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financial institutions management
Financial Institutions Management A Risk Management 4th Edition Helen Lange, Anthony Saunders, Marcia Millon Cornett - Solutions
1.Discuss the risks faced by FIs with the growth of electronic payment systems.
1.Describe the basic principles behind the production approach to testing for economies of scale and economies of scope.
1.Make a list of the potential economies of scope or cost synergies if a bank merged with a fund manager.
1.If there are diseconomies of scope, do specialised FIs have a relative cost advantage or disadvantage over product-diversified FIs?
1.What are some of the technological services in banking that may have contributed to the generation of fee revenues for FIs?
1.Go to the RBA website and find from RBA Statistical Table B4 the total amount of unused commitments and letters of credit, and the notional value of interest rate swaps of Australian banks for the most recent period available. LO 16.1 , 16.4
1.Defend the statement that although OBS activities expose FIs to several forms of risks, they also can alleviate the risks of FIs. LO 16.5
1.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. LO 16.3 , 16.4
1.What is meant by when-issued trading? Explain how forward purchases of when-issued government Treasury securities can expose FIs to contingent interest rate risk. LO 16.3 , 16.4
1.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
1.A corporation is planning to issue $1 million of 270-day commercial paper for an effective yield of 5 per cent. 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.What are the net savings to the corporation
1.How do standby letters of credit differ from documentary letters of credit? With what other types of FI products do SLCs compete? What types of FIs can issue SLCs? LO 16.4
1.A German bank issues a three-month letter of credit on behalf of its customer in Germany, who is planning to import $100 000 worth of goods from Australia. It charges an upfront fee of 100 basis points.What upfront fee does the bank earn?If the Australian exporter decides to discount this letter
1.What is a letter of credit? How is a letter of credit like an insurance contract? LO 16.4
1.Do the contingent risks of interest rate, drawdown, credit and aggregate funding tend to increase the insolvency risk of an FI? Why or why not? LO 16.3
1.How is an FI exposed to drawdown risk and aggregate funding risk? How are these two contingent risks related? LO 16.3
1.How is the 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? LO 16.3 , 16.4
1.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? LO 16.3 , 16.4
1.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 requires a compensating balance of 10 per cent to be placed in demand deposits, has a cost of funds of 7
1.An FI has issued a one-year loan commitment of $2 million for an upfront fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FI requires a compensating balance of 5 per cent as demand deposits. The FI’s cost of funds is 6 per cent, the
1.An FI makes a loan commitment of $2.5 million with an upfront fee of 50 basis points and a back-end fee of 25 basis points on the unused portion of the loan. The drawdown on the loan is 50 per cent and drawdown occurs at the beginning of the year.What total fees does the FI earn when the loan
1.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?
1.What factors explain the growth of FI OBS activities from the 1980s up to the early 2000s? LO 16.2
1.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
1.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’? LO 16.1 , 16.2
1.Contingent Bank has the following balance sheet in market value terms (in millions of dollars):In addition, the bank has contingent assets with $100 million market value and contingent liabilities with $80 million market value. What is the true stockholder net worth? What does the term
1.How does one distinguish between an OBS asset and an OBS liability? LO 16.1
1.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 accounts:Loan commitments Loan loss reserves Letters of credit Bankers’ acceptance (BA)Rediscounted bankers’ acceptance
1.Other than hedging and speculation what reasons do FIs have for engaging in OBS activities?
1.While recognising that OBS instruments may add to the riskiness of an FI’s activities, explain how they also work to reduce the overall insolvency risk of FIs.
1.How can option pricing theory be used to price OBS assets and liabilities?
1.Define ‘contingent asset’ and ‘contingent liability’.
1.Go to the website for the Reserve Bank of Australia and find the latest list of ‘eligible securities’ that an Australian DI can use for any repo transaction with the RBA. Also note any conditions of use for the securities (www.rba.gov.au/mkt-operations/tech-notes/eligible-securities.html ).
1.Look up the website of National Australia Bank (www.nab.com.au ) or another large bank and click on ‘Shareholder Centre’. Click ‘Annual reports’, and select the latest annual report (also downloadable in a PDF form).Scroll through to see what the bank has to say about its liquidity
1.How do deposit insurance and deposit guarantees help mitigate the problem of bank runs and what schemes are available in Australia to protect DI deposits? LO 15.8
1.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? LO 15.7
1.Briefly explain the approach taken to liquidity management by APRA in its role as prudential supervisor of DIs. LO 15.5 , 15.7
1.How does the cash balance, or liquidity, of an FI determine the types of repurchase agreement into which it will enter? LO 15.4
1.How is the withdrawal risk different for interbank funds and repurchase agreements? LO 15.4
1.A cheque account requires a minimum balance of $750 for interest to be earned at an annual rate of 4 per cent. An account holder has maintained an average balance of $500 for the first six months and $1000 for the remaining six months. The account holder writes an average of 60 cheques per month
1.An FI has estimated the following annual costs for its demand deposits: management cost per account = $140, average account size = $1500, average number of cheques processed per account per month = 75, cost of clearing a cheque = $0.10, fees charged to customer per cheque = $0.05 and average fee
1.What is the relationship between funding cost and funding or withdrawal risk? LO 15.4
1.Suppose a bank wishes to raise $20 million in deposits to cover lending projections for the next quarter. It can raise the funds through fixed-term deposits at an interest rate of 6 per cent or through variable-rate savings accounts at an interest rate of 4 per cent. The bank currently has $100
1.Calculate the average implicit interest rate on the following non-interest-bearing accounts:A $1 million account with average management costs of $150 000 and fees earned of $35 000.A $150 000 account with average management costs of $25 000 and fees earned of $5000.A $1000 account with average
1.How can liquidity and interest rate risk management objectives conflict in a DI? Where possible, provide examples. Are these conflicts resolvable?Explain. LO 15.1
1.Discuss the risks and returns associated with using liability management to meet liquidity needs.Suppose the manager of a DI’s liquid assets portfolio anticipates that interest rates will rise over the next few years. How might this manager structure the liquid assets portfolio to take
1.Outline the main features of exchange settlement accounts and identify the safety valves used by the RBA to assist DIs to maintain their exchange settlement accounts. LO 15.2 , 15.6
1.Rank these financial assets according to their liquidity: cash, corporate bonds, ASX-traded stocks, and T-notes. LO 15.1 , 15.2
1.How do liquid asset reserve requirements enhance the implementation of monetary policy? How are reserve requirements a tax on DIs? LO 15.2
1.What concerns motivate regulators to require DIs to hold minimum amounts of liquid assets? LO 15.5
1.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 the stronger liquidity position? Which bank probably has a higher profit? LO 15.1 , 15.2 Bank A assets Cash Bank Bassets 10 Cash 20 Treasury
1.How is an FI’s liability and liquidity risk management problem related to the maturity of its assets relative to its liabilities? LO 15.1
1.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? LO 15.1
1.The Guarantee Scheme for Large Deposits and Wholesale Funding was a temporary scheme. Why was it introduced, and why was it subsequently withdrawn?
1.What are the key features of the depository institution Financial Claims Scheme?
1.Why did the Australian government’s approach to deposit protection change from implicit to explicit deposit guarantees?
1.What are the costs and benefits of the Basel III regulatory reforms?
1.How will the Basel III liquidity reforms complement the APS 210 liquidity regulation?
1.What are the two parts of the new Basel III liquidity reforms and how do their objectives differ?
1.What are the advantages and disadvantages of the use of scenario analysis for liquidity needs measurement?
1.What are the major differences between interbank funds and repurchase agreements?
1.Which deposit accounts are the most costly for FIs?
1.Which deposit accounts provide the least withdrawal risk for FIs?
1.What has affected the reliance on foreign funding of Australian banks since 1990?
1.Describe the changes in the liability structure of Australian banks since the mid-2000s.
1.Describe the trade-off faced by a DI manager in structuring the liability side of the balance sheet.
1.What are the four types of liquidity facilities provided by the RBA? When can these be used, and by which institutions?
1.A DI manager who intends to hold liquid assets until their maturity (passive strategy) will also be concerned about an increase in market yields on the assets and/or an unexpected increase in the rate of inflation. Discuss.
1.What are the three main reasons for holding securities portfolios and how are they useful in liquidity management?
1.In general, would it be better to hold three-month Treasury Notes or 10-year Treasury Bonds as buffer assets? Explain.
1.Where do you find ‘liquidity’ in the asset side of an FI’s balance sheet?
1.What are the two main sources of an FI’s liquidity?
1.Go to the Reserve Bank of Australia’s website and update Table 14.1 from Statistics Tables B2 and B3 (Banks’ assets and liabilities). Comment on any changes in balance sheet structure as it relates to liquidity risk. Note the differences when using total assets and liabilities and only
1.A managed fund has $1 million in cash and $9 million invested in securities. It currently has 1 million shares outstanding.What is the net asset value (NAV) of this fund?Assume that some of the unit holders decide to cash in their units of the fund. How many units at its current NAV can the fund
1.A managed fund has the following assets in its portfolio: $40 million in fixed-income securities and $40 million in stocks at current market values. In the event of a liquidity crisis, the fund can sell the assets at 96 per cent of market value if they are disposed of in two days. The fund will
1.How is the liquidity problem faced by managed funds different from that faced by DIs and insurance companies? How does the liquidity risk of an open-end managed fund compare with that of a closed-end fund? LO 14.6 , LO 14.9
1.What are the levels of defence against liquidity risk for a life insurance company? How does liquidity risk for a general insurance company differ from that for a life insurance company? LO 14.9
1.What government safeguards are in place to reduce liquidity risk for DIs? LO 14.8, 14.9
1.The following is the balance sheet of a DI (in millions of dollars):The asset-liability management committee has estimated that the loans, whose average interest rate is 6 per cent and whose average life is three years, will have to be discounted at 10 per cent if they are to be sold in less than
1.What is a bank run? What are some possible withdrawal shocks that could initiate a bank run? What feature of the demand deposit contract provides deposit withdrawal momentum that can result in a bank run? LO 14.6
1.How can an FI’s liquidity plan help reduce the effects of liquidity shortages? What are the components of a liquidity plan? LO 14.5
1.Plainbank has $10 million in cash and equivalents, $30 million in loans and $15 million in core deposits.Calculate the financing gap.What is the financing requirement?How can the financing gap be used in the day-to-day liquidity management of the bank? LO 14.4
1.Conglomerate Corporation has acquired Acme Corporation. To help finance the takeover, Conglomerate will liquidate the over-funded portion of Acme’s superannuation fund. The face values and current and one-year future liquidation values of the assets that will be liquidated are given
1.A DI has the following assets in its portfolio: $20 million in cash reserves with the Reserve Bank, $20 million in T-notes, and $50 million in mortgage loans. If the assets need to be liquidated at short notice, the DI will receive only 99 per cent of the fair market value of the T-bills and 90
1.A DI has $10 million in T-notes, a $5 million line of credit to borrow in the repo market and $5 million in excess cash reserves (above the regulatory reserve requirements). The DI currently has borrowed $6 million in central bank funds and $2 million from the central bank rediscounting facility
1.Define each of the following four measures of liquidity risk. Explain how each measure would be implemented and utilised by a DI:sources and uses of liquidity peer group ratio comparisons liquidity index financing gap and financing requirement. LO 14.4
1.AllStar Bank has the following balance sheet (in millions of dollars):AllStar Bank’s largest customer decides to exercise a $15 million loan commitment. How will the new balance sheet appear if AllStar uses the following liquidity risk strategies:stored liquidity management purchased liquidity
1.A DI with the following balance sheet (in millions of dollars) expects a net deposit drain of $15 million.Show the DI’s balance sheet if the following conditions occur:the DI purchases liabilities to offset this expected drain the reserve-asset adjustment method is used to meet the expected
1.What are two ways in which a DI can offset the effects of asset-side liquidity risk such as the drawing down of a loan commitment? LO 14.3
1.What are two ways in which a DI can offset the liquidity effects of a net deposit drain of funds? How do the two methods differ? What are the operational benefits and costs of each method? LO 14.2, 14.3
1.How is a DI’s distribution pattern of net deposit drains affected by the following:a long weekend the summer holidays a severe economic recession double-digit inflation? LO 14.1, 14.2
1.The probability distribution of the net deposit drain of a DI has been estimated to have a mean of 2 per cent and a standard deviation of 1 per cent. Is this DI increasing or decreasing in size? Explain. LO 14.2
1.What are core deposits? What role do core deposits play in predicting the probability distribution of net deposit drains? LO 14.2
1.What are the two reasons why liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance sheet? What is meant by ‘fire-sale prices’? LO 14.1, 14.3
1.How does the degree of liquidity risk differ for different types of financial institutions? LO 14.1, 14.6
1.How do the incentives of managed fund investors to engage in runs compare with the incentives of DI depositors?
1.What would be the impact on their liquidity needs if DIs offered deposit contracts of an open-ended managed fund type rather than the traditional all or nothing demand deposit contract?
1.Is the liquidity risk of general insurers in general greater or less than that of life insurers?
1.What is the greatest cause of liquidity exposure faced by general insurers?
1.What are the measures of liquidity risk used by FIs?
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