Financial Markets and Institutions
Final Exam Questions
Course Introduction
Financial Markets and Institutions provides an in-depth exploration of the structure, function, and importance of financial systems within the global economy. This course examines the roles of key financial markets including stock, bond, money, and derivatives markets and the institutions that operate within them, such as banks, insurance companies, investment firms, and regulatory bodies. Students will analyze how these markets and institutions facilitate the flow of funds, allocate resources, manage risk, and influence economic stability and growth. Emphasis is placed on understanding the mechanisms behind financial intermediation, interest rate determination, regulatory frameworks, and current trends shaping financial environments worldwide.
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) The federal government has traditionally extended safety nets to DTIs consisting of
A)deposit insurance, central bank borrowing, and reserve requirements.
B)deposit insurance and borrowing from the Bank of Canada.
C)deposit insurance, unemployment insurance, and borrowing from the bank of Canada.
D)deposit insurance, open market operations, and borrowing from the Bank of Canada.
E)deposit insurance protection.
Answer: B
Q2) The passage of legislation to ensure that FIs are meeting the needs of their local communities is an example of entry regulation.
A)True
B)False
Answer: False
Q3) The liabilities of deposit-taking institutions are significant components of the money supply.
A)True
B)False
Answer: True
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3
Chapter 2: Deposit-Taking Institutions
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Q1) Holdings of Government of Canada securities are classified on a DTI's balance sheet as
A)assets, because Government of Canada securities are default risk-free.
B)liabilities, because the DTI must pay cash in order to acquire the securities.
C)assets, because securities holdings represent a use of funds for investment.
D)liabilities, because the Government of Canada securities must be pledged as collateral against borrowing from the Bank of Canada.
E)assets, because the market for Canadian government securities is the most liquid in the world.
Answer: C
Q2) The securitization of mortgages involves the pooling of mortgage loans for sale in the financial markets.
A)True
B)False
Answer: True
Q3) In recent years, the number of banks in Canada has been increasing.
A)True
B)False
Answer: False
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Page 4
Chapter 3: Finance Companies
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Q1) As a percent of assets, finance companies currently rely more heavily on commercial paper as a source of financing than in 1977.
A)True
B)False
Answer: False
Q2) Because finance companies do not accept deposits, they do not have bank regulators providing oversight of their activities.
A)True
B)False
Answer: True
Q3) Finance companies that prey on desperate higher-risk customers charging unfairly exorbitant interest rates are referred to as
A)refinancing companies.
B)captive companies.
C)business credit companies.
D)loan shark companies.
E)personal credit companies.
Answer: D
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Chapter 4: Securities, Brokerage, and Investment Banking
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Q1) As of 2012, equity capital in the securities industry measured over 12 percent.
A)True
B)False
Q2) Principal transactions allow the market maker to always make a profit regardless of whether the market price for a specific stock is rising or falling.
A)True
B)False
Q3) An angel venture capitalist is likely to be a wealthy individual that makes equity investments in unsuccessful, bankrupt firms.
A)True
B)False
Q4) Investment banks engage in activities such as advising on mergers, acquisitions, and corporate restructuring.
A)True
B)False
Q5) Agency transactions of market makers are two-way transactions on behalf of customers
A)True
B)False
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Chapter 5: Mutual Funds, Hedge Funds, and Pension Funds
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Q1) Which of the following is common to both hedge funds and mutual funds?
A)Registration with an exchange.
B)Disclosure norms.
C)Management fees.
D)Performance fees.
E)Investor profiles.
Q2) Mutual fund supermarkets often allow investors to purchase funds within large number of fund companies with no transaction fees.
A)True
B)False
Q3) The rate of investing in mutual funds tends to be positively correlated with economic activity in Canada, but is negatively correlated with economic activity in other countries.
A)True
B)False
Q4) Mutual funds are financial intermediaries that invest in diversified portfolios of assets.
A)True
B)False
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Chapter 6: Insurance Companies
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Q1) Variable universal life insurance policies
A)have fixed premiums and a fixed benefit payout.
B)have fixed premiums, but allow the benefit payout to vary with investment returns.
C)have a fixed benefit payout, but allow the premium to vary with investment returns.
D)allow both the premium and benefit payout to vary with investment returns.
E)allow both the premium and benefit payout to vary with investment returns, but have a fixed maturity date.
Q2) Property insurance involves coverage against the loss of personal property as well as protection against legal liability claims.
A)True
B)False
Q3) Adverse selection is a situation where customers who most need insurance are more likely to apply for insurance.
A)True
B)False
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Chapter 7: Risks of Financial Institutions
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Q1) The risk that borrowers are unable to repay their loans on time is
A)credit risk.
B)sovereign risk.
C)currency risk.
D)liquidity risk.
E)interest rate risk.
Q2) Matching the maturities of assets and liabilities supports the asset transformation function of FIs.
A)True
B)False
Q3) Managerial monitoring efficiency and credit risk management strategies affect the shape of the risk of the loan return distribution.
A)True
B)False
Q4) The risk that many depositors withdraw their funds from an FI at once is A)credit risk.
B)sovereign risk.
C)currency risk.
D)liquidity risk.
E)interest rate risk.
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) The net worth of a bank is the difference between the A)value of retained earnings and the provision for loan losses.
B)market value of assets and the market value of liabilities.
C)book value of assets and book value of liabilities.
D)rate-sensitive assets and rate-sensitive liabilities.
E)None of these.
Q2) Which of the following relationships does NOT hold in the pricing of fixed-rate assets given changes in market rate?
A)A decrease in interest rates generally leads to an increase in the value of assets.
B)Longer maturity assets have greater changes in price than shorter maturity assets for given changes in interest rates.
C)The absolute change in price per unit of maturity time for given changes in interest rates decreases over time, although the relative changes actually increase.
D)For a given percentage decrease in interest rates, assets will increase in price more than they will decrease in price for the same, but opposite increase in rates.
E)None of these.
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Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) Duration measures the average life of a financial asset.
A)True
B)False
Q2) 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. What is the bond's current market price?
A)$962.09.
B)$961.39.
C)$1,000.
D)$1,038.90.
E)$995.05.
Q3) The difference between the changes in the market value of the assets and market value of liabilities for a given change in interest rates is, by definition, the change in the FI's net worth.
A)True
B)False
Q4) Duration normally is less than the maturity for a fixed income asset.
A)True
B)False
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Chapter 10: Credit Risk: Individual Loans
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Q1) What is the essential idea behind RAROC?
A)Evaluating the actual or contractually promised annual ROA on a loan.
B)Analyzing historic or past default risk experience.
C)Balancing expected interest and fee income less the cost of funds against the loan's expected risk.
D)Extracting expected default rates from the current term structure of interest rates.
E)Dividing net interest and fees by the amount lent.
Q2) Long-term loans are more likely to be made under a loan commitment agreement than short-term loans.
A)True
B)False
Q3) Credit scoring models include all of the following broad types of models EXCEPT
A)Linear discriminant models.
B)Linear probability models.
C)Term structure models.
D)Logit models.
E)None of these.
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Q1) One advantage of portfolio diversification methods is that they are applicable to all FIs, regardless of their size.
A)True
B)False
Q2) Concentration limits are used to either reduce or increase exposure to specific industries.
A)True
B)False
Q3) Banks whose loan portfolio composition deviates from the national benchmark should immediately implement policies to move toward benchmark alignment.
A)True
B)False
Q4) A Hypothetical Rating Migration, or Transition Matrix, reflects all of the following EXCEPT
A)rating at which the portfolio ended the year.
B)transition probabilities.
C)rating at which the portfolio of loans began the year.
D)future migration expected in the portfolio.
E)the average proportions of loans that began the year.
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Chapter 12: Liquidity Risk
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Q1) Purchased liquidity management carries the potential risk of significant increases in the cost of funds during periods of high interest rate volatility.
A)True B)False
Q2) A problem exists with the net stable funds ratio (NSFR) in that it does not include off-balance-sheet activities.
A)True B)False
Q3) The Bank of Canada maintains lending programs to assist members of the Canada Payments System in managing liquidity problems.
A)True B)False
Q4) The liquidity index should be a number that is either greater than one or less than zero.
A)True B)False
Q5) Open-end mutual funds issue a fixed number of shares as liabilities. A)True B)False
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Chapter 13: Foreign Exchange Risk
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Q1) When purchasing and selling foreign currencies to allow customers to take positions in foreign real and financial investments, the FI
A)acts defensively as a hedger.
B)acts aggressively as a speculator.
C)assumes the FX risk itself.
D)acts as an agent.
E)acts as a market maker.
Q2) Purchasing power parity is based on the difference in productive output (GDP) that exists between two countries.
A)True
B)False
Q3) The foreign exchange market in Tokyo is the largest FX trading market.
A)True
B)False
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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Q1) Sovereign country risk is largely independent of the credit standing of the foreign borrower.
A)True
B)False
Q2) Which of the following describes debt rescheduling?
A)Outright cancellation of all current and future debt obligations.
B)Changing the contractual terms of a loan, such as its maturity and interest payments.
C)Direct nationalization of private sector assets.
D)Automatic default of all international loans upon default of any one loan.
E)Debt conversion schemes of debtor countries that signal creditworthiness.
Q3) Which of the following are normally traded at very deep discounts from 100 percent?
A)Restructured loans.
B)Brady bonds.
C)Sovereign bonds.
D)Performing loans.
E)Nonperforming loans.
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Chapter 15: Market Risk
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Q1) Which term defines the risk related to the uncertainty of an FI's earnings on its trading portfolio caused by changes, and particularly extreme changes in market conditions?
A)Interest rate risk.
B)Credit risk.
C)Sovereign risk.
D)Market risk.
E)Default risk.
Q2) If a trader in charge of an investment portfolio of an FI generates returns that are higher than other traders at the FI, she should be rewarded with higher compensation.
A)True
B)False
Q3) The major traders of mortgage-backed securities prior to the recent financial crisis were investment banks and securities firms.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Risk
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Q1) Which of the following is the newest addition to the derivative securities markets?
A)Options contracts.
B)Futures contracts.
C)Swap agreements.
D)Forward contracts.
E)Credit derivatives.
Q2) 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.
Q3) Standby letters of credit perform an insurance function similar to that of commercial and trade letters of credit.
A)True
B)False
Q4) Funds transferred on CHIPS are settled immediately.
A)True
B)False
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Chapter 17: Technology and Other Operational Risks
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Q1) Using encryption technology to assist in the electronic transaction of business between customers and businesses.
Q2) The following information is available on the average costs of the three major banks in a given local market. Bank A has assets of $10 million and average costs are 15 percent, Bank B has assets of $20 million and average costs of 13 percent while Bank C has assets of $30 million with average costs of 12 percent. Average costs are measured as a proportion of total assets. By how much should operating costs of the combined entity (Bank A + Bank B) be reduced in order to stay competitive in the local market, ceteris paribus?
A)$900,000.
B)$600,000.
C)$500,000.
D)$400,000.
E)$300,000.
Q3) The increased use of technology may have positive and negative effects on the perceived service quality provided to retail customers.
A)True
B)False
Q4) Encoding, endorsing, microfilming, and handling customers' checks.
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Chapter 18: Liability and Liquidity Management
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Q1) Managing liabilities as a means of managing liquidity risk involves the tradeoff between lower funding cost and higher risk of withdrawals.
A)True
B)False
Q2) Because investment banks typically buy and sell securities on a regular basis; they have no need for a liability management plan.
A)True
B)False
Q3) Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?
A)These assets carry a reserve requirement tax.
B)These assets offer low returns.
C)These assets offer higher returns that reflect their risk.
D)Inflation increases the purchasing power value of these assets.
E)All of these.
Q4) In the U.S. excess reserves held at the central bank pay interest to the DTI.
A)True
B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) Interest rates charged to healthy banks that borrow from the Bank of Canada are typically set one percent below the fed funds target interest rate.
A)True
B)False
Q2) Moral hazard at FIs may
A)result when actions and consequences are separated.
B)occur when interest rates are very high and volatile.
C)occur when commodity prices are very high and volatile.
D)be a consequence of strict regulatory supervision.
E)be a consequence of an erosion of family values.
Q3) Under the option pricing model of deposit insurance, the cost of the insurance
A)decreases as the insured deposit base increases.
B)decreases as the period over which the insurance coverage extends is increased.
C)increases with the level of risk of the assets held by the DTI increase.
D)decreases with market interest rates.
E)increase as the level of leverage used by the DTI decreases.
Q4) A run on a bank is not necessarily a bad occurrence.
A)True
B)False
Page 21
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Chapter 20: Capital Adequacy
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Q1) An FI may be insolvent in market value terms even if the book value of equity is positive.
A)True B)False
Q2) Basel III guidelines for determining credit risk-adjusted on-balance-sheet assets relies more heavily on credit agency ratings than did Basel I.
A)True B)False
Q3) The four (five) risk weight categories in Basel I (Basel II) may not reflect the true credit risk.
Q4) Capital is the primary protection for an FI against the risk of insolvency and failure.
A)True B)False
Q5) The benefits may not support the significant cost of developing and implementing new risk management systems.
Q6) Banks likely would need additional capital to meet the new minimum standards.
Q7) Regulators may not be trained or willing to make the necessary decisions that may rely heavily on judgment.
Page 22
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Chapter 21: Product and Geographic Expansion
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Q1) International expansion by a commercial bank should provide increased access to funding sources.
A)True
B)False
Q2) To avoid being exposed to potential losses in a securities offering, a bank may place the securities in the accounts of customers in the trust department or other areas over which it has discretionary investment powers.
Q3) Large size is an important characteristic in international banking because it gives a bank a greater ability to diversify across borders.
A)True
B)False
Q4) Historically, commercial banks have been prohibited from acting as an underwriter of insurance products.
A)True
B)False
Q5) In late 2012, shadow banking activities came under OSFI'S regulation.
A)True
B)False
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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/£. If the current (spot) rate for one-year British pound futures is currently at $1.58/£ and each contract size is £62,500, how many contracts are required to be purchased or sold in order to fully hedge against the pound exposure? (Assume no basis risk).
A)Sell 1,600 BP futures.
B)Buy 1,600 BP futures.
C)Sell 1,712 BP futures.
D)Buy 2,560 BP futures.
E)Buy 1,712 BP futures.
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) A spot contract specifies deferred delivery and payment.
A)True
B)False
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Page 24
Chapter 23: Options, Caps, Floors, and Collars
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Q1) An FI buys a collar by buying a floor and selling a cap.
A)True
B)False
Q2) An FI manager purchases a zero-coupon bond that has two years to maturity. The manager paid $826.45 per $1,000 for the bond. The current yield on a one-year bond of equal risk is 9 percent, and the one-year rate in one year is expected to be either 11.60 percent or 10.40 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)$862.10.
B)$743.23.
C)$900.93.
D)$811.70.
E)$917.36.
Q3) An FI would normally purchase a cap if it was funding fixed-rate assets with variable-rate liabilities.
A)True
B)False
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Chapter 24: Swaps
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Q1) A total return credit swap is eliminates interest rate risk as well as credit risk.
A)True
B)False
Q2) A credit union has funded 10 percent fixed-rate assets with variable-rate liabilities at LIBOR + 2 (L + 2) percent. A bank has funded variable-rate assets with fixed-rate liabilities at 6 percent. The bank's variable-rate assets earn LIBOR + 1 (L + 1) percent. The credit union and the bank have reached agreement on an interest-rate swap with the fixed-rate swap payment at 6 percent and the variable-rate swap payment at LIBOR. What will be the net after-swap cost of funds for the bank if the cash market liabilities are included in the analysis?
A)Variable-rate at LIBOR.
B)Fixed-rate at 8 percent.
C)Fixed-rate at 1 percent.
D)Fixed-rate at 2 percent.
E)None of these.
Q3) Swaps generally have a shorter maturity than other derivative instruments.
A)True
B)False
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Chapter 25: Loan Sales
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Q1) When an FI sells a loan without recourse, the credit risk of the loan is completely eliminated from the FIs balance sheet.
A)True
B)False
Q2) Which of the following is NOT a reason for using a bad bank as a vehicle to add value in the loan sale process?
A)Contracts for managers can be created to maximize the incentives to generate enhanced values from loan sales.
B)The bad bank enables bad assets to be managed by loan workout specialists.
C)The bad bank does not need to be concerned about liquidity needs since it does not have any deposits.
D)Moving the bad loans off the balance sheet of the good bank will improve the markets perception, and thus performance, of the good bank.
E)The good bank-bad bank structure increases information asymmetries regarding the value of the good bank's assets.
Q3) The buyer of a loan participation bears double monitoring costs.
A)True
B)False
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Chapter 26: Securitization Index
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Q1) A commercial bank operating under an originate-to-distribute model is acting most like
A)an asset transformer.
B)an asset broker.
C)a portfolio lender.
D)an asset accumulator.
E)an investment bank.
Q2) Prepayment risk means that realized cash flows on pass-through securities may be more than expected cash flows.
A)True
B)False
Q3) Which of these CMO issues has characteristics of both a zero-coupon bond and a regular bond?
A)Class A bonds.
B)Class B bonds.
C)Class C bonds.
D)Class Z bonds.
E)None of these.
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