Deck 21: Managing Liquidity Risk on the Balance Sheet

Question 1

If a bank's brokered deposits increase $3 million and their savings accounts decrease $1 million, then core deposits decreased.

Answer 1

True

Question 2

If a bank meets a net deposit drain by borrowing money in the fed funds market, it is using purchased liquidity.

Answer 2

True

Question 3

The financing gap is defined as average core deposits minus average borrowed funds.

Answer 3

False

Question 4

The fear that liquidity problems at one bank may cause depositors to worry about the solvency of other banks is called the disease effect.

Question 5

The greater the discount required to sell assets quickly, the higher the value of the bank's liquidity index.

Question 6

If FNBNA is expecting a $15 million net deposit drain and the securities liquidity index is 0.98, how many securities would have to be liquidated if the bank used only its securities to fund the expected deposit drain?

A) $15,000,000
B) $16,444,331
C) $15,600,000
D) $15,306,122
E) $16,772,345 15 million/0.98 = $15,306,122

Question 7

Using stored liquidity to offset a deposit drain will reduce the size of the bank, but using purchased liquidity to offset the drain will not.

Question 8

Relying on purchased liquidity is more risky than relying on stored liquidity.

Question 9

Closed-end mutual funds have less need to maintain liquid asset holdings than open-end mutual funds.

Question 10

A bank meets a deposit withdrawal with one of the following alternatives. Which one of the following is an example of using stored liquidity to meet a deposit withdrawal?

A) Increase in Euro dollar deposits
B) Contacting an investment banker to find new corporate deposits
C) Increasing Fed funds borrowed
D) Issuance of a negotiable CD
E) Selling the bank's holdings of T-bills

Question 11

What are Second National Bank's total sources of liquidity?

A) $6,520
B) $13,500
C) $14,200
D) $12,280
E) $5,760 Cash assets + Max can borrow + Excess cash = 3700 + 8500 + 80 = $12,280

Question 12

Repos and fed funds borrowed are examples of stored liquidity.

Question 13

When money market interest rates are higher than deposit rates, using purchased liquidity to replace deposit drains can reduce a bank's profit margin.

Question 14

A corporation informs the bank they will immediately draw down the maximum amount on their credit line. This is an example of liability side risk.

Question 15

Which one of the following situations creates the most liquidity risk?

A) Long-term assets funded by long-term liabilities
B) Short-term assets funded by short-term liabilities
C) Long-term assets funded by short-term liabilities
D) Short-term assets funded by long-term liabilities
E) Long-term liabilities funded by short-term assets

Question 16

Which of the following results in a net liquidity drain?

A) Demand deposits increase $100; loans increase $50
B) Demand deposits decrease $100; loan repayments are $150
C) Repurchase agreements increase $100; demand deposits decrease $50
D) Reverse repurchase agreements increase $50; demand deposits decrease $50
E) None of the above

Question 17

A bank's financing gap is calculated as average loans minus average deposits plus liquid assets.

Question 18

If FNBNA is expecting a $20 million net deposit drain and the bank wishes to fund the drain by borrowing more money, how much will pre-tax net income change if the borrowing cost is the same as on its existing borrowed funds?

A) $600,000
B) -$312,000
C) -$2,000,000
D) -$600,000
E) $312,000 20 million x (4% - 7%) = -$600,000

Question 19

If FNBNA is expecting a $10 million net deposit drain and the securities liquidity index is 0.97, by how much will pre-tax net income change if the drain is funded entirely through securities sales?

A) -$306,122
B) -$150,000
C) -$375,339
D) -$476,289
E) -$474,490 Liquidate securities totaling 10M/0.97 = 10,309,278, losing interest income = 5.5% x 10,309,278 = 567,010, losing $309,278 on the fire sale, and gain in interest expense of 4% x 10 million core deposits = 400,000, for net total loss of $476,289.

Question 20

Property and casualty insurers have a greater need for liquidity than life insurers.

Question 21

What is Second National Bank's total net liquidity?

A) $6,520
B) $13,500
C) $14,200
D) $12,280
E) $5,760 Sources - Uses = 3700 + 8500 + 80 - (6500 + 20) = $5,760

Question 22

Runs on insurance firms are more likely to occur than runs on banks even in states with guaranty funds for insurers because these funds generally

A) lack a permanent reserve fund.
B) do not repay insurance policyholders immediately.
C) lack federal government backing.
D) all of the above

Question 23

In the absence of deposit insurance, a deposit is a _______________ to the bank's assets.

A) pro rata claim
B) first come/first serve claim
C) full pay or no pay claim
D) both A and B
E) both B and C

Question 24

If a bank relies solely on purchased liquidity, the bank will likely

A) maintain large amounts of liquid assets.
B) fund its loan commitments with asset sales.
C) be required to borrow money at short notice.
D) be required to raise equity capital quickly.
E) be forced to liquidate liabilities at fire sale prices.

Question 25

Which of the following can create liquidity risk for a life insurer?
I) Unexpectedly high number of policy surrenders
II) Unexpectedly low number of new policies sold
III) Unexpectedly high insurance claims filed by policyholders

A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III

Question 26

Insurance industry guarantee funds do not eliminate runs on insurers because
I) the funds are not backed by the federal government.
II) the funds lack permanent reserves to back policies.
III) the funds have low maximum annual contribution amounts that limit insurer's liability.

A) I only
B) II only
C) III only
D) I and III only
E) I, II, and III

Question 27

The two main reasons why runs on U.S. banks no longer occur are

A) reserve requirements and higher bank liquidity ratios.
B) a required positive financing gap and bank use of purchased liquidity.
C) the FDIC and the discount window.
D) insurance funds operated by individual states and tighter bank regulations.
E) none of the above

Question 28

When calculating the liquidity index, the larger the discount from fair value, the ______________ the liquidity index and the _________________ the liquidity risk the FI faces.

A) larger; greater
B) smaller; greater
C) larger; lower
D) smaller; lower

Question 29

A financial intermediary has two assets in its investment portfolio. It has 35% of its security portfolio invested in one-month Treasury bills and 65% in real estate loans. If it liquidated the bills today, the bank would receive $98 per hundred of face value. If the real estate loans were sold today, they would be worth $85 per 100 of face value. In one month, the real estate loans could be liquidated at $94 per 100 of face value. What is the intermediary's one-month liquidity index?

A) 0.93
B) 0.92
C) 0.91
D) 0.90
E) 0.89 [(0.35 x 0.98) + (0.65 x 0.85)]/[(0.35 x 1.00) + (0.65 x 0.94)] = 0.93

Question 30

Discount window borrowing is available to
I) banks.
II) thrifts.
III) investment banks.
IV) nonfinancial corporations.

A) I and II only
B) I and III only
C) I, II, and III only
D) II, III, and IV only
E) I, II, III, and IV

Question 31

Which one of the following is a source of liquidity risk for a bank?

A) Predicted increase in net deposit drain before Christmas
B) Maturation of notes payable
C) Corporation calls in a bond the bank is holding
D) A natural disaster in the bank's community
E) None of the above

Question 32

Core deposits include all but which of the following?

A) Retail demand deposits
B) NOW accounts
C) MMDAs
D) Savings accounts
E) Negotiable CDs

Question 33

How does reliance on purchased liquidity rather than core deposits affect a bank?
I) Increases the risk of a liquidity crisis
II) Allows the bank to adjust to deposit drains without affecting bank size
III) Increases overall interest sensitivity of the bank's profits to interest rates

A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III

Question 34

Bank A has a loan to deposit ratio of 110%, core deposits equal 55% of total assets, and borrowed funds are 25% of assets. Bank B has a loan to deposit ratio of 80%. Core deposits are 65% of assets and borrowed funds are 5% of assets. Which bank has more liquidity risk? Ceteris paribus, which bank will probably be more profitable when interest rates are low?

A) Bank A; Bank A
B) Bank A; Bank B
C) Bank B; Bank A
D) Bank B; Bank B
E) You can't tell

Question 35

An increasingly positive financing gap can indicate ________________ liquidity risk because it may indicate _______________ deposits and/or rising loan commitments.

A) increasing; increasing
B) decreasing; decreasing
C) increasing; decreasing
D) decreasing; increasing

Question 36

The amount that a policyholder receives when they cash in an insurance policy is called the

A) cash value.
B) surrender value.
C) face value.
D) policy value.
E) fair market value.

Question 37

The BIS recommends that depository institutions do which of the following to realistically measure liquidity risk?
I) Construct a maturity ladder of funding requirements over both the short and long run.
II) Conduct scenario analyses of the bank's implied liquidity position under different bank and economic conditions.
III) Always keep the loan to deposit ratio less than one.

A) I only
B) II only
C) I and II only
D) II and III only
E) I, II, and III

Question 38

Which of the following statements, if any, is(are) true?
I) Mutual funds never have runs.
II) Funds invested with insurers are as safe as deposits at a bank.
III) Pension funds generally have less liquidity risk than banks.

A) All three are true
B) Only I is true
C) Only II and III are true
D) Only III is true
E) None are true

Question 39

A married couple each has an IRA and deposits at a bank. The couple also has one child. If they had the money, what is the total amount of their accounts that could be insured at one bank?

A) $250,000
B) $750,000
C) $1,250,000
D) $1,500,000
E) $2,000,000 $750,000 for a couple (two separate accounts and one joint account), $250,000 child's account held in trust by parents, and $250,000 for each IRA for a total of $1,500,000.

Question 40

What are Second National Bank's total uses of liquidity?

A) $6,520
B) $13,500
C) $14,200
D) $12,280
E) $5,760 Funds borrowed + Fed borrowing = 6500 + 20 = $6,520

Question 41

A bank has $6 million in Treasury bills, $3 million in excess reserves at the Fed, $1 million in vault cash, and an $8 million line of credit on the repo market. The bank has borrowed $6 million in Fed funds and $12 million in short-term notes borrowed to finance loans. What is the net liquidity position of the bank and what can you conclude from it?

Question 42

Explain how liquidity risk can lead to insolvency risk.

Question 43

Explain the relationship between each of the following ratios and liquidity risk.
a) Loan-to-deposit ratio
b) Borrowed funds to total assets
c) Loan commitments to total assets

Question 44

The greater the _________________ ratio the more liquid is the institution, ceteris paribus.

A) borrowed funds to total assets
B) core deposits to total assets
C) loans to deposits
D) unused commitments to lend to total assets
E) unused commitments to lend to liquid assets

Question 45

What are the tradeoffs involved between storing liquidity and purchasing liquidity as needed for a bank?

Question 46

What are the major sources of liquidity risk for a bank? For a life insurer?

Question 47

Why might a bank face abnormal deposit drains?

Question 48

The BIS maturity ladder approach to managing liquidity includes which of the following?
I) Assessing expected cash inflows and outflows in different time periods.
II) Calculation of daily and cumulative funding requirements.
III) Estimating funding requirements under different scenarios.
IV) Minimizing the securities holdings to increase the bank's ROE.

A) I and II only
B) II and III only
C) I, II, and IV only
D) I, II, and III only
E) I, II, III, and IV

Question 49

You have the following data for a bank (Million $):

Question 50

Does a positive or a negative financing gap indicate greater liquidity risk? Explain.

Question 51

The Fed now operates the discount window differently than it used to. What are the major changes?

Question 52

We rarely see bank runs since the advent of Federal deposit insurance, but runs on life insurers and mutual funds do occur even though claimants have pro rata claims in the event of default. Why do these runs still occur?