Question 1

The greater the Tier I leverage using the Standardized Approach under Basel III, the more highly leveraged the bank.

Accepted Answer

A) True 
 B)False

Question 2

Market value accounting is likely to increase the variability of earnings of an FI.

Accepted Answer

A) True 
 B)False

Question 3

One function of capital is to provide funding for real assets, such as branches and technology that are necessary to provide financial services.

Accepted Answer

A) True 
 B)False

Question 4

In the NAIC model for life insurance companies, which risk captures the risk of adverse changes in mortality risk and morbidity risk?

Accepted Answer

A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk. 
A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk.

Question 5

The market value of capital is equal to market value of assets minus the market value of liabilities.

Accepted Answer

A) True 
 B)False

Question 6

The measurement of credit risk under the Basel II Accord allows banks to choose between

Accepted Answer

A) a standardized approach similar to that used under Basel I. 
B) a basic indicator approach that will cause banks to hold an additional 12 percent of capital. 
C) an internal rating system in which they must adhere to strict methodological and disclosure standards. 
D) All of the above. 
E) Answers A and C only. 
A) a standardized approach similar to that used under Basel I. 
B) a basic indicator approach that will cause banks to hold an additional 12 percent of capital. 
C) an internal rating system in which they must adhere to strict methodological and disclosure standards. 
D) All of the above. 
E) Answers A and C only.

Question 7

The implementation of true market value accounting for FIs may have adverse effects on small business finance and economic growth because of the hesitancy of FIs to invest in long-term assets.

Accepted Answer

A) True 
 B)False

Question 8

Under FDICIA, the ability for regulators to show forbearance is limited by a set of mandatory actions for each level of capital that an FI achieved.

Accepted Answer

A) True 
 B)False

Question 9

Under Basel II (2006), total capital is equal to Tier I capital plus Tier II capital.

Accepted Answer

A) True 
 B)False

Question 10

Under market value accounting methods, FIs

Accepted Answer

A) must write down the value of their assets to fully reflect market values. 
B) have a great deal of discretion in timing the write downs of problem loans. 
C) must conform to regulatory write-down schedules. 
D) have an incentive to fully reflect problem assets as they become known. 
E) are required to invest in expensive computerized bookkeeping systems. 
A) must write down the value of their assets to fully reflect market values. 
B) have a great deal of discretion in timing the write downs of problem loans. 
C) must conform to regulatory write-down schedules. 
D) have an incentive to fully reflect problem assets as they become known. 
E) are required to invest in expensive computerized bookkeeping systems.

Question 11

$\begin{array}{c}
\begin{array}{lll}
 \text {Cash and Treasury securities}\
 \text {Fed Funds Sold}\
 \text {Residential Mortgages 1-4 family}\
 \text {Commercial Loans}
\end{array}
\begin{array}{lll}
 \text { \$ 100 million}\
  \text {\$ 100 million}\
 \text { \$ 200  million}\
 \text {\$ 600  million}
\end{array}
\end{array}$
 Note: The residential mortgages all have a loan-to-value of between 60 and 80 percent.
-What is the ratio of capital to risk-adjusted assets, if the bank has capital of $50 million?

Accepted Answer

A) 5.00 percent. 
B) 5.56 percent. 
C) 6.94 percent. 
D) 8.33 percent. 
E) 6.25 percent. 
A) 5.00 percent. 
B) 5.56 percent. 
C) 6.94 percent. 
D) 8.33 percent. 
E) 6.25 percent.

Question 12

Capital is the primary protection for an FI against the risk of insolvency and failure.

Accepted Answer

A) True 
 B)False

Question 13

Under historical accounting methods for the market value of capital, FIs

Accepted Answer

A) must write down the value of their assets to fully reflect market values. 
B) have a great deal of discretion in timing the write downs of problem loans. 
C) must conform to regulatory write-down schedules. 
D) have an incentive to fully reflect problems in the asset portfolio as they become known. 
E) invest in expensive computerized bookkeeping systems. 
A) must write down the value of their assets to fully reflect market values. 
B) have a great deal of discretion in timing the write downs of problem loans. 
C) must conform to regulatory write-down schedules. 
D) have an incentive to fully reflect problems in the asset portfolio as they become known. 
E) invest in expensive computerized bookkeeping systems.

Question 14

Basel II attempts to encourage market discipline by having banks disclose capital structure, risk exposures, and capital adequacy in a systematic manner.

Accepted Answer

A) True 
 B)False

Question 15

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

Accepted Answer

A) True 
 B)False

Question 16

The bank is considering changing its asset mix by moving $100 million of commercial loans into Treasury securities. If it does change the asset mix and capital remains the same, the risk-based capital ratio

Accepted Answer

A) will not change because the total assets have not changed. 
B) will decrease because the earnings rate on Treasuries is less than on loans. 
C) will increase by 16.67 percent. 
D) will increase because the assets will have less risk. 
E) will change, but the direction cannot be determined with the information given. 
A) will not change because the total assets have not changed. 
B) will decrease because the earnings rate on Treasuries is less than on loans. 
C) will increase by 16.67 percent. 
D) will increase because the assets will have less risk. 
E) will change, but the direction cannot be determined with the information given.

Question 17

The primary role of capital for an FI is to assure the highest possible return on equity for its shareholders.

Accepted Answer

A) True 
 B)False

Question 18

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 Sigma Bank's risk-adjusted assets as defined by the Basel standards for its on-balance-sheet assets only?

Accepted Answer

A) $400 million. 
B) $360 million. 
C) $310 million. 
D) $287 million. 
E) $236 million. 
A) $400 million. 
B) $360 million. 
C) $310 million. 
D) $287 million. 
E) $236 million.

Question 19

The risk-based capital model in the life insurance industry includes asset risk, business risk, insurance risk, and interest rate risk.

Accepted Answer

A) True 
 B)False

Question 20

In the NAIC model for life insurance companies, this risk measures the liquidity of liabilities for given rate changes.

Accepted Answer

A) Interest rate risk 
B) Business risk 
C) Asset risk 
D) Foreign exchange risk 
E) Insurance risk 
A) Interest rate risk 
B) Business risk 
C) Asset risk 
D) Foreign exchange risk 
E) Insurance risk

Exam 20: Capital Adequacy

The greater the Tier I leverage using the Standardized Approach under Basel III, the more highly leveraged the bank.

Market value accounting is likely to increase the variability of earnings of an FI.

One function of capital is to provide funding for real assets, such as branches and technology that are necessary to provide financial services.

In the NAIC model for life insurance companies, which risk captures the risk of adverse changes in mortality risk and morbidity risk?

The market value of capital is equal to market value of assets minus the market value of liabilities.

The measurement of credit risk under the Basel II Accord allows banks to choose between

The implementation of true market value accounting for FIs may have adverse effects on small business finance and economic growth because of the hesitancy of FIs to invest in long-term assets.

Under FDICIA, the ability for regulators to show forbearance is limited by a set of mandatory actions for each level of capital that an FI achieved.

Under Basel II (2006), total capital is equal to Tier I capital plus Tier II capital.

Under market value accounting methods, FIs

Capital is the primary protection for an FI against the risk of insolvency and failure.

Under historical accounting methods for the market value of capital, FIs

Basel II attempts to encourage market discipline by having banks disclose capital structure, risk exposures, and capital adequacy in a systematic manner.

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

The bank is considering changing its asset mix by moving $100 million of commercial loans into Treasury securities. If it does change the asset mix and capital remains the same, the risk-based capital ratio

The primary role of capital for an FI is to assure the highest possible return on equity for its shareholders.

The risk-based capital model in the life insurance industry includes asset risk, business risk, insurance risk, and interest rate risk.

In the NAIC model for life insurance companies, this risk measures the liquidity of liabilities for given rate changes.

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