Question 1

Which of the following statements is true?

Accepted Answer

A)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI less the annual spread between the loan rate paid by the borrower and the FI's cost of funds. 
B)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI plus the annual spread between the loan rate paid by the borrower and the FI's cost of funds. 
C)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI plus the loan rate paid by the borrowers. 
D)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI less the FI's cost of funds. 
A)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI less the annual spread between the loan rate paid by the borrower and the FI's cost of funds. 
B)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI plus the annual spread between the loan rate paid by the borrower and the FI's cost of funds. 
C)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI plus the loan rate paid by the borrowers. 
D)  The annual all-in-spread (AIS) measures annual fees earned on the loan by the FI less the FI's cost of funds. B

Question 2

The concentration limit for a loan portfolio is calculated as the expected default frequency of the borrower multiplied by (one divided by the loss rate).

Accepted Answer

A) True 
 B)False  True

Question 3

A transition matrix can be used to establish the probabilities that a currently rated borrower will be upgraded, downgraded or will default over time.

Accepted Answer

A) True 
 B)False  True

Question 4

Using the KMV Portfolio Manager Model, the risk on a loan can be calculated as the volatility of the loan's default rate times the loss in the event of default.

Accepted Answer

A) True 
 B)False

Question 5

Financial institutions do not use options to hedge credit risk exposures as credit risk is a natural risk that comes with the core activities of the bank, namely lending.

Accepted Answer

A) True 
 B)False

Question 6

Assume that the maximum loss as a percentage of capital is 12 per cent of an FI's capital to a particular sector. The FI's concentration limit on this sector 35 per cent. What is the sector's loss rate (round to two decimals)?

Accepted Answer

A)  4.20 per cent 
B)  23.00 per cent 
C)  34.29 per cent 
D)  2.92 per cent. 
A)  4.20 per cent 
B)  23.00 per cent 
C)  34.29 per cent 
D)  2.92 per cent.

Question 7

A forward contract:

Accepted Answer

A)  has more credit risk than a futures contract. 
B)  is more standardised than a futures contract. 
C)  is marked to market more frequently than a futures contract. 
D)  has a shorter time to delivery than a futures contract. 
A)  has more credit risk than a futures contract. 
B)  is more standardised than a futures contract. 
C)  is marked to market more frequently than a futures contract. 
D)  has a shorter time to delivery than a futures contract.

Question 8

Which of the following statements is true?

Accepted Answer

A)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are negatively correlated. 
B)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are highly correlated. 
C)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are not correlated. 
D)  FIs may set an aggregate limit of more than the sum of two individual industry limits if two industry groups' performance are negatively correlated. 
A)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are negatively correlated. 
B)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are highly correlated. 
C)  FIs may set an aggregate limit of less than the sum of two individual industry limits if two industry groups' performance are not correlated. 
D)  FIs may set an aggregate limit of more than the sum of two individual industry limits if two industry groups' performance are negatively correlated.

Question 9

The return (Ri) on a loan can be measured as follows:

Accepted Answer

A)  AISi - E(Li), whereby E(Li) = (EDFi $\times$ LGDi) 
B)  AISi - E(Li), whereby E(Li) = (EDFi / LGDi) 
C)  AISi + E(Li), whereby E(Li) = (EDFi $\times$ LGDi) 
D)  AISi + E(Li), whereby E(Li) = (EDFi / LGDi) 
A)  AISi - E(Li), whereby E(Li) = (EDFi $\times$ LGDi) 
B)  AISi - E(Li), whereby E(Li) = (EDFi / LGDi) 
C)  AISi + E(Li), whereby E(Li) = (EDFi $\times$ LGDi) 
D)  AISi + E(Li), whereby E(Li) = (EDFi / LGDi)

Question 10

Minimum risk portfolio refers to a combination of assets:

Accepted Answer

A)  and liabilities that reduces the variance of portfolio returns to the lowest feasible level. 
B)  that leverages the variance of portfolio returns to the optimal level. 
C)  that reduces the variance of portfolio returns to the lowest feasible level. 
D)  that reduces the variance of portfolio returns to zero. 
A)  and liabilities that reduces the variance of portfolio returns to the lowest feasible level. 
B)  that leverages the variance of portfolio returns to the optimal level. 
C)  that reduces the variance of portfolio returns to the lowest feasible level. 
D)  that reduces the variance of portfolio returns to zero.

Question 11

Which of the following is a major difference between forwards and futures?

Accepted Answer

A)  Forwards are marked-to-market, while futures are not. 
B)  Futures are tailor made, while forwards are standardised. 
C)  The default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards. 
D)  Forwards are marked-to-market, while futures are not, futures are tailor made, while forwards are standardised and the default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards. 
A)  Forwards are marked-to-market, while futures are not. 
B)  Futures are tailor made, while forwards are standardised. 
C)  The default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards. 
D)  Forwards are marked-to-market, while futures are not, futures are tailor made, while forwards are standardised and the default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards.

Question 12

Which of the following statements is true?

Accepted Answer

A)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated 
B)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its size, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated. 
C)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are perfectly correlated. 
D)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated. 
A)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated 
B)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its size, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated. 
C)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are perfectly correlated. 
D)  The fundamental lesson of modern portfolio theory (MPT) is that by taking advantage of its profitability, an FI can diversify considerable amounts of credit risk as long as the returns on different assets are imperfectly correlated.

Question 13

Which of the following statements is true?

Accepted Answer

A)  One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that the upside returns are equal to the downside risks. 
B)  One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have unlimited upside returns and long-tail downside risks. 
C)  One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that most loans have unlimited upside returns and unlimited downside risks. 
D)  One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have limited upside returns and long-tail downside risks. 
A)  One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that the upside returns are equal to the downside risks. 
B)  One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have unlimited upside returns and long-tail downside risks. 
C)  One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that most loans have unlimited upside returns and unlimited downside risks. 
D)  One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have limited upside returns and long-tail downside risks.

Question 14

Which of the following statements is true?

Accepted Answer

A)  As with loans, swap participants deal with the credit risk of counterparties by setting bilateral limits on the notional amount of swaps entered into. 
B)  As with loans, swap participants deal with the credit risk of counterparties by adjusting the fixed and/or floating rates by including credit risk premiums. 
C)  As with loans, swap participants deal with the credit risk of counterparties by using Monte Carlo simulations to model potential default risk. 
D)  As with loans, swap participants deal with the credit risk of counterparties by setting bilateral limits on the notional amount of swaps entered into and as with loans, swap participants deal with the credit risk of counterparties by adjusting the fixed and/or floating rates by including credit risk premiums. 
A)  As with loans, swap participants deal with the credit risk of counterparties by setting bilateral limits on the notional amount of swaps entered into. 
B)  As with loans, swap participants deal with the credit risk of counterparties by adjusting the fixed and/or floating rates by including credit risk premiums. 
C)  As with loans, swap participants deal with the credit risk of counterparties by using Monte Carlo simulations to model potential default risk. 
D)  As with loans, swap participants deal with the credit risk of counterparties by setting bilateral limits on the notional amount of swaps entered into and as with loans, swap participants deal with the credit risk of counterparties by adjusting the fixed and/or floating rates by including credit risk premiums.

Question 15

Which of the following is not a reason for the credit risk on a swap to be less than the credit risk on a loan?

Accepted Answer

A)  Swap contracts often extend beyond the maturity of normal loan contracts. 
B)  Swap payments can be netted across more than on contract. 
C)  Interest rate swaps involve interest, but not principal. 
D)  Swap contracts often extend beyond the maturity of normal loan contracts, swap payments can be netted across more than on contract and Interest rate swaps involve interest, but not principal. 
A)  Swap contracts often extend beyond the maturity of normal loan contracts. 
B)  Swap payments can be netted across more than on contract. 
C)  Interest rate swaps involve interest, but not principal. 
D)  Swap contracts often extend beyond the maturity of normal loan contracts, swap payments can be netted across more than on contract and Interest rate swaps involve interest, but not principal.

Question 16

Which of the following is incorrect in relation to debt recovery rates?

Accepted Answer

A)  Macro-economic factors are found to be significant in explaining recovery rates on defaulted bonds. 
B)  Macro-economic factors are found to be insignificant in explaining recovery rates on defaulted bonds. 
C)  Senior securities tend to have higher recovery rates than subordinated securities. 
D)  Industrial revenue bonds tend to have higher recovery rates than subordinated securities. 
A)  Macro-economic factors are found to be significant in explaining recovery rates on defaulted bonds. 
B)  Macro-economic factors are found to be insignificant in explaining recovery rates on defaulted bonds. 
C)  Senior securities tend to have higher recovery rates than subordinated securities. 
D)  Industrial revenue bonds tend to have higher recovery rates than subordinated securities.

Question 17

Concentration limits are external limits set on the maximum loan size that can be made to an individual borrower.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following statements is true?

Accepted Answer

A)  The minimum risk portfolio generates the highest returns and is thus likely to be chosen by risk-seeking FI managers. 
B)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-averse FI managers. 
C)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-seeking FI managers. 
D)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-indifferent FI managers. 
A)  The minimum risk portfolio generates the highest returns and is thus likely to be chosen by risk-seeking FI managers. 
B)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-averse FI managers. 
C)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-seeking FI managers. 
D)  The minimum risk portfolio does not generate the highest returns and is thus likely to be chosen by risk-indifferent FI managers.

Question 19

The term 'transition matrix' refers to a matrix that provides a measurement of the probability of a loan:

Accepted Answer

A)  being upgraded over some period. 
B)  being downgraded over some period. 
C)  defaulting over some period. 
D)  All of the listed options are correct. 
A)  being upgraded over some period. 
B)  being downgraded over some period. 
C)  defaulting over some period. 
D)  All of the listed options are correct.

Question 20

An FI that invests 40 per cent of funds in a loan with an expected return of 10 per cent and 60 per cent of funds in a loan with an expected return of 12 per cent can expect to earn 11 per cent on its portfolio.

Accepted Answer

A) True 
 B)False

Which of the following statements is true?

The concentration limit for a loan portfolio is calculated as the expected default frequency of the borrower multiplied by (one divided by the loss rate).

A transition matrix can be used to establish the probabilities that a currently rated borrower will be upgraded, downgraded or will default over time.

Using the KMV Portfolio Manager Model, the risk on a loan can be calculated as the volatility of the loan's default rate times the loss in the event of default.

Financial institutions do not use options to hedge credit risk exposures as credit risk is a natural risk that comes with the core activities of the bank, namely lending.

Assume that the maximum loss as a percentage of capital is 12 per cent of an FI's capital to a particular sector. The FI's concentration limit on this sector 35 per cent. What is the sector's loss rate (round to two decimals)?

A forward contract:

Which of the following statements is true?

The return (R_i) on a loan can be measured as follows:

Minimum risk portfolio refers to a combination of assets:

Which of the following is a major difference between forwards and futures?

Which of the following statements is true?

Which of the following statements is true?

Which of the following statements is true?

Which of the following is not a reason for the credit risk on a swap to be less than the credit risk on a loan?

Which of the following is incorrect in relation to debt recovery rates?

Concentration limits are external limits set on the maximum loan size that can be made to an individual borrower.

Which of the following statements is true?

The term 'transition matrix' refers to a matrix that provides a measurement of the probability of a loan:

An FI that invests 40 per cent of funds in a loan with an expected return of 10 per cent and 60 per cent of funds in a loan with an expected return of 12 per cent can expect to earn 11 per cent on its portfolio.

Why Are Financial Institutions Special

The Financial Services Industry: Depository Institutions

The Financial Services Industry: Other Financial Institutions

Risk of Financial Institutions

Interest Rate Risk Measurement: The Repricing Model

Interest Rate Risk Measurement: the Duration Model

Managing Interest Rate Risk Using Off Balance Sheet Instruments

Credit Risk I: Individual Loan Risk

Market Risk

Credit Risk I: Individual Loan Risk

Sovereign Risk

Foreign Exchange Risk

Liquidity Risk

Liability and Liquidity Management

Off-Balance-Sheet Activities

Technology and Other Operational Risk

Capital Management and Adequacy

Filters

Exam 11: Credit Risk II: Loan Portfolio and Concentration Risk

Which of the following statements is true?

The concentration limit for a loan portfolio is calculated as the expected default frequency of the borrower multiplied by (one divided by the loss rate).

A transition matrix can be used to establish the probabilities that a currently rated borrower will be upgraded, downgraded or will default over time.

Using the KMV Portfolio Manager Model, the risk on a loan can be calculated as the volatility of the loan's default rate times the loss in the event of default.

Financial institutions do not use options to hedge credit risk exposures as credit risk is a natural risk that comes with the core activities of the bank, namely lending.

Assume that the maximum loss as a percentage of capital is 12 per cent of an FI's capital to a particular sector. The FI's concentration limit on this sector 35 per cent. What is the sector's loss rate (round to two decimals)?

A forward contract:

Which of the following statements is true?

The return (Ri) on a loan can be measured as follows:

Minimum risk portfolio refers to a combination of assets:

Which of the following is a major difference between forwards and futures?

Which of the following statements is true?

Which of the following statements is true?

Which of the following statements is true?

Which of the following is not a reason for the credit risk on a swap to be less than the credit risk on a loan?

Which of the following is incorrect in relation to debt recovery rates?

Concentration limits are external limits set on the maximum loan size that can be made to an individual borrower.

Which of the following statements is true?

The term 'transition matrix' refers to a matrix that provides a measurement of the probability of a loan:

An FI that invests 40 per cent of funds in a loan with an expected return of 10 per cent and 60 per cent of funds in a loan with an expected return of 12 per cent can expect to earn 11 per cent on its portfolio.

Why Are Financial Institutions Special

The Financial Services Industry: Depository Institutions

The Financial Services Industry: Other Financial Institutions

Risk of Financial Institutions

Interest Rate Risk Measurement: The Repricing Model

Interest Rate Risk Measurement: the Duration Model

Managing Interest Rate Risk Using Off Balance Sheet Instruments

Credit Risk I: Individual Loan Risk

Market Risk

Credit Risk I: Individual Loan Risk

Sovereign Risk

Foreign Exchange Risk

Liquidity Risk

Liability and Liquidity Management

Off-Balance-Sheet Activities

Technology and Other Operational Risk

Capital Management and Adequacy

Filters

The return (R_i) on a loan can be measured as follows: