Chapter 7

Question 1

Liquidity risk + how to deal with

Answer 1

Risk that sudden withdrawals may require FI to liquidate assets at less than market prices

FIs can accept new deposits or borrow funds in the ST money markets

Question 2

Interest rate risk

Answer 2

Risk when price of (LT) assets react differently to changes in interest rates than the price of (ST) liabilities

Question 3

Refinancing risk

Answer 3

Risk that the cost of reborrowing funds will rise above the returns being earned on asset investments (part of interest rate risk)

-> FIs benefit from a decrease in interest rate as cost of renewing liabilities decreases and asset doesn’t change

Question 4

Reinvestment risk

Answer 4

Risk that return on funds to be reinvested fall below the cost of funds. Happen when assets maturity is lower than liabilities’.

-> FI risk that interest rates decrease

Question 5

Credit risk

Answer 5

Risk that promised CFs from loans/securities may not be paid in full. More susceptible for FIs that lend for long periods

Question 6

Foreign exchange risk

Answer 6

Risk that exchange rate changes affect the value of FI’s assets and liabilities denominated in foreign currencies

Question 7

Net long/short in foreign assets

Answer 7

Long: when foreign currency-denominated asset > foreign currency-denominated liability

-> FI suffers potential losses if domestic currency strengthens relative to foreign currency

Question 8

Country/sovereign risk

Answer 8

Risk that repayment to foreign lenders or investors may be interrupted because of intervention from foreign governmments

Question 9

Market risk + how to deal with

Answer 9

Risk due to changes in interest rates, exchange rates or asset prices

Can be minimized by using hedging techniques (futures, options, …)