Question 1

Regulatory-defined capital and required leverage ratios are based in whole or in part on

Accepted Answer

A) market value accounting concepts. 
B) book value accounting concepts. 
C) the net worth concept. 
D) the economic meaning of capital. 
E) None of the options. 
A) market value accounting concepts. 
B) book value accounting concepts. 
C) the net worth concept. 
D) the economic meaning of capital. 
E) None of the options.

Question 2

The SEC requires securities firms to follow capital rules that utilize market value accounting.

Accepted Answer

A) True 
 B)False

Question 3

Under Basel III a depository institution's capital is divided into five categories.

Accepted Answer

A) True 
 B)False

Question 4

The concept of prompt corrective action refers to the requirement

Accepted Answer

A) that bank managers must address problems in the loan portfolio when they are first identified. 
B) that regulators must take specific actions when bank capital levels fall outside the well-capitalized category. 
C) that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent. 
D) that regulators must take specific actions when bank capital levels fall outside the well-capitalized category and that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent. 
E) that all of the options are correct. 
A) that bank managers must address problems in the loan portfolio when they are first identified. 
B) that regulators must take specific actions when bank capital levels fall outside the well-capitalized category. 
C) that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent. 
D) that regulators must take specific actions when bank capital levels fall outside the well-capitalized category and that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent. 
E) that all of the options are correct.

Question 5

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. $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 40 & \text { Deposits } & \$ 370 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 60 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages } \
\text { 1-4 family } \
\left( 80 \% { - 90\% } \text { LTV } \right)
\end{array} & \$ 100 & \begin{array} { l } 
\text { Perpetual Preferred } \
\text { Stock }
\end{array} & \$ 20 \
\hline \begin{array} { l } 
\text { Commercial loans } \
\text { BB + rated }
\end{array} & \$ 200 & \text { Equity } & \
\hline \text { Total Assets } & \$ 400 & & \$ 10 \
\hline
\end{array}$$ 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 Sigma Bank's risk-weighted assets as defined by the Basel standards for its on-balance-sheet assets only?

Accepted Answer

A) $400 million. 
B) $360 million. 
C) $310 million. 
D) $287 million. 
E) $236 million. 
A) $400 million. 
B) $360 million. 
C) $310 million. 
D) $287 million. 
E) $236 million.

Question 6

It is likely that the discrepancy between book value of equity and market value of equity will increase as volatility in interest rates increases.

Accepted Answer

A) True 
 B)False

Question 7

The Basel capital requirements are based upon the premise that

Accepted Answer

A) banks with riskier assets should have higher capital ratios. 
B) banks with riskier assets should have lower capital ratios. 
C) banks with riskier assets should have lower absolute amounts of capital. 
D) banks with riskier assets should have higher absolute amounts of capital. 
E) there is no relationship between asset risk and capital. 
A) banks with riskier assets should have higher capital ratios. 
B) banks with riskier assets should have lower capital ratios. 
C) banks with riskier assets should have lower absolute amounts of capital. 
D) banks with riskier assets should have higher absolute amounts of capital. 
E) there is no relationship between asset risk and capital.

Question 8

The evaluation of credit risk of off-balance-sheet (OBS) assets under Basel III requires that the notional amount of OBS items be converted to credit equivalent amounts of on-balance-sheet items.

Accepted Answer

A) True 
 B)False

Question 9

Market value of equity is more appropriate than book value of equity at reflecting changes in the credit risk and interest rate risk of an FI.

Accepted Answer

A) True 
 B)False

Question 10

Under Basel III, Globally Systematically Important Banks (G-SIBs) were identified by the Bank for International Settlements (BIS) by all of the following indicators except:

Accepted Answer

A) Size. 
B) Lack of substitutes for the institution's services. 
C) Cross-jurisdictional activity. 
D) Interconnectedness with other institutions. 
E) Ability to obtain insurance or other guarantees on deposits. 
A) Size. 
B) Lack of substitutes for the institution's services. 
C) Cross-jurisdictional activity. 
D) Interconnectedness with other institutions. 
E) Ability to obtain insurance or other guarantees on deposits.

Question 11

The bank is considering changing its asset mix by moving $100 million of commercial loans into Treasury securities.If it does change the asset mix and capital remains the same, the risk-based capital ratio

Accepted Answer

A) will not change because the total assets have not changed. 
B) will decrease because the earnings rate on Treasuries is less than on loans. 
C) will increase by 16.67 percent. 
D) will increase because the assets will have less risk. 
E) will change, but the direction cannot be determined with the information given. 
A) will not change because the total assets have not changed. 
B) will decrease because the earnings rate on Treasuries is less than on loans. 
C) will increase by 16.67 percent. 
D) will increase because the assets will have less risk. 
E) will change, but the direction cannot be determined with the information given.

Question 12

The Standardized Approach in calculating capital to cover operational risk requires DIs to separate activities into business units from which a capital charge is determined based on the amount of operational risk in each unit.

Accepted Answer

A) True 
 B)False

Question 13

Under FDICIA, regulators are required to take prompt corrective action steps when a DI falls outside of Zone 1.

Accepted Answer

A) True 
 B)False

Question 14

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 credit equivalent amount of the off-balance-sheet letters of credit, both standby and commercial?

Accepted Answer

A) $9.6 million. 
B) $16.0 million. 
C) $48 million. 
D) $72 million. 
E) $80 million. 
A) $9.6 million. 
B) $16.0 million. 
C) $48 million. 
D) $72 million. 
E) $80 million.

Question 15

Operational risk increased to a point that the Bank for International Settlements (BIS) required DIs to account for the risk in the capital adequacy standards under Basel II.

Accepted Answer

A) True 
 B)False

Question 16

More frequent regulatory examinations and stricter regulator standards will cause greater discrepancies in book value of equity and the market value of equity.

Accepted Answer

A) True 
 B)False

Question 17

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

Accepted Answer

A) True 
 B)False

Question 18

Fifth Bank has the following balance sheet with values stated in millions of dollars.All assets are associated with corporate customers (not governments or sovereigns).Refer to Table 20-8 for associated risk weights. $$\begin{array} { | l | r | l | r | } 
\hline \text { Cash } & \$ 80 & \text { Deposits } & \$ 550 \
\hline \begin{array} { l } 
\text { Municipal General } \
\text { Obligation Bonds }
\end{array} & \$ 100 & & \
\hline \begin{array} { l } 
\text { Residential Mortgages 1-4 family } \
\text { (LTV } 60 \% - 80  \%)
\end{array} & \$ 220 & \text { Long-Term Debt } & \$ 290 \
\hline \text { Commercial loans } & \$ 500 & \text { Equity } & \$ 60 \
\hline \text { Total Assets } & \$ 900 & & \$ 900 \
\hline
\end{array}$$ In addition, Fifth Bank has off-balance sheet items as follows: (Refer to Tables 20-10 and 20-11) $50 million in commercial letters of credit (LCs),
$300 million in 3-year interest rate swaps that are in-the-money by $2 million
$50 million in 4-year forward FX contracts that are out-of-the money by $2 million
Is Fifth Bank currently over or under capitalized for on-balance-sheet assets in order to be considered well capitalized according to Basel III?

Accepted Answer

A) Overcapitalized for both Tier I and Total capital standards. 
B) Overcapitalized for Tier I standard; Undercapitalized for Total standard. 
C) Undercapitalized for Tier I standard; Overcapitalized for Total standard. 
D) Undercapitalized for both Tier I and Total capital standards. 
E) Unable to determine. 
A) Overcapitalized for both Tier I and Total capital standards. 
B) Overcapitalized for Tier I standard; Undercapitalized for Total standard. 
C) Undercapitalized for Tier I standard; Overcapitalized for Total standard. 
D) Undercapitalized for both Tier I and Total capital standards. 
E) Unable to determine.

Question 19

Under Basel III, Tier I capital measures the market value of common equity plus the amount of perpetual preferred stock plus minority equity interest held by the bank in subsidiaries minus goodwill.

Accepted Answer

A) True 
 B)False

Question 20

The ratio of the common equity Tier 1 capital to the risk-weighted assets of the DI is defined as a CETI 1 risk-based capital ratio.

Accepted Answer

A) True 
 B)False

Exam 21: Capital Adequacy

Regulatory-defined capital and required leverage ratios are based in whole or in part on

The SEC requires securities firms to follow capital rules that utilize market value accounting.

Under Basel III a depository institution's capital is divided into five categories.

The concept of prompt corrective action refers to the requirement

It is likely that the discrepancy between book value of equity and market value of equity will increase as volatility in interest rates increases.

The Basel capital requirements are based upon the premise that

The evaluation of credit risk of off-balance-sheet (OBS) assets under Basel III requires that the notional amount of OBS items be converted to credit equivalent amounts of on-balance-sheet items.

Market value of equity is more appropriate than book value of equity at reflecting changes in the credit risk and interest rate risk of an FI.

Under Basel III, Globally Systematically Important Banks (G-SIBs) were identified by the Bank for International Settlements (BIS) by all of the following indicators except:

The bank is considering changing its asset mix by moving $100 million of commercial loans into Treasury securities.If it does change the asset mix and capital remains the same, the risk-based capital ratio

The Standardized Approach in calculating capital to cover operational risk requires DIs to separate activities into business units from which a capital charge is determined based on the amount of operational risk in each unit.

Under FDICIA, regulators are required to take prompt corrective action steps when a DI falls outside of Zone 1.

Operational risk increased to a point that the Bank for International Settlements (BIS) required DIs to account for the risk in the capital adequacy standards under Basel II.

More frequent regulatory examinations and stricter regulator standards will cause greater discrepancies in book value of equity and the market value of equity.

Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.

Under Basel III, Tier I capital measures the market value of common equity plus the amount of perpetual preferred stock plus minority equity interest held by the bank in subsidiaries minus goodwill.

The ratio of the common equity Tier 1 capital to the risk-weighted assets of the DI is defined as a CETI 1 risk-based capital ratio.

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