Exam 7: Risks of Financial Institutions

Direct foreign investment and foreign portfolio investment both can be beneficial to an FI because of imperfectly correlated returns with domestic investments.

Matching the foreign currency book of assets and liability maturity does not protect the FI from

The risk that interest income will increase at a slower rate than interest expense is

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

Interest rate risk stems from the impact of both anticipated and unanticipated changes in interest rates on FI profitability.

Managerial monitoring efficiency and credit risk management strategies affect the shape of the risk of the loan return distribution.

Which of the following would one typically find in the trading portfolio of an FI?

Off-balance-sheet activities often affect the shape of an FIs current balance sheet through the creation of contingent claims.

Regulation limits FI investment in non-investment grade bonds (rated below Baa or non-rated). What kind of risk is this designed to limit?

The risk that many depositors withdraw their funds from an FI at once is

One method of guarding against credit risk is to assess a risk premium based on the estimate of default risk exposure that a borrower carries.

The risk that an FI may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities is referred to as

Canada 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. What is the net interest income in dollars if the spot prices at the end of the year are $1.35/£ and €1.35/$ and the liabilities instead cost 7 percent instead of 8 percent?

The asymmetric return distribution (relatively high probability of anticipated return; lower probability of default) on risky debt exposes the FI to

Funding a portion of assets with equity capital means that hedging risk does not require perfect matching of the assets and liabilities.

A mortgage loan officer is found to have provided false documentation that resulted in a lower interest rate on a loan approved for one of her friends. The loan was subsequently added to a loan pool, securitized and sold. Which of the following risks applies to the false documentation by the employee?

An FI is exposed to reinvestment risk by holding longer-term assets relative to liabilities.

Off-balance-sheet activities have become an important source of fee income, even though losses on these activities can cause a financial institution to fail.

A natural consequence of the effects of realized liquidity risk across several institutions is the ability to recognize capital gains on the sale of assets in the attempt to generate cash.

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. What is the bank's net interest income for the current year?