Deck 17: Liquidity Risk

Question 1

17-7 Demand deposits pose a liquidity risk for FIs because funds may be withdrawn at any time.

Answer 1

True

Question 2

17-17 Managing asset-side liquidity risk can involve either purchased liquidity management or stored liquidity management.

Answer 2

True

Question 3

17-12 Core deposits represent a relatively short-term source of funds.

Answer 3

False

Question 4

17-20 The liquidity index should be a number that is either greater than one or less than zero.

Question 5

17-15 Purchased liquidity management carries the potential risk of significant increases in the cost of funds during periods of high interest rate volatility.

Question 6

17-11 Asset-side liquidity risk may be a result of OBS lending commitments.

Question 7

17-4 During the financial crisis of 2008,there were large deposit inflows to the banking system.

Question 8

17-10 Bank runs occur because customers know that banks will be forced to liquidate assets at fire-sale prices.

Question 9

17-1 When liquidity risk problems occur at a DI,they often threaten the solvency of the institution.

Question 10

17-21 The greater the difference between fair market prices and fire-sale prices for assets,the less liquid the DI's portfolio of assets.

Question 11

17-3 During the financial crisis of 2008,liquidity problems were avoided as banks continued to provide lending to each other.

Question 12

17-9 Liquidity risk for an FI includes the possibility of an unexpected inflow of funds.

Question 13

17-14 Purchased liquidity risk management usually involves purchased funds such as fed funds,repurchase agreements and CDs.

Question 14

17-16 Because cash reserves at the Federal Reserve do not earn interest,DIs do not hold any excess cash reserves beyond the minimum requirements.

Question 15

17-19 High loan commitment banks face less liquidity risk exposure than low commitment banks.

Question 16

17-2 Depository institutions generally rely on each other for cash and to meet their daily liquidity needs.

Question 17

17-6 An FI's most liquid asset is cash.

Question 18

17-5 Mutual funds tend to have less exposure to liquidity risk than do banks and thrifts.

Question 19

17-13 An expected net deposit drain on any given day means that deposit withdrawals are less than deposit inflows.

Question 20

17-18 Liquid funds can be obtained by a DI through unlimited borrowing in the money or purchased funds markets.

Question 21

17-41 Government securities represent the reserve asset fund for life insurance companies.

Question 22

17-38 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 23

17-22 In terms of liquidity risk measurement,the financing gap is defined as rate sensitive assets minus rate sensitive liabilities.

Question 24

17-27 The cost of stored liquidity management is the interest that must be paid on the stored funds.

Question 25

17-34 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 26

17-28 The future liquidity position of a DI cannot be forecasted.

Question 27

17-25 Liquidity planning primarily is designed to assist management in dealing with relatively predictable events.

Question 28

17-30 A liquidity plan for a DI should provide a detailed list of fund providers who are most likely to withdraw in the case of a liquidity crisis.

Question 29

17-36 The Fed discount window maintains three lending programs to assist DIs in managing liquidity problems.

Question 30

17-40 Insurance companies have had to deal with liability runs by policyholders.

Question 31

17-31 Even with liquidity planning,net deposit withdrawals and/or the exercise of loan commitments can pose significant liquidity problems for banks.

Question 32

17-24 The relative time frame for active liquidity management is 2 to 4 months.

Question 33

17-26 Abnormally large and unexpected deposit withdrawals can occur because of concerns by depositors about a bank's solvency relative to other banks.

Question 34

17-35 In general,money center banks are exposed to less liquidity risk than smaller,regional banks.

Question 35

17-37 For life insurance companies,the distribution of premium income minus policyholder liquidations normally is predictable.

Question 36

17-32 Liquidity planning should identify the size of potential deposit withdrawals over various time horizons in the future,as well as alternative emergency private funding sources to meet those withdrawals.

Question 37

17-23 Maturity ladder/scenario analysis is a method of measuring liquidity risk and net funding requirements.

Question 38

17-39 The assets of PC insurers are relatively short term and more liquid than those of life insurance companies.

Question 39

17-29 Deposit insurance is the only deterrent to bank runs,contagious runs,and bank panics.

Question 40

17-33 In the event of a bank run,depositor claims on the bank are satisfied on a pro rata basis.

Question 41

17-62 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.
E)A $100,000 increase in liabilities.

Question 42

17-52 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 drain such that new deposit funds more than offset deposit withdrawals.
D)The liability side of its balance sheet is decreasing.
E)Unused loan commitments is increasing.

Question 43

17-61 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 44

17-50 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.
E)Book value of an asset.

Question 45

17-54 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 liability 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.
E)None of the above.

Question 46

17-49 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.
E)Pension funds.

Question 47

17-53 Which of the following balance sheet entries is not a part of liability management?

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

Question 48

17-45 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 49

17-43 Open-end mutual funds issue a fixed number of shares as liabilities.

Question 50

17-57 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)Bank sustains no cost under stored liquidity risk management.

Question 51

17-60 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.
E)there will be no effect on the balance sheet.

Question 52

17-55 A disadvantage of using liability 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.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 53

17-42 Liquidity risk for a life insurance company only occurs when asset returns do not provide sufficient cash flows to meet policyholder liquidations.

Question 54

17-46 It is impossible for money market mutual fund share prices to fall below $1.00.

Question 55

17-56 A disadvantage of using asset 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.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 56

17-48 Which of the following is NOT a potential causes 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.
E)A decrease in asset prices of securities held in the investment portfolio.

Question 57

17-44 Net asset value is the current value of a mutual fund's assets divided by the number of shares outstanding.

Question 58

17-51 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.
E)fluctuates unpredictably on any given day.

Question 59

17-47 Hedge funds are not susceptible to liquidity risk or a liquidity crisis.

Question 60

17-63 An open-end bond mutual fund is holding a three-year,$1 million par value 5 percent annual coupon bond.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.
E)The answer depends upon the number of mutual funds shares outstanding..

Question 61

17-80 Which of the following observations concerning the Fed's discount window is true?

A)The facility is provided to meet DIs' permanent liquidity needs.
B)Four lending programs are offered through the Fed's discount window.
C)Primary credit is available to sound depository institutions on a very short-term basis.
D)Secondary credit is available only to depository institutions that are eligible for primary credit.
E)Eligible institutions for seasonal credit are big banks located in urban areas.

Question 62

17-68 How does liability 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.
E)By enhancing the liquidity of assets held.

Question 63

17-67 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.
E)Brokering between funds deficit units and funds surplus units.

Question 64

17-64 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 par value 7 percent annual coupon bond? 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.
E)An increase of $0.265 per share.

Question 65

17-79 In a crisis,which of the following are relatively less likely to withdraw funds quickly from banks and thrifts?

A)Correspondent banks.
B)Small business corporations.
C)Individual depositors.
D)Mutual funds.
E)Pension funds.

Question 66

17-75 What does a high ratio of loans to deposits indicate?

A)DI relies heavily on the short-term money market to fund loans.
B)High degree of loan commitments.
C)DI has large amounts of asset-side liquidity.
D)Liquidity concerns are at a bare minimum for the FI.
E)DI relies heavily on core deposits to fund loans.

Question 67

17-76 In terms of liquidity risk measurement,the financing gap is defined as

A)total deposits minus core deposits.
B)financing requirement plus liquid assets.
C)rate sensitive assets minus rate sensitive liabilities.
D)total assets minus total liabilities.
E)average loans minus average deposits.

Question 68

17-66 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.
E)its holdup value.

Question 69

17-70 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.
E)Cash-type assets that can be sold with little price risk and low transaction costs.

Question 70

17-72 What information does the net liquidity statement provide?

A)Maturity ladder.
B)Sources and uses of liquidity.
C)Net asset value.
D)Liquidity index information.
E)Peer group ration comparison.

Question 71

17-65 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.
E)have an incentive to avoid a run since the Federal Reserve guarantees mutual fund holdings.

Question 72

17-69 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.
E)mutual funds have 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 73

17-71 Which of the following is NOT a method of measuring liquidity?

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

Question 74

17-74 A DI has two assets: 50 percent in one-month Treasury bills and 50 percent in real estate loans.If the DI must liquidate its T-bills today,it receives $98 per $100 of face value; if it can wait to liquidate them on maturity (in one month's time),it will receive $100 per $100 of face value.If the DI has to liquidate its real estate loans today,it receives $90 per $100 of face value liquidation at the end of one month will produce $92 per $100 of face value.The one-month liquidity index value for this DI's asset portfolio is

A).973.
B).940.
C).979.
D)1.06.
E)1.10.

Question 75

17-83 Which of the following is NOT a component of liquidity planning?

A)Establishing internal limits on subsidiary and branch borrowings.
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 itemization of managerial responsibilities.
E)A summary of the size of potential net deposit drains over various time horizons.

Question 76

17-81 What are the two major liquidity risk insulation devices available?

A)Deposit insurance and discount window.
B)Liquidity planning and maturity ladder.
C)Scenario analysis and liquidity index.
D)Financing gap and the financing requirement.
E)Secondary credit and seasonal credit.

Question 77

17-82 What is the drawback of deposit insurance facility?

A)Even when the DI is in trouble,the deposit holder has no incentive to run.
B)DIs are more likely to increase the liquidity risk on their balance sheets.
C)Deposit holder's place in line affects his or her ability to obtain the funds.
D)Deposit insurance does not deter contagious runs and panics.
E)Deposit holders are less likely to panic if there is a perceived bank solvency problem.

Question 78

17-77 In terms of liquidity risk measurement,the financing requirement is defined as

A)total deposits minus core deposits.
B)financing gap plus liquid assets.
C)rate sensitive assets minus rate sensitive liabilities.
D)total assets minus total liabilities.
E)average loans minus average deposits.

Question 79

17-73 Which of the following is a measure of the potential losses an FI could suffer as the result of fire-sale disposal of assets?

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

Question 80

17-78 In a crisis,which of the following are more likely to withdraw funds quickly from banks and thrifts?

A)Correspondent banks.
B)Small business corporations.
C)Individual depositors.
D)Mutual funds.
E)Foreign depositors.