Corporate Financial Risk Management Exam Review
Course Introduction
Corporate Financial Risk Management explores the identification, assessment, and mitigation of financial risks faced by corporations in an increasingly globalized economy. The course covers key concepts such as market risk, credit risk, liquidity risk, and operational risk, providing students with a thorough understanding of both qualitative and quantitative tools used in risk analysis. Students will learn to evaluate the impact of risk on corporate strategy and value, and examine various hedging techniques, including the use of derivatives and insurance products. The course emphasizes practical decision-making through real-world case studies and develops skills necessary for designing and implementing effective risk management frameworks in contemporary business environments.
Recommended Textbook
Financial Institutions Management A Risk Management Approach 8th Edition by Saunders
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Verifying the minimum level of capital or equity that must be held to fund the operations of an FI is part of the goal of
A)investor protection regulation.
B)safety and soundness regulation.
C)entry regulation.
D)credit allocation regulation.
E)consumer protection regulation.
Answer: B
Q2) Which of the following refers to the possibility that a firm's owners or managers will take actions contrary to the promises contained in the covenants of the securities the firm issues to raise funds?
A)Liquidity risk.
B)Price risk.
C)Credit risk.
D)Intermediation.
E)Agency costs.
Answer: E
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Chapter 2: Financial Services: Depository Institutions
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Sample Questions
Q1) A significant advantage for credit unions in competing with commercial banks is the tax-exempt status that has been granted to credit unions.
A)True
B)False
Answer: True
Q2) Small banks make proportionately larger amounts of real estate loans than large banks.
A)True
B)False
Answer: True
Q3) By late 2012, the number of branches of existing commercial banks in the U.S. approximated ________, which was a(an) _________ from 1985.
A)83,000; increase
B)43,000; increase
C)68,000; decrease
D)103,000; decrease
E)72,000; increase
Answer: A
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Chapter 3: Financial Services: Finance Companies
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Sample Questions
Q1) Ally Financial [formerly General Motors Acceptance Corporation (GMAC)]
A)is a wholly owned subsidiary of General Motors.
B)only provides financing to purchasers of automobiles built by General Motors.
C)was classified as a commercial bank holding company in 2008.
D)did not participate in federal bailout funds during the financial crisis because of their financial strength.
E)is the largest finance company in the U.S.
Answer: C
Q2) Securitized mortgage assets are used as collateral backing secondary market securities.
A)True
B)False
Answer: True
Q3) Finance companies charge different rates than do commercial banks which
A)tend to be higher than bank rates.
B)often reflect a more risky borrower.
C)causes some finance companies to be classified as subprime lenders.
D)must meet state usury law guidelines.
E)All of the above.
Answer: E
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Chapter 4: Financial Services: Securities Brokerage and Investment Banking
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Sample Questions
Q1) Decimalization involves making quotes in the equities markets in units of 1 cent ($0.01) rather than in units of one-eights of a dollar ($0.125).
A)True
B)False
Q2) Which of the following would be a key area of activity for an investment bank specializing in the commercial side of the business?
A)Purchase of existing securities.
B)Sale of securities in the secondary market.
C)Brokerage of existing securities.
D)Underwriting issues of new securities.
E)All of the above.
Q3) If the investment bank sells 8 million shares for $9.75 per share, how much money does Rochester Industries receive?
A)$76,200,000.
B)$84,000,000.
C)$105,000,000.
D)$82,200,000.
E)$78,000,000.
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Chapter 5: Financial Services: Mutual Funds and Hedge Funds
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Sample Questions
Q1) Equity mutual funds may contain common stock, but not preferred stock.
A)True
B)False
Q2) The front-end or back-end loads charged by some mutual funds often are combined with 12b-1 fees.
A)True
B)False
Q3) As of 2012, the total investment in long-term mutual funds is less than the total investment in money market mutual funds.
A)True
B)False
Q4) The short-term mutual fund sector includes
A)money market mutual funds.
B)hybrid funds.
C)equity funds.
D)bond funds.
E)tax-exempt municipal bond funds.
Q5) As of 2012, Commercial banks are not allowed to own or invest in mutual funds. A)True
B)False
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Chapter 6: Financial Services: Insurance
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Sample Questions
Q1) The growth of HMOs has increased the amount of health insurance premiums collected by life insurance companies.
A)True
B)False
Q2) The largest line of life insurance in terms of total contract value in the U.S. is
A)ordinary life.
B)group life.
C)industrial life.
D)credit life.
E)noncontributory life.
Q3) Life insurance guaranty funds
A)are sponsored by state insurance regulators.
B)involve a permanent reserve fund similar to the FDIC's bank deposit reserve.
C)require uniform contributions from each state when there is a failure of an insurance company.
D)make policyholder payments immediately in the event of an insurance company failure.
E)are regulated by the Federal Reserve Bank.
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Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) Which of the following situations pose a refinancing risk for an FI?
A)An FI issues $10 million of liabilities of one-year maturity to finance the purchase of $10 million of assets with a two-year maturity.
B)An FI issues $10 million of liabilities of two-year maturity to finance the purchase of $10 million of assets with a two-year maturity.
C)An FI issues $10 million of liabilities of three-year maturity to finance the purchase of $10 million of assets with a two-year maturity.
D)An FI matches the maturity of its assets and liabilities.
E)All of the above.
Q2) FIs typically are concerned about the value at risk of their trading portfolios. A)True B)False
Q3) An FI is short-funded when the maturity of its liabilities is less than the maturity of its assets.
A)True
B)False
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9
Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) What is market value of the two-year CD if all market interest rates increase by 2 percent?
A)$40.381 million.
B)$39.626 million.
C)$40.000 million.
D)$38.573 million.
E)$40.769 million.
Q2) 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
Q3) The gap ratio expresses the reprice gap for a given time period as a percentage of A)equity.
B)total liabilities.
C)current liabilities.
D)total assets.
E)current assets.
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10
Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) As the investment horizon approaches, the duration of an unrebalanced portfolio that originally was immunized will be less than the time remaining to the investment horizon.
A)True
B)False
Q2) What is the interest rate risk exposure of the optimal transaction in the previous question over the next 2 years?
A)The risk that interest rates will rise since the FI must purchase a 2-year CD in one year.
B)The risk that interest rates will rise since the FI must sell a 1-year CD in one year.
C)The risk that interest rates will fall since the FI must sell a 2-year loan in one year.
D)The risk that interest rates will fall since the FI must buy a 1-year loan in one year.
E)There is no interest rate risk exposure.
Q3) Duration measures the average life of a financial asset.
A)True
B)False
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Chapter 10: Credit Risk: Individual Loan Risk
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Sample Questions
Q1) Which of the following statements involving the promised return on a loan is NOT true?
A)Credit risk may be the most important factor affecting the return on a loan.
B)Compensating balances reduce the effective cost of loans for the borrower because the deposit interest rate is typically greater than the loan rate.
C)Compensating balances represents the portion of the loan that must be kept on deposit at the bank.
D)Compensating balance requirements provide an additional source of return for the lending institution.
E)Increased collateral is a method of compensating for lending risk.
Q2) Using the term structure of default probabilities, the implied default probability for BBB corporate debt during the second year is
A)4.20 percent.
B)98.0 percent.
C)2.35 percent.
D)2.71 percent.
E)3.88 percent.
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
Risk
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Sample Questions
Q1) If a bank's concentration limit (as a percentage of capital) is 25.0 percent, and it does not permit a loss of any loan to impact more than 10 percent of its capital, what is the expected recovery on loans that are defaulted?
A)20 percent.
B)30 percent.
C)40 percent.
D)50 percent.
E)60 percent.
Q2) As part of measuring unobservable default risk between borrowers, the Moody's Analytics model decomposes asset returns into
A)credit risk and market risk.
B)systematic risk and unsystematic risk.
C)market risk and sovereign risk.
D)regional risk and maturity risk.
E)systematic risk and default risk.
Q3) In the past, data availability limited the use of sophisticated portfolio models to set concentration limits.
A)True
B)False
Page 13
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) 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.
Q2) What will be the cost of using a strategy of purchased liquidity management to meet the expected decline in deposits? Assume that the bank intends to keep $2 million in cash as liquidity precaution.
A)$10,000.
B)$15,000.
C)$30,000.
D)$40,000.
E)$50,000.
Q3) Insurance companies have had to deal with liability runs by policyholders.
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 an FI has purchased more foreign currency than it has sold.
A)True
B)False
Q2) The weighted return on the bank's portfolio of investments would be A)15%.
B)12%.
C)16%.
D)13%.
E)7%.
Q3) What must be the forward exchange rate to eliminate the preference for the yen loans?
A)$0.6416/×.
B)$0.5798/×.
C)$0.6118/×.
D)$0.5991/×.
E)Insufficient information.
Q4) Forward contracts in FX are typically written for periods exceeding 6 months. A)True
B)False
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Chapter 14: Sovereign Risk
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Sample Questions
Q1) All of the following are relevant determinants of sovereign risk exposure: the rate of domestic money supply growth; the variance of export revenue, and the size of the population.
A)True
B)False
Q2) For any given country risk variable, the greater the size of the systematic risk relative to the unsystematic risk, the less important the variable is to the lender.
A)True
B)False
Q3) The advantage to the lender (purchaser) of a Brady bond versus a loan to a foreign country is that U.S. Treasury bonds serve as collateral for Brady bonds.
A)True
B)False
Q4) One advantage of swapping a sovereign loan for a bond is the capability to sell the bond in the secondary market.
A)True
B)False
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Page 16
Chapter 15: Market Risk
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Sample Questions
Q1) Considering the Capital Asset Pricing Model, which of the following observations is incorrect?
A)In a well-diversified portfolio, unsystematic risk can be largely diversified away.
B)Systematic risk is considered to be a diversifiable risk.
C)Total risk is the sum of systematic risk and unsystematic risk.
D)Systematic risk reflects the co-movement of a stock with the market portfolio.
E)Unsystematic risk is specific to the firm.
Q2) Monte-Carlo simulation is a process of creating asset returns based on actual trading days so that the probabilities of occurrence are consistent with recent historical experience.
A)True
B)False
Q3) When using the RiskMetrics model, price volatility is calculated as
A)the price sensitivity times an adverse daily yield move.
B)the dollar value of a position times the price volatility.
C)the dollar value of a position times the potential adverse yield move.
D)the price volatility times the N.
E)None of the above.
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) Contingent credit risk is more serious for futures contracts than forward contracts because the over-the-counter arrangements necessary to replicate the guarantees at a later date.
A)True
B)False
Q2) Why is the default risk much more serious for forward contracts than for futures contracts?
A)Because forward contracts are nonstandard contracts.
B)Forward contracts are entered into bilaterally by the negotiating parties.
C)For forwards, all cash flows are required to be paid at one time on contract maturity.
D)Forwards are essentially OTC arrangements with no external guarantees in case of default.
E)All of the above.
Q3) Even though an FI has off-balance-sheet activities, the true net worth is equal to on-balance sheet assets minus on-balance sheet liabilities.
A)True
B)False
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18
Chapter 17: Technology and Other Operational Risks
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Sample Questions
Q1) What are average costs for each FI?
A) 0.40 for A and 2.50 for B.
B) 2.50 for both A and B.
C) 2.50 for A and 0.40 for B.
D) 0.40 for both A and B.
E) Insufficient information.
Q2) Which of the following observations concerning the intermediation approach to measure the cost function of FIs is true?
A)It views FIs' outputs of services as having two underlying inputs.
B)Labor and capital are the only inputs.
C)It views the output as being produced by labor, capital and the funds used to produce intermediated services.
D)Premiums or reserves are viewed as an input in the banking and thrift industries.
E)None of the above.
Q3) The U.S. tax burden faced by domestic FIs has been minimized, in part, by the ability to use international wire networks for the transfer of funds.
A)True
B)False
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19
Chapter 18: Liability and Liquidity Management
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Sample Questions
Q1) Regulators in the U.S. do not allow government securities to perform the role of a required reserve.
A)True
B)False
Q2) Excessive illiquidity can result in an FI's inability to meet required payments on liability claims and, at the extreme, in insolvency.
A)True B)False
Q3) Passbook savings accounts are less liquid than demand deposit accounts.
A)True
B)False
Q4) One cost of demand deposits to DIs is the reserve requirement placed on the bank by the Federal Reserve.
A)True
B)False
Q5) Excessive amounts of liquid asset holdings can penalize the earnings of a DI.
A)True B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Sample Questions
Q1) The deficit realized by the PBGC in 1992 was a result of risk-taking by fund administrators.
A)True
B)False
Q2) As a result of the Financial Institutions Reform, Recovery, and Enforcement Act (FIRREA), the deposit insurance fund for the savings and loan industry has been combined with the deposit insurance fund for the commercial banking industry.
A)True
B)False
Q3) One of the overall objectives in using subordinated debt in addition to common stock for a DI's capital base is to improve market discipline of a DI's risk structure.
A)True
B)False
Q4) The average cost to the FDIC of each bank failure during the decade of the 1980s was larger than the total cost of all bank failures during the period 1933-79.
A)True
B)False
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Chapter 20: Capital Adequacy
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Sample Questions
Q1) What is the minimum total capital (Tier I + Tier II) required to be adequately capitalized for the off-balance sheet derivative contracts (both interest rate swaps and foreign exchange forwards) under Basel II?
A)$0.24 million.
B)$0.36 million.
C)$0.72 million.
D)$0.60 million.
E)$0.48 million.
Q2) What is the minimum total risk-adjusted capital (Tier I + Tier II) required for both of the off-balance-sheet letters of credit under the Basel II standards?
A)$3.84 million.
B)$3.68 million.
C)$3.20 million.
D)$4.80 million.
E)$6.40 million.
Q3) FDICIA required that banks and thrifts adopt the same capital requirements.
A)True
B)False
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Chapter 21: Product and Geographic Expansion
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Q1) The conflict of interest that occurs when a bank suggests the issuance of capital market debt for the purpose of reducing bank loans under conditions of deteriorating or questionable firm financial health is commonly referred to as bankruptcy risk transference.
A)True
B)False
Q2) The safety and soundness of a holding company that has both a bank subsidiary and a securities affiliate can be enhanced over time by the product diversification benefits of a more stable earnings stream caused by having well-diversified financial services.
A)True
B)False
Q3) In late 2012, shadow banking activities came under federal government regulation. A)True
B)False
Q4) The Financial Services Modernization Act of 1999 allows bank holding companies to open insurance underwriting affiliates.
A)True
B)False
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Chapter 22: Futures and Forwards
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Sample Questions
Q1) Who are the common buyers of credit forwards?
A)Insurance companies.
B)Banks.
C)Federal Reserve.
D)Stock brokers.
E)Credit unions.
Q2) If a 12-year, 6.5 percent semi-annual $100,000 T-bond, currently yielding 4.10 percent, is used to deliver against a 6-year, 5 percent T-bond at 110-17/32, what is the conversion factor? What would the buyer have to pay the seller?
A)1.1027; $110,531.
B)1.2257; $135,478.
C)1.8370; $253,830.
D)1.3622; $163,339.
E)1.7263; $141,788.
Q3) Selling a credit forward agreement generates a payoff similar to
A)selling a call option.
B)buying a call option.
C)selling a put option.
D)buying a put option.
E)buying forward contracts.
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Chapter 23: Options, Caps, Floors, and Collars
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Sample Questions
Q1) An option's delta has a value between 0 and 100.
A)True
B)False
Q2) Hedging the FI's interest rate risk by buying a put option on a bond is an attractive alternative to a manager.
A)True
B)False
Q3) 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.
Q4) A naked option is an option written that has no identifiable underlying asset or liability position.
A)True
B)False
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Chapter 24: Swaps
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Sample Questions
Q1) A swap used to hedge against exchange rate risk from mismatched currencies on assets and liabilities is
A)a commodity swap.
B)a credit swap.
C)a currency swap.
D)an equity swap.
E)an interest rate swap.
Q2) What is the special feature of an off-market swap arrangement?
A)It involves special nonstandard considerations that must be negotiated between the parties.
B)The swap is used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.
C)It involves additional financing costs resulting from the fixed-fixed currency swap.
D)It involves an obligation to pay interest at a fixed or floating rate for payments representing the total return on a specified amount.
E)FI receives the par value of the loan on default in return for paying a periodic swap fee.
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Chapter 25: Loan Sales
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Q1) Loan participations
A)are riskier than loan assignments.
B)are less risky than loan assignments.
C)are always sold without recourse.
D)are always sold with partial recourse.
E)are made in smaller denominations than are loan assignments.
Q2) An FI that sells a loan with recourse retains ownership of the loan.
A)True
B)False
Q3) The buyer of a loan participation benefits because the only risk exposure is to the borrower.
A)True
B)False
Q4) Which of the following is NOT true of loan assignments?
A)All rights are transferred on sale.
B)The loan buyer holds a direct claim on the borrower.
C)Transfer of U.S.domestic loans is normally associated with a Uniform Commercial Code filing.
D)Ownership rights are generally much clearer in a loan sale by assignment.
E)Contract terms are unrestrictive from the seller's perspective.
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Chapter 26: Securitization
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Sample Questions
Q1) The Government National Mortgage Association
A)is a private corporation owned by shareholders.
B)purchases pools of mortgages originated by FIs.
C)provides timing insurance to investors in mortgage-backed securities.
D)only approves conventional and FHA/VA insured mortgages.
E)was the first agency to securitize residential mortgages.
Q2) What is the monthly payment received by investors of the mortgage pass-through if the FI deducts a 50 basis points servicing fee?
A)$49,237.
B)$50,713.
C)$50,459.
D)$51,200.
E)$52,100.
Q3) Historically, FNMA has had a secured line of credit with the U.S. Treasury.
A)True
B)False
Q4) Early prepayments on mortgages backing a CMO are normally allocated to the earliest existing tranche maturity.
A)True
B)False
Page 28
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