FINAN 420 Ch. 20 Types of Risk Incurred by Financial Institutions Flashcards
What is credit risk in financial institutions?
The risk that promised cash flows from loans or securities may not be paid in full
How do financial institutions manage credit risk?
By charging an interest rate that compensates for risk
Liquidity risk refers to the risk that a financial institution may:
Have to liquidate assets at low prices due to unexpected withdrawals
Which of the following can increase liquidity risk for a financial institution?
The need to sell illiquid assets quickly to meet withdrawals
What is refinancing risk?
The risk that an institution will need to borrow at a higher rate than its asset returns
What happens to a financial institution’s assets when interest rates rise?
Asset prices decrease
Market risk arises from:
Changes in interest rates, exchange rates, and asset prices
Why has market risk become more important for financial institutions?
They are more involved in active trading strategies
What is off-balance-sheet risk?
The risk from contingent assets and liabilities that may later impact the balance sheet
Which of the following is an example of an off-balance-sheet activity?
Issuing a letter of credit
Foreign exchange risk occurs when:
Exchange rate changes affect the value of assets and liabilities in foreign currencies
A financial institution with a net long position in a foreign currency will:
Lose when the foreign currency depreciates
Sovereign risk is the risk that:
A foreign government interferes with debt repayments
How does sovereign risk differ from domestic credit risk?
Foreign borrowers may be unable to pay due to government restrictions
What is technology risk?
The risk that an FI’s technology investments do not generate expected savings
How does fintech risk differ from technology risk?
Fintech risk includes competition from new financial technology firms
Insolvency risk occurs when:
A financial institution cannot offset a decline in asset value with capital
What is one way to reduce insolvency risk?
Maintain a strong capital adequacy ratio
