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financial institutions management
ISE Financial Institutions Management A Risk Management Approach 10th International Edition Anthony Saunders Professor, Marcia Millon Cornett, Otgo Erhemjamts - Solutions
2. If deposit insurance is similar to a put option, who exercises that option?
1. Bank A has a ratio of deposits to assets of 90 percent and a variance of asset returns of 10 percent. Bank B has a ratio of deposits to assets of 85 percent and a variance of asset returns of 5 percent. Which bank should pay the higher insurance premium?
1. Historically, what effect has deposit insurance had on DI panics and runs?
2. Why was interest rate risk less of a problem for banks than for thrifts in the early 1980s?
1. What two basic views are offered to explain why depository institution insurance funds become insolvent?
2. What events brought about the demise of the FSLIC?
1. What events led to Congress’s passing of the FDIC Improvement Act(FDICIA)?
29. Go to the Federal Deposit Insurance Corporation’s website at www.fdic.gov and update Tables 19–5 and 19–6 using the following steps. Click on “Researchers & Analysts.” Click on“Statistics on Depository Institutions.” In the first column, select“Standard Peer Group,” “All
28. What are the primary methods that insurance companies can use to reduce their exposure to liquidity risk?
27. What trends have been observed between 1960 and 2018 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?
26. 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?
25. What characteristics of fed funds may constrain a DI’s ability to use fed funds to expand its liquidity quickly?
24. Why do wholesale CDs have minimal withdrawal risk to the issuing FI?
23. How does the cost of MMMFs differ from the cost of MMDAs?How is the spread useful in managing the withdrawal risk of MMDAs?
22. How does the cash balance, or liquidity, of an FI determine the types of repurchase agreements into which it will enter?
21. How is the withdrawal risk different for federal funds and repurchase agreements?
20. Rank the following liabilities with respect, first, to funding risk and, second, to funding cost.a. Money market deposit account.b. Demand deposits.c. Certificates of deposit.d. Federal funds.e. Bankers’ acceptances.f. NOW accounts.g. Wholesale CDs.h. Passbook savings.i. Repos.j. Commercial
19. 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
18. 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
17. What is the relationship between funding cost and funding or withdrawal risk?
16. 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.
15. What is the “weekend game”? Contrast a DI’s ability and incentive to play the weekend game under LRA as opposed to CRA.
14. In July 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 CRA system with an LRA system.b. Under which accounting system, CRA or LRA, are DI reserves higher? Why?c. Under which
13. If over the first 12 days of the current reserve maintenance period the average daily reserves held by the bank in problem 12 were $56 million (or 12 × $56 m = $672 m cumulative total over the 12 days), what does the bank need to hold as reserves over the last two days to (1) exactly meet the
12. During the two-week period, July 14–27, a bank has an average balance of transactions accounts of $850.55 million. The average balance in the cash account is $19.150 million over this period. The bank is carrying forward a deficit of $1.756 million from the last reserve period. Calculate the
11. Assume that the 14-day reserve computation period for problem 10 above extended from May 18 through May 31.a. What is the corresponding reserve maintenance period under the rules effective in 2018?b. Given your answers to parts (a) and (b) of problem 10, what would the average required reserves
10. City Bank has estimated that its average daily net transaction accounts 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 $7.2 million and the average daily balance of vault cash over the
9. 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
8. The average daily net transaction accounts 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 $21.2 million and the average daily vault cash corresponding to the
7. Define the reserve computation period, the reserve maintenance period, and the lagged reserve accounting system.
6. Rank these financial assets according to their liquidity: cash, corporate bonds, NYSE-traded stocks, and T-bills.
5. How do liquid asset reserve requirements enhance the implementation of monetary policy? How are reserve requirements a tax on DIs?
4. What concerns motivate regulators to require DIs to hold minimum amounts of liquid assets?
3. 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? Bank A Assets Cash Bank B Assets $ 10 Cash $ 20 Treasury securities 40
2. How is an FI’s liability and liquidity risk management problem related to the maturity of its assets relative to its liabilities?
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?
2. Why would property–casualty insurers hold more shortterm liquid assets to manage liquidity risk than life insurers hold?
1. Discuss two strategies insurance companies can use to reduce liquidity risk.
2. Look at Table 19–6. How has the liability composition of banks changed over the 1960–2018 period?
1. Look at Table 19–5. How has the ratio of traditional liquid to illiquid assets changed over the 1960–2018 period?
2. Describe the trade-off faced by an FI manager in structuring the liability side of the balance sheet.
1. How are liquidity and liability management related?
4. What explains the decline in the level of required reserves held by DIs between 1990 and August 2008 and the rise in August of 2009 (see Table 19–3)?
3. Since 1998, U.S. DIs have operated under a lagged reserve accounting system in which the reserve computation period ends 17 days before the reserve maintenance period begins.Does the reserve manager face any uncertainty at all in managing a DI’s reserve position? Explain your answer.
2. For a DI that undershoots its reserve target, what ways are available to a reserve manager to build up reserves to meet the target?
1. In addition to the target reserve ratio, what other pieces of information does a DI reserve manager require to manage the DI’s reserve requirement position?
1. In general, would it be better to hold three-month T-bills or 10-year T-notes as buffer assets? Explain.
2. Can we view reserve requirements as a tax when the consumer price index (CPI) is falling?
1. Why do regulators set minimum liquid asset requirements for FIs?
21. Explain the European Union’s Payment Services Directive 2(PSD2) and how it might benefit the fintechs.
20. Explain the European Union’s General Data Protection Regulation(GDPR) and how it might benefit the fintechs.
19. What is a fintech sandbox?
18. Explain one of the reasons why high-frequency trading (HFT) has hit a speed bump. Do you think fintechs will experience the same difficulties that HFT firms have experienced?
17. What is crowdfunding? Have you used any crowdfunding apps recently?
16. Describe applications of the Internet of things (IoT) in financial services industry.
15. Describe applications of artificial intelligence and machine learning in financial services industry.
14. What is a difference between bitcoin and ethereum?
13. What are the risks associated with DLT?
12. How does distributed ledger technology (DLT) work? What is blockchain?
11. What is fiat currency? Is bitcoin a fiat currency?
10. What are the three purposes of money? Does cryptocurrency fulfill these purposes?
9. What is cryptocurrency? Explain how cryptocurrency differs from cryptoasset.
8. What are peer-to-peer (P2P) payments? What P2P apps have you used recently?
7. What are four categories of fintech innovations according to the Basel Committee of Banking Supervision (BCBS)? Give specific examples for each category of innovation.
6. Describe the advantages and disadvantages of incumbent banks compared to fintechs.
5. Describe the advantages and disadvantages of fintechs compared to incumbent banks.
4. What are the demand factors that contributed to the recent emergence of fintechs?
3. What are the supply factors that contributed to the recent emergence of fintechs?
2. What are fintech risks?
1. Which country has the highest fintech adoption rate?
26. Go to the BIS website at www.bis.org/statistics/payment_stats.htm and find the most recent data on the participation in major payment systems (Table 17–3). Click on “BIS Statistics Explorer.” Click on “United States.” This will bring Table 7 which contains data on participation in
25. Go to the BIS website at www.bis.org/statistics/payment_stats.htm and find the most recent data on the volume and value of payment system transactions in the United States (Table 17–1) using the following steps. Click on “BIS Statistics Explorer.” Click on “United States.”This will
24. What actions has the BIS taken to protect depository institutions from insolvency due to operational risk?
23. How has technology altered the competition risk of FIs?
22. What are usury ceilings? How does technology create regulatory risk?
21. What has been the impact of rapid technological improvements in the electronic payment systems on crime and fraud risk?
20. Why do FIs in the United States face a higher degree of international technology risk than do the FIs in other countries?
19. How does Regulation F of the 1991 FDICIA reduce the problem of daylight overdraft risk?
18. 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
17. What are the differences between the Fedwire and CHIPS payment systems?
16. 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?
15. 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
14. What are diseconomies of scope? How could diseconomies of scope occur?
13. 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
12. 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 expenses. Did this acquisition generate either economies of
11. What information on the operating costs of FIs is provided by the measurement of economies of scope?
10. 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
9. 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?
8. Distinguish between economies of scale and economies of scope.
7. Identify and discuss three benefits of technology in generating revenue for FIs.
6. 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
5. 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
4. What are some of the risks inherent in being the first to introduce a financial innovation?
3. What is technology vendor and third-party risk? What actions have regulators takenwith respect to third-party risk management?
2. What is cybersecurity risk? What are the primary methods of breaching data systems? Use some specific examples.
1. Describe the sources of operational risk. Use some specific examples.
3. What steps have the members of CHIPS taken to lower settlement, or daylight overdraft, risk?
2. Why do daylight overdrafts create more of a risk problem for banks on CHIPS than on Fedwire?
1. Describe the six risks faced by FIs with the growth of wire transfer payment systems.
5. Make a list of the potential economies of scope or cost synergies if a commercial bank merged with an investment bank.
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