Question 1

The amount of leverage of a borrower and the probability of default are positively related, but only after some minimum level of debt.

Accepted Answer

A) True 
 B)False  True

Question 2

Which of the following is NOT a valid conceptual or application problem of the mortality rate approach to estimate default risk?

Accepted Answer

A) Implied future probabilities are sensitive to the period over which MMRs are calculated. 
B) The estimates are sensitive to the number of issues in each investment grade. 
C) Syndicated loans seem to have higher mortality rates than corporate bonds. 
D) The estimated probability values are historic or backward-looking measures. 
E) The estimates are sensitive to the relative size of issues in each investment grade. 
A) Implied future probabilities are sensitive to the period over which MMRs are calculated. 
B) The estimates are sensitive to the number of issues in each investment grade. 
C) Syndicated loans seem to have higher mortality rates than corporate bonds. 
D) The estimated probability values are historic or backward-looking measures. 
E) The estimates are sensitive to the relative size of issues in each investment grade. C

Question 3

Because they are secured by homes, residential mortgages have demonstrated very little credit risk for FIs.

Accepted Answer

A) True 
 B)False  False

Question 4

Recessionary phases in the business cycle typically cause greater hardship on companies that borrow large amounts.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following is not a characteristic of a loan commitment?

Accepted Answer

A) The maximum amount of the loan is negotiated at the time of the loan agreement. 
B) The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. 
C) Floating-rate loans transfer the interest rate risk to the borrower. 
D) The time period for which the loan is available is negotiated at the time of the loan agreement. 
E) In a floating-rate loan the borrower pays interest rate in force when the loan is actually taken down. 
A) The maximum amount of the loan is negotiated at the time of the loan agreement. 
B) The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. 
C) Floating-rate loans transfer the interest rate risk to the borrower. 
D) The time period for which the loan is available is negotiated at the time of the loan agreement. 
E) In a floating-rate loan the borrower pays interest rate in force when the loan is actually taken down.

Question 6

The debt holders a corporation essentially hold a call option on the value of the firm's assets.

Accepted Answer

A) True 
 B)False

Question 7

Commercial loans have been decreasing in importance in bank loan portfolios.

Accepted Answer

A) True 
 B)False

Question 8

If the cumulative mortality rate in year 3 is 3.46 percent for the B-rated loan, what is its yearly mortality rate in year 3?

Accepted Answer

A) 1.25 percent. 
B) 1.21 percent. 
C) 1.00 percent. 
D) 0.90 percent. 
E) 0.875 percent. [Refer to: 10-112] 
A) 1.25 percent. 
B) 1.21 percent. 
C) 1.00 percent. 
D) 0.90 percent. 
E) 0.875 percent. [Refer to: 10-112]

Question 9

Which of the following factors may affect the promised return an FI receives on a loan?

Accepted Answer

A) The collateral backing of the loan. 
B) Fees relating to the loan. 
C) The interest rate on the loan. 
D) The credit risk premium on the loan. 
E) All of the options. 
A) The collateral backing of the loan. 
B) Fees relating to the loan. 
C) The interest rate on the loan. 
D) The credit risk premium on the loan. 
E) All of the options.

Question 10

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

Accepted Answer

A) True 
 B)False

Question 11

Because of compensating balances and fees used to increase return on a loan, the credit risk premium is not the fundamental factor driving the promised return once the base rate on the loan has been set.

Accepted Answer

A) True 
 B)False

Question 12

Willingness to post collateral may be a signal of more, rather than less, credit risk on the part of the borrower.

Accepted Answer

A) True 
 B)False

Question 13

The risk premium, or spread, between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

Accepted Answer

A) True 
 B)False

Question 14

In terms of rating agencies such as S&P, investment grade companies are those whose bond ratings are grade B or above.

Accepted Answer

A) True 
 B)False

Question 15

Credit risk applies only to bond investment and loan portfolios of depository institutions and other FIs.

Accepted Answer

A) True 
 B)False

Question 16

Default by a large corporation is seldom a problem for FIs since these corporations have many different sources of borrowed funds.

Accepted Answer

A) True 
 B)False

Question 17

Residential mortgages are a relatively small component of bank real estate loan portfolios.

Accepted Answer

A) True 
 B)False

Question 18

Sustained credit quality problems can drain an FI's capital and net worth.

Accepted Answer

A) True 
 B)False

Question 19

Since their introduction, the proportion of adjustable rate mortgages (ARMs) to fixed-rate residential mortgages has remained very stable over interest rate cycles.

Accepted Answer

A) True 
 B)False

Question 20

Commercial paper typically is secured by specific assets of the borrower.

Accepted Answer

A) True 
 B)False

Exam 10: Credit Risk: Individual Loan Risk

The amount of leverage of a borrower and the probability of default are positively related, but only after some minimum level of debt.

Which of the following is NOT a valid conceptual or application problem of the mortality rate approach to estimate default risk?

Because they are secured by homes, residential mortgages have demonstrated very little credit risk for FIs.

Recessionary phases in the business cycle typically cause greater hardship on companies that borrow large amounts.

Which of the following is not a characteristic of a loan commitment?

The debt holders a corporation essentially hold a call option on the value of the firm's assets.

Commercial loans have been decreasing in importance in bank loan portfolios.

If the cumulative mortality rate in year 3 is 3.46 percent for the B-rated loan, what is its yearly mortality rate in year 3?

Which of the following factors may affect the promised return an FI receives on a loan?

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

Because of compensating balances and fees used to increase return on a loan, the credit risk premium is not the fundamental factor driving the promised return once the base rate on the loan has been set.

Willingness to post collateral may be a signal of more, rather than less, credit risk on the part of the borrower.

The risk premium, or spread, between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

In terms of rating agencies such as S&P, investment grade companies are those whose bond ratings are grade B or above.

Credit risk applies only to bond investment and loan portfolios of depository institutions and other FIs.

Default by a large corporation is seldom a problem for FIs since these corporations have many different sources of borrowed funds.

Residential mortgages are a relatively small component of bank real estate loan portfolios.

Sustained credit quality problems can drain an FI's capital and net worth.

Since their introduction, the proportion of adjustable rate mortgages (ARMs) to fixed-rate residential mortgages has remained very stable over interest rate cycles.

Commercial paper typically is secured by specific assets of the borrower.

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: 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

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

Filters