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financial institutions management
Financial Institutions Management A Risk Management 4th Edition Helen Lange, Anthony Saunders, Marcia Millon Cornett - Solutions
1.What is a maturity bucket in the repricing model? Why is the length of time selected for repricing assets and liabilities important when using the repricing model? LO 5.3 1.The repricing model requires specification of repricing buckets. Why must a bucket time period be specified? How does the
1.What is the repricing gap? In using this model to evaluate interest rate risk, what is meant by rate sensitivity? On what financial performance variable does the repricing model focus? Explain. LO 5.3
1.How has the increased level of financial market integration affected interest rates? LO 5.1, 5.2
1.How do monetary policy actions made by the Reserve Bank of Australia impact interest rates? LO 5.1
1.Despite the weaknesses, how is the repricing model useful to FI managers in managing interest rate risk?
1.What are four major problems with the repricing model?
1.What is meant by a ‘runoff’?
1.Summarise the case for and against the inclusion of savings account deposits as a rate-sensitive liability.
1.How can FIs change the size and direction of their repricing gaps quickly?
1.Why is it useful to express the repricing gap in terms of a percentage of assets? What specific information does this provide?
1.Through what mechanisms do RBA decisions impact the market rates of interest?
1.What are the key objectives of the Reserve Bank of Australia when setting monetary policy?
1.Why does the Reserve Bank have to be involved in the first place: why can’t the determination of interest rates be left to the market ?
1.Why does the Reserve Bank have to change interest rates at all: why can’t they be left conptant ?
1.Go to the RBA’s ‘Cash rate target’ web page at www.rba.gov.au/statistics/cash-rate and to the Trading Economics ‘Australian dollar’ web page at www.tradingeconomics.com/australia/currency . Compare the RBS’s target cash rate decisions with the value of the Australian dollar at the
1. Discuss the interrelationships among the different sources of bank risk exposure. Why would the construction of a bank risk-management model to measure and manage only one type of risk be incomplete?
1. Why can insolvency risk be classified as a consequence or outcome of any or all of the other types of risks? LO 4.9
1. What is liquidity risk ? What routine operating factors allow FIs to deal with this risk in times of normal economic activity? What market reality can create severe financial difficulty for an FI in times of extreme liquidity crises? LO 4.6
1. Consider these four types of risks: credit, foreign exchange, market and sovereign. These risks can be separated into two pairs of risk types in which each pair consists of two related risk types, with one being a subset of the other. How would you pair off the risk types, and which risk types
1. Characterise the risk exposure(s) of the following FI transactions (i–vii) by choosing one or more of the risk types listed below:Interest rate risk Credit risk Off-balance-sheet risk Technology risk Foreign exchange rate risk Country or sovereign risk A bank finances a $10 million, six-year
1. What is the difference between technology risk and operational risk ? How does internationalising the payments system among banks increase operational risk? LO 4.8
1. What is technology risk ? What is the difference between economies of scale and economies of scope? How can these economies create benefits for an FI? How can these economies prove harmful to an FI? LO 4.8
1. What is country or sovereign risk ? What remedy does an FI realistically have in the event of a collapsing country or currency? LO 4.4
1. Suppose you purchase a 10-year, AAA-rated Swiss bond for par that is paying an annual coupon of 8 per cent. The bond has a face value of 1000 Swiss francs (SF). The spot rate at the time of purchase is SF1.50/A$1. At the end of the year, the bond is downgraded to AA and the yield increases to 10
1. Six months ago, Qualitybank Ltd issued a $100 million, one-year maturity CD denominated in euro (euro CD). On the same date, $60 million was invested in a euro-denominated loan and A$40 million was invested in an Australian Treasury Bond. The exchange rate on this date was €1.7382/A$1.Assume
1. Assume that a bank has assets located in Singapore that are worth S$150 million, on which it earns an average of 8 per cent per year. The bank has S$100 million in liabilities, on which it pays an average of 6 per cent per year. The current spot rate is S$1.50/A$1.If the exchange rate at the end
1.An Australian insurance company invests $1 million in a private placement of UK bonds. Each bond pays £300 in interest per year for 20 years. If the current exchange rate is £1.7612/A$1, what is the nature of the insurance company’s exchange rate risk? Specifically, what type of exchange rate
1.If an FI has the same amount of foreign assets and foreign liabilities in the same currency, has that FI necessarily reduced to zero the risk involved in these international transactions? Explain. LO 4.5
1.If international capital markets are well integrated and operate efficiently, will FIs be exposed to foreign exchange risk? What are the sources of foreign exchange risk for FIs? LO 4.5
1.If you expect the euro to depreciate in the near future, would an Australian-based FI in Paris prefer to be net long or net short in its asset positions?Discuss. LO 4.5
1.What is foreign exchange risk ? What does it mean for an FI to be net long in foreign assets? What does it mean for an FI to be net short in foreign assets? In each case, what must happen to the foreign exchange rate to cause the FI to suffer losses? LO 4.5
1.What two factors provide potential benefits to FIs that expand their asset holdings and liability funding sources beyond their domestic economies? LO 4.5
1.What is the nature of an off-balance-sheet activity? How does an FI benefit from such activities? Identify the various risks that these activities generate for an FI and explain how these risks can create varying degrees of financial stress for the FI at a later time. LO 4.7
1.Many US banks and savings institutions that failed in the 1980s had made loans to oil companies in Louisiana, Texas and Oklahoma. When oil prices fell, these companies, the three state economies and the banks and savings institutions in these states all experienced financial problems. What types
1.What is the difference between firm-specific credit risk and systematic credit risk ? How can an FI alleviate firm-specific credit risk? LO 4.3
1.What is credit risk ? Which types of FIs are more susceptible to this type of risk? Why? LO 4.3
1.What is market risk ? How do the results of this risk surface in the operating performance of financial institutions? What actions can be taken by an FI’s management to minimise the effects of this risk? LO 4.2
1.A bank invested $50 million in a two-year asset paying 10 per cent interest per annum and simultaneously issued a $50 million, one-year liability paying 8 per cent interest per annum. What will be the impact on the bank’s net interest income if at the end of the first year all interest rates
1.A cash management trust bought $1 million of two-year Treasury Bonds six months ago. During this time, the value of the securities has increased, but for tax reasons the trust wants to postpone any sale for two more months. What type of risk does the trust face for the next two months? LO 4.1
1.Consider again the two bonds in Question 9. If the investment goal is to leave the assets untouched until maturity, such as for a child’s education or for one’s retirement, which of the two bonds has more interest rate risk? What is the source of this risk? LO 4.1
1.Two 10-year bonds are being considered for an investment that may have to be liquidated before the maturity of the bonds. The first bond is a 10-year premium bond with a coupon rate higher than its required rate of return and the second bond is a zero-coupon bond that pays only a lump-sum payment
1.Corporate bonds usually pay interest semi-annually. If a company decided to change from semi-annual to annual interest payments, how would this affect the bond’s interest rate risk? LO 4.1
1.How does the policy of matching the maturities of assets and liabilities work (a) to minimise interest rate risk, and (b) against the asset-transformation function of FIs? LO 4.1
1. A financial institution has the following market value balance sheet structure:The bond has a 10-year maturity and a fixed-rate coupon of 10 per cent. The certificate of deposit has a one-year maturity and a 6 per cent fixed rate of interest. The FI expects no additional asset growth.What will
1. How can interest rate risk adversely affect the economic or market value of an FI? LO 4.1
1. The sales literature of a managed fund claims that the fund has no risk exposure since it invests exclusively in federal government securities which are free of default risk. Is this claim true? Explain why or why not. LO 4.1
1. What is reinvestment risk? How is reinvestment risk part of interest rate risk? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest? An increase in the rate of interest? LO 4.1
1. What is refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest? A decrease in the rate of interest? LO 4.1
1. What is the process of asset transformation performed by a financial institution? Why does this process often lead to the creation of interest rate risk?What is interest rate risk? LO 4.1
1. What are some examples of event and general macroeconomic risks that impact FIs?
1. is meant by the term ‘event risk’?
1. How is insolvency risk related to the other risks discussed in this chapter?
1. When does insolvency risk occur?
1. How does technological expansion help an FI better exploit economies of scale and economies of scope? When might technology risk interfere with these goals?
1. How is operational risk related to technology risk?
1. What is the difference between economies of scale and economies of scope?
1. Why are FIs motivated to pursue off-balance-sheet business? What are the risks?
1. Why are letters of credit off-balance-sheet items?
1.What circumstances might lead an FI to liquidate assets at fire-sale prices?
1.Why might an FI face a sudden liquidity crisis?
1.An Australian bank is net long in Indonesian rupiah assets. If the rupiah appreciates against the Australian dollar, will the bank gain or lose?
1.Explain why the returns on domestic and foreign portfolio investments are not, in general, perfectly correlated.
1.What is one major way in which an FI can discipline a country that threatens not to repay its loans?
1.Can a bank be subject to sovereign risk if it lends only to AAA-rated or the highest quality foreign corporations?
1.How does diversification affect an FI’s credit risk exposure?
1.Why does credit risk exist for FIs?
1.What modern conditions have led to an increase in this particular type of risk for FIs?
1.What is trading or market risk?
1.Explain the concept of maturity matching
1.Why does a rise in the level of interest rates adversely affect the market value of both assets and liabilities?
1.What is refinancing risk?
1.Go to APRA’s website and find the list of registered financial corporations. Try to identify the number of money market corporations that are owned or associated with Australian or foreign banks. LO 3.6
1.Go to the APRA website and find the Guidelines on Authorisation of General Insurers. Identify the key factors determining APRA’s assessment of an application for authorisation. LO 3.3
The total assets of securitisation vehicles equal their total liabilities. Does this mean that securitisation vehicles have no equity? Why is this the case and what is the nature of their liabilities? LO 3.6
What is the main business activity of finance companies? Discuss the changes in the distribution of their activities since the 1980s. LO 3.6
What are merchant banks and why is the term ‘merchant bank’ no longer allowed to be used? LO 3.6
Which institutions make up the ‘shadow banking system’? LO 3.6
How are public unit trusts, life insurance and superannuation similar? LO 3.5
Why has superannuation grown so rapidly in Australia? LO 3.4
What are the key regulators for each of the following: life insurers, general insurers, superannuation funds, managed funds, finance companies? LO 3.2, 3.3, 3.4, 3.6
Why is the structure of the balance sheet of general insurers different to the structure of life office balance sheets? LO 3.2, 3.3
How do general insurance companies earn profits? Use the method by which insurance companies generate profits to explain their investment in high risk securities. LO 3.3
Contrast the balance sheet of DIs with that of a typical life insurance company, a money market company and a managed fund. LO 3.1, 3.2, 3.6
How can you use life insurance and annuity products to create a steady stream of cash disbursements and payments so as to avoid either the payment or the receipt of a single lump sum cash amount? LO 3.2
What are the similarities and differences between the four basic lines of life insurance products? LO 3.2
1.Which of the listed risks are faced by life insurance companies, general insurers, superannuation funds, cash management trusts, money market corporations, finance companies and securitisation vehicles: liquidity risk, operational risk, underwriting risk, interest rate risk, derivative related
1.What is the role of a securitisation vehicle and why was there a significant drop in SPV assets after 2007?
1.What role does APRA play in the supervision of registered financial corporations?
1.Since finance companies seem to compete in the same lending markets as banks, why aren’t they subject to the same regulations as banks?
1.How are the activities of money market companies different from those of banks?
1.How has the rise in superannuation affected the managed funds industry?
1.What is the structure of the Australian managed funds industry?
1.Which agencies regulate superannuation?
1.What risks do superannuation funds face?
1.What is the main role of a superannuation fund?
1.What is the difference between the loss ratio and the expense ratio?
1.Suppose the pure loss ratio is 80 per cent, the underwriting expense ratio is 27 per cent, and investment yields are 11 per cent. Is the general insurer profitable?
1.Why are general insurers’ assets, on average, shorter in maturity than life insurers’ assets?
1.Why do general insurers hold more capital and reserves than life insurers?
1.Why is traditional life insurance in decline?
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