Question 1

Which theory of term structure argues that individual investors have specific maturity preferences?

Accepted Answer

A) The unbiased expectations theory. 
B) The liquidity premium theory. 
C) The loanable funds theory. 
D) The market segmentation theory. 
E) None of the above. 
A) The unbiased expectations theory. 
B) The liquidity premium theory. 
C) The loanable funds theory. 
D) The market segmentation theory. 
E) None of the above.

Question 2

$$\begin{array} { | l | r | l | l | r | l | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 1-year bonds } & \$ 60 & 7 \% & \text { 1-year CD } & \$ 50 & 5 \% \
\hline \text { 10-year loan } & \$ 40 & 12 \% & \text { 2-year CD } & \$ 40 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is this FI's maturity gap?

Accepted Answer

A) 4.00 years. 
B) 4.28 years. 
C) 3.16 years. 
D) 4.06 years. 
E) 5.10 years. 
A) 4.00 years. 
B) 4.28 years. 
C) 3.16 years. 
D) 4.06 years. 
E) 5.10 years.

Question 3

$$\begin{array} { | l | r | r | l | r | c | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 2-year loans } & \$ 40 & 8 \% & \text { 3-year CD } & \$ 60 & 7 \% \
\hline \text { 3-year loans } & \$ 60 & 8 \% & \text { 5-year term deposit } & \$ 30 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is the FI's maturity gap?

Accepted Answer

A) -2.03 years. 
B) -2.50 years. 
C) -1.07 years. 
D) -0.70 years. 
E) -0.40 years. 
A) -2.03 years. 
B) -2.50 years. 
C) -1.07 years. 
D) -0.70 years. 
E) -0.40 years.

Question 4

The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values for the individual time periods that make up the extended time period.

Accepted Answer

A) True 
 B)False

Question 5

What is the change in the value of its liabilities if all interest rates decrease by 1 percent?

Accepted Answer

A) Approximately $2.003 million. 
B) Approximately -$2.355 million. 
C) Approximately $2.697 million. 
D) Approximately $2.906 million. 
E) Approximately $3.211 million. 
A) Approximately $2.003 million. 
B) Approximately -$2.355 million. 
C) Approximately $2.697 million. 
D) Approximately $2.906 million. 
E) Approximately $3.211 million.

Question 6

$$\begin{array} { | l | c | c | l | c | c | } 
\hline \text { Assets } & \text { Amount } & \text { Rate } & \text { Liabilities } & \text { Amount } & \text { Rate } \
\hline \begin{array} { l } 
\text { Rate } \
\text { Sensitive }
\end{array} & \$ 35,000,000 & 10 \% & \begin{array} { l } 
\text { Rate } \
\text { Sensitive }
\end{array} & \$ 40,000,000 & 8 \% \
\hline \text { Fixed Rate } & \$ 21,000,000 & 9 \% & \text { Fixed Rate } & \$ 12,000,000 & 7 \% \
\hline \text { Non-earning } & \$ 4,000,000 & & \text { Equity } & \$ 8,000,000 & \
\hline
\end{array}$$
-What will be the FI's net interest income at year-end if interest rates do not change?

Accepted Answer

A) $3.20 million. 
B) $5.39 million. 
C) $4.04 million. 
D) $1.89 million. 
E) $1.35 million. 
A) $3.20 million. 
B) $5.39 million. 
C) $4.04 million. 
D) $1.89 million. 
E) $1.35 million.

Question 7

$$\begin{array} { | l | l | l | l | l | l | } 
\hline \text { Assets } & \text { Par Amount } & \text { Rate } & \text { Liabilities } & \text { Par Amount } & \text { Rate } \
\hline \text { 2-year commercial loans } & \$ 600 \text { million } & 10 \% & \text { 1-year CDs } & \$ 900 \text { million } & 7 \% \
\hline \text { 1-year Treasury bills } & \$ 400 \text { million } & & \text { Net Worth } & \$ 100 \text { million } & \
\hline
\end{array}$$
-If all interest rates decrease by 15 basis points, what is the expected impact on the FI's net interest income? (Hint: Use the repricing model to answer this question.)

Accepted Answer

A) +$150,000. 
B) -$150,000. 
C) -$750,000. 
D) +$750,000. 
E) No changE. 
A) +$150,000. 
B) -$150,000. 
C) -$750,000. 
D) +$750,000. 
E) No changE.

Question 8

Because the increased level of financial market integration has increased the speed with which interest rate changes are transmitted among countries, control of U.S. interest rates by the Federal Reserve is more difficult and less certain.

Accepted Answer

A) True 
 B)False

Question 9

The balance sheet of XYZ Bank appears below. All figures in millions of US Dollars.  
-Total one-year rate-sensitive assets is

Accepted Answer

A) $540 million. 
B) $580 million. 
C) $555 million. 
D) $415 million. 
E) $720 million. 
A) $540 million. 
B) $580 million. 
C) $555 million. 
D) $415 million. 
E) $720 million.

Question 10

$$\begin{array} { | l | r | l | l | r | l | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 1-year bonds } & \$ 60 & 7 \% & \text { 1-year CD } & \$ 50 & 5 \% \
\hline \text { 10-year loan } & \$ 40 & 12 \% & \text { 2-year CD } & \$ 40 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is market value of the one-year bond if all market interest rates increase by 2 percent?

Accepted Answer

A) $60.000 million. 
B) $60.566 million. 
C) $59.444 million. 
D) $58.899 million. 
E) $61.142 million. 
A) $60.000 million. 
B) $60.566 million. 
C) $59.444 million. 
D) $58.899 million. 
E) $61.142 million.

Question 11

$$\begin{array} { | l | r | l | l | r | l | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 1-year bonds } & \$ 60 & 7 \% & \text { 1-year CD } & \$ 50 & 5 \% \
\hline \text { 10-year loan } & \$ 40 & 12 \% & \text { 2-year CD } & \$ 40 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is market value of the ten-year loan if all market interest rates increase by 2 percent?

Accepted Answer

A) $40.000 million. 
B) $44.916 million. 
C) $37.830 million. 
D) $42.356 million. 
E) $35.827 million. 
A) $40.000 million. 
B) $44.916 million. 
C) $37.830 million. 
D) $42.356 million. 
E) $35.827 million.

Question 12

If an FI's repricing gap is less than zero, then

Accepted Answer

A) it is deficient in its required reserves. 
B) it is deficient in its capital ratio requirement. 
C) its liability costs are more sensitive to changing market interest rates than are its asset yields. 
D) its liability costs are less sensitive to changing market interest rates than are its asset yields. 
E) the duration of the FI's liabilities exceeds the duration of FI's assets. 
A) it is deficient in its required reserves. 
B) it is deficient in its capital ratio requirement. 
C) its liability costs are more sensitive to changing market interest rates than are its asset yields. 
D) its liability costs are less sensitive to changing market interest rates than are its asset yields. 
E) the duration of the FI's liabilities exceeds the duration of FI's assets.

Question 13

$$\begin{array} { | l | r | l | l | r | l | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 1-year bonds } & \$ 60 & 7 \% & \text { 1-year CD } & \$ 50 & 5 \% \
\hline \text { 10-year loan } & \$ 40 & 12 \% & \text { 2-year CD } & \$ 40 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is the impact on the FI's equity of a 2 percent overall increase in market interest rates on all fixed-rate instruments?

Accepted Answer

A) Equity rises by $4.318 million. 
B) Equity declines by $2.912 million. 
C) Equity rises by $2.060 million. 
D) Equity declines by $1.880 million. 
E) Equity does not change. 
A) Equity rises by $4.318 million. 
B) Equity declines by $2.912 million. 
C) Equity rises by $2.060 million. 
D) Equity declines by $1.880 million. 
E) Equity does not change.

Question 14

The following are the assets and liabilities of a government security dealer. $$\begin{array} { | l | l | } 
\hline \text { Assets: } & \text { \$150 million } 30 \text { day Treasury bills } \
\hline & \text { \$275 million } 91 \text { day Treasury bills } \
\hline & \text { \$90 million } 180 \text { day municipal notes } \
\hline & \$ 350 \text { million } 2 \text { year Treasury notes } \
\hline & \
\hline \text { Liabilities: } & \text { \$575 million } 14 \text { day repurchase agreements } \
\hline & \$ 290 \text { million } 1 \text { year commercial paper } \
\hline
\end{array}$$
-What is the impact over the next 30 days on the dealer's net interest income if all interest rates increase by 50 basis points?

Accepted Answer

A) Net interest income will decrease by $50,000. 
B) Net interest income will decrease by $2.125 million. 
C) Net interest income will decrease by $475,000. 
D) Net interest income will decrease by $2.375 million. 
E) Net interest income will increase by $750,000. 
A) Net interest income will decrease by $50,000. 
B) Net interest income will decrease by $2.125 million. 
C) Net interest income will decrease by $475,000. 
D) Net interest income will decrease by $2.375 million. 
E) Net interest income will increase by $750,000.

Question 15

The following are the assets and liabilities of a government security dealer. $$\begin{array} { | l | l | } 
\hline \text { Assets: } & \text { \$150 million } 30 \text { day Treasury bills } \
\hline & \text { \$275 million } 91 \text { day Treasury bills } \
\hline & \text { \$90 million } 180 \text { day municipal notes } \
\hline & \$ 350 \text { million } 2 \text { year Treasury notes } \
\hline & \
\hline \text { Liabilities: } & \text { \$575 million } 14 \text { day repurchase agreements } \
\hline & \$ 290 \text { million } 1 \text { year commercial paper } \
\hline
\end{array}$$
-Use the repricing model to determine the funding gap for a maturity bucket of 30 days.

Accepted Answer

A) -$425 million. 
B) -$95 million. 
C) -$10 million. 
D) -$475 million. 
E) +$150 million. 
A) -$425 million. 
B) -$95 million. 
C) -$10 million. 
D) -$475 million. 
E) +$150 million.

Question 16

A positive repricing gap implies that a decrease in interest rates will cause interest expense to decrease more than the decrease in interest income.

Accepted Answer

A) True 
 B)False

Question 17

If interest rates decrease 40 basis points (0.40 percent) for an FI that has a cumulative gap of -$25 million, the expected change in net interest income is

Accepted Answer

A) +$100,000. 
B) -$100,000. 
C) -$625,000. 
D) -$250,000. 
E) +$250,000. 
A) +$100,000. 
B) -$100,000. 
C) -$625,000. 
D) -$250,000. 
E) +$250,000.

Question 18

Defining buckets of time over a range of maturities assures the capture of all relevant information necessary to accurately assess the interest rate risk exposure of an FI.

Accepted Answer

A) True 
 B)False

Question 19

$$\begin{array} { | l | r | l | l | r | l | } 
\hline \text { Assets } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} & \text { Liabilities } & \begin{array} { l } 
\text { Amount } \
\text { (\$ millions) }
\end{array} & \begin{array} { l } 
\text { Annual } \
\text { Rate }
\end{array} \
\hline \text { 1-year bonds } & \$ 60 & 7 \% & \text { 1-year CD } & \$ 50 & 5 \% \
\hline \text { 10-year loan } & \$ 40 & 12 \% & \text { 2-year CD } & \$ 40 & 6 \% \
\hline & & & \text { Equity } & \$ 10 & \
\hline \text { Total } & \$ 100 & & \text { Total } & \$ 100 & \
\hline
\end{array}$$
-What is market value of the two-year CD if all market interest rates increase by 2 percent?

Accepted Answer

A) $40.381 million. 
B) $39.626 million. 
C) $40.000 million. 
D) $38.573 million. 
E) $40.769 million. 
A) $40.381 million. 
B) $39.626 million. 
C) $40.000 million. 
D) $38.573 million. 
E) $40.769 million.

Question 20

Defining buckets of time over wider intervals creates greater accuracy in the use of the repricing model because fewer calculations are required.

Accepted Answer

A) True 
 B)False

Exam 8: Interest Rate Risk I

Which theory of term structure argues that individual investors have specific maturity preferences?

Assets Amount (\ millions) Annual Rate Liabilities Amount (\ millions) Annual Rate 1-year bonds \ 60 7\% 1-year CD \ 50 5\% 10-year loan \ 40 12\% 2-year CD \ 40 6\% Equity \ 10 Total \ 100 Total \ 100 -What is this FI's maturity gap?

Assets Amount (\ millions) Annual Rate Liabilities Amount (\ millions) Annual Rate 2-year loans \ 40 8\% 3-year CD \ 60 7\% 3-year loans \ 60 8\% 5-year term deposit \ 30 6\% Equity \ 10 Total \ 100 Total \ 100 -What is the FI's maturity gap?

The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values for the individual time periods that make up the extended time period.

What is the change in the value of its liabilities if all interest rates decrease by 1 percent?

Assets Amount Rate Liabilities Amount Rate Rate Sensitive \ 35,000,000 10\% Rate Sensitive \ 40,000,000 8\% Fixed Rate \ 21,000,000 9\% Fixed Rate \ 12,000,000 7\% Non-earning \ 4,000,000 Equity \ 8,000,000 -What will be the FI's net interest income at year-end if interest rates do not change?

Because the increased level of financial market integration has increased the speed with which interest rate changes are transmitted among countries, control of U.S. interest rates by the Federal Reserve is more difficult and less certain.

The balance sheet of XYZ Bank appears below. All figures in millions of US Dollars. -Total one-year rate-sensitive assets is

Assets Amount (\ millions) Annual Rate Liabilities Amount (\ millions) Annual Rate 1-year bonds \ 60 7\% 1-year CD \ 50 5\% 10-year loan \ 40 12\% 2-year CD \ 40 6\% Equity \ 10 Total \ 100 Total \ 100 -What is market value of the one-year bond if all market interest rates increase by 2 percent?

Assets Amount (\ millions) Annual Rate Liabilities Amount (\ millions) Annual Rate 1-year bonds \ 60 7\% 1-year CD \ 50 5\% 10-year loan \ 40 12\% 2-year CD \ 40 6\% Equity \ 10 Total \ 100 Total \ 100 -What is market value of the ten-year loan if all market interest rates increase by 2 percent?

If an FI's repricing gap is less than zero, then

A positive repricing gap implies that a decrease in interest rates will cause interest expense to decrease more than the decrease in interest income.

If interest rates decrease 40 basis points (0.40 percent) for an FI that has a cumulative gap of -$25 million, the expected change in net interest income is

Defining buckets of time over a range of maturities assures the capture of all relevant information necessary to accurately assess the interest rate risk exposure of an FI.

Assets Amount (\ millions) Annual Rate Liabilities Amount (\ millions) Annual Rate 1-year bonds \ 60 7\% 1-year CD \ 50 5\% 10-year loan \ 40 12\% 2-year CD \ 40 6\% Equity \ 10 Total \ 100 Total \ 100 -What is market value of the two-year CD if all market interest rates increase by 2 percent?

Defining buckets of time over wider intervals creates greater accuracy in the use of the repricing model because fewer calculations are required.

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 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

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

Filters