Core Ideas Flashcards
what is the Importance of Financial Institutions? (2)
- brokerage function: reduce transaction costs, economies of scale
- intermediation: asset transformation
formula for ROE (2) and ROA and PM
ROE= Net income / total equity ROE= ROA x EM ROA= PM x AU PM= net income / operating income
What are the two interest rate risks faced by investors/FIs?
Reinvestment risk
Refinancing risk
when is an FI exposed to refinancing risk?
when marturity of assets exceeds marturity of liabilities,
at risk of increasing interest rates when trying to borrow new funds to finance asset.
When is an FI exposed to reinvestment risk?
when marturity of assets is less than the marturity of liabilities,
at risk of decreasing interest rates when trying to reinvest funds.
when the maturities of assets and liabilities are matched, the FI is said to be?
immunised
what happens to the market value of assets and liabilities when interest rates increase?
MV decreases
When interest rates decrease MV increases
what determins the magnitude of the effect of an interest rate increase or decrease.
an assets/liability’s maturity, the greater the maturity the greated the magnitude of effect.
what is market risk?
the risk of trading
what is credit risk? what are the 2 types of credit risk?
risk of default on repayment.
firm specific and systematic:
what are off balance sheet risks?
contingent liabilities
what is liquidity risk?
risk of mass bank withdrawals, causing banks to liquidate assets to meet liquidity needs.
how is the maturity gap calculated?
find the weighted average maturity of all assets and then subracted the weighter average marturity of liabilities.
a1/total assets x maturity + a2/total asset x maturity = WMA
WMA - WML = Maturity Gap
what is the weakness of maturity matching?
timing of CFs can still cause banks to be exposed to interest rate risk.
what is duration?
the weighted average time to maturity of a series of CFs, using PV of CFs as weights.
