CHAPTER 5

Question 1

Refers to trades used to reduce risk

Answer 1

Hedging

Question 2

Hedgers include (4)

Answer 2

Financial institutions
Commercial producers
Processors
Users of agricultural commodities

Question 3

Is a financial contract whose value is derived from the performance of underlying market factors, such as interest rates, currency exchange rates, commodity, credit, and equity prices.

Answer 3

Derivatives

Question 4

Can be used to short risk to hedge, to reduce risk, or to speculate

Answer 4

Derivatives

Question 5

Can be a lower-cost way to invest funds that buying for cash

Answer 5

Derivatives

Question 6

Derivatives can be used to reduce risk, but they are not risk-free (True/False)

Answer 6

True

Question 7

Include a wide assortment of financial contracts

Answer 7

Derivative Transactions

Question 8

Are traders who attempt to profit by anticipating the prices of financial instruments and commodities

Answer 8

Speculators

Question 9

Is the nominal or face amount that is used to calculate payments made on swaps and other risk management products

Answer 9

Notional Amount

Question 10

Is used because the principal amounts rarely change hands

Answer 10

Notional

Question 11

Financial institutions and others use derivatives for: (6)

Answer 11

Hedging
Reducing overall risk
Speculating
Price discovery
Obtaining better financial terms
Changing the asset mix of their portfolios

Question 12

Protect the value of their assets or liabilities by using derivative transactions whose values are expected to change in the opposite direction of their assets or liabilities.

Answer 12

Hedgers

Question 13

Use derivatives to take advantage of anticipated price changes in interest rates, mortgages, commodities, and so on.

Answer 13

Speculators

Question 14

Is a significant risk in bank derivatives trading activities

Answer 14

Credit risk

Question 15

Is referref to as counterparty risk that stems from the creditworthiness of banks, broker-dealees, and other financial institutions that gail to deliver on their over-the-counter (OTC) derivative obligations

Answer 15

Credit risk

Question 16

Is a reference amount from which contractual payments will be derived, but it is generally not an amount at risk

Answer 16

Notional amount of a derivative contract

Question 17

Is a function of a number of variables, such as whether coubterparties exchange notionak principal… and the credit worthiness of the counterparty.

Answer 17

Credit Risk in a derivative contract

Question 18

Banks control market risk in trading operations primarily by establishing limits against potentio losses

Answer 18

Market Risk

Question 19

Is a statistical measure that banks use to quantify the mqximum expected loss, over a specified horizon and at a certain confidence level, in normal market

Answer 19

Value at Risk (VaR)

Question 20

Is the difference between the spot or cash price of a commodity and the price of the nearest futures contract for the same or a related commodity (cash minus futures)

Answer 20

Basis

Question 21

Is usually computed in relation to the futures contract next to expure and may reflect different time periods, product forms, grades, or locations

Answer 21

Basis

Question 22

Is the risk associated with an unexpected widening or narrowing of the basis between the time a hedge position is establish and the time that it is lifted

Answer 22

Basis risk

Question 23

Are standardized contracts for the purchqse and sale of financial instruments or physical commodities for future exchange

Answer 23

Futures

Question 24

Are private, cash-market agreements between a buyer and seller fof the future delivery of a commodity at an agreement price; forwards contracts qre not standardized and not transferable

Answer 24

Forwards

Question 25

Refer to the simultaneous purchase and sale of currencies or interest rate products in spot and forward market transaction

Answer 25

Swaps

Question 26

Is the market in which cash transactions for the physical commodity occur, currencies, stocks and the like are brought and sold for cash and delivered immediately

Answer 26

Spot Market

Question 27

Refers for future delivery

Answer 27

Forward Market

Question 28

Are contracts that give the bearer the right, but not the obligation, to be long or short on a futures contract at a specified price (strike price) within a specified time period

Answer 28

Options

Question 29

The futures contract that the long may establish by exercising the option

Answer 29

Underlying Futures Contract

Question 30

Are contractual agreements designed to shift credit risk between parties

Answer 30

Credit Derivatives

Question 31

Were originally used primarilly by banks to hedge and diversify the credit risk of their customers in the event they could not pay back their loans

Answer 31

Credit Derivatives

Question 32

Is similar to an insurance contract, providing a buyer, usually a debt holder, with protection against the borrower not repaying their debt

Answer 32

Credit Default Swaps

Question 33

Are thw derivative product most widely used by banks and others

Answer 33

Interest rate swaps

Question 34

Is the fixed interest rate that the receiver gets in exchangw for the uncertainty of paying a floating rate (LIBOR) over time

Answer 34

Swap Rate

Question 35

The value of the swap's fixed-rate flows is called

Answer 35

Swap spread

Question 36

The difference between the swap rate and the government bond yields for the same maturity

Answer 36

Swap spread

Question 37

Is a long-term agreement between counterparties to exchangw principal and periodic interest payments in diffwrwnt currencies (e.g. foreign exchange) durinf the life of the contract

Answer 37

Currency Swap

Question 38

Is one type of foreign exchange derivative

Answer 38

Currency Swap

Question 39

Are usually exchanged at the beginning and end of the contract and are based on thw current cash price of the currencies

Answer 39

Principal amounts

Question 40

The ratio of the currency amounts to be paid at ghe expiration of the currency swap

Answer 40

Forward Price

Question 41

Is a bilateral financial contract in which a buyer seeking protwction on loans or other assets makes periodic payments to a seller who is offering financial protection if a predefined credit event occurs

Answer 41

Credit Default Swaps

Question 42

Provide lenders with a credit insurance, and they provide sellers with a source of income

Answer 42

Credit Default Swaps

Question 43

a CDS covering multiple credit events

Answer 43

Basket Swap

Question 44

Are swaps in which the holder has no risk of financial loss if the underlying security fails

Answer 44

Naked Credit Default Swaps

Question 45

Allows traders to speculate by buying insurance on corporate or government bonds that they do not own

Answer 45

Naked Credit Default Swaps

Question 46

Major buyer of CDS (credit default swaps)

Answer 46

American Internation Group

Question 47

Are a type of structured asset-backed security (ABS) wgose value and payments are derived from a portfolio of fixed-income underlying assets

Answer 47

CDOs

Question 48

The portfolio is divided into different risk classes and maturities called

Answer 48

Tranches or slices

Question 49

The packaging and selling of loans, such as mortgages (MBS), and credit card loans

Answer 49

Securization

Question 50

are contracts that give the bearer the right, but not the obligation, to be long (own) or short (promise to sell) a futures contract on a security or commodity at a specified price within a specified time period

Answer 50

Options

Question 51

option buyer pays a premium to the seller for the right to buy (a call option) or to sell (a put option) the underlying asset at an agreed price (strike or exercise price) until the contract expires (expiry)

Answer 51

Options

Question 52

are options on the spot yields of U.S. Treasury securities

Answer 52

Interest Rate Options

Question 53

are settled for cash, rather than the delivery of a security.

Answer 53

Interest Rate Options

Question 54

refers to standardized contracts for the purchase and sale of financial instruments or physical commodities for future delivery on a reg- ulated commodity futures exchange.

Answer 54

Futures

Question 55

are based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather, and real estate

Answer 55

Futures Contracts

Question 56

are debt obligations issued by financial institutions.

Answer 56

Covered bonds

Question 57

also called special purpose entities (SPEs) - are legal entities created by a sponsoring firm (also called the sponsor, originator, seller, or administrator)

Answer 57

Special Purpose Vehicles (SPVs)

Question 58

meaning that the bankruptcy of the sponsor will not affect the assets of the SPV

Answer 58

Bankruptcy Remote

Question 59

can be defined as the way we do things in this organization

Answer 59

Corporate Culture

Question 60

must be established, applied, and carefully monitored to ensure that they are being carried out across the entire firm.

Answer 60

Risk Management Policies

Question 61

is defined as a process, effected by an entity’s board of directors, management, and other personnel, applied in strategy setting and across the enterprise, de- signed to identify potential events that may affect the entity, and manage risk to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.”

Answer 61

Enterprise Risk Management

Question 62

The current and prospective risk to earnings or capital arising from violations of, or nonconformance with, laws, rules, regulations, prescribed practices, internal policies and procedures, or ethical standards.

Answer 62

Compliance Risk

Question 63

arises in situations where the laws or rules governing certain bank products or activities of bank’s clients may be ambiguous or untested

Answer 63

Compliance risk

Question 64

Arises from the potential that a borrower or counterpart will fail to perform on an obligation.

Answer 64

Credit Risk

Question 65

The risk to capital and earnings arising from the conversion of a bank’s financial statements from one currency to another.

Answer 65

Foreign Exchange Transaction Risk

Question 66

Arises from the potential that unenforceable contracts, law suits, or adverse judgments can disrupt or otherwise negatively affect the operations or condition of a banking organization.

Answer 66

Legal Risk

Question 67

Arises from the potential that an institution will be unable to meet its obligations as they come due because of an inability to liquidate assets or obtain adequate funding (referred to as funding liquidity risk) or that it cannot easily unwind or offset specific exposures without significantly lowering market prices because of inadequate market depth or market disruptions (market liquidity risk).

Answer 67

Liquidity Risk

Question 68

The risk to a financial institution’s condition resulting from adverse movements in market rates or prices, such as interest rates, foreign exchange rates, or equity prices.

Answer 68

Market Risk

Question 69

Arises from the potential that inadequate information systems, operational problems, breaches in internal controls, fraud, or unforeseen catastrophes will result in unexpected losses.

Answer 69

Operational Risk

Question 70

Arises from the potential that negative publicity regarding an institution’s business practices, whether true or not, will cause a decline in the customer base, costly litigation, or revenue reductions.

Answer 70

Reputational Risk

Question 71

Arises from cyberattacks, bank robberies, fraud, or other such problems.

Answer 71

Security Risk

Question 72

The current and prospective impact on earnings or capital arising from adverse business decisions, improper implementation of decisions, or lack of responsiveness to industry changes.

Answer 72

Strategic Risk

Question 73

WIDE RANGE OF RISK (10) (CCFLLMORSS)

Answer 73

Compliance Risk Credit Risk Foreign Exchange Transaction Risk Legal Risk Liquidity Risk Market Risk Operational Risk Reputational Risk Security Risk Strategic Risk