Short answer questions ( please one paragraph for each question- each question has up to 4 points).

While recognizing that OBS ( Off- Balance Sheet) instruments may add to the risk of an FIs activities, explain how they also work to reduce the overall insolvency risk of FIsOther than hedging and speculation, what reasons do FIs have for engaging in OBS activities?What is the difference between VAR and ES?, and why ES is superior to VAR as a measure of market risk?Why is duration considered a more complete measure of an assets or liabilitys interest rate sensitivity than maturity?, and when is the duration of an asset equal to its maturity?a- How can FIs change the size and the direction of their repricing gap?

b- Why is it useful to express the repricing gap in terms of a percentage of assets? What specific information does this provide?

Multiple Choice Questions- Please give only one answer for each question -two points each

1.

Why is the failure of a large bank more detrimental to the economy than the failure of a large steel manufacturer?

A. The bank failure usually leads to a government bailout.

B.	There are fewer steel manufacturers than there are banks.

C.	The large bank failure reduces credit availability throughout the economy.

D.	Since the steel company's assets are tangible, they are more easily reallocated than the intangible bank assets.

E.	Everyone needs money, but not everyone needs steel.

2.

Why do households prefer to use FIs as intermediaries to invest their surplus funds?

A.	Transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information.

B.	To receive the benefits of diversification that households may not be able to achieve on their own.

C.	The FI has can benefit from combining funds and negotiating lower asset prices and transactions costs.

D.	The FI can provide insurance at relatively low cost that will protect funds under management.

E.	All of the above.

3.

Which of the following is NOT a major function of financial intermediaries?

A.	Brokerage services.

B.	Asset transformation services.

C.	Information production.

D.	Management of the nation's money supply.

E.	Administration of the payments mechanism.

4.

What type of risk focuses upon mismatched asset and liability maturities and durations?

A.	Liquidity risk.

B.	Interest rate risk.

C.	Credit risk.

D.	Foreign exchange rate risk.

E.	Off-balance sheet risk.

5.

Politically motivated limitations on payments of foreign currency may expose an FI to

A.	sovereign country risk.

B.	interest rate risk.

C.	credit risk.

D.	foreign exchange risk.

E.	off-balance-sheet risk.

6.

The risk that a debt security's price will fall, subjecting the investor to a potential capital loss is

A.	credit risk.

B.	market risk.

C.	currency risk.

D.	liquidity risk.

E.	political risk.

7.

As commercial banks move from their traditional banking activities of deposit taking and lending and shift more of their activities to trading, they are more subject to

A.	credit risk.

B.	market risk.

C.	political risk.

D.	sovereign risk.

E.	liquidity risk.

8.

An advantage FIs have over individual household investors is that they are able to diversify away credit risk by holding a large portfolio of loans to different entities. This reduces

A.	firm-specific credit risk.

B.	systematic credit risk.

C.	interest rate risk.

D.	market risk.

E.	political risk.

9.

The risk that an FI may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities is referred to as

A.	currency risk.

B.	sovereign risk.

C.	insolvency risk.

D.	liquidity risk.

E.	interest rate risk.

Bank of the Atlantic has liabilities of $4 million with an average maturity of two years paying interest rates of 4.0 percent annually. It has assets of $5 million with an average maturity of 5 years earning interest rates of 6.0 percent annually.

10.

To what risk is the bank exposed?

A.	Reinvestment risk.

B.	Refinancing risk.

C.	Interest rate risk.

D.	Answers A and C only.

E.	Answers B and C only.

11.

What is the bank's net interest income for the current year?

A.

$300,000.

B.

$140,000.

C.

$160,000.

D.

$280,000.

E.

$80,000.

12.

What is the bank's net interest income in dollars in year 3, after it refinances all of its liabilities at a rate of 6.0 percent?

A.

-$60,000.

B.	-$140,000.

C.	+$140,000.

D.

+$60,000.

E.	+$800,000.

13.

If the year-end spot exchange rate for the British pound is $1.50/ and the liabilities pay 8 percent, what is the maximum that the can appreciate and the bank still maintain a zero profit?

A.

1.30/$.

B.

1.33/$.

C.

1.35/$.

D.

1.50/$.

E.

1.60/$.

14.	The cumulative repricing gap position of an FI for a given extended time period is the sum of the repricing gap values for the individual time periods that make up the extended time period. True False

15.	When a bank's repricing gap is positive, net interest income is positively related to changes in interest rates. True False

16.

If interest rates decrease 50 basis points for an FI that has a gap of +$5 million, the expected change in net interest income is

A.

+ $2,500.

B.	+ $25,000.

C.	+ $250,000.

D.	- $250,000.

E. $ 25,000

- .

Hadbucks National Bank current balance sheet appears below. All assets and liabilities are currently priced at par and pay interest annually.

17.

What is the weighted average maturity of assets?

A.	5.50 years.

B.	6.40 years.

C.	5.00 years.

D.	4.60 years.

E.	10.0 years.

18.

What is the weighted average maturity of liabilities?

A.	5.50 years.

B.	6.40 years.

C.	1.44 years.

D.	1.30 years.

E.	1.10 years.

19.

What is this FI's maturity gap?

A.	4.00 years.

B.	4.28 years.

C.	3.16 years.

D.	4.06 years.

E.	5.10 years.

20.

What is market value of the one-year bond if all market interest rates increase by 2 percent?

A.	$60.000 million.

B.	$60.566 million.

C.	$59.444 million.

D.	$58.899 million.

E.	$61.142 million.

21.	The greater is convexity, the more insurance a portfolio manager has against interest rate increases and the greater potential gain from rate decreases. True False

22.

A $1,000 six-year Eurobond has an 8 percent coupon, is selling at par, and contracts to make annual payments of interest. The duration of this bond is 4.99 years. What will be the new price using the duration model if interest rates increase to 8.5 percent?

A.

$23.10.

B.

$976.90.

C.

$977.23.

D.	$1,023.10.

E.

-$23.10.

Consider a one-year maturity, $100,000 face value bond that pays a 6 percent fixed coupon annually.

First Duration Bank has the following assets and liabilities on its balance sheet

23.

What is the duration of the commercial loans?

A.	1.00 years.

B.	2.00 years.

C.	1.73 years.

D.	1.91 years.

E.	1.50 years.

24.

What is the FI's leverage-adjusted duration gap?

A.	0.91 years.

B.	0.83 years.

C.	0.73 years.

D.	0.50 years.

E.

0 years.

25.	The Volker Rule is intended to reduce market risk at depository institutions. True False

26.	The Value at Risk (VAR) provides information about the potential size of the expected loss given a level of probability. True False

27.	The Expected Shortfall (ES) is a measure of market risk that estimates the expected losses beyond a given confidence level. True False

28.

Daily earnings at risk (DEAR) is calculated as

A.	the price sensitivity times an adverse daily yield move.

B.	the dollar value of a position times the price volatility.

C.	the dollar value of a position times the potential adverse yield move.

D.	the price volatility times the N.

E.	More than one of the above is correct.

The mean change in the value of a portfolio of trading assets has been estimated to be 0 with a standard deviation of 20 percent. Yield changes are assumed to be normally distributed.

29.

What is the maximum yield change expected if a 90 percent confidence (one-tailed) limit is used?

A.

3.30%.

B.

20.0%.

C.

33.0%.

D.

39.2%.

E.

46.6%.

City bank has six-year zero coupon bonds with a total face value of $20 million. The current market yield on the bonds is 10 percent.

30.

What is the modified duration of these bonds?

A.	5.45 years.

B.	6.00 years.

C.	6.60 years.

D.	10.0 years.

E.	10.9 years.

31.

What is the price volatility if the maximum potential adverse move in yields is estimated at 20 basis points?

A.	-1.32 percent.

B.	-2.00 percent.

C.	-2.18 percent.

D.	-1.09 percent.

E.	-1.20 percent.

32.

What is the daily earnings at risk (DEAR) of this bond portfolio?

A.	-$246,111.

B.	-$218,180.

C.	-$135,474.

D.	-$149,021.

E.	-$225,789.

33.

What is the 10-day VAR assuming the daily returns are independently distributed?

A.	-$714,009.31

B.	-$778,270.16

C.	-$389,135.09

D.	-$428,405.58

E.	-$471,246.16

34.

If interest rates increase 75 basis points for an FI that has a gap of -$15 million, the expected change in net interest income is

A.	-$112,500.

B.	+$112,500.

C.	+$1,125,0000.

D.	-$1,125,0000.

E.	-$150,000.

35.

The gap ratio expresses the reprice gap for a given time period as a percentage of

A.

equity.

B.	total liabilities.

C.	current liabilities.

D.	total assets.

E.	current assets.

The balance sheet of XYZ Bank appears below. All figures in millions of US Dollars.

36.

Total one-year rate-sensitive assets is

A.	$540 million.

B.	$580 million.

C.	$555 million.

D.	$415 million.

E.	$720 million.

37.

Total one-year rate-sensitive liabilities is

A.	$540 million.

B.	$580 million.

C.	$555 million.

D.	$415 million.

E.	$720 million.

38.

The cumulative one-year repricing gap (CGAP) for the bank is

A.	$25 million.

B.	$-140 million.

C.	$15 million.

D.	$-150 million.

E.	$-15 million.

39.

The gap ratio is

A.

.015.

B.

-.015.

C.

.025.

D.

-.144.

E.

.154.

A $200 million loan commitment has an up-front fee of 20 basis points and a back-end fee of 25 basis points on the unused portion.

40.

The up-front fee is

A.

$250,000.

B.	$4,000,000.

C.

$400,000.

D.

$775,000.

E.

$375,000.