Financial Intermediation Textbook
Exam Questions
Course Introduction
Financial Intermediation explores the crucial role that financial institutions such as banks, insurance companies, and investment funds play in facilitating the flow of funds between savers and borrowers within the economy. This course examines the structure of financial markets, the functions and risks associated with different types of intermediaries, and the regulatory frameworks that govern their activities. Areas of focus include the management of liquidity and credit risk, the process of asset transformation, and the impact of financial intermediation on economic growth and stability. Students will also analyze contemporary issues such as technological innovations, financial crises, and changing regulatory environments.
Recommended Textbook
Financial Institution Management 3rd Edition by Helen Lange
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Chapter 1: Why Are Financial Institutions Special
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Q1) Which of the following are reasons for the specialness of financial intermediaries?
A) Higher average information costs.
B) Lower price risk and superior liquidity attributes for financial claims to household savers.
C) Higher average transaction costs.
D) All of the listed options are correct.
Answer: B
Q2) In the principal-agent relationship between savers and a borrowing firm the savers are the agents and the borrowing firm is the principal.
A)True
B)False
Answer: False
Q3) An example of negative externality is the costs faced by small businesses in a one-bank town if the local bank fails.
A)True
B)False
Answer: True
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Chapter 2: The Financial Services Industry: Depository
Institutions
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Q1) Which of the following observations concerning credit unions is not true?
A) They invest heavily in corporate securities.
B) Member loans constitute a majority of their total assets.
C) They engage in off-balance-sheet activities.
D) They focus more on providing services and less on profitability.
Answer: A
Q2) APRA's supervisory oversight and response system (SOARS) is designed to assess the:
A) likelihood of FI failure.
B) impact of the FI failure.
C) impact of FI failure and provide the appropriate supervisory response, which in the case of a low PAIRS probability rating will require restructure.
D) impact of FI failure and provide the appropriate supervisory response, which in the case of an extreme PAIRS probability rating will require restructure.
Answer: D
Q3) Non-bank depository institutions are also referred to as CUBS.
A)True
B)False
Answer: True
Page 4
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Chapter 3: The Financial Services Industry: Other Financial Institutions
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Q1) In general, the maximum levels of losses are less predictable for property lines than liability lines.
A)True
B)False
Answer: False
Q2) 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
Q3) 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
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Chapter 4: Risk of Financial Institutions
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Q1) Sovereign risk refers to the risk that repayments from:
A) local borrowers are interrupted because of interference from foreign governments.
B) foreign borrowers are interrupted because of interference from local governments.
C) foreign borrowers are interrupted because of interference from foreign governments.
D) None of the listed options are correct.
Q2) A short-funded FI is exposed to increasing interest rates.
A)True
B)False
Q3) Which of the following are typical operational risk sources?
A) employee fraud
B) back-office failures
C) general technological glitches
D) All of the listed options are correct.
Q4) Credit risk refers to the possibility that promised cash flows on financial claims such as loans and securities are not paid in full.
A)True
B)False
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Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Q1) Which of the following statements is true?
A) The major focus of the repricing gap is the capital loss effect.
B) The major focus of the repricing gap is the capital gains effect.
C) The repricing gap focuses on all three, the capital gains, the capital loss and the interest income effect.
D) The major focus of the repricing gap is the interest income effect.
Q2) Which of the following statements is true?
A) An FI with a repricing gap of zero is unsure about interest rate movements.
B) An FI with a repricing gap of zero expects interest rates to rise.
C) An FI with a repricing gap of zero expects interest rates to remain fall.
D) An FI with a repricing gap of zero does not measure and manage its interest rate exposures.
Q3) What is meant by the 'run-off' problem and how can bank managers deal with this problem?
Q4) An FI with a positive gap of $30 million suffers a $0.15 million decrease in its net interest income if interest rates increase by 0.5 per cent.
A)True
B)False
Page 7
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Chapter 6: Interest Rate Risk Measurement: the Duration
Model
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Q1) Using the duration gap to measure the change in an FI's net worth in case of large interest rate shocks:
A) produces exact results.
B) only produces exact results if interest rates change instantaneously.
C) produces approximate results only due to concavity.
D) produces approximate results only due to convexity.
Q2) Which of the following statements about leverage adjusted duration gap is true?
A) It is equal to the duration of the assets minus the duration of the liabilities.
B) The larger the gap in absolute terms, the more exposed the FI is to interest rate shocks.
C) It reflects the degree of maturity mismatch in an FI's balance sheet.
D) It indicates the dollar size of the potential net worth and its value is equal to duration divided by (1+R).
Q3) One method of changing the positive leverage adjusted duration gap for the purpose of immunising the net worth of a typical depository institution is to increase the duration of the assets and to decrease the duration of the liabilities.
A)True
B)False
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Chapter 7: Managing Interest Rate Risk Using Off Balance
Sheet Instruments
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Q1) Which of the following best describes a derivative contract?
A) Contractual commitments to make a loan up to a stated amount at a given interest rate in the future.
B) Contingent guarantees sold by an FI to underwrite the performance of the buyer of the guaranty.
C) Agreement between two parties to exchange a standard quantity of an asset at a predetermined price at a specified date in the future.
D) Trading in securities prior to their actual issue.
Q2) The benefit of a futures exchange is:
A) elimination of customer risk exposure.
B) provision of clearing services.
C) guarantee of trading volume.
D) intervention on the trader's behalf with government regulators.
Q3) An Australian bank must pay US$10 million in 90 days. It wishes to hedge the risk in the futures market. To do so, the bank should:
A) buy A$10 million in US dollar futures.
B) sell A$10 million in US dollar futures, with three-month maturity.
C) buy US$10 million in US dollar futures.
D) sell US$10 million in US dollar futures
Page 9
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Chapter 8: Credit Risk I: Individual Loan Risk
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Q1) Benefits of securitisation include:
A) increased liquidity of bank loans
B) enhanced ability to manage the duration gap.
C) if off-balance-sheet, the issuer saves on reserve requirements, deposit insurance premiums and capital adequacy requirements.
D) All of the listed options are correct.
Q2) While collateralised mortgage obligation (CMO) is still the primary mechanism for securitisation, the pass-throughs are second and growing vehicle for securitising bank assets.
A)True
B)False
Q3) Securitisation removes assets (such as loans) from the balance sheets of FIs, similar to loan sales.
A)True
B)False
Q4) A bank loan sale occurs when an FI originates a loan and sells the loan with or without recourse to an outside buyer.
A)True
B)False
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Chapter 9: Market Risk
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Q1) Which of the following statements is true?
A) Technically, 90 per cent of the area under a normal distribution lies between +/1.65\(\sigma\) from the mean.
B) Technically, 90 per cent of the area under a normal distribution lies between +/2.33\(\sigma\) from the mean.
C) Technically, 99 per cent of the area under a normal distribution lies between +/1.65\(\sigma\) from the mean.
D) Technically, 99 per cent of the area under a normal distribution lies between +/2.33\(\sigma\) from the mean.
Q2) Why is market risk measurement important?
Q3) Specific risk charge is a charge reflecting the risk of the decline in the liquidity or credit risk quality of the trading portfolio.
A)True
B)False
Q4) Vertical offsets are calculated using the sum of the general market risk charges from long and short positions in each time zone.
A)True
B)False
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Chapter 10: Credit Risk I: Individual Loan Risk
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Q1) Which of the following statements is true?
A) Arbitrage means the inability to make a profit without taking risk.
B) Arbitrage means that an FI takes risks in order to make a profit.
C) Arbitrage means that an FI does not take any and thus does not make a profit.
D) Arbitrage means the ability to make a profit without taking risk.
Q2) Which of the following statements is false?
A) Default risk is the risk that the borrower is willing but unable to fulfil the terms promised under loan contract.
B) Default risk is the risk that the borrower refinances the loan before maturity.
C) Default risk is the risk that the borrower is able but unwilling to fulfil the terms promised under loan contract.
D) Default risk is the risk that the borrower is unable and unwilling to fulfil the terms promised under loan contract.
Q3) The estimate of loan (or capital) risk (\( \Delta~ \)L) can be calculated as follows: D<sub>L</sub> \(\times\) L \(\times\) [\( \Delta\)R / (1+R)].
A)True
B)False
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
Risk
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Q1) An FI that invests 40 per cent of funds in a loan with an expected return of 10 per cent and 60 per cent of funds in a loan with an expected return of 12 per cent can expect to earn 11 per cent on its portfolio.
A)True
B)False
Q2) Which of the following statements is true?
A) The risk of a loan reflects the volatility of the loan's default rate around its expected value times the amount lost given default.
B) The product of the volatility of the default rate and the loss give default (LGD) is called the 'unexpected loss'.
C) The product of the volatility of the default rate and the loss give default (LGD) is a measure of the loan's risk.
D) All of the listed options are correct.
Q3) Concentration limits are external limits set on the maximum loan size that can be made to an individual borrower.
A)True B)False
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Chapter 12: Sovereign Risk
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Q1) The Euromoney Index is based on the spread in the Euromarket of the required interest rate on a country's debt over the LIBOR.
A)True
B)False
Q2) Which of the following expressions truly represents the calculation of a country's import ratio?
A) Total imports divided by total exports.
B) Total imports divided by total foreign currency exchange reserves.
C) Total imports divided by total debt.
D) Total imports divided by GDP.
Q3) Lenders may find it costly to reschedule non-accruing sovereign country debt because:
A) it is politically embarrassing.
B) bankruptcy costs are high.
C) they might be subject to greater regulatory attention.
D) it is detrimental to maintaining good customer relations.
Q4) What are the major advantages and disadvantages of using scoring models to assess country risk?
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Chapter 13: Foreign Exchange Risk
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Q1) Which of the following statements is true for an FI that holds 200 000 in assets and 250 000 in liabilities?
A) The FI is in a net short position.
B) The FI has net foreign assets of 50 000.
C) The FI faces the risk that the euro will fall in value against domestic currency.
D) All of the listed options are correct.
Q2) The case of the National Australia Bank shows that:
A) FX trading can result in significant losses for an FI.
B) FX trading losses can result in reputational loss for an FI.
C) the announcement of FX trading losses can lead to a fall in the share price of the FI at which the losses occurred.
D) All of the listed options are correct.
Q3) An FI acts defensively as a hedger to reduce FX exposure if it engages in the purchase and sale of foreign currencies for hedging purposes to offset customer or FI exposure in any given currency.
A)True
B)False
Q4) Explain how forward contracts can be used to hedge an FI's FX exposures.
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Chapter 14: Liquidity Risk
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Q1) Discuss the advantages and disadvantages of stored liquidity management and purchased liquidity management. In your opinion, which is the better approach for a DI to adopt?
Q2) What are the main components of a liquidity plan? Discuss the vital role such a plan plays in reducing liquidity risk?
Q3) Distinguish between liquidity risk arising from the asset-side and the liability-side of the balance sheet.
Q4) The aim of open market transactions is to influence the level of liquidity in the market.
A)True
B)False
Q5) 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
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Chapter 15: Liability and Liquidity Management
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Q1) Which of the following statements is true?
A) FIs are required to hold some liquid assets to lessen the threat of insolvency.
B) FIs are required to hold some liquid assets for the purpose of monetary policy.
C) FIs are required to hold some liquid assets for the purpose of taxation implications.
D) FIs are required to hold some liquid assets to lessen the threat of insolvency, for the purpose of monetary policy and for the purpose of taxation implications.
Q2) Which of the following statements is true?
A) Australian FIs are required to hold a minimum of three days' estimated cash requirements to enable them to manage a short run on deposits.
B) Australian FIs are required to hold a minimum of five days' estimated cash requirements to enable them to manage a short run on deposits.
C) Australian FIs are required to hold a minimum of seven days' estimated cash requirements to enable them to manage a short run on deposits.
D) None of the listed options are correct.
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Chapter 16: Off-Balance-Sheet Activities
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Q1) An exporter demands a letter of credit in order to:
A) guarantee safe delivery of goods to the importer.
B) guarantee receipt of payment from the importer upon receipt of the goods.
C) protect against adverse changes in foreign exchange rates.
D) ascertain the creditworthiness of the importer.
Q2) Assume that the market value of assets is $120 and the market value of liabilities is $90. What is the bank's net worth?
A) $210
B) $30
C) -$30
D) None of the listed options are correct.
Q3) Letters of credit are:
A) contingent guarantees sold by an FI to underwrite the trade or commercial performance of the buyer of the guarantee.
B) another word for cheques.
C) guarantees bought by an FI because they are convinced by the issuer's commercial performance.
D) reminders sent by FIs to customers who have outstanding debit balances.
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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Q1) According to economic theory involving economies of scale, larger and more cost-efficient FIs should prevail over smaller, less cost-efficient FIs.
A)True
B)False
Q2) Which of the following observations concerning the production approach is true?
A) It views FIs' outputs of services as having three underlying inputs.
B) Labour and capital are the only inputs.
C) It views the output as being produced by labour, capital and the funds used to produce intermediated services.
D) Deposit costs are viewed as an input in the banking and non-banking deposit institutions.
Q3) Losses on technological innovations and new technology could weaken an FI because scarce capital resources were invested in value-decreasing projects.
A)True
B)False
Q4) Outline the main sources of operational risk and why operational risk gained prominence during the GFC.
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Chapter 18: Capital Management and Adequacy
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Q1) Retained earnings are:
A) the accumulated value of past profits not yet paid out in dividends to shareholders.
B) the face value of the ordinary shares issued by the FI.
C) a special reserve set aside out of retained earnings to meet expected and actual losses on the portfolio.
D) the difference between the price the public paid for common stock or shares when originally offered and their par values times the number of shares outstanding.
Q2) The term 'credit equivalent amount' refers to the:
A) nominal value of an on-balance-sheet item exposed to credit risk.
B) credit risk exposure of an on-balance-sheet item.
C) credit risk exposure of an off-balance-sheet item.
D) nominal value of an off-balance-sheet item exposed to credit risk.
Q3) Why is a regulatory capital charge against operational risk necessary?
Q4) Which of the following are arguments against market value accounting?
A) It introduces a higher degree of stability into an FI's earnings.
B) It is difficult to implement.
C) FI's would be less willing to accept investments in shorter term assets.
D) There are no arguments against market value accounting.
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