Question 1

Excessive illiquidity can result in an FI's inability to meet required payments on liability claims and, at the extreme, in insolvency.

Accepted Answer

A) True 
 B)False  True

Question 2

Because investment banks typically buy and sell securities on a regular basis; they have no need for a liability management plan.

Accepted Answer

A) True 
 B)False  False

Question 3

An FI offers a $2,500 minimum balance chequing account paying 4 percent annual interest, and there are no service charges as long as the customer maintains the minimum balance. The customer maintains a balance of $5,000, and averages 750 cheques per year. Each cheque has a processing cost to the FI of $0.15. What is the annual gross interest return on this account to the customer?

Accepted Answer

A) $112.50. 
B) $100.00. 
C) $312.50. 
D) $137.50. 
E) $212.50. 
A) $112.50. 
B) $100.00. 
C) $312.50. 
D) $137.50. 
E) $212.50. C

Question 4

Which of the following observations is NOT true of a liquid asset?

Accepted Answer

A) It can be turned into cash quickly. 
B) Conversion to cash entails low transaction costs. 
C) Conversion to cash happens with little or no loss in principal value. 
D) It is traded in an active market. 
E) Large transactions may move its market price substantially. 
A) It can be turned into cash quickly. 
B) Conversion to cash entails low transaction costs. 
C) Conversion to cash happens with little or no loss in principal value. 
D) It is traded in an active market. 
E) Large transactions may move its market price substantially.

Question 5

In many countries, regulators often set minimum liquid reserve requirements on FIs.

Accepted Answer

A) True 
 B)False

Question 6

Holding small amounts of liquid assets could cause an FI to be unable to meet the claims of liability holders.

Accepted Answer

A) True 
 B)False

Question 7

A DI offers a $500 minimum balance account paying 5.5 percent annual interest. The account has a service charge of $0.05 per cheque, and processing costs per cheque are $0.15. The customer maintains a balance of $1,000, and averages 150 cheques per year. What is the annual gross interest return on this account to the customer?

Accepted Answer

A) $22.50. 
B) $70.00. 
C) $15.00. 
D) $55.00. 
E) $7.50. 
A) $22.50. 
B) $70.00. 
C) $15.00. 
D) $55.00. 
E) $7.50.

Question 8

Property & casualty insurance companies typically have greater liquidity risk than life insurance companies.

Accepted Answer

A) True 
 B)False

Question 9

The interest rate paid deposit accounts by Canadian DTIs must directly reflect the rates earned on investments in commercial paper, bankers acceptances, repurchase agreement, and T-bills.

Accepted Answer

A) True 
 B)False

Question 10

Implicit interest involves the process of crediting the interest payment directly to a deposit account as opposed to sending an explicit interest check to the customer.

Accepted Answer

A) True 
 B)False

Question 11

Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.

Accepted Answer

A) True 
 B)False

Question 12

Most large Canadian banks directly issue commercial paper to meet their liquidity needs.

Accepted Answer

A) True 
 B)False

Question 13

Demand deposits are a costless source of funds and have a high degree of withdrawal risk.

Accepted Answer

A) True 
 B)False

Question 14

Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?

Accepted Answer

A) These assets carry a reserve requirement tax. 
B) These assets offer low returns. 
C) These assets offer higher returns that reflect their risk. 
D) Inflation increases the purchasing power value of these assets. 
E) All of these. 
A) These assets carry a reserve requirement tax. 
B) These assets offer low returns. 
C) These assets offer higher returns that reflect their risk. 
D) Inflation increases the purchasing power value of these assets. 
E) All of these.

Question 15

Property & casualty insurance companies can reduce their exposure to liquidity risk by diversifying coverage across different types of disasters.

Accepted Answer

A) True 
 B)False

Question 16

Excessive amounts of liquid asset holdings can penalize the earnings of a DTI.

Accepted Answer

A) True 
 B)False

Question 17

Banks often convert on-balance-sheet bankers acceptances into off-balance-sheet letters of credit for the purpose of minimizing total assets and thus improving performance ratios such as ROA.

Accepted Answer

A) True 
 B)False

Question 18

Savings accounts normally receive a lower interest rate than chequing accounts.

Accepted Answer

A) True 
 B)False

Question 19

One reason FIs such as deposit-taking institutions and life insurance companies are exposed to liquidity risk is the relatively illiquid nature of their liabilities.

Accepted Answer

A) True 
 B)False

Question 20

The concept of constrained optimization facing an FI manager involving the minimum amount of liquid reserve assets required by regulators may

Accepted Answer

A) penalize the FI if the minimum amount is less than the amount warranted by the actual withdrawal risk. 
B) benefit the FI if the minimum amount is more than is warranted by actual withdrawal risk. 
C) lead to increased withdrawals by depositors that do not meet the minimum requirement. 
D) assist the FI manager by providing an optimal target amount of cash that will exactly match withdrawal expectations. 
E) None of these. 
A) penalize the FI if the minimum amount is less than the amount warranted by the actual withdrawal risk. 
B) benefit the FI if the minimum amount is more than is warranted by actual withdrawal risk. 
C) lead to increased withdrawals by depositors that do not meet the minimum requirement. 
D) assist the FI manager by providing an optimal target amount of cash that will exactly match withdrawal expectations. 
E) None of these.

Exam 18: Liability and Liquidity Management

Excessive illiquidity can result in an FI's inability to meet required payments on liability claims and, at the extreme, in insolvency.

Because investment banks typically buy and sell securities on a regular basis; they have no need for a liability management plan.

Which of the following observations is NOT true of a liquid asset?

In many countries, regulators often set minimum liquid reserve requirements on FIs.

Holding small amounts of liquid assets could cause an FI to be unable to meet the claims of liability holders.

Property & casualty insurance companies typically have greater liquidity risk than life insurance companies.

The interest rate paid deposit accounts by Canadian DTIs must directly reflect the rates earned on investments in commercial paper, bankers acceptances, repurchase agreement, and T-bills.

Implicit interest involves the process of crediting the interest payment directly to a deposit account as opposed to sending an explicit interest check to the customer.

Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.

Most large Canadian banks directly issue commercial paper to meet their liquidity needs.

Demand deposits are a costless source of funds and have a high degree of withdrawal risk.

Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?

Property & casualty insurance companies can reduce their exposure to liquidity risk by diversifying coverage across different types of disasters.

Excessive amounts of liquid asset holdings can penalize the earnings of a DTI.

Banks often convert on-balance-sheet bankers acceptances into off-balance-sheet letters of credit for the purpose of minimizing total assets and thus improving performance ratios such as ROA.

Savings accounts normally receive a lower interest rate than chequing accounts.

One reason FIs such as deposit-taking institutions and life insurance companies are exposed to liquidity risk is the relatively illiquid nature of their liabilities.

The concept of constrained optimization facing an FI manager involving the minimum amount of liquid reserve assets required by regulators may

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