Exam revision

Question 1

Which of the following is a method that may overcome weaknesses in the historic or back
simulation model in measuring market risk?
(a) The use of smaller sample sizes to estimate return distributions.
(b) Weight sample size observations so that the more recent observations contribute a larger
amount to the model.
(c) Decrease the number of assets in the trading portfolio so that past returns will provide more
accuracy to the model.
(d) Increase the number of assets in the trading portfolio in order to benefit from higher levels
of diversification.
(e) The weaknesses in the model cannot be overcome.

Answer 1

Weight sample size observations so that the more recent observations contribute a larger
amount to the model.

Question 2

A2.Which of the following statements is NOT true?
(a) Stored liquidity management involves liquidation of assets.
(b) Traditionally Depository Institutions have stored cash reserves at the Central bank and in
their vaults to overcome liquidity risk.
(c) When the Depository Institution uses its cash as the liquidity adjustment mechanism, both
sides of its balance sheet contract.
(d) DIs hold cash reserves in excess of the minimum required to meet liquidity drains.
(e) Bank sustains no cost under stored liquidity risk management.

Answer 2

Bank sustains no cost under stored liquidity risk management.

Question 3

A3.Losses in asset values due to adverse changes in interest rates are borne initially by the

(a) equity holders of an FI.
(b) liability holders of an FI.
(c) regulatory authorities.
(d) taxpayers.
(e) insured depositor

Answer 3

equity holders of an FI.

Question 4

A4.A criticism of the Basel I risk-based capital ratio is
(a) the incorporation of off-balance-sheet risk exposures.
(b) the application of a similar capital requirement across major banks in international banking
centers across the world.
(c) the more systematic accounting of credit risk differences.
(d) the lack of appropriate consideration of the portfolio diversification effects of credit risk
(e) Answers B and C only.

Answer 4

the lack of appropriate consideration of the portfolio diversification effects of credit risk

Question 5

A5.Which of the following statements best describes the treatment of adjusting for credit risk of
off-balance-sheet activities under Basel II risk based capital ratio ?
(a) All OBS activities are treated equally in making credit-risk adjustments.
(b) Standby letter of credit guarantees issued by banks to back commercial paper have a 50
percent conversion factor.
(c) The credit or default risk of over-the-counter contracts is approximately zero.
(d) The current exposure component of the credit equivalent amount of OBS derivative
contracts reflects the credit risk if the contract counterparty defaults.
(e) The treatment of interest rate forward, option, and swap contracts differs from the treatment
of contingent or guarantee contracts.

Answer 5

The treatment of interest rate forward, option, and swap contracts differs from the treatment
of contingent or guarantee contracts.

Question 6

A6.Which of the following statements is true?
(a) Convexity is desirable because the larger the convexity the greater the interest rate
protection against interest rate decreases and the greater the potential gains following
increasing interest rates.
(b) Convexity is desirable because the larger the convexity the greater the interest rate
protection against interest rate rises and the greater the potential gains following decreasing
interest rates.
(c) Convexity is undesirable because the larger the convexity the lower the interest rate
protection against interest rate decreases and the smaller the potential gains following
increasing interest rates
(d) Convexity is undesirable because the larger the convexity the lower the interest rate
protection against interest rate rises and the smaller the potential gains following decreasing
interest rates.
(e) None of the given answers.

Answer 6

Convexity is desirable because the larger the convexity the greater the interest rate
protection against interest rate rises and the greater the potential gains following decreasing
interest rates.

Question 7

A7.X Bank has a higher ROE than YBank, but YBank has a higher ROA than XBank. XBank
also has a higher Asset Utilisation ratio than YBank; however, the two banks have the same
total assets. Which of the following statements is most correct?
(a) X Bank has a lower equity multiplier than YBank.
(b) X Bank has a lower profit margin than YBank.
(c) X Bank has a lower net income than YBank.
(d) Statements b and c are correct.
(e) All of the statements above are correct.

Answer 7

Statements b and c are correct.

Question 8

A8.A decline in an FI’s asset quality due to, for instance, increasing loan defaults:

(a) exposes the FI to increasing credit risk.
(b) can have an impact on the FI’s funding cost.
(c) might lead to refusal of lenders to renew or issue new loans to the FI.
(d) might threaten the FI’s solvency.
(e) All of the given answers.

Answer 8

All of the given answers.

Question 9

A9.Why are money market managed funds and general insurance companies more exposed to
credit risk than, for instance, credit unions or banks?
(a) Because the average maturities of their assets are longer than those of banks/credit unions.
(b) Because the average maturities of their assets are shorter than those of banks/credit unions.
(c) They are not.
(d) Because they are not specialised in credit risk management.
(e) Because banks and credit unions have more stringent credit controls.

Answer 9

They are not.

Question 10

A10. An Australian FI that invests €50m in 3-year maturity loans and partially funds these
loans with €30m 1-year deposits is exposed to the following risks.
(a) A depreciation of the Euro against the Australian dollar plus credit risk plus refinancing
risk, i.e. increasing interest rates in the Euro zone.
(b) An appreciation of the Euro against the Australian dollar plus credit risk plus refinancing
risk, i.e. increasing interest rates in the Euro zone.
(c) A depreciation of the Euro against the Australian dollar plus credit risk plus reinvestment
risk, i.e. decreasing interest rates in the Euro zone.
(d) A depreciation of the Euro against the Australian dollar reinvestment risk, i.e. increasing
interest rates in the Euro zone.
(e) A depreciation of the Euro against the Australian dollar refinancing risk, i.e. decreasing
interest rates in the Euro zone.

Answer 10

A depreciation of the Euro against the Australian dollar plus credit risk plus refinancing
risk, i.e. increasing interest rates in the Euro zone.

Question 11

A11. Consider a security with a face value of $100,000 to be repaid at maturity. The maturity
of the security is 3 years. The coupon rate is 9% p.a. and coupon payments are made semiannually.
The current discount rate is 12% p.a. What is the security’s price (round your
answer to two decimals)?
(a) $127,000.
(b) $73,668.38.
(c) $100,000.
(d) $76,046.08.
(e) $92,624.01.

Answer 11

$92,624.01.

Question 12

A12. Assume you are the manager of an FI. How would you structure your balance sheet using
the repricing gap model if you expected interest rates to decrease?
(a) It would depend on my FI’s current profitability.
(b) I would create a negative gap.
(c) I would create a positive gap.
(d) I would create a neutral gap.
(e) None of the given answers.

Answer 12

I would create a negative gap.

Question 13

A13. The Basel capital requirements differ from previous capital standards in all except one of
the following ways?
(a) More stringent capital standards for large banks than for small banks.
(b) Inclusion of off balance sheet assets in the asset base.
(c) Restrictions on the amount of goodwill that can be counted towards primary or tier I capital.
(d) Risk weighting of assets on the basis of credit risk exposure.
(e) Risk weighting of off balance sheet contingencies.

Answer 13

More stringent capital standards for large banks than for small banks.

Question 14

A14. Investors in mortgage-backed pass-through securities are exposed to a variety of risks.
Compared to other fixed-income securities, the most unique of these risks is
(a) prepayment risk
(b) default risk
(c) credit risk
(d) interest rate risk
(e) liquidity risk

Answer 14

prepayment risk

Question 15

A15. Assume a $500,000 loan has a duration of 2.5 years. The current interest rate level is 10%
and a sudden change in the credit premium of 1% is expected. Further assume that the oneyear
income on the loan is $2,500. What is the loan’s RAROC (round to two decimals)?
(a) 10.00%.
(b) 11.00%.
(c) 22.00%.
(d) 50.00%.
(e) None of the above answers

Answer 15

22%

Question 16

A16. A disadvantage of using asset management to manage a FI’s liquidity risk is

(a) the resulting shrinkage of the FI’s balance sheet.
(b) the high cost of purchased liabilities.
(c) the accessibility of international money markets.
(d) tax considerations.
(e) loss of flexibility as a result of dependence upon purchased liabilities.

Answer 16

the resulting shrinkage of the FI’s balance sheet.

Question 17

A17. A small local bank failed because housing market collapsed following the departure of the
area’s largest employer. What type of risk applies to the failure of the institution?
(a) Firm-specific risk.
(b) Technological risk.
(c) Operational risk.
(d) Sovereign risk.
(e) Insolvency risk.

Answer 17

Insolvency risk.

Question 18

A18. Assume the dollar market value of an FI’s position is $200,000 and the calculated price
volatility is 1.25%. What is the VAR of the position if the FI is required to hold the position
for 6 days (round to two decimals)?
(a) $2,683.28.
(b) $6,123.72.
(c) $200,000.00.
(d) $489,897.95.
(e) None of the above answers

Answer 18

$6,123.72.

Question 19

A19. Assume the interest rate in the market for one-year zero-coupon government bonds is i =
8% and the rate for one-year zero-coupon grade BBB bonds is k = 10.2%. What is the
implied probability of repayment on the corporate bond (round to two decimals)?
(a) 2.00%.
(b) 2.04%.
(c) 97.96%.
(d) 98.00%.
(e) 98.96%

Answer 19

98.00%.

Question 20

A20. The following are the net currency positions of a US Financial Institution (stated in US dollars).
Note: Net currency positions are foreign exchange bought minus foreign exchange sold
restated in US dollar terms.

Euro -US$245,000

How would you characterize the FI’s risk exposure to fluctuations in the Euro to dollar exchange rate?

(a) The Financial Institution is net short in the Euro and therefore faces the risk that the Euro
will rise in value against the U.S. dollar.
(b) The Financial Institution is net short in the Euro and therefore faces the risk that the Euro
will fall in value against the U.S. dollar.
(c) The Financial Institution is net long in the Euro and therefore faces the risk that the Euro will
fall in value against the U.S. dollar.
(d) The Financial Institution is net long in the Euro and therefore faces the risk that the Euro will
rise in value against the U.S. dollar.
(e) The Financial Institution has a balanced position in the Euro.

Answer 20

The Financial Institution is net short in the Euro and therefore faces the risk that the Euro
will rise in value against the U.S. dollar.