Deck 14: Liquidity Risk

Question 1

Which of the following statements is true?

A) A net liquidity statement focuses on the sources of liquidity and thus provides a measure of an FI's available liquidity.
B) A net liquidity statement list focuses on the uses of liquidity and thus provides a measure of an FI's liquidity needs.
C) A net liquidity statement lists sources and uses of liquidity and thus provides a measure of an FI's net liquidity position.
D) None of the given answers.

Answer 1

C

Question 2

Which of the following items may expose an FI to liquidity risk?

A) $500 000 in demand deposits and $100 000 in overnight deposits made by another FI.
B) $500 000 in demand deposits and $50 000 in credit line facilities.
C) $500 000 in demand deposits, $100 000 in loan commitments and $50 000 in short-term securities.
D) $500 000 in demand deposits, $100 000 in overnight deposits made by another FI and $50 000 in credit line facilities.

Answer 2

D

Question 3

Bank panic refers to a contagious run on the deposits of:

A) banking institutions in particular suburbs.
B) the big four banks.
C) all branches of a particular institution.
D) the banking industry as a whole.

Answer 3

D

Question 4

An FI's financing gap is the difference between an FI's:

A) average core deposits and average loans.
B) average loans and average core deposits.
C) assets and liabilities.
D) liabilities and assets.

Question 5

Which of the following statements is true?

A) Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay shareholders immediately.
B) Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to finance new loan demand.
C) Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay fully and promptly all maturing liabilities.
D) Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay all short-term liabilities immediately.

Question 6

Contingent liquidity needs refers to the liquidity needs necessary to:

A) fund contingent assets.
B) fund assets.
C) meet an unforeseen event.
D) meet a foreseen event.

Question 7

Which of the following statements is true?

A) In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
B) In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
C) In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.
D) In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.

Question 8

Which of the following statements is true?

A) The net asset value equals the total market value of the assets of the fund.
B) The net asset value equals the total market value of the assets of the fund divided by the number of shares in the funds outstanding.
C) The net asset value equals the number of shares in the funds outstanding divided by the total market value of the assets of the fund.
D) The net asset value equals the total market value of the assets of the fund multiplied by the number of shares in the funds outstanding.

Question 9

Net deposit drains refer to the amount by which cash withdrawals:

A) are less than additions-this is a cash outflow.
B) are less than additions-this is a cash inflow.
C) exceed additions-this is a cash outflow.
D) exceed additions-this is a cash inflow.

Question 10

Which of the following statements is true?

A) The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the Christmas effect.
B) The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called seasonal liquidity.
C) The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the January effect.
D) The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called the four seasons liquidity gap.

Question 11

Which of the following statements is true?

A) The financing requirement is the financing gap plus an FI's liquid assets.
B) The financing requirement is the financing gap minus an FI's liquid assets.
C) The financing requirement is the financing gap multiplied by an FI's liquid assets.
D) The financing requirement is the financing gap divided by an FI's liquid assets.

Question 12

Net asset value is the:

A) product of the price at which a managed fund's shares are sold and the number of outstanding shares.
B) price at which a managed fund's shares are sold.
C) value of an investor's holding in managed fund's shares.
D) None of the listed options are correct.

Question 13

Fire-sale price refers to the price received for:

A) an asset that has to be sold at half price.
B) a liability that has to be sold at half price.
C) an asset that has to be sold immediately.
D) a liability that has to be sold immediately.

Question 14

An open-end fund is defined as an investment fund that sells:

A) an elastic number of shares to outside investors.
B) a fixed number of shares to an elastic number of outside investors.
C) an elastic number of shares to outside investors, but that never buys back any of these shares.
D) a fixed number of shares to an elastic number of outside investors, but that never buys back any of these shares.

Question 15

A bank run refers to a sudden:

A) but expected increase in deposit withdrawals from an FI.
B) and unexpected increase in deposit withdrawals from an FI.
C) and unexpected increase in customers that wish to undertake business with the FI.
D) but expected increase in customers that wish to undertake business with the FI.

Question 16

Trend liquidity needs are liquidity needs that relate to the:

A) trends occurring in the community where, for example, loan growth exceeds deposits growth.
B) trends occurring in the community where, for example, deposit growth exceeds loan growth.
C) demand for liquidity that fluctuates with seasonal factors.
D) demand for liquidity that fluctuates with seasonal factors within a community.

Question 17

Cyclical liquidity needs are those which vary with the:

A) seasonal cycle.
B) business cycle.
C) weather cycle, for example influencing droughts.
D) FI's maturity cycle.

Question 18

Which of the following statements is true?

A) An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.
B) Traditionally, FI managers have relied on stored liquidity management as the primary mechanism of liquidity management.
C) Today, there is a higher reliance on purchased liquidity management.
D) All of the listed options are correct.

Question 19

An investment fund that sells a fixed number of shares in the fund to outside investors is called:

A) open-end fund.
B) closed-end fund.
C) fixed fund.
D) fixed number fund.

Question 20

Which of the following statements is true?

A) Open market operations are interventions in the short-term money market by APRA to affect the cash interest rate.
B) Open market operations are interventions in the short-term money market by the RBA to affect the cash interest rate.
C) Open market operations are interventions in the long-term capital market by APRA to affect long-term interest rates.
D) Open market operations are interventions in the long-term capital market by the RBA to affect long-term interest rates.

Question 21

Which of the following is false?

A) Appropriate liquidity planning can lower the cost of funds of an FI and thus increase its profitability.
B) Appropriate liquidity planning can maximise the amount of excess cash reserves.
C) Appropriate liquidity planning can limit an FI's liquidity risk.
D) None of the listed options are correct.

Question 22

Which of the following statements is true?

A) A positive financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
B) A negative financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
C) A positive financing gap means that the FI has excess liquidity.
D) A negative financing gap means that the FI is in need of liquidity.

Question 23

Which of the following is not a potential cause of liquidity risk for a DI?

A) A decrease in the DI's stock price caused by market factors.
B) An increase in requests to fund large amounts of loan commitments.
C) A decrease in the availability of short-term borrowed funds.
D) An increase in requests by depositors to withdrawal large amounts of deposits.

Question 24

Which of the following is a way in which an FI can raise liquidity?

A) Sell liquid assets.
B) Borrow funds in money markets.
C) Use excess cash reserves over and above the amount held in its exchange settlement account with the RBA.
D) All of the listed options are correct.

Question 25

Which of the following statements is true?

A) The liquidity index compares the liquidity of a single institution with the industry average and thus measures the liquidity risk of that particular institution.
B) The liquidity index provides guidance for FIs on how much liquidity they should hold on a seasonal basis.
C) The liquidity index measures the potential losses an FI could suffer if new market entrants take away market share from the existing institutions.
D) The liquidity index measures the potential losses an FI could suffer from a sudden disposal of assets compared to the mount it would receive at a fair market value established under normal sales conditions.

Question 26

Which of the following statements is true?

A) In case of a liquidity crisis, depositors do not need to worry as the RBA will pay out any deficit balances.
B) In case of a liquidity crisis, any available balances will be divided equally among depositors.
C) In case of a liquidity crisis, any available balances will be divided proportionally to each depositor's investment.
D) In case of a liquidity crisis, the 'first comes, first serves' principle holds.

Question 27

Which of the following statements is true in the context of the liquidity index?

A) The greater the difference between immediate fire-sale asset prices and fair market value prices, the more liquid is the FI's portfolio of assets.
B) The greater the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI's portfolio of assets.
C) The smaller the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI's portfolio of assets.
D) None of the listed options are correct.

Question 28

What are typical reasons for abnormal deposit drains?

A) Concerns about an FI's solvency relative to other FIs.
B) Failure of a related FI leading to heightened depositor concerns about the solvency of other FIs.
C) Sudden changes in investor preferences regarding holding non-bank financial assets relative to deposits.
D) All of the listed options are correct.

Question 29

A disadvantage of using asset management to manage an FI's liquidity risk is:

A) the resulting shrinkage of the FI's balance sheet.
B) the high cost of purchased liabilities.
C) the accessibility of international money markets.
D) loss of flexibility as a result of dependence upon purchased liabilities.

Question 30

Consider the following situation: an FI holds two assets in equal proportions, these being liquid securities with a fair market value of $200 and housing loans with a fair market value of $800. Further assume that in case of immediate liquidation, the FI would receive $185 for its liquid securities and $700 for its housing loans. What is the FI's liquidity index (round to two decimals)?

A) I = (185/200) + (700/800) = 1.80
B) I = (185/200) $\times$ (700/800) = 0.81
C) I = 0.5 $\times$ (185/200) + 0.5 $\times$ (700/800) = 0.90
D) I = [0.5 $\times$ (185/200)] $\times$ [0.5 $\times$ (700/800)] = 0.20

Question 31

A disadvantage of using liability management to manage an FI's liquidity risk is:

A) the resulting shrinkage of the FI's balance sheet.
B) the high cost of purchased liabilities.
C) the accessibility of international money markets.
D) loss of flexibility as a result of dependence upon purchased liabilities.

Question 32

What are the possible ways that a bank can meet an expected net deposit drain of +4 per cent using purchased liquidity management techniques?

A) Utilise the interbank funds market and repurchase agreements.
B) Utilise repurchase agreements.
C) Liquidate all cash holdings.
D) All of the listed options are correct.

Question 33

Assume the value of an FI's average loans is $300 and the value of its average deposits is $400. The FI has liquid assets of $100. What is the FI's financing requirement?

A) $400 - $300 - $100 = $0
B) $300 - $400 - $100 = -$200
C) $400 - $300 + $100 = $200
D) $300 - $400 + $100 = $0

Question 34

Consider the following hypothetical data: What is the FI's net liquidity position?

A) ($12 500 + $500) - ($3000 + $22 000 + $1000) = -$13 000
B) ($3000 + $22 000 + $1000) - ($12 500 + $500) = $13 000
C) ($12 500 - $500) = $13 000
D) ($3000 + $22 000 + $1000) = $26 000

Question 35

Which of the following statements is true?

A) Under the BIS scenario analysis, an FI needs to assess its liquidity position in comparison to other FIs in the market based on different scenarios.
B) Under the BIS scenario analysis, an FI needs to estimate the size of cash flows for each type of asset and liability based on past experience.
C) Under the BIS scenario analysis, an FI needs to assign a timing of cash flows for each type of asset and liability by assessing the probability of behaviour of those cash flows under the scenario being examined.
D) None of the listed options are correct.

Question 36

Which of the following statements is true?

A) In Australia, depositors received preference over other liability holders in the event of a liquidation of an FI.
B) In Australia, depositors receive preference over other liability holders in the event of a liquidation of an FI being replaced by a financial claims scheme to protect deposit accounts.
C) In Australia, only customers of the major banks are covered by deposit insurance.
D) Australia has had a well-developed deposit insurance system for decades that has protected depositors without a bank failure for over a century.

Question 37

Which of the following statements is false?

A) It is difficult to isolate which part of past deposits and loan fluctuations is due to cyclical liquidity.
B) Forecasting future liquidity needs based on past patterns is always risky due to changes in seasonal patterns, regulation and economic conditions.
C) Liquidity planning tools typically ignore cyclical liquidity needs and liquidity needs due to FI confidence crises.
D) None of the listed options are correct.

Question 38

Which of the following equations correctly defines an FI's financing requirements?

A) Average loans - average deposits
B) Average deposits - average loans
C) Average loans - average deposits + liquid assets
D) Financing gap - liquid assets

Question 39

Consider the following situation: an FI holds 40 per cent of its assets in liquid securities with a fair market value of $100 and the remaining 60 per cent of its assets in housing loans with a fair market value of $500. Further assume that in case of immediate liquidation, the FI would receive $90 for its liquid securities and $450 for its housing loans. What is the FI's liquidity index (round to two decimals)?

A) 0.19
B) 0.54
C) 0.67
D) 0.90

Question 40

Assume that an FI's average loan value is $500 and the average value of deposits is $450. The FI has liquid assets of $50. What is the FI's financing gap?

A) $500 - $450 - $50 = $0
B) $450 - $500 = -$50
C) $500 - $450 = $50
D) $500 - $450 + $50 = $100

Question 41

Australia has recently developed a market for deposit insurance guarantee that protects deposit accounts.

Question 42

An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.

Question 43

Which type of financial intermediary is more highly exposed to liquidity risk?

A) property-casualty insurance companies
B) life insurance companies
C) mutual funds
D) depository institutions

Question 44

APRA requires every FI to hold sufficient liquid assets to meet a name crisis situation.

Question 45

The maturity ladder model allows a comparison of cash inflows and cash outflows over a series of specified time periods.

Question 46

The Reserve Bank of Australia (RBA) took a number of temporary actions during the global financial crisis to provide liquidity and avert financial system disturbance. Which of the following were not actions supplied by the RBA?

A) Extension of collateral eligible for open market operations.
B) Longer term repos offered daily that provided funding for 6-month and 1-year terms.
C) Residential mortgage-backed securities and asset-backed commercial paper.
D) A foreign exchange swap facility to address the global shortage of euro in financial markets.

Question 47

What are the two main liquidity facilities available to Australian FIs to prevent financial disturbances occurring?

A) Deposit insurance and the discount window.
B) Intra-day repurchase agreement and overnight repurchase agreement.
C) Financing gap and the financing requirement.
D) Secondary credit and seasonal credit.

Question 48

Which of the following is not a component of liquidity planning?

A) A summary of the size of potential net deposit drains over various time horizons.
B) Detailed list of funds providers who have seasonal patterns of funds usage.
C) A calculation of the value of assets at fire-sale prices relative to the fair market value of those assets.
D) A detailed itemisation of managerial responsibilities.

Question 49

The Bank for International Settlements requires FIs to measure their liquidity positions under normal market conditions only.

Question 50

Liquidation of a mutual fund causes assets to be liquidated and funds received to the dispersed to shareholders on a first come, first served basis.

Question 51

When comparing banks and mutual funds, mutual funds have:

A) more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
B) less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
C) more liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first-served basis.
D) the same liquidity risk as banks because both shareholders and depositors share the fall in the loss of value on a pro rata basis.

Question 52

The liquidity index will always lie between -1 and +1.

Question 53

The aim of open market transactions is to influence the level of liquidity in the market.

Question 54

Consider a mutual fund with 100 shareholders who each invested $10 for a total of $1000. If the assets of the mutual fund are worth $900, what is the net asset value for each one of the mutual fund shares?

A) $0.9
B) $9
C) $90
D) $10

Question 55

Liquidity risk can only arise on the asset-side of an FI's balance sheet as this means that the FI does not hold enough liquid assets such as cash or liquid securities.

Question 56

In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts knows that normally only a small proportion of these deposits will be withdrawn on any given day.

Question 57

As part of the Basel III liquidity reforms the RBA will establish a secure committed liquidity facility.

A) This is necessary due to the shortage of capital required to be held by FIs.
B) This is necessary due to the shortage of Australian government debt, T-bonds and T-notes, used in open market operations.
C) This is necessary due to the shortage of international funds to purchase repos.
D) All of the listed options are correct.

Question 58

Use the following balance sheet (values in thousands of dollars) to answer the question. If the bank experiences a $50 000 sudden liquidity drain caused by a loan commitment draw down, what will be the impact on the balance sheet if stored liquidity management techniques are used?

A) A reduction in cash of $21 000 and an increase in demand deposits of $29 000.
B) A reduction in securities and/or current loans totalling $50 000.
C) A reduction in cash of $21 000 and a decrease in securities holdings of $29 000.
D) A decrease in equity of $50 000.

Question 59

Trend liquidity planning calculates an FI's liquidity need as the simple difference between the FI's liquid assets and its volatile sources of funds.

Question 60

Use the following balance sheet (values in thousands of dollars) to answer the question. If the bank experiences a $50 000 sudden liquidity drain caused by withdrawal of their demand deposits, what will be the impact on the balance sheet if purchased liquidity management techniques are used?

A) A reduction in cash of $21 000 and a decrease in demand deposits of $29 000.
B) A reduction in securities and/or current loans totalling $50 000.
C) A reduction in demand deposits of $50 000 and an increase in interbank borrowings of $50 000.
D) A decrease in equity of $50 000.

Question 61

A contagious run, or bank panic, differs from a run on a bank in that a contagious run involves loss of faith in the entire banking system as opposed to just one bank.

Question 62

Discuss the advantages and disadvantages of stored liquidity management and purchased liquidity management. In your opinion, which is the better approach for a DI to adopt?

Question 63

Distinguish between liquidity risk arising from the asset-side and the liability-side of the balance sheet.

Question 64

What are the main components of a liquidity plan? Discuss the vital role such a plan plays in reducing liquidity risk?