the

In the life insurance model, morbidity risk differs from mortality risk by the circumstances surrounding the actual death event.

The current exposure component of the credit equivalent amount of OBS derivative items reflects

In calculating the net capital for a securities firms, which of the following is NOT an adjustment to the book value of net worth?

Cash and Treasury securities Fed Funds Sold Residential Mortgages 1-4 family Commercial Loans \ 100 million \ 100 million \ 200 million \ 600 million Note: The residential mortgages all have a loan-to-value of between 60 and 80 percent. -What is the amount of risk-adjusted assets?

The capital requirements for broker-dealers include a net worth market value to assets ratio of at least 2 percent.

Under Basel II (2006), operational risk can be measured by four different approaches.

The determination of risk-adjusted on-balance-sheet assets under Basel III requires the segregation of assets into nine categories of credit risk exposure.

Calculation of the "add-on" to the risk-based capital ratio to measure operational risk

Except in cases of extreme credit risk shocks or interest rate risk shocks, the book value of equity is equal to the economic or market value of equity.

Basel III capital ratios were enacted due to Basel II weaknesses exposed during the financial crisis of 2008-20009.

The FASB set its guidelines to allow for the valuation of assets to be based on

One function of bank capital is to protect uninsured depositors, bondholders, and creditors in the event of insolvency and liquidation.

The book value of equity is seldom equal to the market value of equity.

The economic definition of the value of an FI's equity is the book value of assets minus the market value of liabilities.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

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

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

Filters