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Financial Institutions Management A Risk Management Approach 8th edition Marcia Cornett, Patricia McGraw, Anthony Saunders - Solutions
What are some of the risks inherent in being the first to introduce a financial innovation?
The operations department of a major FI is planning to reorganize several of its back-office functions. Its current operating expense is $1.5 million, of which $1 million is for staff expenses. The FI uses a 12 percent cost of capital to evaluate cost-saving projects.a. One way of reorganizing is
City Bank upgrades its computer equipment every five years to keep up with changes in technology. Its next upgrade is two years from today and is budgeted to cost $1 million. Management is considering moving up the date by two years to install some new computers with breakthrough software that
Identify and discuss three benefits of technology in generating revenue for FIs?
Distinguish between economies of scale and economies of scope.
What information on the operating costs of FIs does the measurement of economies of scale provide? If economies of scale exist, what implications do they have for regulators?
What are the benefits and costs to an FI of holding large amounts of liquid assets? Why are Treasury securities considered good examples of liquid assets?
The average daily net transaction accounts deposit balance of a local bank during the most recent reserve computation period is $325 million. The amount of average daily reserves at the Fed during the reserve maintenance period is $24.60 million, and the average daily vault cash corresponding to
The following net transaction accounts and cash reserves at the Fed have been documented by a bank for computation of its reserve requirements (in millions) under lagged reserve accounting.The average vault cash for the computation period has been estimated to be $1 million per day. a. What level
In July of 1998 the lagged reserve accounting (LRA) system replaced a contemporaneous reserve accounting (CRA) system as the method of reserve calculation for DIs. a. Contrast a contemporaneous reserve accounting (CRA) system with a lagged reserve accounting (LRA) system.b. Under which accounting
What is the “weekend game”? Contrast the DI's ability and incentive to play the weekend game under LRA as opposed to CRA.
Under CRA, when is the uncertainty about the reserve requirement resolved? Discuss the feasibility of making large reserve adjustments during this period of complete information.
An FI has estimated the following annual costs for its demand deposits: management cost per account = $140, average account size = $1,500, average number of checks processed per account per month = 75, cost of clearing a check = $0.10, fees charged to customer per check = $0.05, and average fee
A NOW account requires a minimum balance of $750 for interest to be earned at an annual rate of 4 percent. An account holder has maintained an average balance of $500 for the first six months and $1,000 for the remaining six months. The account holder writes an average of 60 checks per month and
Rank the following liabilities, with respect, first, to funding risk and second to funding cost:
How is the withdrawal risk different for federal funds and repurchase agreements?
How is an FI’s liability and liquidity risk management problem related to the maturity of its assets relative to its liabilities?
How does the cash balance, or liquidity, of an FI determine the types of repurchase agreements into which it will enter?
How does the cost of MMMFs differ from the cost of MMDAs? How is the spread useful in managing the withdrawal risk of MMDAs?
Why do wholesale CDs have minimal withdrawal risk to the issuing FI?
What characteristics of fed funds may constrain a DI’s ability to use fed funds to expand its liquidity quickly?
What does a low fed funds rate indicate about the level of DI reserves? Why does the fed funds rate have higher-than-normal variability around the last two days in the reserve maintenance period?
What trends have been observed between 1960 and 2012 in regard to liquidity and liability structures of commercial banks? What changes have occurred in the management of assets that may cause the measured trends to be overstated?
What are the primary methods that insurance companies can use to reduce their exposure to liquidity risk?
Consider the assets (in millions) of two banks, A and B. Both banks are funded by $120 million in deposits and $20 million in equity. Which bank has a stronger liquidity position? Which bank probably has a higher profit?
What concerns motivate regulators to require DIs to hold minimum amounts of liquid assets?
How do liquid asset reserve requirements enhance the implementation of monetary policy? How are reserve requirements a tax on DIs?
Define the reserve computation period, the reserve maintenance period, and the lagged reserve accounting system.
City Bank has estimated that its average daily net transaction accounts deposit balance over the recent 14-day reserve computation period was $225 million. The average daily balance with the Fed over the 14-day maintenance period was $9 million, and the average daily balance of vault cash over the
Assume that the 14-day reserve computation period for problem (8) above extended from May 18 through May 31. a. What is the corresponding reserve maintenance period under the rules effective in 2012?b. Given your answers to parts (a) and (b) of problem (8), what would the average required reserves
What is a contagious run? What are some of the potentially serious adverse social welfare effects of a contagious run? Do all types of FIs face the same risk of contagious runs?
What four factors were provided by FDICIA as guidelines to assist the FDIC in the establishment of risk-based deposit insurance premiums? What happened to the level of deposit insurance premiums in the late 1990s and early 2000s? Why?
What is capital forbearance? How does a policy of forbearance potentially increase the costs of financial distress to the insurance fund as well as the stockholders?
Why did the fixed-rate deposit insurance system fail to induce insured and uninsured depositors to impose discipline on risky DIs in the United States in the 1980s? a. How is it possible to structure deposits in a DI to reduce the effects of the insured ceiling? b. What are brokered deposits? Why
What changes did the Federal Deposit Insurance Reform Act of 2005 make to the deposit insurance cap?
What is the too-big-to-fail doctrine? What factors caused regulators to act in a way that caused this doctrine to evolve?
What are some of the essential features of the FDICIA of 1991 with regard to the resolution of failing DIs? a. What is the least-cost resolution (LCR) strategy? b. When can the systemic risk exemption be used as an exception to the LCR policy of DI closure methods? c. What procedural steps must be
What is the primary goal of the FDIC when employing the LCR strategy?
The following is a balance sheet of a commercial bank (in millions of dollars).The bank experiences a run on its deposits after it declares it will write off $10 million of its loans as a result of nonpayment. The bank has the option of meeting the withdrawals by first drawing down its cash and
A bank with insured deposits of $55 million and uninsured deposits of $45 million has assets valued at only $75 million. What is the cost of failure resolution to insured depositors, uninsured depositors, and the FDIC if an insured depositor transfer method is used?
How does federal deposit insurance help mitigate the problem of bank runs. What other elements of the safety net are available to DIs in the United States?
A commercial bank has $150 million in assets at book value. The insured and uninsured deposits are valued at $75 million and $50 million, respectively, and the book value of equity is $25 million. As a result of loan defaults, the market value of the assets has decreased to $120 million. What is
In what ways did FDICIA enhance the regulatory discipline to help reduce moral hazard behavior? What has the operational impact of these directives been?
Match the following policies with their intended consequences: Policies: a. Lower FDIC insurance levels b. Stricter reporting standards c. Risk-based deposit insurance Consequences: 1. Increased stockholder discipline 2. Increased depositor discipline 3. Increased regulator discipline
How does the Federal Reserve’s discount window serve as an alternative to deposit insurance as a lender of last resort facility to financial institutions? What changes occurred in 2008 that expanded the scope of coverage for the Fed’s discount window?
Why is access to the discount window of the Fed less of a deterrent to bank runs than deposit insurance?
How do insurance guaranty funds differ from deposit insurance? What impact do these differences have on the incentive for insurance policyholders to engage in a contagious run on an insurance company?
What was the purpose of the establishment of the Pension Benefit Guaranty Corporation (PBGC)?PBGC was established to protect pension benefits from the underfunding of pension plans by corporations.a. How does the PBGC differ from the FDIC in its ability to control risk?b. How were the 1994
Under the Federal Deposit Insurance Reform Act of 2005, how is a Category I deposit insurance premium determined?
Webb Bank has a composite CAMELS rating of 2, a total risk-based capital ratio of 10.2 percent, a Tier I risk-based capital ratio of 5.2 percent, and a Tier I leverage ratio of 4.8 percent. What deposit insurance risk category does the bank fall into, and what is the bank’s deposit insurance
What major changes did the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 make to the FDIC and the FSLIC?
Million Bank has a composite CAMELS rating of 2, a total risk-based capital ratio of 9.8 percent, a Tier I risk-based capital ratio of 5.8 percent, and a Tier I leverage ratio of 4.9 percent. The average total assets of the bank equal $500 million and average Tier I equity equal $24.5 million. What
Two depository institutions have composite CAMELS ratings of 1 or 2 and are “well capitalized.” Thus, each institution falls into the FDIC Risk Category I deposit insurance assessment scheme. Further, the institutions have the following financial ratios and CAMELS ratings:Calculate the initial
Contrast the two views on, or reasons why, depository institution insurance funds can become insolvent.
What is moral hazard? How did the fixed-rate deposit insurance program of the FDIC contribute to the moral hazard problem of the savings association industry? What other changes in the savings association environment during the 1980s encouraged the developing instability of the industry?
How does a risk-based insurance program solve the moral hazard problem of excessive risk taking by FIs? Is an actuarially fair premium for deposit insurance always consistent with a competitive banking system?
What are three suggested ways a deposit insurance contract could be structured to reduce moral hazard behavior?
What are some ways of imposing stockholder discipline to prevent FI managers from engaging in excessive risk taking?
How is the provision of deposit insurance by the FDIC similar to the FDIC’s writing a put option on the assets of a DI that buys the insurance? What two factors drive the premium of the option?
A bank's balance sheet information is shown below (in $000).1. What is the bank's risk-adjusted asset base under Basel III?2. To be adequately capitalized, what are the bank's CET1, Tier I, and total risk-based capital requirements under Basel III?3. Using the leverage ratio requirement, what is
Identify and briefly discuss the importance of the five functions of an FI’s capital?
What are the definitional differences between CET1, Tier I and Tier II capital?
What are the credit risk-adjusted assets in the denominator of the common equity Tier I (CET1) risk-based capital ratio, the Tier I risk-based capital ratio, and the total risk-based capital ratio?
How is the leverage ratio for an FI defined?
Explain the process of calculating credit risk-adjusted on-balance-sheet assets.
Why are regulators concerned with the levels of capital held by an FI compared with those held by a nonfinancial institution?
What is the countercylical capital buffer? If the home country set a countercyclical capital buffer of 1.5 percent, how would this buffer affect your answers to question 18?
Explain the process of calculating risk-adjusted off-balance-sheet contingent guaranty contracts? The first step is to convert the off-balance-sheet items to credit equivalent amounts of an on-balance-sheet item by multiplying the notional amounts by an appropriate conversion factor as given in
Explain how off-balance-sheet market contracts, or derivative instruments, differ from contingent guaranty contracts.Off-balance-sheet contingent guaranty contracts in effect are forms of insurance that FIs sell to assist customers in the financial management of the customers’ businesses. FI
What are G-SIBs? How do capital ratio requirements differ for these FIs?
Identify and discuss the problems in the risk-based capital approach to measuring capital adequacy.
What is the contribution to the credit risk-adjusted asset base of the following items under Basel III requirements?
How does the leverage ratio test impact the stringency of regulatory monitoring of DI capital positions?
Third Bank has the following balance sheet (in millions), with the risk weights in parentheses.The cumulative preferred stock is qualifying and perpetual. In addition, the bank has $30 million in performance-related standby letters of credit (SLCs) to a public corporation, $40 million in two-year
Third Fifth Bank has the following balance sheet (in millions), with the risk weights in parentheses.In addition, the bank has $20 million in commercial direct-credit substitute standby letters of credit to a public corporation and $40 million in 10-year FX forward contracts that are in the money
What is the difference between the economic definition of capital and the book value definition of capital? a. How does economic value accounting recognize the adverse effects of credit risk? b. How does book value accounting recognize the adverse effects of credit risk?
According to SEC Rule 15C 3-1, what adjustments must securities firms make in the calculation of the book value of net worth?
A securities firm has the following balance sheet (in millions):The debt securities have a coupon rate of 6 percent, 20 years remaining until maturity, and trade at a yield of 8 percent. The equity securities have a market value equal to book value, and the other assets represent building and
An investment bank specializing in fixed-income assets has the following balance sheet (in millions). Amounts are in market values, and all interest rates are annual unless indicated otherwise.Assume that the haircut for all assets is 15 basis points and for all liabilities, 25 basis points (per
Identify and define the five risk categories incorporated into the life insurance risk-based capital model.
A life insurance company has estimated capital requirements for each of the following risk classes: asset risk-affiliate (C0) = $2 million, asset risk-other (C1) = $5 million, insurance risk (C2) = $4 million, interest rate, credit, market risk (C3) = $1 million, and business risk (C4) = $3
How do the risk categories in the risk-based capital model for property-casualty insurance companies differ from those of life insurance companies? What are the assumed relationships between the risk categories in the model?
A property-casualty insurance company has estimated the following required charges for its various risk classes (in millions):a. What is the RBC charge as per the model recommended by the NAIC?b. If the firm currently has $7 million in capital, what should be its surplus to meet the minimum capital
Why is the market value of equity a better measure of an FI's ability to absorb losses than book value of equity?
State Bank has the following year-end balance sheet (in millions):The loans primarily are fixed-rate, medium-term loans, while the deposits are either short-term or variable-rate deposits. Rising interest rates have caused the failure of a key industrial company, and as a result, 3 percent of the
What are the arguments for and against the use of market value accounting for DIs?
What are the major features of the Basel III capital requirements?
How does product segmentation reduce the profitability and risk of FIs? How does it increase the profitability and risk of FIs?
A Section 20 affiliate agrees to underwrite a debt issue for one of its clients. It has suggested a firm commitment offering for issuing 100,000 shares of stock. The FI quotes a bid-ask spread of $97-$97.50 to its customer on the issue date.a. What are the total underwriting fees generated if all
What are three ways that the failure of a securities affiliate in a holding company organizational form could negatively affect a bank affiliate? How has the Fed attempted to prevent a breakdown of the firewalls between bank and nonbank affiliates in these situations?
What role does bank activity diversification play in the ability of a bank to exploit economies of scale and scope? What remains as the limitation to creating potentially greater benefits?
What six conflicts of interest have been identified as potential roadblocks to the expansion of banking powers into the financial services area?
Under what circumstances could the existence of deposit insurance provide an advantage to banks in competing with other traditional securities firms?
In what ways does the current regulatory structure argue against providing additional securities powers to the banking industry? Does this issue concern only banks?
How do limitations on domestic geographic diversification affect an FI’s profitability?
In what way did the Garn-St. Germain Act and FIRREA provide incentives for the expansion of interstate branching?
What is an interstate banking pact?
What general prohibition regarding the activities of commercial banking and investment banking did the Glass-Steagall Act impose?
How did the provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 allow for full interstate banking? What are the expected profit performance effects of interstate banking? What has been the impact on the structure of the banking and financial services industry?
What cost synergies may be obtained by an FI from domestic geographic expansion?
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