Question 1

Loan loss reserves are classified as

Accepted Answer

A) on-balance-sheet assets. 
B) off-balance-sheet assets. 
C) off-balance-sheet liabilities. 
D) on-balance-sheet liabilities. 
E) equity capital. 
A) on-balance-sheet assets. 
B) off-balance-sheet assets. 
C) off-balance-sheet liabilities. 
D) on-balance-sheet liabilities. 
E) equity capital.

Question 2

Which of the following refers to the fee charged on the unused balance of a loan commitment.

Accepted Answer

A) Up-front fee. 
B) Facility fee. 
C) Compensating balance. 
D) Commitment fee. 
E) Closing costs. 
A) Up-front fee. 
B) Facility fee. 
C) Compensating balance. 
D) Commitment fee. 
E) Closing costs.

Question 3

An FI can protect itself against insolvency resulting from off-balance sheet activities by purchasing insurance.

Accepted Answer

A) True 
 B)False

Question 4

Sun Bank has issued a one-year $5 million loan commitment to a customer for an up-front fee of 15 basis points and at a fixed rate of 12 percent. The back-end fee for the unused portion of the commitment is 5 basis points. The bank requires a 10 percent compensating balance in demand deposits. Reserve requirements on demand deposits are 10 percent.
-What is the expected return on the loan to the bank if 50 percent of the loan is drawn immediately and there are no reserve requirements on demand deposits? Do not take future values of fees or interest income received.

Accepted Answer

A) 13.45 percent. 
B) 13.57 percent. 
C) 13.60 percent. 
D) 13.72 percent. 
E) 13.90 percent. 
A) 13.45 percent. 
B) 13.57 percent. 
C) 13.60 percent. 
D) 13.72 percent. 
E) 13.90 percent.

Question 5

Settlement risk on wire transfers involves intraday credit risk.

Accepted Answer

A) True 
 B)False

Question 6

The current market value or contingent claim value of OBS items overestimates their notional value.

Accepted Answer

A) True 
 B)False

Question 7

The Federal Reserve requires banks to complete schedule L with their quarterly call reports to list the notional size and variety of off-balance-sheet activities.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following observations is NOT true?

Accepted Answer

A) The settlement risk that an FI is exposed to within-day appears on its balance sheet. 
B) Settlement Risk is a form of OBS risk that FIs participating on private wholesale wire transfer system networks face. 
C) A holding company is a corporation that owns more than 25 percent of the shares of other corporations. 
D) Failure of an affiliated firm or bank imposes affiliate risk on another bank in a holding company structure in a number of ways. 
E) Investors do not distinguish between the failing corporation and its surviving affiliate because of name similarity. 
A) The settlement risk that an FI is exposed to within-day appears on its balance sheet. 
B) Settlement Risk is a form of OBS risk that FIs participating on private wholesale wire transfer system networks face. 
C) A holding company is a corporation that owns more than 25 percent of the shares of other corporations. 
D) Failure of an affiliated firm or bank imposes affiliate risk on another bank in a holding company structure in a number of ways. 
E) Investors do not distinguish between the failing corporation and its surviving affiliate because of name similarity.

Question 9

Off-balance-sheet activities are an important source of fee income for many FIs.

Accepted Answer

A) True 
 B)False

Question 10

Why is the default risk much more serious for forward contracts than for futures contracts?

Accepted Answer

A) Because forward contracts are nonstandard contracts. 
B) Forward contracts are entered into bilaterally by the negotiating parties. 
C) For forwards, all cash flows are required to be paid at one time on contract maturity. 
D) Forwards are essentially OTC arrangements with no external guarantees in case of default. 
E) All of the above. 
A) Because forward contracts are nonstandard contracts. 
B) Forward contracts are entered into bilaterally by the negotiating parties. 
C) For forwards, all cash flows are required to be paid at one time on contract maturity. 
D) Forwards are essentially OTC arrangements with no external guarantees in case of default. 
E) All of the above.

Question 11

Where are the contingent items disclosed in the financial statements?

Accepted Answer

A) On the assets side of the balance sheet. 
B) On the liabilities side of the balance sheet. 
C) As footnotes to financial statements. 
D) In the income statement. 
E) In the director's report. 
A) On the assets side of the balance sheet. 
B) On the liabilities side of the balance sheet. 
C) As footnotes to financial statements. 
D) In the income statement. 
E) In the director's report.

Question 12

Derivative products used in managing contingent credit risk can only be acquired as over-the-counter arrangements.

Accepted Answer

A) True 
 B)False

Question 13

The current market value of an off-balance-sheet item is determined by finding the current market value of the underlying item.

Accepted Answer

A) True 
 B)False

Question 14

Which of the following is the newest addition to the derivative securities markets?

Accepted Answer

A) Options contracts. 
B) Futures contracts. 
C) Swap agreements. 
D) Forward contracts. 
E) Credit derivatives. 
A) Options contracts. 
B) Futures contracts. 
C) Swap agreements. 
D) Forward contracts. 
E) Credit derivatives.

Question 15

Standby letters of credit are classified as

Accepted Answer

A) on-balance-sheet assets. 
B) off-balance-sheet assets. 
C) off-balance-sheet liabilities. 
D) on-balance-sheet liabilities. 
E) equity capital. 
A) on-balance-sheet assets. 
B) off-balance-sheet assets. 
C) off-balance-sheet liabilities. 
D) on-balance-sheet liabilities. 
E) equity capital.

Question 16

Off-balance-sheet items can generate cash flows that immediately impact the bank's financial performance.

Accepted Answer

A) True 
 B)False

Question 17

An "adverse material changes in conditions" clause is included in loan commitments to protect the FI against

Accepted Answer

A) credit risk. 
B) interest rate risk. 
C) takedown risk. 
D) funding risk. 
E) exchange rate risk. 
A) credit risk. 
B) interest rate risk. 
C) takedown risk. 
D) funding risk. 
E) exchange rate risk.

Question 18

The use of an up-front fee by a bank eliminates the contingent risk on a loan commitment.

Accepted Answer

A) True 
 B)False

Question 19

Sun Bank has issued a one-year $5 million loan commitment to a customer for an up-front fee of 15 basis points and at a fixed rate of 12 percent. The back-end fee for the unused portion of the commitment is 5 basis points. The bank requires a 10 percent compensating balance in demand deposits. Reserve requirements on demand deposits are 10 percent.
-What is the expected return on the loan at the end of the year if 50 percent of the loan is drawn? Estimate using future values of fee and interest income received, that is, return is defined as all fee and interest income earned at year-end as a percentage of funds used. Assume the cost of funds to the bank is 8 percent.

Accepted Answer

A) 13.45 percent. 
B) 13.57 percent. 
C) 13.60 percent. 
D) 13.72 percent. 
E) 13.90 percent. 
A) 13.45 percent. 
B) 13.57 percent. 
C) 13.60 percent. 
D) 13.72 percent. 
E) 13.90 percent.

Question 20

An exporter demands a letter of credit in order to

Accepted Answer

A) guarantee safe delivery of goods to the importer. 
B) guarantee receipt of payment from the importer upon receipt of the goods. 
C) protect against adverse changes in foreign exchange rates. 
D) protect against adverse changes in international interest rates. 
E) ascertain the creditworthiness of the importer. 
A) guarantee safe delivery of goods to the importer. 
B) guarantee receipt of payment from the importer upon receipt of the goods. 
C) protect against adverse changes in foreign exchange rates. 
D) protect against adverse changes in international interest rates. 
E) ascertain the creditworthiness of the importer.

Exam 16: Off-Balance-Sheet Risk

Loan loss reserves are classified as

Which of the following refers to the fee charged on the unused balance of a loan commitment.

An FI can protect itself against insolvency resulting from off-balance sheet activities by purchasing insurance.

Settlement risk on wire transfers involves intraday credit risk.

The current market value or contingent claim value of OBS items overestimates their notional value.

The Federal Reserve requires banks to complete schedule L with their quarterly call reports to list the notional size and variety of off-balance-sheet activities.

Which of the following observations is NOT true?

Off-balance-sheet activities are an important source of fee income for many FIs.

Why is the default risk much more serious for forward contracts than for futures contracts?

Where are the contingent items disclosed in the financial statements?

Derivative products used in managing contingent credit risk can only be acquired as over-the-counter arrangements.

The current market value of an off-balance-sheet item is determined by finding the current market value of the underlying item.

Which of the following is the newest addition to the derivative securities markets?

Standby letters of credit are classified as

Off-balance-sheet items can generate cash flows that immediately impact the bank's financial performance.

An "adverse material changes in conditions" clause is included in loan commitments to protect the FI against

The use of an up-front fee by a bank eliminates the contingent risk on a loan commitment.

An exporter demands a letter of credit in order to

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

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