Question 1

What is a swap?

Accepted Answer

A) An agreement between two parties to exchange assets or a series of cash flows for a specific period of time at a specified interval. 
B) An agreement between a buyer and a seller at time 0 to exchange a nonstandardized asset for cash at some future date. 
C) A contract that gives the holder the right, but not the obligation to buy or sell the underlying asset at a specified price within a specified period of time. 
D) Trading in securities prior to their actual issue. 
E) Contractual commitment to make a loan up to a stated amount at a given interest rate in the future. 
A) An agreement between two parties to exchange assets or a series of cash flows for a specific period of time at a specified interval. 
B) An agreement between a buyer and a seller at time 0 to exchange a nonstandardized asset for cash at some future date. 
C) A contract that gives the holder the right, but not the obligation to buy or sell the underlying asset at a specified price within a specified period of time. 
D) Trading in securities prior to their actual issue. 
E) Contractual commitment to make a loan up to a stated amount at a given interest rate in the future. A

Question 2

Why is the default risk much more serious for forward contracts than for futures contracts?

Accepted Answer

A) Because forward contracts are nonstandard contracts. 
B) Forward contracts are entered into bilaterally by the negotiating parties. 
C) For forwards, all cash flows are required to be paid at one time on contract maturity. 
D) Forwards are essentially OTC arrangements with no external guarantees in case of default. 
E) All of these. 
A) Because forward contracts are nonstandard contracts. 
B) Forward contracts are entered into bilaterally by the negotiating parties. 
C) For forwards, all cash flows are required to be paid at one time on contract maturity. 
D) Forwards are essentially OTC arrangements with no external guarantees in case of default. 
E) All of these. E

Question 3

Off-balance-sheet items are

Accepted Answer

A) items omitted from the short form balance sheet. 
B) contingent assets and liabilities. 
C) risk-free assets and liabilities. 
D) exceptionally risky assets and liabilities. 
E) foreign (off shore) assets and liabilities. 
A) items omitted from the short form balance sheet. 
B) contingent assets and liabilities. 
C) risk-free assets and liabilities. 
D) exceptionally risky assets and liabilities. 
E) foreign (off shore) assets and liabilities. B

Question 4

Commercial letters of credit are used only in international trade.

Accepted Answer

A) True 
 B)False

Question 5

Which of the following observations is NOT true?

Accepted Answer

A) The settlement risk that an FI is exposed to within-day appears on its balance sheet. 
B) Settlement Risk is a form of OBS risk that FIs participating on private wholesale wire transfer system networks face. 
C) A holding company is a corporation that owns more than 25 percent of the shares of other corporations. 
D) Failure of an affiliated firm or bank imposes affiliate risk on another bank in a holding company structure in a number of ways. 
E) Investors do not distinguish between the failing corporation and its surviving affiliate because of name similarity. 
A) The settlement risk that an FI is exposed to within-day appears on its balance sheet. 
B) Settlement Risk is a form of OBS risk that FIs participating on private wholesale wire transfer system networks face. 
C) A holding company is a corporation that owns more than 25 percent of the shares of other corporations. 
D) Failure of an affiliated firm or bank imposes affiliate risk on another bank in a holding company structure in a number of ways. 
E) Investors do not distinguish between the failing corporation and its surviving affiliate because of name similarity.

Question 6

The extremely high growth of OBS activities since the early 1990s has caused regulators to recognize the potential risk exposure to FIs from their use.

Accepted Answer

A) True 
 B)False

Question 7

Off-balance-sheet items often are called contingent assets and liabilities because they may, or may not, affect the balance sheet in the future.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following is true of the delta of an option?

Accepted Answer

A) It lies between 0 and 0.5. 
B) It is always negative. 
C) It lies between 0 and 1. 
D) It is greater than 1. 
E) It is always equal to 1. 
A) It lies between 0 and 0.5. 
B) It is always negative. 
C) It lies between 0 and 1. 
D) It is greater than 1. 
E) It is always equal to 1.

Question 9

As of June 2012, the vast majority of OBS activities of commercial banks was

Accepted Answer

A) future and forward contracts. 
B) credit derivatives. 
C) commitments to buy FX. 
D) swap contracts. 
E) loans sold with recourse. 
A) future and forward contracts. 
B) credit derivatives. 
C) commitments to buy FX. 
D) swap contracts. 
E) loans sold with recourse.

Question 10

One way to minimize contingent credit risk is to use derivative products sold on organized exchanges.

Accepted Answer

A) True 
 B)False

Question 11

Which of the following is true of the market price of an options contract over time?

Accepted Answer

A) It is set at time 0. 
B) It is fixed over the life of the contract. 
C) It changes based on the market value of the underlying asset. 
D) It increases with time to expiration. 
E) It is based on supply and demand. 
A) It is set at time 0. 
B) It is fixed over the life of the contract. 
C) It changes based on the market value of the underlying asset. 
D) It increases with time to expiration. 
E) It is based on supply and demand.

Question 12

An FI can protect itself against insolvency resulting from off-balance sheet activities by purchasing insurance.

Accepted Answer

A) True 
 B)False

Question 13

Off-balance-sheet activities are an important source of fee income for many FIs.

Accepted Answer

A) True 
 B)False

Question 14

A corporation is planning to issue $10 million worth of 180-day commercial paper. In order to reduce the interest rates by 25 basis points (per year), it plans to back this issue with a standby letter of credit or a loan commitment. The standby letter of credit is available for 20 basis points (per year) to be paid up-front. The loan commitment for $10 million is available for an up-front fee of 15 basis points (per year) and a 5 basis points back-end fee. What are the savings to the corporation if it obtains a loan commitment to back its $10 million issue of commercial paper?

Accepted Answer

A) $1,250. 
B) $2,500. 
C) $3,750. 
D) $5,000. 
E) $6,250 
A) $1,250. 
B) $2,500. 
C) $3,750. 
D) $5,000. 
E) $6,250

Question 15

An exporter demands a letter of credit in order to

Accepted Answer

A) guarantee safe delivery of goods to the importer. 
B) guarantee receipt of payment from the importer upon receipt of the goods. 
C) protect against adverse changes in foreign exchange rates. 
D) protect against adverse changes in international interest rates. 
E) ascertain the creditworthiness of the importer. 
A) guarantee safe delivery of goods to the importer. 
B) guarantee receipt of payment from the importer upon receipt of the goods. 
C) protect against adverse changes in foreign exchange rates. 
D) protect against adverse changes in international interest rates. 
E) ascertain the creditworthiness of the importer.

Question 16

An up-front fee on a loan commitment rewards the FI for its willingness to stand ready to lend the commitment amount during some agreed upon time period.

Accepted Answer

A) True 
 B)False

Question 17

The current market value of an off-balance-sheet item is determined by finding the current market value of the underlying item.

Accepted Answer

A) True 
 B)False

Question 18

Off-balance-sheet activities generally have risk-reducing attributes, but seldom have risk-increasing attributes.

Accepted Answer

A) True 
 B)False

Question 19

A corporation is planning to issue $10 million worth of 180-day commercial paper. In order to reduce the interest rates by 25 basis points (per year), it plans to back this issue with a standby letter of credit or a loan commitment. The standby letter of credit is available for 20 basis points (per year) to be paid up-front. The loan commitment for $10 million is available for an up-front fee of 15 basis points (per year) and a 5 basis points back-end fee. Which method is preferable, between the loan commitment and the standby letter of credit?

Accepted Answer

A) The loan commitment is preferable because the savings are greater. 
B) The standby letter of credit is preferable because the savings are greater. 
C) The loan commitment is preferable it has a lower risk of default. 
D) The standby letter of credit is preferable because it has a lower risk of default. 
E) The loan commitment is preferable because the back-end fee is payable at the end of the year. 
A) The loan commitment is preferable because the savings are greater. 
B) The standby letter of credit is preferable because the savings are greater. 
C) The loan commitment is preferable it has a lower risk of default. 
D) The standby letter of credit is preferable because it has a lower risk of default. 
E) The loan commitment is preferable because the back-end fee is payable at the end of the year.

Question 20

All call options are eventually exercised and the underlying asset must be delivered.

Accepted Answer

A) True 
 B)False

Exam 16: Off-Balance-Sheet Risk

What is a swap?

Why is the default risk much more serious for forward contracts than for futures contracts?

Off-balance-sheet items are

Commercial letters of credit are used only in international trade.

Which of the following observations is NOT true?

The extremely high growth of OBS activities since the early 1990s has caused regulators to recognize the potential risk exposure to FIs from their use.

Off-balance-sheet items often are called contingent assets and liabilities because they may, or may not, affect the balance sheet in the future.

Which of the following is true of the delta of an option?

As of June 2012, the vast majority of OBS activities of commercial banks was

One way to minimize contingent credit risk is to use derivative products sold on organized exchanges.

Which of the following is true of the market price of an options contract over time?

An FI can protect itself against insolvency resulting from off-balance sheet activities by purchasing insurance.

Off-balance-sheet activities are an important source of fee income for many FIs.

An exporter demands a letter of credit in order to

An up-front fee on a loan commitment rewards the FI for its willingness to stand ready to lend the commitment amount during some agreed upon time period.

The current market value of an off-balance-sheet item is determined by finding the current market value of the underlying item.

Off-balance-sheet activities generally have risk-reducing attributes, but seldom have risk-increasing attributes.

All call options are eventually exercised and the underlying asset must be delivered.

Why Are Financial Institutions Special

Deposit-Taking Institutions

Finance Companies

Securities, Brokerage, and Investment Banking

Mutual Funds, Hedge Funds, and Pension Funds

Insurance Companies

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Individual Loans

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Technology and Other Operational 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 Index

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