Financial Intermediation Exam Review
Course Introduction
This course examines the critical role financial intermediaries, such as banks, insurance companies, and investment funds, play in the global economy. Students will explore how these institutions facilitate the flow of funds between savers and borrowers, manage risks, and contribute to economic growth and stability. Key topics include the structure and functioning of different intermediaries, regulation and supervision, risk management, the impact of technological innovation, and issues related to financial crises. Through case studies and real-world examples, students will develop a deeper understanding of the importance and challenges of financial intermediation in modern financial systems.
Recommended Textbook
Financial Institutions Management 3rd Edition by Lange
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Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Economies of scale is the concept that:
A)a cost reduction in trading and other transaction services results from increased efficiency when FIs perform these services.
B)a profitability increase in trading and other transaction services results from increased efficiency when FIs perform these services.
C)a cost reduction in trading and other transaction services results from stable efficiency when FIs perform these services.
D)None of the listed options are correct.
Answer: B
Q2) Which of the following is an adequate definition of broad money?
A)Currency plus bank current deposits of the private non-bank sector.
B)'M1' plus borrowings from the private sector by non-bank financial institutions less the latter's holdings of currency ad bank deposits.
C)'M3' plus borrowings from the private sector by non-bank financial institutions.
D)None of the listed options are correct.
Answer: C
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Chapter 2: The Financial Services Industry: Depository
Institutions
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Q1) Non-bank depository institutions are also referred to as CUBS.
A)True
B)False Answer: True
Q2) Which of the following is not an off-balance-sheet activity for banks?
A)derivative contracts
B)loan commitments
C)standby letters of credit
D)trust services
Answer: D
Q3) In which way did building societies respond to the competitive pressures resulting from the deregulation of the banking system in the 1980s?
A)They engaged in mergers for efficiency and scale reasons.
B)They adopted improved technology.
C)They diversified their products and activities.
D)All of the listed options are correct.
Answer: D
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Page 4
Chapter 3: The Financial Services Industry: Other Financial Institutions
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Sample Questions
Q1) Pure insurance companies are exposed to a single risk only, this being insurance risk.
A)True
B)False
Answer: False
Q2) Private placement refers to a securities issue placed:
A)with one or a few large institutional investors.
B)in private, that is, without announcing it to the public.
C)by a private person.
D)with one of the stock exchanges.
Answer: A
Q3) Insurance policy benefits are classified on an insurance company's balance sheet as:
A)liabilities, because the insurance company may have to pay out the benefits.
B)assets, because policy benefits are valuable to the company.
C)liabilities, because customers may fall behind on their premium payments.
D)assets, because policy benefits are fully covered by premium payments.
Answer: A
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Page 5
Chapter 4: Risk of Financial Institutions
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Sample Questions
Q1) The Bank for International Settlements:
A)defines operational risk as the risk of direct or indirect loss resulting from inadequate or failed internal processes, people, and systems or from external events.
B)does not include technology risk in its categorisation of operational risk.
C)is the principal organisation of central banks in the minor economies of the world.
D)All of the listed options are correct.
Q2) Many of the various risks, such as interest rate risk, market risk, credit risk and off-balance-sheet risk, faced by an FI often are interrelated with each other.
A)True
B)False
Q3) The risk that a debt security's price will fall, subjecting the investor to a capital loss is: A)credit risk.
B)political risk.
C)currency risk.
D)market risk.
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Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Sample Questions
Q1) How do you interpret the position of an FI with a negative on-balance-sheet gap and a positive off-balance-sheet gap?
A)The FI uses its on-balance-sheet activities to hedge its off-balance-sheet activities.
B)The FI uses its off-balance-sheet activities to hedge its on-balance-sheet activities.
C)The FI believes that interest rates will decrease and made a mistake in setting its gap for off-balance-sheet activities.
D)The FI believes that interest rates will decrease and made a mistake in setting its gap for on-balance-sheet activities.
Q2) When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, the cumulative gap will be: A)zero.
B)one.
C)greater than one. D)a negative value.
Q3) What is meant by the 'run-off' problem and how can bank managers deal with this problem?
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Chapter 6: Interest Rate Risk Measurement: The Duration
Model
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Sample Questions
Q1) Would you consider convexity of a fixed-income security to be desirable or undesirable for an FI? Explain your opinion.
Q2) Assume that the required yield to maturity on a consol bond increases from 6 per cent to 12 per cent.What is the impact on the consol bond's duration?
A)As there are no intervening cash flows between issue and maturity, the duration will always equal the bond's maturity.
B)As interest rates rise, the duration of consol bonds falls.
C)As interest rates rise, the duration of consol bonds rises.
D)There will be no impact on the bond's duration.
Q3) In order to achieve a zero duration gap, an FI can:
A)change the duration of its assets only.
B)change the duration of its liabilities only.
C)change the duration of both, assets and liabilities.
D)All of the listed options are correct.
Q4) Duration matching is a desirable interest rate risk management tool as it captures changes in interest rates over long periods of time.
A)True
B)False
Page 8
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Chapter 7: Managing Interest Rate Risk Using Off Balance
Sheet Instruments
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Sample Questions
Q1) Within the futures market, to be fully hedged means:
A)Buying a sufficient number of futures contracts so that the loss of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise.
B)Selling a sufficient number of futures contracts so that the loss of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise.
C)Selling a sufficient number of futures contracts so that the gain of net worth on the FI's balance sheet when interest rates rise is just offset by the gain from the off-balance-sheet selling of futures when interest rates rise.
D)None of the listed options are correct.
Q2) The Sydney Futures Exchange only offers cash-settled contracts.
A)True
B)False
Q3) Explain the differences between using futures and options contracts to hedge interest rate risk.Use diagrams where possible to support your points.
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Page 9
Chapter 8: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) The buyer of a loan participation benefits because the only risk exposure is to the borrower.
A)True
B)False
Q2) Currently, this basic type of loan sale contracts comprises the bulk of loan sales trading.
A)participations
B)originations
C)syndications
D)assignments
Q3) Besides reducing credit risks, an FI has an incentive to sell loans it originates for all of the following reasons except to:
A)geographically diversify.
B)decrease core deposits.
C)lower reserve requirements.
D)lower capital requirements.
Q4) Banks have been partially responsible for big corporate collapses such as Enron.
A)True
B)False
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Chapter 9: Market Risk
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Sample Questions
Q1) Which of the following statements is true?
A)Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3.
B)The idea of a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
C)Regulators can punish FIs that underestimate their capital charges by raising the multiplication factor to as high as 5.
D)Under BIS, the capital charge is calculated as DEAR multiplied by the square root of 10 multiplied by 3 and the idea of a minimum multiplication factor of 3 is to create a scheme that is 'incentive compatible'.
Q2) Consider a VAR of $100 000 for a 95 per cent confidence level.A problem with this information is that while we know that we will lose more than the VAR amount on 5 days out of every 100, we do not know the maximum amount we can lose.
A)True
B)False
Q3) Why is market risk measurement important?
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Chapter 10: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) Compensating balance is a proportion of:
A)a loan that a borrower is required to hold on deposit at a correspondent bank.
B)a loan that a borrower is required to hold on deposit in foreign reserves.
C)a loan that a borrower is required to hold on deposit at the lending institution.
D)the investment that a borrower is required to hold on deposit at the lending institution.
Q2) Linear discriminant models rely on a company's forecasted financial data so that the FI manager is able to assess the borrower's future payment ability.
A)True
B)False
Q3) Mortality rates analyse historic default risk experience of bonds and loans of similar quality.
A)True
B)False
Q4) Explain the concept of RAROC and the major role RAROC models play in credit risk analysis.
Q5) What are the major ideas behind KMV's Credit Monitor Model?
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
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Q1) Which of the following is not a reason for the credit risk on a swap to be less than the credit risk on a loan?
A)Swap contracts often extend beyond the maturity of normal loan contracts.
B)Swap payments can be netted across more than on contract.
C)Interest rate swaps involve interest, but not principal.
D)Swap contracts often extend beyond the maturity of normal loan contracts, swap payments can be netted across more than on contract and Interest rate swaps involve interest, but not principal.
Q2) The most important swap contract in terms of quantity is the credit swap.
A)True
B)False
Q3) A forward contract:
A)has more credit risk than a futures contract.
B)is more standardised than a futures contract.
C)is marked to market more frequently than a futures contract.
D)has a shorter time to delivery than a futures contract.
Q4) Loan loss ratio based models estimate systematic loan losses by running a time-series regression of quarterly losses of the ith sector's loss rate on the quarterly loss rate of an FI's total loans.
Page 13
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Chapter 12: Sovereign Risk
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Sample Questions
Q1) Which of the following statements is true?
A)A lender wishing to provide funds to a borrower residing in a foreign country only needs to consider the credit quality of the borrower.
B)A lender wishing to provide funds to a borrower residing in a foreign country only needs to consider the sovereign risk quality of the country in which the borrower resides.
C)A lender wishing to provide funds to a borrower residing in a foreign country should consider either the credit quality of the borrower or the sovereign risk quality of the country in which the borrower resides.
D)A lender wishing to provide funds to a borrower residing in a foreign country should consider both the credit quality of the borrower and the sovereign risk quality of the country in which the borrower resides.
Q2) What are the costs and benefits of rescheduling for the lenders and for the borrowers?
Q3) Lenders considering lending money to a firm in another country only need to consider the firm's credit standing.
A)True
B)False
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Assume an FI holds US$250 000 in assets and US$350 000 in liabilities.Which of the following statements is true?
A)The FI has a net long in US$.
B)The FI has a net short in US$.
C)The FI has a net exposure of US$100 000.
D)The FI has a net exposure of -US$100 000.
Q2) Which of the following statements is true?
A)Holding less assets than liabilities in a given currency is referred to as a net short position.
B)Holding less assets than liabilities in a given currency is referred to a net long position.
C)Holding less assets than liabilities in a given currency is referred to as a gross short position.
D)Holding less assets than liabilities in a given currency is referred to as a gross long position.
Q3) Currency swaps are used to hedge against exchange rate risk from mismatched currencies on assets and liabilities.
A)True
B)False
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Chapter 14: Liquidity Risk
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Sample Questions
Q1) The Reserve Bank of Australia (RBA) took a number of temporary actions during the global financial crisis to provide liquidity and avert financial system disturbance.Which of the following were not actions supplied by the RBA?
A)Extension of collateral eligible for open market operations.
B)Longer term repos offered daily that provided funding for 6-month and 1-year terms.
C)Residential mortgage-backed securities and asset-backed commercial paper.
D)A foreign exchange swap facility to address the global shortage of euro in financial markets.
Q2) Assume that an FI's average loan value is $500 and the average value of deposits is $450.The FI has liquid assets of $50.What is the FI's financing gap?
A)$500 - $450 - $50 = $0
B)$450 - $500 = -$50
C)$500 - $450 = $50
D)$500 - $450 + $50 = $100
Q3) The liquidity index will always lie between -1 and +1.
A)True
B)False
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Chapter 15: Liability and Liquidity Management
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Q1) Which of the following are characteristics of a liquid asset?
A)The asset can be turned into cash quickly.
B)Turning the asset into cash will result in low transaction costs.
C)Turning the asset into cash will result in little or no loss in principal value.
D)All of the listed options are correct.
Q2) What are the withdrawal risks and costs associated with the following types of liabilities? a) cheque account and other demand deposits.
B) fixed-term deposits
C) interbank funds
Q3) Which of the following procedures does APRA require to be adopted by FIs as part of their liquidity management strategies?
A)Liquidity management policy approved by the board.
B)Procedures for assessing and measuring liquidity.
C)A formal contingency plan for dealing with a liquidity crisis.
D)All of the listed options are correct.
Q4) Why have regulators of financial service firms in Australia introduced the deposit guarantee programs? Why may regulators seek to provide greater protection to depositors than to other DI creditors?
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Page 17
Chapter 16: Off-Balance-Sheet Activities
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Q1) Which of the following is an out-of-the-money counterparty?
A)Counterparty in a loan commitment contract.
B)FI that trades in securities prior to their actual issue.
C)Counterparty that is currently at an advantage in terms of cash flows.
D)Counterparty that is currently at a disadvantage in terms of cash flows
Q2) The 'face value of an OBS item' is also referred to as the notional value.
A)True
B)False
Q3) Which of the following statements is true?
A)Large increases in the value of the OBS assets can render an FI economically insolvent.
B)Large increases in the value of the OBS liabilities will not render an FI economically insolvent as the liabilities are only contingent.
C)Large increases in the value of the OBS liabilities will not render an FI economically insolvent as the net worth of the institution will not be affected.
D)Large increases in the value of the OBS liabilities can render an FI economically insolvent.
Q4) Briefly explain how off-balance-sheet transactions can affect an FI's solvency.
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Chapter 17: Technology and Other Operational Risk
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Sample Questions
Q1) A major advantage of EFTPOS is that:
A)the transaction value will be debited from the customer's account at a later point in time.
B)customers can use cheques to pay for their purchases.
C)customers do not have to carry cash to make purchases.
D)All of the listed options are correct.
Q2) What are the advantages and disadvantages of technological advancements from the viewpoint of FIs? Use examples where appropriate.
Q3) Operational risk came into prominence during the global financial crisis (GFC) due to:
A)Lehman Brothers using 'recycled collateral' to expand their funding beyond on-balance-sheet assets.
B)The classification of 'sophisticated investors' led to investment banks not providing material information about the riskiness of derivative transactions.
C)the credit default swap market was likely to cause systemic market risk due to difficulties in settling out trades with distressed or failed counterparties.
D)All of the listed options are correct.
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19
Chapter 18: Capital Management and Adequacy
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Q1) Tier 1 capital is used to provide loss absorption on a gone-concern basis and must be subordinated to depositors and general creditors and an original maturity of at least five years.
A)True
B)False
Q2) What are the major differences between the Basel I and the Basel II approaches to capital regulation?
Q3) Current credit exposure is the:
A)credit risk exposure of an off-balance-sheet item.
B)cost of replacing a derivative securities contract at today's prices.
C)risk that a counterparty to a derivative securities contract will default in the future.
D)potential loss on current loans.
Q4) Procyclicality refers to features or characteristics that:
A)serve to exacerbate or amplify the underlying cyclicality of economic activity.
B)are only apparent during the down cycle of an economy.
C)help the economy to recover from a down cycle.
D)None of the listed options are correct.
Q5) Why is a regulatory capital charge against operational risk necessary?
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