Deck 12: Liquidity Risk

Question 1

Purchased liquidity risk management usually involves purchased funds such as fed funds,repurchase agreements and CDs.

Answer 1

True

Question 2

Liquid funds can be obtained by a DI through unlimited borrowing in the money or purchased funds markets.

Answer 2

False

Question 3

During the financial crisis of 2008,there were large deposit outflows from the banking system.

Answer 3

False

Question 4

Depository institutions generally rely on each other for cash and to meet their daily liquidity needs.

Question 5

During the financial crisis of 2008,liquidity problems were avoided as banks continued to provide lending to each other.

Question 6

Managing asset-side liquidity risk can involve either purchased liquidity management or stored liquidity management.

Question 7

Because cash reserves at the Federal Reserve do not earn interest,DIs do not hold any excess cash reserves beyond the minimum requirements.

Question 8

Bank runs occur because customers know that banks will be forced to liquidate assets at fire-sale prices.

Question 9

Core deposits represent a relatively short-term source of funds.

Question 10

Asset-side liquidity risk may be a result of off-balance sheet (OBS)lending commitments.

Question 11

Liquidity risk is a normal aspect of everyday management of an FI.

Question 12

An FI's most liquid asset is cash.

Question 13

An expected net deposit drain on any given day means that deposit withdrawals are less than deposit inflows.

Question 14

When liquidity risk problems occur at a DI,they often threaten the solvency of the institution.

Question 15

Demand deposits pose a liquidity risk for FIs because funds may be withdrawn at any time.

Question 16

A bank must be ready to pay out all demand deposit liabilities on any given day.

Question 17

Liquidity risk for an FI includes the possibility of an unexpected inflow of funds.

Question 18

Mutual funds tend to have more exposure to liquidity risk than banks and thrifts.

Question 19

Purchased liquidity management carries the potential risk of significant increases in the cost of funds during periods of high interest rate volatility.

Question 20

Banks with relatively high loan commitments face less liquidity risk exposure than banks with a low level of loan commitments.

Question 21

Liquidity planning primarily is designed to assist management in dealing with relatively predictable events.

Question 22

A DI's financing requirement is defined as its financing gap plus the DI's liquid asset holdings.

Question 23

In the event of a bank run,depositor claims on the bank are satisfied on a pro rata basis.

Question 24

Abnormally large and unexpected deposit withdrawals can occur because of concerns by depositors about a bank's solvency relative to other banks.

Question 25

The liquidity coverage ratio for a DI incorporates an "acute liquidity stress scenario" specified by banking supervisors.

Question 26

The net stable funds ratio (NSFR)is a longer-term measure than the liquidity coverage ratio (LCR).

Question 27

The net stable funds ratio (NSFR)attempts to ensure illiquid assets and securities are funded with a minimum amount of stable liabilities for at least a one year time horizon.

Question 28

The greater the difference between fair market prices and fire-sale prices for assets,the less liquid the DI's portfolio of assets.

Question 29

As of 2014,all U.S.banks must report their The Liquidity Coverage Ratio (LCR)to the FDIC rather than to the Federal Reserve.

Question 30

A problem exists with the net stable funds ratio (NSFR)in that it does not include off-balance-sheet activities.

Question 31

Deposit insurance is the only deterrent to bank runs,contagious runs,and bank panics.

Question 32

The future liquidity position of a DI cannot be forecasted.

Question 33

The cost of stored liquidity management is the interest that must be paid on the stored funds.

Question 34

In terms of liquidity risk measurement,the financing gap is defined as rate sensitive assets minus rate sensitive liabilities.

Question 35

When computing the liquidity coverage ratio,high-quality liquid assets (HQLAs)are divided into two levels.

Question 36

Even with liquidity planning,net deposit withdrawals and/or the exercise of loan commitments can pose significant liquidity problems for banks.

Question 37

Most demand deposits stay at DIs for periods of two years or more.

Question 38

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 39

When using peer group comparisons to determine liquidity risk of a DI,peer groups are defined by the Federal Reserve.

Question 40

The liquidity index should be a number that is either greater than one or less than zero.

Question 41

The Fed discount window maintains three lending programs to assist DIs in managing liquidity problems.

Question 42

Open-end mutual funds issue a fixed number of shares classified as liabilities.

Question 43

The assets of PC insurers are relatively short term and more liquid than those of life insurance companies.

Question 44

Of the following,which financial intermediary is least likely to be exposed to liquidity risk?

A)Property-casualty insurance companies
B)Life insurance companies
C)Mutual funds
D)Depository institutions

Question 45

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 46

A bank's net deposit drain

A)is negative if deposits exceed withdrawals.
B)is positive if deposits exceed withdrawals.
C)decreases during holiday and vacation periods.
D)in unaffected by holiday and vacation periods.

Question 47

What is a fire-sale price?

A)Market value of an asset.
B)Price received for an asset that has to be liquidated immediately.
C)Maximum price that will be received on sale of an asset irrespective of the time of sale.
D)Replacement value of an asset.

Question 48

Surrender value is the amount of cash a life insurance policy holder can receive by turning in the policy before it expires or matures.

Question 49

It is impossible for money market mutual fund share prices to fall below $1.00.

Question 50

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 51

Government securities represent the reserve asset fund for life insurance companies.

Question 52

Which of the following is a condition for a DI to be growing?

A)Net positive drain on deposits.
B)Peak of the net deposit drain probability distribution should lie at a point to the right of zero.
C)Average deposit drains such that new deposit funds more than offset deposit withdrawals.
D)The liability side of its balance sheet is decreasing.

Question 53

Both PC and life insurance companies have to deal with liability runs by policyholders seeking to cash out their policies before maturity.

Question 54

Unlike DIs,there is never a need for a life insurance company to have a liquidity plan for a "run" resulting from concerns about its solvency.

Question 55

Hedge funds are not susceptible to liquidity risk or a liquidity crisis.

Question 56

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 57

For life insurance companies,the distribution of premium income minus policyholder liquidations is unpredictable.

Question 58

Net asset value is the current value of a mutual fund's assets divided by the number of shares outstanding.

Question 59

Liquidity risk for a life insurance company only occurs when asset returns do not provide sufficient cash flows to meet policyholder liquidations.

Question 60

In general,money center banks are exposed to less liquidity risk than smaller,regional banks.

Question 61

What is the impact of a 50 basis point increase in interest rates on the net asset value of an open-end bond mutual fund holding a seven year,$100 million face value 7 percent annual coupon bond selling at par? The fund has 10 million shares.

A)An increase of $0.24 per share.
B)A decrease of $0.265 per share.
C)An increase of $0.05 per share.
D)A decrease of $0.05 per share.

Question 62

When banks use stored liquidity management,they

A)must pay interest on the funds that are stored.
B)store the funds at the U.S.Treasury.
C)necessarily increase the asset side of the balance sheet.
D)may shrink the balance sheet if cash is used as the liquidity adjustment mechanism.

Question 63

How does purchased liquidity management affect profitability?

A)By its impact on the interest rate sensitivity of assets.
B)By its impact on the interest rate sensitivity of liabilities.
C)By determining the default risk of investment securities.
D)By its impact on the cost of purchased funds.

Question 64

Which of the following statements is NOT true?

A)Stored liquidity management involves liquidation of assets.
B)Traditionally DIs have stored cash reserves at the Federal Reserve and in their vaults to overcome liquidity risk.
C)When the DI uses its cash as the liquidity adjustment mechanism,both sides of its balance sheet contract.
D)DIs hold cash reserves in excess of the minimum required to meet liquidity drains.
E)A DI sustains no cost under stored liquidity risk management.

Question 65

Which of the following is NOT used as a method of measuring liquidity risk?

A)Liquidity coverage ratio.
B)Liquidity index.
C)Financing gap and financing requirement.
D)Peer group ratio comparison.
E)Current ratio.

Question 66

Which of the following balance sheet entries is not a tool used in purchased liquidity management?

A)Bonds.
B)Federal fund.
C)Demand deposit.
D)Repurchase agreement.

Question 67

The surrender value of an insurance policy is

A)its promised payoff.
B)normally a portion of the contract's face value.
C)its value upon bankruptcy.
D)the value of the junk bonds in the insurance company's portfolio.

Question 68

Why have purchased liquidity management techniques become very popular in spite of its limitations?

A)Because it insulates the assets of an FI from normal drains on liability liquidity.
B)Because funds can be easily raised in the eventuality of a liquidity crunch.
C)Because of decrease in the cost of funds during periods of high interest rate volatility.
D)Because the funds are covered by deposit insurance.

Question 69

Which of the following is NOT a primary source of liquidity?

A)Excess cash reserves over and above regulatory reserve requirements.
B)Borrowings in the money market.
C)Borrowings in the purchased funds market.
D)Capital notes and other long-term financing alternatives.

Question 70

A disadvantage of using purchased liquidity management to manage a FI's liquidity risk is

A)the resulting shrinkage of the FI's balance sheet.
B)the relatively high cost of purchased liabilities.
C)the accessibility of international money markets.
D)tax considerations.

Question 71

Which intermediation function results in an FI's exposure to liquidity risk?

A)Information production.
B)Asset transformation.
C)Conduit for monetary policy.
D)Lender of last resort.

Question 72

An open-end bond mutual fund is holding a three-year,$1 million face value 5 percent annual coupon bond selling at par.What is the impact on the total asset value of the fund of a 1 percent decrease in interest rates?

A)A decrease of $10,000.
B)An increase of $10,000.
C)A decrease of $26,730.
D)An increase of $27,751.

Question 73

A disadvantage of using stored liquidity management to manage a 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)tax considerations.

Question 74

When comparing banks and mutual funds,

A)mutual funds have more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
B)mutual funds have less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis.
C)mutual funds have more liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.
D)mutual funds have less liquidity risk than banks because all shareholders have the ability to withdraw their money on a first-come first basis.

Question 75

In the event of financial distress,open-ended mutual fund investors

A)have an incentive to cash in their shares quickly since they are paid on a first come,first served basis.
B)have an incentive to avoid a run since that will deplete the fund net asset value.
C)have an incentive to cash in their shares quickly since that will increase the fund's net asset value.
D)will switch into low risk bank deposits.

Question 76

What is the asset adjustment to a bank's balance sheet if the bank sold a five-year,7 percent annual coupon $100,000 bond acquired at par,but now yielding 8 percent? The bond was not in the mark-to-market portfolio.

A)A $96,007 reduction in assets.
B)A $96,007 increase in assets.
C)A $100,000 reduction in assets.
D)A $100,000 increase in assets.

Question 77

If stored liquidity is used by a DI to fund an exercised loan commitment

A)the balance sheet will decrease by the amount of the new loan.
B)only the asset side of the balance sheet will increase.
C)the balance sheet will increase by the amount of the new loan.
D)only the liability side of the balance sheet will increase.
E)there will be no effect on the balance sheet.

Question 78

Which of the following observations is NOT true?

A)Traditionally,DI managers have relied on purchased liquidity management as the primary mechanism of liquidity management.
B)Today,many DIs rely on purchased liquidity management to deal with the risk of cash shortfalls.
C)The largest banks with access to the money market and other nondeposit markets for funds rely on purchased liquidity management to deal with the risk of cash shortfalls.
D)Purchased liquidity management and stored liquidity management are ways of managing a drain on deposits.

Question 79

What information does the net liquidity statement provide?

A)A long-term focus on liquidity.
B)Sources and uses of liquidity.
C)Net asset value.
D)Liquidity index information.

Question 80

If purchased liquidity is used by a DI to fund an exercised loan commitment

A)the balance sheet will decrease by the amount of the new loan.
B)only the asset side of the balance sheet will increase.
C)the balance sheet will increase by the amount of the new loan.
D)only the liability side of the balance sheet will increase.