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Financial Institutions Management A Risk Management Approach 8th edition Marcia Cornett, Patricia McGraw, Anthony Saunders - Solutions

What is the difference between debt rescheduling and debt repudiation?
Which variables typically are negotiation points in a multiyear restructuring agreement (MYRA)? How do changes in these variables provide benefits to the borrower and to the lender?
How would the restructuring, such as rescheduling, of sovereign bonds affect the interest rate risk of the bonds? Is it possible that such restructuring would cause the FI’s cost of capital to not change? Explain.
A bank is in the process of renegotiating a sovereign loan. The principal outstanding is $50 million and is to be paid back in two installments of $25 million each, plus interest of 8 percent. The new terms will stretch the loan out to five years with only interest payments of 6 percent, no
A bank is in the process of renegotiating a three-year nonamortizing loan. The principal outstanding is $20 million, and the interest rate is 8 percent. The new terms will extend the loan to 10 years at a new interest rate of 6 percent. The cost of funds for the bank is 7 percent for both the old
A $20 million loan outstanding to the Nigerian government is currently in arrears with City Bank. After extensive negotiations, City Bank agrees to reduce the interest rates from 10 percent to 6 percent and to lengthen the maturity of the loan to 10 years from the present 5 years remaining to
A bank was expecting to receive $100,000 from a loan issued to the Spanish government. Since Spain has problems repaying the loan immediately, the bank extends the loan for another year at the same interest rate of 10 percent. However, in the rescheduling agreement, the bank reserves the right to
What are the major benefits and costs of loan sales to an FI?
What are the major costs and benefits of converting loans to bonds for an FI?
Identify and explain at least four reasons that rescheduling debt in the form of loans is easier than rescheduling debt in the form of bonds.
What three country risk assessment models are available to investors? How is each model compiled?
What types of variables normally are used in a CRA Z score model? Define the following ratios and explain how each is interpreted in assessing the probability of rescheduling.
An FI manager has calculated the following values and weights to assess the credit risk and likelihood of having to reschedule a loan. From the Z-score calculated using these weights and values, is the manager likely to approve the loan?
Countries A and B have exports of $2 billion and $6 billion, respectively. The total interest and amortization on foreign loans for both countries are $1 billion and $2 billion, respectively.a. What is the debt service ratio (DSR) for each country?b. Based only on this ratio, to which country
How do price and quantity risks affect the variability of a country’s export revenue?
Explain the following relation: p = f (IR, INVR) +, + or - p = Probability of rescheduling IR = Total imports/Total foreign exchange reserves INVR = Real investment/GNP
An FI wants to obtain the DEAR on its trading portfolio. The portfolio consists of the following securities.Fixed-income securities:i) The FI has a $1 million position in a six-year zero bonds with a face value of $1,543,302. The bond is trading at a yield to maturity of 7.50 percent. The
What is meant by market risk?
Bank Beta has an inventory of AAA-rated, 10-year zero-coupon bonds with a face value of $100 million. The modified duration of these bonds is 12.5 years, the DEAR is $2,150,000, and the potential adverse move in yields is 35 basis points. What is the market value of the bonds, the yield on the
Bank Two has a portfolio of bonds with a market value of $200 million. The bonds have an estimated price volatility of 0.95 percent. What are the DEAR and the 10-day VAR for these bonds?
Suppose that an FI has a €1.6 million long trading position in spot euros at the close of business on a particular day. Looking back at the daily percentage changes in the exchange rate of the €/$ for the past year, the volatility or standard deviation (σ) of daily percentage changes in the
Bank of Southern Vermont has determined that its inventory of 20 million euros (€) and 25 million British pounds (£) is subject to market risk. The spot exchange rates are $1.25/€ and $1.60/£, respectively. The σ’s of the spot exchange rates of the € and £, based on the daily changes of
Bank of Bentley has determined that its inventory of yen (¥) and Swiss franc (SF) denominated securities is subject to market risk. The spot exchange rates are ¥80.00/$ and SF0.9600/$, respectively. The σ’s of the spot exchange rates of the ¥ and SF, based on the daily changes of spot rates
Suppose that an FI holds a $15 million trading position in stocks that reflect the U.S. stock market index (e.g., the S&P 500). Over the last year, the σm of the daily returns on the stock market index was 156 bp. Calculate the DEAR for this portfolio of stocks using a 99 percent confidence limit.
Bank of Alaska’s stock portfolio has a market value of $10 million. The beta of the portfolio approximates the market portfolio, whose standard deviation ((m) has been estimated at 1.5 percent. What is the five-day VAR of this portfolio using adverse rate changes in the 99th percentile?
Jeff Resnick, vice president of operations at Choice Bank, is estimating the aggregate daily DEAR of the bank’s portfolio of assets consisting of loans (L), foreign currencies (FX), and common stock (EQ). The individual DEARs are $300,700, $274,000, and $126,700 respectively. If the correlation
Calculate the DEAR for the following portfolio with the correlation coefficients and then with perfect positive correlation between various asset groups.What is the amount of risk reduction resulting from the lack of perfect positive correlation between the various assets groups?
What are the advantages of using the back simulation approach to estimate market risk? Explain how this approach would be implemented.
Why is the measurement of market risk important to the manager of a financial institution?
Export Bank has a trading position in Japanese yen and Swiss francs. At the close of business on February 4, the bank had ¥300 million and SF10 million. The exchange rates for the most recent six days are given below:a. What is the foreign exchange (FX) position in dollar equivalents using the FX
Export Bank has a trading position in euros and Australian dollars. At the close of business on October 20, the bank had ‚¬20 million and A$30 million. The exchange rates for the most recent six days are given below:a. What is the foreign exchange (FX) position in dollar equivalents using the FX
What is the primary disadvantage to the back simulation approach in measuring market risk? What effect does the inclusion of more observation days have as a remedy for this disadvantage? What other remedies can be used to deal with the disadvantage?
How is Monte Carlo simulation useful in addressing the disadvantages of back simulation? What is the primary statistical assumption underlying its use?
What is the difference between VAR and expected shortfall (ES) as measure of market risk?
Consider the following discrete probability distribution of payoffs for two securities, A and B, held in the trading portfolio of an FI:Which of the two securities will add more market risk to the FI€™s trading portfolio according to the VAR and ES measures?
Consider the following discrete probability distribution of payoffs for two securities, A and B, held in the trading portfolio of an FI:Which of the two securities will add more market risk to the FI's trading portfolio according to the VAR and ES measures?
An FI has ₤5 million in its trading portfolio on the close of business on a particular day. The current exchange rate of pounds for dollars is ₤0.6400/$, or dollars for pounds is $1.5625, at the daily close. The volatility, or standard deviation (σ), of daily percentage changes in the spot
An FI has ¥500 million in its trading portfolio on the close of business on a particular day. The current exchange rate of yen for dollars is ¥80.00/$, or dollars for yen is $0.0125, at the daily close. The volatility, or standard deviation (σ), of daily percentage changes in the spot ¥/$
Bank of Hawaii’s stock portfolio has a market value of $250 million. The beta of the portfolio approximates the market portfolio, whose standard deviation ((m) has been estimated at 2.25 percent. What are the five-day VAR and ES of this portfolio using adverse rate changes in the 99th percentile?
What is meant by daily earnings at risk (DEAR)? What are the three measurable components? What is the price volatility component?
Despite the fact that market risk capital requirements have been imposed on FIs since the 1990s, huge losses in value were recorded from losses incurred in FIs’ trading portfolios. Why did this happen? What changes to capital requirements did regulators propose to prevent such losses from
In its trading portfolio, an FI holds 10,000 Exxon Mobil (XOM) shares at a share price of $86.50 and has sold 5,000 General Electric (GE) shares under a forward contract that matures in one year. The current share price for GE is $20.50. The shift risk factor (i.e., standard deviation) for level 1
In its trading portfolio, a U.S. FI is long ₤20 million worth of pound FX forward contracts and has sold €40 million of euro FX forward contracts that mature in one year. The current exchange rate of dollars for pounds is $1.5625 and the exchange rate of euros for pounds is $1.25 at the daily
Suppose an FI’s portfolio VAR for the previous 60 days was $3 million and stressed VAR for the previous 60 days was $8 million using the 1 percent worst case (or 99th percentile). Calculate the minimum capital charge for market risk for this FI.
Follow Bank has a $1 million position in a five-year, zero-coupon bond with a face value of $1,402,552. The bond is trading at a yield to maturity of 7.00 percent. The historical mean change in daily yields is 0.0 percent and the standard deviation is 12 basis points.a. What is the modified
How can DEAR be adjusted to account for potential losses over multiple days? What would be the VAR for the bond in problem 4 for a 10-day period? What statistical assumption is needed for this calculation? Could this treatment be critical?
The DEAR for a bank is $8,500. What is the VAR for a 10-day period? A 20-day period? Why is the VAR for a 20-day period not twice as much as that for a 10-day period?
The mean change in the daily yields of a 15-year, zero-coupon bond has been five basis points (bp) over the past year with a standard deviation of 15 bp. Use these data and assume that the yield changes are normally distributed.a. What is the highest yield change expected if a 99 percent confidence
In what sense is duration a measure of market risk?
Bank Alpha has an inventory of AAA-rated, 15-year zero-coupon bonds with a face value of $400 million. The bonds currently are yielding 9.5 percent in the over-the-counter market.a. What is the modified duration of these bonds?b. What is the price volatility if the potential adverse move in yields
Dudley National has issued the following off-balance-sheet items: • A one-year loan commitment of $1 million with an up-front fee of 40 basis points. The back-end fee on the unused portion of the commitment is 55 basis points. The bank’s base rate on loans is 8 percent, and loans to this
Classify the following items as (1) On-balance-sheet assets, (2) On-balance-sheet liabilities, (3) Off-balance-sheet assets, (4) Off-balance-sheet liabilities, or (5) Capital account. Classification
Use the following information on a one-year loan commitment to calculate the return on the loan commitment. BR = FI’s base interest on the loans = 8% Φ = Risk premium on loan commitment = 2.5% f1 = Up-front fee on the whole commitment = 25 basis points f2 = Back-end fee on the unused
A FI has issued a one-year loan commitment of $2 million for an up-front fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FI’s base rate on loans is 7.5 percent and loans to this customer carry a risk premium of 2.5 percent. The FI requires
Suburb Bank has issued a one-year loan commitment of $10 million for an up-front fee of 50 basis points. The back-end fee on the unused portion of the commitment is 20 basis points. The bank’s base rate on loans is 7 percent, and loans to this customer carry a risk premium of 2 percent. The bank
How is an FI exposed to interest rate risk when it makes loan commitments? In what way can an FI control for this risk? How does basis risk affect the implementation of the control for interest rate risk?
How is an FI exposed to credit risk when it makes loan commitments? How is credit risk related to interest rate risk? What control measure is available to an FI for the purpose of protecting against credit risk? What is the realistic opportunity to implement this control feature?
How is an FI exposed to takedown risk and aggregate funding risk? How are these two contingent risks related?
Do the contingent risks of interest rate, takedown, credit, and aggregate funding tend to increase the insolvency risk of an FI? Why or why not?
What is a letter of credit? How is a letter of credit like an insurance contract?
A German bank issues a three-month letter of credit on behalf of its German customer who is planning to import $100,000 worth of goods from the United States. The bank charges an up-front fee of 100 basis points. a. What up-front fee does the bank earn? How is this fee recorded on the bank’s
How do standby letters of credit differ from commercial letters of credit? With what other types of FI products do SLCs compete? What types of FIs can issue SLCs?
How does one distinguish between an off-balance-sheet asset and an off-balance-sheet liability?
A corporation is planning to issue $1 million of 270-day commercial paper for an effective yield of 5 percent. The corporation expects to save 30 basis points on the interest rate by using either an SLC or a loan commitment as collateral for the issue.a. What are the net savings to the corporation
Explain how the use of derivative contracts such as forwards, futures, swaps, and options creates contingent credit risk for an FI. Why do OTC contracts carry more contingent credit risk than do exchange-traded contracts? How is the default risk of OTC contracts related to the time to maturity and
What is meant by when-issued trading? Explain how forward purchases of when-issued government T-Bills can expose FIs to contingent interest rate risk.
Distinguish between loan sales with and without recourse. Why would FIs want to sell loans with recourse? Explain how loan sales can leave FIs exposed to contingent interest rate risks.
The manager of Shakey Bank sends a $2 million funds transfer payment message via CHIPS to the Trust Bank at 10 AM. Trust Bank sends a $2 million funds transfer message via CHIPS to Hope Bank later that same day. What type of risk is inherent in this transaction? How will the risk become reality?
Explain how settlement risk is incurred in the interbank payment mechanism and how it is another form of off-balance-sheet risk.
What is the difference between a one-bank holding company and a multibank holding company? How does the principle of corporate separateness ensure that a bank is safe from the failure of its affiliates?
Discuss how the failure of an affiliate can affect the holding company or its affiliates even if the affiliates are structured separately.
Discuss how the failure of an affiliate can affect the holding company or its affiliates even if the affiliates are structured separately. Discuss.
Defend the statement that although off-balance-sheet activities expose FIs to several forms of risks, they also can alleviate the risks of FIs.
Contingent Bank has the following balance sheet in market value terms (in millions of dollars):
Why are contingent assets and liabilities like options? What is meant by the delta of an option? What is meant by the term notional value?
An FI has purchased options on bonds with a notional value of $500 million and has sold options on bonds with a notional value of $400 million. The purchased options have a delta of 0.25 and the sold options have a delta of 0.30. What is (a) The contingent asset value of this position, (b) The
What factors explain the growth of off-balance-sheet activities in the 1980s through the 2000s among U.S. FIs?
What role does Schedule L play in reporting off-balance-sheet activities? Refer to Table 16-4. What was the annual growth rate over the 21-year period 1992-2012 in the notional value of off-balance-sheet items compared with on-balance-sheet items? Which contingencies have exhibited the most rapid
What are the characteristics of a loan commitment that an FI may make to a customer? In what manner and to whom is the commitment an option? What are the various possible pieces of the option premium? When does the option or commitment become an on-balance-sheet item for the FI and the borrower?
A FI makes a loan commitment of $2.5 million with an up-front fee of 50 basis points and a back-end fee of 25 basis points on the unused portion of the loan. The takedown on the loan is 50 percent and takedown occurs at the beginning of the year. a. What total fees does the FI earn when the loan
Explain how technological improvements can increase an FI’s interest and noninterest income and reduce interest and noninterest expenses. Use some specific examples.
What are diseconomies of scale? What are the risks of large-scale technological investments, especially to large FIs? Why are small FIs willing to outsource production to large FIs against which they are competing? Why are large FIs willing to accept outsourced production from smaller FI
What information on the operating costs of FIs is provided by the measurement of economies of scope? What implications do economies of scope have for regulators?
Buy Bank had $130 million in assets and $20 million in expenses before the acquisition of Sell Bank, which had assets of $50 million and expenses of $10 million. After the merger, the bank had $180 million in assets and $35 million in costs. Did this acquisition generate either economies of scale
A commercial bank with assets of $2 billion and expenses of $200 million has acquired an investment banking firm subsidiary with assets of $40 million and expenses of $15 million. After the acquisition, the expenses of the bank are $180 million and the expenses of the subsidiary are $20 million.
What are diseconomies of scope? How could diseconomies of scope occur?
A survey of a local market has provided the following average cost data: Mortgage Bank A (MBA) has assets of $3 million and an average cost of 20 percent. Life Insurance Company B (LICB) has assets of $4 million and an average cost of 30 percent. Corporate Pension Fund C (CPFC) has assets of $4
What is the difference between the production approach and the intermediation approach to estimating costs functions of FIs?
What are some of the conclusions of empirical studies on economies of scale and scope? How important is the impact of cost reductions on total average costs? What are X-inefficiencies? What role do these factors play in explaining cost differences among FIs?
Why does the United States lag behind most other industrialized countries in the proportion of annual electronic noncash transactions per capita? What factors probably will be important in causing the gap to decrease?
What are the differences between the Fedwire and CHIPS payment systems?
Table 17-1 shows data on earnings, expenses, and assets for all insured banks. Calculate the annual growth rates in the various income, expense, earnings, and asset categories from 1991 to 2010. If part of the growth rates in assets, earnings, and expenses can be attributed to technological change,
What is a daylight overdraft? How do an FI’s overdraft risks incurred during the day differ for each of the two competing electronic payment systems, Fedwire and CHIPS? What provision has been taken by the members of CHIPS to introduce an element of insurance against the settlement risk problem?
How does Regulation F of the 1991 FDICIA reduce the problem of daylight overdraft risk?
Why do FIs in the United States face a higher degree of international technology risk than do the FIs in other countries?
What has been the impact of rapid technological improvements in the electronic payment systems on crime and fraud risk?
What are usury ceilings? How does technology create regulatory risk?
How has technology altered the competition risk of FIs?
What actions has the BIS taken to protect depository institutions from insolvency due to operational risk?
Compare the effects of technology on an FI’s wholesale operations with the effects of technology on an FI’s retail operations. Give some specific examples.

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