Deck 11: Risk Assessment and Management

Question 1

A major problem in pursuing the highest return is that

A) there is an enormous amount of investment needed in assets.
B) it usually entails investing in risky investments.
C) the government limits the amount of profits that can be generated by banks.
D) it is not consistent with the notion of stability.

Answer 1

it usually entails investing in risky investments.

Question 2

The ________________ is responsible in shaping the basic borrowing and lending policy of a bank.

A) asset-liability committee
B) liability management
C) asset management
D) deposit-loan committee

Answer 2

asset-liability committee

Question 3

The twin mandate in achieving the financial management goals are to

A) maintain high profitability and high risk.
B) maintain low profitability and low risk.
C) maintain high profitability and low risk.
D) maintain low profitability and high risk.

Answer 3

maintain high profitability and low risk.

Question 4

Bank risk management refers to

A) managing the credit risk of lending to diverse borrowers.
B) managing the bank assets.
C) managing the banks liabilities and capital
D) managing the assets, liabilities and capital of a bank.

Question 5

Consumer loans, mortgage loans, government and municipal securities and reserves will be found in the of a typical depository institution.

A) income statement
B) capital category of the balance sheet .
C) asset category in the balance sheet
D) liability category of the balance sheet.

Question 6

The basic goal in managing the rate spread between the return on assets and the cost of liabilities.

A) To maintain a negative spread.
B) To maintain a positive spread
C) To maintain profitability.
D) both A and C above

Question 7

Small and large time deposits, savings and checkable deposits will be found in the _______________ of a typical bank.

A) income statement
B) capital category of the balance sheet
C) asset category in the balance sheet
D) liability category in the balance sheet

Question 8

When the value of the bank's liabilities are greater that the value of its assets.

A) insolvent
B) negative spread
C) positive spread
D) gap

Question 9

Inherent in all loan process are the presence of

A) moral hazard
B) asymmetric information
C) adverse selection
D) All of the above

Question 10

The five C's of credit stands for

A) cooperation, capacity, collateral, creativity, conditions
B) capacity, character, conditions, collateral, capital
C) capability, cooperation, creativity, collateral, capital
D) conditions, competence, capital, conditions, capacity

Question 11

In evaluating the applicant's ability to pay, the debt-to-income ratio should

A) be less than 50%
B) be 36% or less
C) be less than 28%
D) be around 15%

Question 12

The best single predictor of the possibility of default on a loan is

A) the amount of equity capital the borrower has in the project.
B) the amount of assets the borrower has.
C) the type of other liabilities the borrower has.
D) the amount of compensating balances the borrower has.

Question 13

____________________is the ratio of total loan amount by the total value of the property.

A) debt-to-income ratio
B) housing-to-income-ratio
C) liability-to-market value ratio
D) loan-to-value ratio

Question 14

The difference between the value of the borrower's property and the amount owed is ____________while the value of the property is ________________given to the lender.

A) collateral, capital
B) capital, collateral
C) capacity, collateral
D) equity, capacity

Question 15

A borrower obtained secured loan of $12,000 to purchase a car and put down $2,000. Today, the outstanding balance on the loan is $9,000 and the car is worth $8,000 if sold. In case of default,

A) the lender can still ask the borrower to pay $1,000 after receiving $8,000 from the sale of the car.
B) the lender will lose $1,000 after the car is sold for $8,000.
C) the lender has no recourse.
D) the borrower has no responsibility to repay the loan after the car is repossessed by the lender.

Question 16

A special form of collateral used by banks whereby the borrower is required to keep a proportion of the proceeds of the loan in a checking account in the bank.

A) checking balances
B) loan collateral balance
C) deposit balances
D) compensating balances

Question 17

Credit reporting agencies play an important role in assessing the default risk of a borrower by

A) providing credit reports containing credit history information.
B) gathering public and private information about the borrowers.
C) generating credit scores to help predict the probability of default.
D) All of the above.

Question 18

To reduce credit or default risk, a bank can

A) diversify lending
B) share the risk through loan participations
C) though selling loans to another bank or firm
D) All of the above

Question 19

The ability of lenders to accurately discern acceptable credit risks from unacceptable one's has improved through

A) the development of technology and access of information provided by credit rating agencies.
B) the creation of risk-based lending.
C) the reduction in interest rates.
D) the use of credit rationing.

Question 20

The degree by which the bank income will be affected by changes in interest rate is

A) price risk.
B) the gap.
C) duration.
D) reinvestment risk.

Question 21

The threat that an increase in interest rates will reduce the market value of security holdings.

A) price risk
B) gap
C) interest rate risk
D) reinvestment rate risk.

Question 22

An expected increase in interest rate would indicate a move towards _______________income gap to increase future bank income.

A) neutral
B) negative
C) positive
D) zero

Question 23

Liquidity risk can be managed on the liability side by

A) attracting different types of deposits and tapping other sources of borrowing.
B) selling loans or securities.
C) attracting deposits and selling loans.
D) reducing the amount of deposits and borrowings relative to assets.

Question 24

If a borrower purchased a home for$100,000, put $8,000 down and borrowed the rest from a bank, what is the amount of equity the homeowner has in the house if the house falls in value to $90,000?

A) the borrower has an equity in the property worth $8,000.
B) the borrower has zero equity in the home.
C) the borrower has negative equity in the home equivalent to $2,000.
D) None of the above.

Question 25

Assuming an income gap of $100 million, what will be the change in bank income if there is a 3 percent decrease in interest rates?

A) $3 million
B) -$3 million
C) $30 million
D) Unable to tell with the information provided.

Question 26

Assuming a gap of $100 million, what will be the change in bank income if there is a 3 percent increase in interest rates?

A) $3 million
B) -$3 million
C) $30 million
D) Unable to tell with the information provided.

Question 27

If interest rate sensitive assets are $50 million and interest rate sensitive liabilities are $40 million, what is the income gap?

A) $90 million
B) $40 million
C) $50 million
D) $10 million

Question 28

If interest rate sensitive assets are $40 million and interest rate sensitive liabilities are $50 million, what is the income gap?

A) -$90 million
B) $40 million
C) -$50 million
D) -$10 million

Question 29

Interest rates go up. What happens to bank income if the income gap is negative?

A) Bank income increases.
B) Bank income stays the same.
C) Bank Income decreases.
D) It's impossible to tell from the information provided

Question 30

Interest rates go up. What happens to bank income if the income gap is positive?

A) Bank income increases.
B) Bank income stays the same.
C) Bank Income decreases.
D) It's impossible to tell from the information provided.

Question 31

Interest rates go down. What happens to bank income if the income gap is positive?

A) Bank income increases.
B) Bank income stays the same.
C) Bank Income decreases.
D) It's impossible to tell from the information provided.

Question 32

Interest rates go down. What happens to bank income if the income gap is negative?

A) Bank income increases.
B) Bank income stays the same.
C) Bank Income decreases.
D) It's impossible to tell from the information provided.

Question 33

Checkable deposits and savings deposits will be found in the of a typical depository institution.

A) income statement
B) capital category of the balance sheet .
C) asset category in the balance sheet
D) liability category of the balance sheet.

Question 34

To reduce interest rate, a bank can

A) make adjustable rate loans
B) share the risk through loan participations
C) though selling loans to another bank or firm
D) All of the above

Question 35

Asymmetric information means

A) after the loan is made, the borrower has an incentive to use the proceeds for a more risky venture.
B) the borrower knows more about the risks of a project than the lender.
C) the worst borrowers will pursue the loan most diligently.
D) the benefits of the loan must be greater than the costs.

Question 36

Moral hazard means

A) after the loan is made, the borrower has an incentive to use the proceeds for a more risky venture.
B) the borrower knows more about the risks of a project than the lender.
C) the worst borrowers will pursue the loan most diligently.
D) the benefits of the loan must be greater than the costs.

Question 37

Adverse selection means

A) after the loan is made, the borrower has an incentive to use the proceeds for a more risky venture.
B) the borrower knows more about the risks of a project than the lender.
C) the worst borrowers will pursue the loan most diligently.
D) the benefits of the loan must be greater than the costs.

Question 38

The gap is the difference between

A) interest sensitive liabilities and interest sensitive assets.
B) interest sensitive assets and interest sensitive liabilities.
C) fixed and variable assets.
D) fixed and variable liabilities.

Question 39

If a borrower purchased a home for $200,000, put $20,000 down, and borrowed the rest from a bank, what happens to the homeowner's equity if the value of house falls to $160,000?

A) the borrower has an equity in the property worth $40,000.
B) the borrower has zero equity in the home.
C) the borrower has negative equity in the home equivalent to $20,000.
D) None of the above.

Question 40

A bank has interest sensitive liabilities equal to $100 million and interest sensitive assets equal to $80 million, then the gap is

A) $20 million
B) -$20 million
C) $180 million
D) -$180 million

Question 41

The risk that after a loan is made, the borrower has an incentive to use the proceeds for a more risky venture is ______________________.

A) adverse selection
B) default risk
C) moral hazard
D) asymmetric information.

Question 42

The risk that the borrower knows more about the risks of the project than the lender is ______________________.

A) adverse selection
B) default risk
C) moral hazard
D) asymmetric information.

Question 43

The risk that the worst borrowers pursue the loan most diligently is ______________________.

A) adverse selection
B) default risk
C) moral hazard
D) asymmetric information.

Question 44

Which of the following is false?

A) The higher the absolute value of the gap, the greater the degree of interest rate risk.
B) Most banks have a positive gap. Thus, increased interest rates cause bank income to rise.
C) One can predict the magnitude of change in bank income due to interest rate changes by multiplying the gap by the percentage point change in the interest rate.
D) If a bank's asset- liability committee believes interest rates will rise in the future, it should move the bank's balance sheet toward a positive gap.

Question 45

The liquidity ratio is

A) A tool frequently used by depository institutions to assess liquidity risk.
B) a measure of the difference between a bank's short- term investments and its short- term liabilities, all divided by the bank's assets.
C) the income gap divided by the bank's total assets.
D) All of the above are true.

Question 46

___________________ is the danger that a financial institution will be required to make a payment when the intermediary has only long- term assets that cannot be converted to liquid funds quickly without a capital loss.

A) Liquidity risk
B) Interest rate risk
C) Timing risk
D) Exchange risk

Question 47

To manage liquidity risk, banks can

A) attract more deposits.
B) sell assets.
C) borrow funds.
D) All of the above.

Question 48

An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult to predict has been called a _______________________ .

A) random event.
B) financial tsunami.
C) black swan.
D) None of the above is correct.

Question 49

Capacity is

A) the borrower's ability to repay a loan
B) the competency and willingness of a business firm's management or an individual borrower to repay his or her debts
C) the amount of equity or wealth a borrower has at stake in the proposed project
D) the amount and liquidity of assets a borrower uses to secure a loan

Question 50

Character is

A) the borrower's ability to repay a loan
B) the competency and willingness of a business firm's management or an individual borrower to repay his or her debts
C) the amount of equity or wealth a borrower has at stake in the proposed project
D) the amount and liquidity of assets a borrower uses to secure a loan

Question 51

Collateral is

A) the borrower's ability to repay a loan
B) the competency and willingness of a business firm's management or an individual borrower to repay his or her debts
C) the amount of equity or wealth a borrower has at stake in the proposed project
D) the amount and liquidity of assets a borrower uses to secure a loan

Question 52

Capital is

A) the borrower's ability to repay a loan
B) the competency and willingness of a business firm's management or an individual borrower to repay his or her debts
C) the amount of equity or wealth a borrower has at stake in the proposed project
D) the amount and liquidity of assets a borrower uses to secure a loan