Question 1

Basel III capital ratios were enacted due to Basel II weaknesses exposed during the financial crisis of 2008-2009.

Accepted Answer

A) True 
 B)False

Question 2

Determining risk-weighted asset values for OBS market contracts requires multiplying the notional values by the appropriate risk weights.

Accepted Answer

A) True 
 B)False

Question 3

In the NAIC model for life insurance companies, which risk captures the risk of adverse changes in mortality risk and morbidity risk?

Accepted Answer

A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk. 
A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk.

Question 4

The Basel capital requirements differ from previous capital standards in all except one of the following ways?

Accepted Answer

A) More stringent capital standards for large banks than for small banks. 
B) Inclusion of off balance sheet assets in the asset base. 
C) Restrictions on the amount of goodwill that can be counted towards primary or Tier I capital. 
D) Risk weighting of assets on the basis of credit risk exposure. 
E) Risk weighting of off balance sheet contingencies. 
A) More stringent capital standards for large banks than for small banks. 
B) Inclusion of off balance sheet assets in the asset base. 
C) Restrictions on the amount of goodwill that can be counted towards primary or Tier I capital. 
D) Risk weighting of assets on the basis of credit risk exposure. 
E) Risk weighting of off balance sheet contingencies.

Question 5

Which of the following risk categories is NOT covered by the risk-based model for the life insurance industry?

Accepted Answer

A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk. 
A) Interest rate risk. 
B) Business risk. 
C) Asset risk. 
D) Foreign exchange risk. 
E) Insurance risk.

Question 6

Which of the following is not included in the Common Equity Tier I capital under Basel III?

Accepted Answer

A) Retained earnings. 
B) Par value of common shares issued by the bank. 
C) Par value of noncumulative perpetual preferred stock. 
D) Paid-in excess (surplus) of common stock. 
E) Common shares issued by consolidated subsidiaries of the bank. 
A) Retained earnings. 
B) Par value of common shares issued by the bank. 
C) Par value of noncumulative perpetual preferred stock. 
D) Paid-in excess (surplus) of common stock. 
E) Common shares issued by consolidated subsidiaries of the bank.

Question 7

The Basic Indicator Approach in calculating capital to cover operational risk requires banks to hold 12 percent of total assets in capital to cover operational risk exposure.

Accepted Answer

A) True 
 B)False

Question 8

A property-casualty (P-C) insurance firm has estimated the following risk-based capital charge for its individual risk classes: $\begin{array}{|c|c|c|}
\hline \text { Risk } & \text { Description } & \text { RBC Charge } \
\hline \text { R0 } & \text { Affiliated P-C } & \$ 6.0 \text { million } \
\hline \text { R1 } & \text { Fixed-income assets } & \$ 2.0 \text { million } \
\hline \text { R2 } & \text { Common Stock } & \$ 1.0 \text { million } \
\hline \text { R3 } & \text { Reinsurance } & \$ 3.0 \text { million } \
\hline \text { R4 } & \text { Loss Adjustment Expense } & \$ 1.0 \text { million } \
\hline \text { R5 } & \text { Written Premiums } & \$ 2.0 \text { million } \
\hline \text { R6 } & \text { Hurricane } & \$ 1.0 \text { million } \
\hline \text { R7 } & \text { Earthquake } & \$ 0.5 \text { million } \
\hline \text { Total } & & \$ 16.50 \text { million } \
\hline
\end{array}$ Is the firm adequately capitalized if it has total capital and surplus of $10 million?

Accepted Answer

A) No, its total risk-based capital charge is higher than $10 million. 
B) No, its total risk-based capital charge is lower than $10 million. 
C) Yes, its total risk-based capital charge is higher than $10 million. 
D) Yes, its total risk-based capital charge is lower than $10 million. 
E) No, its total risk-based capital charge is greater than 0. 
A) No, its total risk-based capital charge is higher than $10 million. 
B) No, its total risk-based capital charge is lower than $10 million. 
C) Yes, its total risk-based capital charge is higher than $10 million. 
D) Yes, its total risk-based capital charge is lower than $10 million. 
E) No, its total risk-based capital charge is greater than 0.

Question 9

Sigma Bank has the following balance sheet in millions of dollars.Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns).Values are in millions of dollars.Refer to table 20-8 for appropriate risk weights. $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { 1-4 family } \
\left( 80 \% { - 90\% } \text { LTV } \right)
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$10\
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10) $40 million direct-credit substitute standby letters of credit issued to a U.S.corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
What is the minimum total capital (Tier I + Tier II) required to be adequately capitalized for the off-balance sheet derivative contracts (both interest rate swaps and foreign exchange forwards) under Basel II?

Accepted Answer

A) $0.24 million. 
B) $0.36 million. 
C) $0.72 million. 
D) $0.60 million. 
E) $0.48 million. 
A) $0.24 million. 
B) $0.36 million. 
C) $0.72 million. 
D) $0.60 million. 
E) $0.48 million.

Question 10

Failure to meet the capital conservations buffer and the countercyclical buffer guidelines instituted under Basel III will result in limits to all of the following except

Accepted Answer

A) bonuses paid to executives of the institution. 
B) regularly scheduled dividends paid to stockholders. 
C) special dividends meant to distribute retained earnings to stockholders. 
D) lending to international entities. 
E) buyback programs of common stock. 
A) bonuses paid to executives of the institution. 
B) regularly scheduled dividends paid to stockholders. 
C) special dividends meant to distribute retained earnings to stockholders. 
D) lending to international entities. 
E) buyback programs of common stock.

Question 11

As compared to Basel I, the standardized approach of Basel III is designed to produce capital ratios that are more in line with the actual economic risks that the DIs are facing.

Accepted Answer

A) True 
 B)False

Question 12

In determining the risk-weighted value of the on-balance-sheet credit equivalent amounts of the contingent guaranty contracts, the risk weights are determined by the credit rating of the underlying counterparty of the off-balance-sheet activity.

Accepted Answer

A) True 
 B)False

Question 13

Sigma Bank has the following balance sheet in millions of dollars.Unless mentioned otherwise, all assets are associated with corporate customers (not governments or sovereigns).Values are in millions of dollars.Refer to table 20-8 for appropriate risk weights. $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { 1-4 family } \
\left( 80 \% { - 90\% } \text { LTV } \right)
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \$10\
\hline \text { Total Assets } & \$ 400 & & \$ 400 \
\hline
\end{array}$$ Off balance sheet contingent liabilities (Refer to Table 20-10) $40 million direct-credit substitute standby letters of credit issued to a U.S.corporation.
$40 million commercial letters of credit issued to a corporation
Off-balance sheet derivatives (Refer to Table 20-11)
$200 million 10-year interest rate swaps
$100 million 2-year forward DM contracts
Is the bank adequately capitalized for its on-balance-sheet assets based on the Basel standards?

Accepted Answer

A) Yes, because both Tier I and Tier II capital each exceed the required minimum. 
B) Yes, because both the Tier I and Tier II combined exceeds the required minimum. 
C) No, because both Tier I and Tier II capital each are below the required minimum. 
D) No, because Tier I is below the required minimum while Tier II exceeds the required minimum. 
E) No, because Tier I is above the required minimum while Tier II is below the required minimum. 
A) Yes, because both Tier I and Tier II capital each exceed the required minimum. 
B) Yes, because both the Tier I and Tier II combined exceeds the required minimum. 
C) No, because both Tier I and Tier II capital each are below the required minimum. 
D) No, because Tier I is below the required minimum while Tier II exceeds the required minimum. 
E) No, because Tier I is above the required minimum while Tier II is below the required minimum.

Question 14

Basel I (1993) requires banks in the member countries of the Bank for International Settlements to utilize risk-based capital ratios.

Accepted Answer

A) True 
 B)False

Question 15

The stress tests run by firms and the Federal Reserve Board apply five scenarios: underperforming, poor, baseline, adverse, and severely adverse.

Accepted Answer

A) True 
 B)False

Question 16

In evaluating the risk-weighted asset value of foreign exchange forward contracts, the value of the current exposure can be either positive or zero.

Accepted Answer

A) True 
 B)False

Question 17

Under Generally Accepted Accounting Principles, FIs have flexible rules in recognizing the amount and timing of loan losses.

Accepted Answer

A) True 
 B)False

Question 18

The use of risk-based capital measures under Basel I (1993) effectively mark-to-market the bank's on- and off-balance-sheet for the purpose of reflecting credit and market risk.

Accepted Answer

A) True 
 B)False

Question 19

Which of the following statements best describes the treatment of adjusting for credit risk of off-balance-sheet activities?

Accepted Answer

A) All OBS activities are treated equally in making credit-risk adjustments. 
B) Standby letter of credit guarantees issued by banks to back commercial paper have a 50 percent conversion factor. 
C) The credit or default risk of over-the-counter contracts is approximately zero. 
D) The current exposure component of the credit equivalent amount of OBS derivative contracts reflects the credit risk if the contract counterparty defaults. 
E) The treatment of interest rate forward, option, and swap contracts differs from the treatment of contingent or guarantee contracts. 
A) All OBS activities are treated equally in making credit-risk adjustments. 
B) Standby letter of credit guarantees issued by banks to back commercial paper have a 50 percent conversion factor. 
C) The credit or default risk of over-the-counter contracts is approximately zero. 
D) The current exposure component of the credit equivalent amount of OBS derivative contracts reflects the credit risk if the contract counterparty defaults. 
E) The treatment of interest rate forward, option, and swap contracts differs from the treatment of contingent or guarantee contracts.

Question 20

The primary difference between Basel I and the proposed Basel III in converting OBS values to on-balance-sheet credit equivalent amounts is

Accepted Answer

A) the use of credit ratings in Basel III to assign credit risk weights on the OBS activities. 
B) the use of six weight classes by Basel III rather than four classes. 
C) the use of the underlying counterparty activity in Basel II to assign credit risk weights on the OBS activities. 
D) All of the options. 
E) a heavier reliance on the use of ratings by external credit rating agencies for the assignment of assets to weight classes and the use of the underlying counterparty activity in Basel II to assign credit risk weights on the OBS activities. 
A) the use of credit ratings in Basel III to assign credit risk weights on the OBS activities. 
B) the use of six weight classes by Basel III rather than four classes. 
C) the use of the underlying counterparty activity in Basel II to assign credit risk weights on the OBS activities. 
D) All of the options. 
E) a heavier reliance on the use of ratings by external credit rating agencies for the assignment of assets to weight classes and the use of the underlying counterparty activity in Basel II to assign credit risk weights on the OBS activities.

Exam 21: Capital Adequacy

Basel III capital ratios were enacted due to Basel II weaknesses exposed during the financial crisis of 2008-2009.

Determining risk-weighted asset values for OBS market contracts requires multiplying the notional values by the appropriate risk weights.

In the NAIC model for life insurance companies, which risk captures the risk of adverse changes in mortality risk and morbidity risk?

The Basel capital requirements differ from previous capital standards in all except one of the following ways?

Which of the following risk categories is NOT covered by the risk-based model for the life insurance industry?

Which of the following is not included in the Common Equity Tier I capital under Basel III?

The Basic Indicator Approach in calculating capital to cover operational risk requires banks to hold 12 percent of total assets in capital to cover operational risk exposure.

Failure to meet the capital conservations buffer and the countercyclical buffer guidelines instituted under Basel III will result in limits to all of the following except

As compared to Basel I, the standardized approach of Basel III is designed to produce capital ratios that are more in line with the actual economic risks that the DIs are facing.

In determining the risk-weighted value of the on-balance-sheet credit equivalent amounts of the contingent guaranty contracts, the risk weights are determined by the credit rating of the underlying counterparty of the off-balance-sheet activity.

Basel I (1993) requires banks in the member countries of the Bank for International Settlements to utilize risk-based capital ratios.

The stress tests run by firms and the Federal Reserve Board apply five scenarios: underperforming, poor, baseline, adverse, and severely adverse.

In evaluating the risk-weighted asset value of foreign exchange forward contracts, the value of the current exposure can be either positive or zero.

Under Generally Accepted Accounting Principles, FIs have flexible rules in recognizing the amount and timing of loan losses.

The use of risk-based capital measures under Basel I (1993) effectively mark-to-market the bank's on- and off-balance-sheet for the purpose of reflecting credit and market risk.

Which of the following statements best describes the treatment of adjusting for credit risk of off-balance-sheet activities?

The primary difference between Basel I and the proposed Basel III in converting OBS values to on-balance-sheet credit equivalent amounts is

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loan Risk

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Fintech Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

Filters