Exam 7: Risks of Financial Institutions

An FI that has liability maturities longer than asset maturities faces the risk that the return of reinvesting assets could exceed the cost of funding those assets.

If an FI holds long-term assets funded by short-term liabilities when interest rates rise, the market value of assets will fall by a greater amount than the market value of its liabilities.

An off-balance-sheet activity does not appear on the current balance sheet because it does not involve holding a current primary claim or the issuance of a current secondary claim.

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

The risk that borrowers are unable to repay their loans on time is

For an FI investing in risky loans or bonds, the probability is relatively the lowest for which of the following occurrences?

Sovereign risk is a different type of credit risk that affects an FI that purchases bonds of foreign corporations and governments.

Which of the following observations is NOT true of a letter of credit?

When the U.S.dollar declines against European currencies, it is

One cause of liquidity risk occurs when customers of an FI pay down their lines of credit.

Millon National Bank has 10 million British pounds (£) in one-year assets and £8 million in one-year liabilities.In addition, it has one-year liabilities of 4 million euros (€).Assets are earning 8 percent and both liabilities are being paid at a rate of 8 percent.All interest and principal will be paid at the end of the year.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?

An FI is net long in foreign assets if it holds more foreign liabilities than foreign assets.

Which of the following may occur when a sufficient number of borrowers are unable to repay interest and principal on loans, thus causing an FI's equity to approach zero?

Matching the maturities of assets and liabilities supports the asset transformation function of FIs.

An FI that finances long-term fixed rate mortgages with short-term deposits is exposed to

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

The risk that a computer system may malfunction during the processing of data is an example of operational risk.

Market risk is present whenever an FI takes an open position in an asset and prices change in a direction opposite to that expected.

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.To what risk is the bank exposed?

Credit risk only exposes the lender to the uncertainty that interest payments may not be received.