Course Introduction
Financial Regulation
Final Exam Questions
Financial Regulation explores the frameworks, policies, and institutions that govern financial markets and institutions, aiming to maintain stability, integrity, and transparency within the financial system. The course examines key regulatory agencies and legislation, the interplay between domestic and international financial rules, and the rationale behind regulatory intervention. Topics include prudential regulation, conduct of business rules, risk management, systemic risk, anti-money laundering measures, and responses to financial crises. Students will analyze recent regulatory reforms and consider the ongoing challenges policymakers face in balancing innovation, market efficiency, and consumer protection.
Recommended Textbook
Financial Institutions Management 4th Edition by SAUNDERS
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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)Agency costs arise whenever economic agents enter into a contract in a world of incomplete information.
B)Monitoring costs are part of overall agency costs.
C)The more difficult and costly it is to collect information, the more likely it is that contracts will be broken.
D)Agency costs arise whenever economic agents enter into a contract in a world of incomplete information, monitoring costs are part of overall agency costs and the more difficult and costly it is to collect information, the more likely it is that contracts will be broken.
Answer: D
Q2) Agency costs are costs relating to the risk that the owners and managers of firms that receive savers' funds will take action with those funds contrary to the best interests of the saver.
A)True
B)False
Answer: True
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Page 3
Chapter 2: The Financial Service Industry: Depository
Institutions
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Q1) Which of the following statements is true?
A)Capital adequacy regulations of banks were introduced in 1989.
B)Capital adequacy regulations require banks to hold, on average, less capital for low-risk assets such as housing loans compared to higher risk assets such as commercial loans.
C)Capital adequacy regulations were abolished in 2000.
D)Capital adequacy regulations of banks were introduced in 1989 and capital adequacy regulations require banks to maintain levels of capital adequate for the type of activity undertaken, on average, less capital for low-risk assets such as housing loans compared to higher risk assets such as commercial loans.
Answer: D
Q2) During the 1960s and 1970s, the growth of credit unions ensured an increasing supply of funds for housing loans at reasonable rates, while the building society expansion ensured the availability of relatively low cost unsecured and secured personal loans.
A)True
B)False
Answer: False
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Chapter 3: The Financial Service Industry: Other Financial Institutions
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Q1) Which of the following statements is true?
A)Finance companies are financial institutions that raise funds through the issue of debentures and unsecured notes from retail investors.
B)Finance companies are financial institutions that raise funds through the issue of debentures and unsecured notes from wholesale investors.
C)Finance companies are financial institutions that raise funds through the issue of T-bonds and secured notes from retail investors.
D)Finance companies are financial institutions that raise funds through the issue of T-bonds and secured notes from wholesale investors.
Answer: A
Q2) Which of the following statements is true?
A)Unbundled life insurance is also called investment-free insurance.
B)Bundled life insurance is also called investment-free insurance.
C)Unbundled life insurance is also called investment-linked insurance.
D)Bundled life insurance is also called investment-linked insurance.
Answer: C
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Chapter 4: Risks of Financial Institutions
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Q1) The risk that interest income will increase at a slower rate than interest expense is:
A)credit risk
B)political risk
C)currency risk
D)interest rate risk
Q2) Technological failure, employee fraud and employee errors are all sources of operational risk.
A)True
B)False
Q3) Unanticipated diseconomies of scale and scope are a result of:
A)technology risk
B)interest rate risk
C)foreign exchange risk
D)credit risk
Q4) The risk that borrowers are unable to repay their loans on time is called:
A)credit risk
B)sovereign risk
C)currency risk
D)liquidity 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) The repricing model ignores information regarding the distribution of assets and liabilities within maturity buckets.This limitation of the model refers to:
A)market value effect
B)over-aggregation
C)runoffs and pre-payments
D)off-balance-sheet activities
Q3) What is meant by the 'runoff' 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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Q1) Duration is defined as:
A)the weighted-average time to maturity of a series of cash flows, using the relative present values of the cash flows as weights
B)the weighted-average present values of a series of cash flows using the timing of the cash flows as weights
C)the standard deviation of the time to maturity of a series of cash flows
D)an asset's or a liability's time to maturity
Q2) Convexity is defined as:
A)the degree of curvature of the price-yield curve around some maturity level
B)the degree of curvature of the price-yield curve around some price level
C)the degree of curvature of the price-yield curve around some interest rate level
D)None of the listed options are correct.
Q3) Which of the following is indicated by high numerical value of the duration of an asset?
A)low sensitivity of an asset price to interest rate shocks
B)high interest inelasticity of a bond
C)high sensitivity of an asset price to interest rate shocks
D)lack of sensitivity of an asset price to interest rate shocks
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Chapter 7: Managing Interest Rate Risk Using
Off-Balance-Sheet Instruments
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Sample Questions
Q1) A forward contract is an agreement between a buyer and seller at time 0, when there is a contractual agreement that an asset will be exchanged for cash at some later date.
A)True
B)False
Q2) The writer of a bond call option:
A)receives a premium and must stand ready to sell the bond at the exercise price
B)receives a premium and must stand ready to buy bonds at the exercise price
C)pays a premium and has the right to sell the underlying bond at the agreed exercise price
D)pays a premium and has the right to buy the underlying bond at the agreed exercise price
Q3) ...is a residual risk that arises because the movement in a spot (cash) asset's price is not perfectly correlated with the movement in the price of the asset delivered under a futures or forward contract.
A)Macro risk
B)Micro risk
C)Basis risk
D)Duration risk
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Chapter 8: Managing Interest Rate Risk Using Securitisation
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Q1) This propensity to prepay means:
A)realised coupons/cash flows on pass-through securities would conform to expected cash flows
B)realised coupons/cash flows on pass-through securities can often deviate substantially from the stated or expected coupon flows
C)realised coupons/cash flows on pass-through securities are prepaid
D)None of the listed options are correct.
Q2) With over $1200 billion in doubtful and troubled loans on their books in the early 2000s, _________ banks presented a huge potential market for the sale of distressed loans.
A)Australian
B)US
C)UK
D)Japanese
Q3) Assignments:
A)are common in loan syndications
B)do not have buyer restrictions
C)comprise less than 30 per cent of the US loan sales market
D)involve extremely high monitoring costs
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Page 10
Chapter 9: Market Risk
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Sample Questions
Q1) 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.
Q2) Explain the basic concept of the RiskMetric model.What are the major disadvantages? How can the major disadvantages be addressed?
Q3) Assume an FI holds a foreign exchange position of EUR 200 000 and further assume that the dollar per unit of EUR rate is $1.053/EUR.What is the dollar value of the position (round to two decimals)?
A)EUR 200,000 * 1.053 = $210,600.00
B)EUR 200,000 * 1.053 = EUR 210 600.00
C)EUR 200,000 / 1.053 = $189,933.52
D)EUR 200,000 / 1.053 = EUR 189,933.52
Q4) 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
Q5) 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) The term 'asset-backed loan' refers to a loan that is backed by a:
A)first claim on certain assets of the borrower if default occurs
B)second claim on certain assets of the borrower at maturity
C)first claim on certain assets of the borrower at maturity
D)None of the listed options are correct.
Q2) Non-performing loans are loans with yield less than 5%.
A)True
B)False
Q3) What are the major ideas behind KMV's Credit Monitor model?
Q4) Which of the following statements is true?
A)Marginal mortality rate is the historic default rate experience of a bond or loan.
B)The mortality rate is the probability of a bond or loan defaulting over a specified multi-year period.
C)Marginal mortality rate is the probability of a bond or loan defaulting in any given year of issue.
D)Marginal mortality rate is the probability of a bond or loan defaulting over a specified multi-year period.
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
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Q1) Which of the following statements is true?
A)One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that the upside returns are equal to the downside risks.
B)One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have unlimited upside returns and long-tail downside risks.
C)One advantage of using MPT for loans is that the returns on individual loans are normally distributed, meaning that most loans have unlimited upside returns and unlimited downside risks.
D)One objection to using MPT for loans is that the returns on individual loans are not normally distributed, meaning that most loans have limited upside returns and long-tail downside risks.
Q2) Using the Moody's Analytics model, the risk on a loan can be calculated as the volatility of the loan's default rate times the loss in the event of default.
A)True
B)False
Q3) Explain the basic concept of loan loss ratio based models.
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Page 13
Chapter 12: Sovereign Risk
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Q1) Changing the contractual terms of a loan, such as its maturity and interest payments is referred to as:
A)debt repudiation
B)debt rescheduling
C)refinancing
D)reinvesting
Q2) Which of the following describes debt moratoria?
A)Delay in repaying interest and/or principal on debt because of government prohibition of such action.
B)Special reserves created on the balance sheet against which to write off bad loans.
C)The official terminology for a sovereign loan rescheduling.
D)Debt issued by an LDC that is swapped for an outstanding loan to that LDC.
Q3) Which of the following is a list of countries that have followed the course of debt repudiation since World War II?
A)China, Cuba, North Korea
B)Japan, South Korea, Afghanistan
C)Malaysia, Mexico, Chile
D)Germany, Argentina, Poland
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Which of the following is the largest market for FX?
A)Tokyo
B)London
C)New York
D)Berlin
Q2) The role of the forward FX contract is to offset the uncertainty regarding the future spot rate on a particular currency at the end of the investment horizon.
A)True
B)False
Q3) Most profits or losses on foreign trading for FIs come from:
A)open positions or speculation
B)market making
C)acting as agents for retail customers
D)hedging activities
Q4) Direct quote shows the amount of foreign currency received for each unit of home currency exchanged.
A)True
B)False
Q5) Discuss four trading activities that reflect FI's position in the FX markets.
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Chapter 14: Liquidity Risk
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Sample Questions
Q1) Which type of financial intermediary is more highly exposed to liquidity risk?
A)property-casualty insurance companies
B)life insurance companies
C)mutual funds
D)depository institutions
Q2) Net deposit drains refer to the amount by which cash withdrawals:
A)are less than additions-this is a cash outflow
B)are less than additions-this is a cash inflow
C)exceed additions-this is a cash outflow
D)exceed additions-this is a cash inflow
Q3) Assume the value of an FI's average loans is $300 and the value of its average deposits is $400.The FI has liquid assets of $100.What is the FI's financing requirement?
A)$400 - $300 - $100 = $0
B)$300 - $400 - $100 = -$200
C)$400 - $300 + $100 = $200
D)$300 - $400 + $100 = $0
Q4) Distinguish between liquidity risk arising from the asset side and the liability side of the balance sheet.
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Page 16
Chapter 15: Liability and Liquidity Management
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Q1) All of the following are associated with contagious runs except:
A)liability holders not distinguishing between good and bad FIs
B)liability holders seeking to quickly turn their liabilities into cash or safe securities
C)a contractionary effect on the supply of credit and negative social welfare effects
D)an expansionary effect on the money supply
Q2) What is the average implicit interest rate on a $100 000 account if the bank's average management costs are $2500 and annual fees average $1750?
A)2.50%
B)1.75%
C)0.75%
D)-0.75%
Q3) Which of the following are determinants of an FI's optimal liquidity?
A)the variability of deposit inflows and outflows
B)the yield on liquid assets
C)the acquisition costs of highly non-liquid assets
D)All of the listed options are correct.
Q4) What are the withdrawal risks and costs associated with the covered bonds?
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17
Chapter 16: Off-Balance-Sheet Activities
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Q1) The vega of an option measures:
A)interest rate risk
B)volatility risk
C)off-balance-sheet risk
D)price elasticity
Q2) Which of the following statements is true?
A)The vega of an option is a measure of volatility risk.
B)The omega of an option is a measure of volatility risk.
C)The delta of an option is a measure of volatility risk.
D)The alpha of an option is a measure of volatility risk.
Q3) Which of the following are typical off-balance-sheet activities undertaken by Australian banks?
A)futures contracts and forward contracts
B)direct credit substitutes
C)commitments
D)All of the listed options are correct.
Q4) Basis risk refers to the variable spread between a lending rate and a borrowing rate, or between any two interest rates or prices.
A)True
B)False
18
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Chapter 17: Technology and Other Operational Risks
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Q1) Technological efficiency focuses exclusively on the cost side of financial intermediation.
A)True
B)False
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%, Bank B has assets of $20 million and average costs of 13% while Bank C has assets of $30 million with average costs of 12%.Average costs are measured as a proportion of total assets.The above figures indicate that:
A)there are significant economies of scale still present in the local markets
B)there are significant diseconomies of scale still present in the local markets
C)there are significant economies of scope still present in the local markets
D)there are significant diseconomies of scope still present in the local markets
Q3) Regulators have proposed that operational risk should be measured for the purpose of meeting overall capital adequacy.
A)True
B)False
Q4) Distinguish between diseconomies of scale and diseconomies of scope.How could they occur?
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Chapter 18: Capital Management and Adequacy
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Q1) Book value is:
A)the asset and liability values of an FI reported according to their historical costs
B)the amount of capital that the DI's shareholders are prepared to contribute so that the business remains as a going concern
C)a measure of an FI's capital that is equal to the difference between the market value of its assets and the market value of its liabilities
D)allows balance sheet values to reflect current rather than historical prices
Q2) Which of the following statements is true for Basel II agreement?
A)The Basel capital framework consists of three mutually reinforcing pillars.
B)Pillar I deals with the calculation of regulatory capital against FIs' credit risk only.
C)Pillar II deals with market discipline.
D)Pillar III deals with the supervisory review process.
Q3) Credit derivatives were included in the banking book with the introduction of:
A)Basel I
B)Basel II
C)Basel 2.5
D)Basel III
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Page 20