Commercial Banking
Mock Exam
Course Introduction
Commercial Banking explores the structure, operations, and regulatory environment of banks and other financial institutions. The course examines the key services offered by commercial banks, including lending, deposit management, payments, risk assessment, and treasury operations. Students analyze the strategies banks use to achieve profitability while maintaining stability and managing various types of risk. Additional topics include asset-liability management, the role of technology in banking innovation, banking regulations, and the impact of commercial banking on economic growth and development. Through case studies and real-world examples, students gain insight into the challenges and opportunities facing the modern banking sector.
Recommended Textbook
Financial Institutions Management 5th Canadian Edition by Anthony Saunders
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Chapter 1: Why Are Financial Institutions Special
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Q1) FIs perform their intermediary function in two ways
A)they specialize as brokers between savers and users.
B)they serve as asset transformers by purchasing primary securities and issuing secondary securities.
C)they serve as asset transformers by purchasing secondary securities and issuing primary securities.
D)they specialize as brokers between savers and users and as asset transformers by purchasing primary securities and issuing secondary securities
E)They specialize as brokers between savers and users, and they serve as asset transformers by purchasing secondary securities and issuing primary securities.
Answer: D
Q2) Firms in industries that have low costs of entry tend to enjoy larger profits than firms in industries with high costs of entry.
A)True
B)False
Answer: False
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3
Chapter 2: Deposit-Taking Institutions
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Q1) Which of the following is NOT an off balance sheet activity for Canadian banks?
A)Derivative contracts.
B)Loan commitments.
C)Standby letters of credit.
D)Trust services.
E)When-issued securities.
Answer: D
Q2) Since 1990, commercial banks decreased the proportion of business loans and increased the proportion of mortgages in their portfolios.
A)True
B)False
Answer: True
Q3) Credit unions make proportionately larger amounts of real estate loans than large Canadian banks.
A)True
B)False
Answer: True
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Chapter 3: Finance Companies
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Sample Questions
Q1) Compared to banks, why do finance companies often have substantial industry and product expertise?
A)Because they have no bank-type regulators looking directly over their shoulders.
B)Because they are specialized in market research and analysis.
C)Because they are often subsidiaries of corporate-sector holding companies.
D)Because they are more often willing to accept risky customers.
E)All of these.
Answer: C
Q2) Sales finance institutions provide financing to customers of specific retailers.
A)True
B)False
Answer: True
Q3) The largest category of business loans of finance companies is securitized business assets.
A)True
B)False
Answer: False
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Page 5
Chapter 4: Securities, Brokerage, and Investment Banking
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Q1) An investment banker agrees to underwrite an issue of 5 million shares of stock for NetChoice, Inc. on a best-efforts basis. The investment banker is able to sell 4.5 million shares for $31.00 per share and it charges NetChoice, Inc. $0.375 per share sold. If the investment bank were able to sell all 5 million shares for $35, how much money would NetChoice, Inc. receive?
A)$195,675,000.
B)$187,500,000.
C)$130,250,000.
D)$175,000,000.
E)$173,125,000.
Q2) The function of institutional venture capital firms is to
A)find and fund the most promising new firms.
B)lend funds on a long-term basis to promising new companies with no track record.
C)take equity positions in successful established companies.
D)lend funds to established companies that are faltering.
E)None of these.
Q3) As of 2012, equity capital in the securities industry measured over 12 percent.
A)True
B)False
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Page 6
Chapter 5: Mutual Funds, Hedge Funds, and Pension Funds
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Q1) As of 2013, the total investment in long-term mutual funds is less than the total investment in money market mutual funds.
A)True
B)False
Q2) Long-term mutual funds invest primarily in long-term, fixed-income securities such as corporate and/or government bonds.
A)True B)False
Q3) The returns obtained by investors of mutual funds include the following except
A)interest income earned on assets.
B)dividend income earned on assets.
C)capital gains on assets sold by the fund.
D)capital appreciation in the underlying value of the assets held in the portfolio. E)refunds of load charges and management fees.
Q4) As of 2013, banks are not allowed to own or invest in mutual funds. A)True B)False
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Chapter 6: Insurance Companies
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Sample Questions
Q1) Which of the following is used as collateral when an insurance company issues policy loans?
A)Expected premium payments.
B)Existing policies.
C)Unearned premiums.
D)Guarantee funds.
E)Government of Canada bonds.
Q2) Which account refers to the reserve set-aside that contains the portion of a premium that has been paid before insurance coverage has been provided.
A)Unearned premiums.
B)Prepaid premiums.
C)Premium reserves.
D)Policy reserves.
E)Outstanding premiums.
Q3) Unexpected increases in inflation cause loss rates to increase more for long-tail risk than for short-tail risks.
A)True
B)False
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8
Chapter 7: Risks of Financial Institutions
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Q1) The objective of technological expansion is to achieve economies of scale at the expense of diseconomies of scope.
A)True
B)False
Q2) Off-balance-sheet activities have become an important source of fee income, even though losses on these activities can cause a financial institution to fail.
A)True
B)False
Q3) For an FI to exactly hedge the foreign investment risk, the foreign currency assets must equal the foreign currency liabilities.
A)True
B)False
Q4) Foreign exchange risk is that the value of assets and liabilities may change because of changes in the foreign exchange rate between two countries.
A)True
B)False
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Page 9
Chapter 8: Interest Rate Risk I
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Q1) A positive repricing gap implies that a decrease in interest rates will cause interest expense to decrease more than the decrease in interest income.
A)True
B)False
Q2) When interest rates increase, banks are more likely to be forced to increase rate-sensitive liabilities to replace decreased balances in demand deposits and savings accounts.
A)True
B)False
Q3) To be more precise in measuring interest rate risk, the runoff component of long-term mortgages should be considered in the time buckets in which the maturities actually occur.
A)True
B)False
Q4) The Bank for International Settlements (BIS) requires deposit-taking institutions to have interest rate risk management systems.
A)True
B)False
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Page 10
Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) A bond is scheduled to mature in five years. Its coupon rate is 9 percent with interest paid annually. This $1,000 par value bond carries a yield to maturity of 10 percent. Calculate the percentage change in this bond's price if interest rates on comparable risk securities increase to 11 percent. Use the duration valuation equation.
A)+4.25 percent
B)-4.25 percent
C)+8.58 percent
D)-3.93 percent
E)-3.84 percent
Q2) Consider a one-year maturity, $100,000 face value bond that pays a 6 percent fixed coupon annually. What is the price of the bond if market interest rates are 7 percent?
A)$99,050.15.
B)$99,457.94.
C)$99,249.62.
D)$100,000.00.
E)$99,065.42.
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Chapter 10: Credit Risk: Individual Loans
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Q1) What is the most important factor determining bankruptcy, according to the Altman Z-score model?
A)Working capital to assets ratio.
B)Retained earnings to assets ratio.
C)Earnings before interest and taxes to assets ratio.
D)Market value of equity to book value of long-term debt ratio.
E)Sales to assets ratio.
Q2) Credit rationing by an FI
A)involves restricting the quantity of loans made available to individual borrowers.
B)results from a positive linear relationship between interest rates and expected loan returns.
C)is not used by FIs at the retail level.
D)involves rationing consumer loans using price or interest rate differences.
E)is only relevant to banks.
Q3) Junk bonds are bonds that are rated less than investment grade by bond-rating agencies.
A)True
B)False
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12
Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Q1) Which model involves estimating the systematic loan loss risk of a particular sector or industry relative to the loan loss risk of an FI's total loan portfolio?
A)Credit Metrics.
B)Credit Risk +.
C)Loan loss ratio-based model.
D)KMV portfolio manager model.
E)Loan volume-based model.
Q2) The variance of returns of a portfolio of loans normally is equal to the arithmetic average of the variance of returns of the individual loans.
A)True
B)False
Q3) On loans fully secured by physical, non-real estate loans, the Basel Committee has set a loss given defaults (LGD) rate of
A)15 percent
B)25 percent
C)40 percent
D)45 percent
E)60 percent
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) In general, large international banks are exposed to less liquidity risk than smaller, domestic banks.
A)True
B)False
Q2) 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.
Q3) During the financial crisis of 2008, liquidity problems were avoided as banks continued to provide lending to each other.
A)True
B)False
Q4) The future liquidity position of a DI cannot be forecasted.
A)True
B)False
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) A positive net exposure position in FX implies the FI is net short in a currency.
A)True
B)False
Q2) Yen Bank wishes to invest in Yen loans at a rate of 10 percent. The bank will fund the loans in the domestic GIC market at a rate of 6.3 percent. This on-balance-sheet FX risk will be hedged in the spot market at a forward rate of $0.62/¥. The spot rate on yen is $0.60/¥. What must be the spot exchange rate to eliminate the preference for the yen loans if the forward rate remains $0.62/¥?
A)$0.6416/¥.
B)$0.5798/¥.
C)$0.6118/¥.
D)$0.5991/¥.
E)Insufficient information.
Q3) The reason an FI receives a fee when purchasing foreign currencies to allow customers to complete international transactions is because the FI assumes some FX risk.
A)True
B)False
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Page 15
Chapter 14: Sovereign Risk
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Q1) The debt service ratio of a country should be negatively related to the probability of rescheduling.
A)True
B)False
Q2) Which of the following is a benefit to the lender in a loan rescheduling?
A)The FI may become locked into a particular loan portfolio structure.
B)Rescheduling may close the market for future loans.
C)Rescheduling may create interruptions in the flow of international trade since letters of credit may be more difficult to acquire.
D)Rescheduling may lower the present value of future payments in hard currencies.
E)The FI may receive additional fees, collateral, and option features on the loan.
Q3) Prior to World War II, most international debt was in the form of bank loans.
A)True
B)False
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Chapter 15: Market Risk
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Q1) A charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading portfolio is the general market risk charge in the BIS framework.
A)True
B)False
Q2) The capital requirements of internally generated market risk exposure estimates can be met
A)only with two types of capital.
B)only with Tier 1, Tier 2, or Tier 3 capital.
C)with retained earnings and common stock only.
D)only with retained earnings, common stock, and long-term subordinated debt.
E)only with short- or long-term subordinated debt.
Q3) The dollar value of a foreign exchange portfolio equals the FX position times the spot exchange rate.
A)True
B)False
Q4) One advantage of Risk Metrics over back simulation is that Risk Metrics provides a worst case scenario value.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Risk
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Q1) Back-end fees on loan commitments are charged as a certain percentage of A)commitment size.
B)loan taken down.
C)utilized portion of commitment size.
D)unused portion of commitment size.
E)interest payable on the loan commitment.
Q2) In many ways, SLCs perform similar functions for a borrower as do loan commitments.
A)True
B)False
Q3) Off-balance-sheet items can generate cash flows that immediately impact the bank's financial performance.
A)True
B)False
Q4) As of June 2012, the vast majority of OBS activities of commercial banks was A)future and forward contracts.
B)credit derivatives.
C)commitments to buy FX.
D)swap contracts.
E)loans sold with recourse.
Page 18
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Chapter 17: Technology and Other Operational Risks
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Q1) A new computer system is expected to cost $40 million and generate annual savings of $12 million over the next five years. What is the IRR for this investment?
A)11.18 percent.
B)12.98 percent.
C)15.24 percent.
D)12.00 percent.
E)18.00 percent.
Q2) Which of the following occurs if the costs of joint production of FI services are higher than they would be if they were produced independently?
A)Economies of scale.
B)Diseconomies of scale.
C)Economies of scope.
D)Diseconomies of scope.
E)Constant returns to scale.
Q3) Cash management services include the collection, disbursement, and transfer of funds.
A)True
B)False
Q4) A feature that records which checks have been paid by the FI.
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Chapter 18: Liability and Liquidity Management
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Q1) Because retail GICs have fixed maturities, FI managers always should have perfect information regarding the scheduling of interest and principal payments.
A)True
B)False
Q2) Funding costs generally are positively related to the period of time the liability remains on the balance sheet.
A)True
B)False
Q3) Which of the following observations is NOT true of a liquid asset?
A)It can be turned into cash quickly.
B)Conversion to cash entails low transaction costs.
C)Conversion to cash happens with little or no loss in principal value.
D)It is traded in an active market.
E)Large transactions may move its market price substantially.
Q4) In most countries, assets used to satisfy the liquid assets ratio may include liquid government securities.
A)True
B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) Moral hazard encourages the FI to take on more, rather than less, risk.
A)True
B)False
Q2) Bank risk taking can be controlled by increasing
A)stockholder discipline by charging stockholders a surcharge.
B)stockholder discipline by setting risk adjusted deposit insurance premiums.
C)depositor discipline by increasing the ceiling for deposit insurance coverage.
D)regulatory discipline by increasing the budgets of the regulatory agencies.
E)depositor discipline by expanding the doctrine of "too big to fail."
Q3) Currently in Canada, deposit insurance premiums increase with the amount of risk of the institution.
A)True
B)False
Q4) The "too big to fail" policy doctrine is premised on the separation of small depositors who would receive deposit insurance and large depositors who would not receive the benefits of deposit insurance.
A)True
B)False
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Chapter 20: Capital Adequacy
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Q1) More frequent regulatory examinations and stricter regulator standards will cause greater discrepancies in book value of equity and the market value of equity.
A)True
B)False
Q2) The four (five) risk weight categories in Basel I (Basel II) may not reflect the true credit risk.
Q3) The buffer proposed by Basel III that is designed to ensure that DTIs build up a capital surplus outside of periods of financial distress is called the A)Capital conservation buffer.
B)Countercyclical buffer.
C)Leverage buffer.
D)Tier II buffer.
E)CET1 capital buffer.
Q4) Equity holders absorb credit losses on the asset portfolio because liability holders are junior claimants.
A)True
B)False
Q5) Banks likely would need additional capital to meet the new minimum standards.
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Chapter 21: Product and Geographic Expansion
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Q1) Chinese walls are barriers within organizations that limit the flow of confidential information between departments of business areas.
A)True
B)False
Q2) Success in a merger from revenue enhancement is more likely if the markets into which expansion occurs are less than fully competitive.
A)True
B)False
Q3) Canadian financial institutions have expanded abroad in recent years, although their foreign counterparts have been prohibited from expanding into Canada.
A)True
B)False
Q4) Identify a condition under which conflicts of interest are exploitable.
A)Market for bank service is very competitive.
B)Banks have monopoly power over their customers.
C)Information flows between the customer and the bank are symmetric.
D)Bank does not possess any information advantage over its customers.
E)Bank places a relatively high value on its reputation.
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Page 23
Chapter 22: Futures and Forwards
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Q1) An FI has a 1-year 8-percent US$160 million loan financed with a 1-year 7-percent
UK£100 million CD. The current exchange rate is $1.60/£. What is the cash spread earned by the FI if at the end of the year the £ is trading at $1.63/£ in the cash market? Again adjust for all exchange rate changes.
A)$1,610,000 gain.
B)$1,610,000 loss.
C)$2,670,000 loss.
D)$2,670,000 gain.
E)$2,390,000 loss.
Q2) The primary benefit of a futures exchange is
A)always knowing its exact location.
B)indemnifying counterparties against credit or default risk.
C)guarantee of trading volume.
D)intervention on the trader's behalf with government regulators.
E)availability of free legal services.
Q3) Derivative contracts allow an FI to manage interest rate and foreign exchange risk.
A)True
B)False
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24
Chapter 23: Options, Caps, Floors, and Collars
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Q1) An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $76.95 per $100 for the bond. The current yield on a one-year bond of equal risk is 12 percent, and the one-year rate in one year is expected to be either 16.65 percent or 15.35 percent. Either rate is equally probable. If the manager buys a one-year option with an exercise price equal to the expected price of the bond in one year, what will be the exercise price of the option?
A)$84.00.
B)$85.99.
C)$86.21.
D)$85.74.
E)$85.96.
Q2) When interest rates rise, writing a bond call option may cause profits to offset the loss on an FI's bonds.
A)True
B)False
Q3) A digital default option pays a stated amount in the event that a portion of the loan is not paid.
A)True
B)False
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Page 25
Chapter 24: Swaps
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Q1) Swap contracts are actively traded on the A)NYSE.
B)AMEX.
C)CBOE.
D)TSX.
E)Swaps are not actively traded.
Q2) The fastest growing type of swap is
A)a commodity swap.
B)a credit swap.
C)a currency swap.
D)an equity swap.
E)an interest rate swap.
Q3) In recent years, the fastest growing type of swap agreement has been a fixed-fixed currency swap.
A)True
B)False
Q4) Credit risk is more likely to lead to failure of an FI than either interest rate or foreign-exchange risk.
A)True
B)False
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Chapter 25: Loan Sales
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Q1) Loan assignments make up more than 90 percent of the Canadian and U.S. loan sale market because
A)they have lower capital requirements than other types of loan sales.
B)they are riskier than are other types of loan sales.
C)monitoring costs are reduced since all rights are transferred upon sale.
D)regulators prefer these transactions to loan participations.
E)there is no secondary market in loan participations.
Q2) Which of the following is NOT true of a loan that is sold without recourse?
A)The loan is removed from the FI's balance sheet.
B)The FI has no explicit liability if the loan eventually goes bad.
C)The FI that originated the loan bears all the credit risk.
D)The buyer can put the loan back to the selling FI.
E)None of these.
Q3) When a portion of a loan is sold from a large bank to a small bank, it is often called a participation.
A)True
B)False
Q4) An FI that sells a loan with recourse retains ownership of the loan.
A)True
B)False
Page 27
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Chapter 26: Securitization Index
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Q1) All tranches in a collateralized mortgage obligation (CMO) have the same prepayment risk exposure.
A)True
B)False
Q2) Which of the following best explains the term burn-out factor?
A)The percent of mortgage contract that is transferred from the seller to the buyer of a house.
B)The required interest spread of a pass-through security over a treasury when prepayment risk is taken into account.
C)The aggregate percent of the mortgage pool that has been prepaid prior to the month under consideration.
D)A mortgage-backed bond issued in multiple classes or tranches.
E)Bonds collateralized by a pool of assets.
Q3) A principal only (PO) mortgage-backed strip is attractive to investors who wish to speculate about decreasing interest rates.
A)True
B)False
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