Financial Markets and Institutions
Pre-Test Questions
Course Introduction
This course provides an in-depth exploration of the structure, function, and significance of financial markets and institutions within the global economy. Students will examine various types of financial markets such as stock, bond, and money markets and the instruments traded within them. The course also covers the roles and operations of key financial institutions including commercial banks, investment firms, insurance companies, and regulatory bodies. Emphasis is placed on understanding the processes of capital allocation, risk management, and regulatory frameworks, as well as how financial markets and institutions interact to facilitate economic growth, financial stability, and innovation. Students will analyze current trends and challenges in the financial sector, preparing them for advanced study or careers in finance.
Recommended Textbook
Financial Institution Management 3rd Edition by Helen Lange
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Q1) Which of the following statements is true?
A) Household savers are likely to be attracted to direct investments in corporate securities because of lower monitoring costs compared to using financial intermediaries.
B) Household savers are likely to be attracted to direct investments in corporate securities because of lower liquidity costs compared to using financial intermediaries.
C) Household savers are likely to be attracted to direct investments in corporate securities because of lower price risk compared to using financial intermediaries.
D) None of the listed options are correct.
Answer: D
Q2) Which of the following statements is true?
A) Bank failures may destroy household savings and restrict a firm's access to credit. B) Bank failures may create doubts in savers' minds regarding the stability and solvency of financial intermediaries in general.
C) Bank failures may threaten the stability of the financial system.
D) All of the listed options are correct.
Answer: D
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Chapter 2: The Financial Services Industry: Depository
Institutions
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Q1) Australia's current financial regulatory framework was reformed in 1999 and moved from industry-based regulation to functional regulation of financial institutions.
A)True
B)False
Answer: True
Q2) Which of the following statements is true for the Australian banking industry?
A) The Australian banking industry is highly concentrated.
B) There are four major banks in Australia.
C) The four major banks and the five regional banks offer a full range of commercial and investment banking services.
D) All of the listed options are correct.
Answer: D
Q3) ASIC stands for Australian Society of Inter-bank Cooperation and ASIC is responsible for market integrity and consumer protection across the financial system.
A)True
B)False
Answer: False
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Page 4
Chapter 3: The Financial Services Industry: Other Financial Institutions
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Q1) Which of the following statements is true?
A) Australian governments have encouraged national savings through superannuation.
B) The government has provided taxation incentives aimed at increasing voluntary contributions to superannuation by both employers and employees.
C) The government has introduced legislative requirements forcing employers to contribute to superannuation on behalf of their employees.
D) All of the listed options are correct.
Answer: D
Q2) Property-casualty insurers tend to have a higher level of liquidity risk than life insurers.
A)True
B)False
Answer: True
Q3) In general, the maximum levels of losses are less predictable for property lines than liability lines.
A)True
B)False
Answer: False
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Chapter 4: Risk of Financial Institutions
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Q1) A small local bank failed because of a housing market collapse following the departure of the area's largest employer. What type of risk applies to the failure of the institution?
A) firm-specific risk
B) technological risk
C) operational risk
D) insolvency risk
Q2) Event risks such as earthquakes, fraud and theft:
A) do not have an impact on an FI's performance.
B) are easy to measure and to predict.
C) form a normal cost of doing business for FIs.
D) may have a significant and negative impact on an FI's performance but are difficult to measure and to predict.
Q3) What type of risk focuses upon future contingencies?
A) liquidity risk
B) interest rate risk
C) credit risk
D) off-balance-sheet risk
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Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Q1) 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
Q2) Which of the following statements is true?
A) One problem with the repricing gap is over-aggregation, which means that while the dollar value of asset-sensitive liabilities and assets within one bucket might be the same, the repricing timing for assets and liabilities within this bucket might differ.
B) One problem with the repricing gap is over-aggregation, which means that managers cannot make informed decisions about interest rate movements.
C) An advantage of the repricing gap is over-aggregation, which means that the information provided in the buckets is precise.
D) None of the listed options are correct.
Q3) Would you consider the repricing model to be a good and well-founded interest rate risk measurement and management tool? Why or why not?
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Chapter 6: Interest Rate Risk Measurement: the Duration
Model
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Q1) 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.
Q2) With increasing maturity of a fixed-income asset or liability the asset or liability's duration:
A) increases, but at a decreasing rate.
B) decreases.
C) increases at an increasing rate.
D) increases at a constant rate.
Q3) When does 'duration' become a less accurate predictor of expected change in security prices?
A) As interest rate shocks increase in size.
B) As interest rate shocks decrease in size.
C) When maturity distributions of an FI's assets and liabilities are considered.
D) As inflation decreases.
Page 8
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Chapter 7: Managing Interest Rate Risk Using Off Balance
Sheet Instruments
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Q1) For a currency that has a futures contract, basis risk is not typically a problem as $1 is the same as any other $1.
A)True
B)False
Q2) It is possible to create a synthetic fixed-rate position from floating rate instruments using futures contracts. Forward contracts cannot be used.
A)True
B)False
Q3) Forwards are on-balance-sheet transactions.
A)True
B)False
Q4) As interest rates increase, the writer of a bond call option stands to make:
A) limited gains.
B) limited losses.
C) unlimited losses.
D) unlimited gains.
Q5) The Sydney Futures Exchange only offers cash-settled contracts.
A)True
B)False
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Chapter 8: Credit Risk I: Individual Loan Risk
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Q1) What are the two basic types of loan sale contracts or mechanisms by which loans can be transferred between seller and buyer?
A) participations and assignments
B) participations and originations
C) syndications and originations
D) transfers and assignments.
Q2) What are four reasons why an FI may prefer the use of either pass-through securities or CMOs to the use of MBBs?
Q3) Credit card facilities is a revolving loan product.
A)True
B)False
Q4) 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.
Q5) Which of the following is true concerning loans sold without recourse?
A) The loan sale is technically removed from the balance sheet ..
B) The buyer cannot put the loan back to the selling FI.
C) The FI has no explicit liability if the loan eventually goes bad.
Page 10
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Chapter 9: Market Risk
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Q1) What is meant by horizontal offset?
A) The deduction of capital charges because long and short positions of the same maturities have durations that more than perfectly hedge each other.
B) The assignment of additional capital charges because long and short positions of the same maturities have durations that do not perfectly hedge each other.
C) The deduction of additional capital because long and short positions of different maturities more than perfectly hedge each other.
D) The assignment of additional capital charges because long and short positions of different maturities do not perfectly hedge each other.
Q2) Which of the following statements is true?
A) Unsystematic risk is specific to a particular firm.
B) Unsystematic risk is specific to a particular industry.
C) Unsystematic risk is specific to a particular geographical area.
D) Unsystematic risk relates to the whole market.
Q3) Explain the basic concept of the RiskMetric model. What are the major disadvantages? How can the major disadvantages be addressed?
Q4) Why is market risk measurement important?
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11
Chapter 10: Credit Risk I: Individual Loan Risk
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Q1) 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
Q2) Consider the following formula for calculating the contractually promised gross return on a loan k, per dollar lent: (1 + k) = 1 + [f + (BR + m)]/ {1 - [b(1 - R)]}. Which of the following statements is true?
A) The denominator is the promised gross cash inflow to the FI per dollar.
B) The denominator reflects direct fees plus the loan interest rate consisting of both, the base lending rate and the credit risk premium.
C) The formula ignores present value aspects.
D) The FI's net benefit from requiring compensating balances must consider the benefits of holding additional non-interest bearing reserve requirements.
Q3) Credit card facilities is a revolving loan product.
A)True
B)False
Q4) What are the major ideas behind KMV's Credit Monitor Model?
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
Risk
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Q1) Which of the following statements is true?
A) The objective of risk-indifferent FI managers is to minimise portfolio risk regardless of the portfolio's return.
B) The objective of risk-indifferent FI managers is to minimise portfolio risk in turn for higher returns on the portfolio.
C) The objective of risk-averse FI managers is to minimise portfolio risk in turn for higher returns on the portfolio.
D) The objective of risk-averse FI managers is to minimise portfolio risk regardless of the portfolio's return.
Q2) Assume that an FI's concentration limit on a particular sector is 15 per cent and that the sector's loss rate is 25 per cent. What is the maximum loss as a percentage of the FI's capital (round to two decimals)?
A) 1.67 per cent
B) 0.60 per cent
C) 10.00 per cent
D) 3.75 per cent
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Chapter 12: Sovereign Risk
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Q1) Which of the following statements is true in relation to the Euromoney Index?
A) The Euromoney Index rates country risk by combined economic and political risk on a maximum of 100 points scale.
B) The Euromoney Index is based on the spread in the Euromarket of the required interest rate on a country's debt over the LIBOR, adjusted for the volume and maturity of the issue.
C) The Euromoney Index weighs subjective scores allocated by rating officers by the exposure of each bank to the country in question.
D) None of the listed options are correct.
Q2) Which of the following statements is true?
A) Debt-for-equity swap programs appear to enhance LCD debt prices.
B) Debt-for-equity swap programs appear to have no impact on LCD debt prices.
C) Debt-for-equity swap programs appear to depress LCD debt prices.
D) Debt-for-equity swaps are not available for traded LCD debt.
Q3) The sovereign risk assessment methods most commonly used by large FIs are logit and probit models.
A)True
B)False
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Page 14
Chapter 13: Foreign Exchange Risk
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Q1) Which of the following statements is true?
A) In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee and does assume part of the FX risk.
B) In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee but does not assume any of the FX risk.
C) In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as a hedger to reduce the FX exposure.
D) In case an FI purchases or sells foreign currencies to allow customers to partake in and complete international commercial trade transactions, the FI acts as an agent of its customers for a fee and as a hedger to reduce the FX exposures.
Q2) Explain how forward contracts can be used to hedge an FI's FX exposures.
Q3) Explain the concept of the interest rate parity theorem (IRPT) and its implications for FIs?
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Page 15
Chapter 14: Liquidity Risk
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Q1) Which of the following statements is true?
A) The liquidity index compares the liquidity of a single institution with the industry average and thus measures the liquidity risk of that particular institution.
B) The liquidity index provides guidance for FIs on how much liquidity they should hold on a seasonal basis.
C) The liquidity index measures the potential losses an FI could suffer if new market entrants take away market share from the existing institutions.
D) The liquidity index measures the potential losses an FI could suffer from a sudden disposal of assets compared to the mount it would receive at a fair market value established under normal sales conditions.
Q2) In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts knows that normally only a small proportion of these deposits will be withdrawn on any given day.
A)True
B)False
Q3) What are the main components of a liquidity plan? Discuss the vital role such a plan plays in reducing liquidity risk?
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Page 16
Chapter 15: Liability and Liquidity Management
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Q1) The Reserve Bank of Australia has responsibility for providing depositor protection. This is seen as:
A) a blanket guarantee for all deposits and a protection against all FIs' failure.
B) the RBA using its available powers in the interest of protecting depositors' funds.
C) deposit insurance for all FIs.
D) All of the listed options are correct.
Q2) Measuring stored liquidity is easy because many assets cannot be clearly classified as liquid or non-liquid.
A)True
B)False
Q3) Although Australia has only had an explicit deposit insurance scheme since 2008, it has had depositor protection since 1959 and has always had depositor preference.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Activities
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Q1) Which of the following statements is true?
A) In general, default risk on OTC contracts decreases with the time to maturity of the contract and the fluctuation of underlying prices, interest rates or exchange rates.
B) In general, default risk on OTC contracts increases with the time to maturity of the contract and the fluctuation of underlying prices, interest rates or exchange rates.
C) In general, default risk on OTC contracts is independent of the time to maturity of the contract and the fluctuation of underlying prices, interest rates or exchange rates.
D) OTC contracts are generally free of default risk.
Q2) Off-balance-sheet items are:
A) items omitted from the short form balance sheet.
B) contingent assets and liabilities.
C) exceptionally risky assets and liabilities.
D) foreign (off shore) assets and liabilities.
Q3) Standby letters of credit can be seen as direct competitors to loan commitments.
A)True
B)False
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) Regulators have proposed that operational risk should be measured for the purpose of meeting overall capital adequacy.
A)True
B)False
Q2) Which of the following is consistent with economies of scope? The subscript 'b' refers to a banking firm, 's' for a securities firm, 'AC' is average costs and 'TC' is total costs.
A) AC<sub>b+s</sub> > AC<sub>b</sub> + AC<sub>s</sub>
B) AC<sub>b+s</sub> = AC<sub>b</sub> + AC<sub>s</sub>
C) AC<sub>b+s</sub> < AC<sub>b</sub> + AC<sub>s</sub>
D) TC<sub>b+s</sub> < TC<sub>b</sub> + TC<sub>s</sub>
Q3) Which of the following are the two basic approaches to analysing the cost functions of FIs?
A) Basic indicator approach and standardised approach.
B) Standardised approach and advanced measurement approach.
C) Production approach and intermediation approach.
D) Basic indicator approach and advanced measurement approach.
Q4) External and internal fraud are both sources of operational risk.
A)True
B)False
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Chapter 18: Capital Management and Adequacy
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Q1) Which of the following elements is usually not included in the book value of capital?
A) the par value of shares
B) the FI's earnings
C) loan loss reserve
D) the surplus value of shares
Q2) Basel II established minimum capital requirements, procedures to ensure that sound internal process are used to assess capital adequacy and set targets that were commensurate with the risk profile and environment in an endeavour to protect solvency of individual FIs. Basel III introduced liquidity and higher capital levels to protect the financial system in general.
A)True
B)False
Q3) Market to book ratio is a ratio that shows the discrepancy between the:
A) stock market value of an FI's equity and the book value of its equity.
B) historic value of an FI's equity and the book value of its equity.
C) US dollar value of an FI's equity and the book value of its equity.
D) value of an FI's debt and the book value of its debt.
Q4) Identify the main functions of an FI's capital and differentiate between Tier 1 and Tier 2 capital.
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