Deck 12: Liquidity Risk

Question 1

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

Answer 1

True

Question 2

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

Answer 2

False

Question 3

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

Answer 3

True

Question 4

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

Question 5

Demand deposits pose a liquidity risk for FIs because funds may be withdrawn at any time.

Question 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

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

Question 13

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

Question 14

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

Question 15

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

Question 16

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

Question 17

An FI's most liquid asset is cash.

Question 18

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

Question 19

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

Question 20

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

Question 21

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

Question 22

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

Question 23

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

Question 24

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

Question 25

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 26

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

Question 27

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

Question 28

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

Question 29

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

Question 30

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 31

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

Question 32

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 33

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

Question 34

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

Question 35

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

Question 36

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

Question 37

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

Question 38

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

Question 39

The future liquidity position of a DI cannot be forecasted.

Question 40

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

Question 41

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

Question 42

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 43

Liquidity index is a measure of the potential losses an FI could suffer as the result of sudden disposal of assets.

Question 44

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 45

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

Question 46

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

Question 47

A net deposit drain is the amount by which cash withdrawals exceed additions; a net cash outflow.

Question 48

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

Question 49

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

Question 50

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

Question 51

Financing requirement is the financing gap minus the liquid assets.

Question 52

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 53

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

Question 54

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

Question 55

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 56

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 57

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.
E)A decrease in asset prices of securities held in the investment portfolio.

Question 58

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

Question 59

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

Question 60

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

Question 61

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 62

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 63

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.
E)Subordinated note.

Question 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 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.
E)An increase of $0.265 per share.

Question 65

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.
E)None of the options.

Question 66

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.
E)By enhancing the liquidity of assets held.

Question 67

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 68

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 69

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.
E)Because the adjustment to the deposit drain occurs on the liability side of the balance sheet.

Question 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 71

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 72

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.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 73

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.
E)loss of flexibility as a result of dependence upon purchased liabilities.

Question 74

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.
E)The answer depends upon the number of mutual funds shares outstanding.

Question 75

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 76

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.
E)Unused loan commitments is increasing.

Question 77

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.
E)threaten the capital position of the institution.

Question 78

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 79

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 80

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.