Financial Risk Management
Pre-Test Questions
Course Introduction
Financial Risk Management explores the identification, analysis, and mitigation of financial risks faced by organizations and individuals. This course covers key concepts including market risk, credit risk, liquidity risk, and operational risk, and introduces tools and techniques such as value-at-risk (VaR), stress testing, and derivatives for hedging risk exposures. Students gain an understanding of regulatory frameworks, risk measurement, and the implementation of effective risk management strategies. Through case studies and real-world applications, the course prepares students to assess risk scenarios and make informed decisions in dynamic financial environments.
Recommended Textbook
Financial Institutions Management A Risk Management Approach 9th Edition by Anthony Saunders
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Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Which function of an FI reduces transaction and information costs between a corporation and individual which may encourage a higher rate of savings?
A) Brokerage services.
B) Asset transformation services.
C) Information production services.
D) Money supply management.
E) Administration of the payments mechanism.
Answer: A
Q2) The charter values of FIs will be higher if regulators
A) increase the cost of entry by requiring more capital.
B) restrict the number of activities permitted by FIs, thereby increasing potential profits.
C) restrict the number of FIs that can operate in a given market.
D) increase the cost of entry by requiring more capital and restrict the number of activities permitted by FIs, thereby increasing potential profits.
E) increase the cost of entry by requiring more capital and restrict the number of FIs that can operate in a given market.
Answer: E
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3
Chapter 2: Financial Services: Depository Institutions
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Sample Questions
Q1) Financial institutions are subject to economies of scale in the collection of information.
A)True
B)False
Answer: True
Q2) Which of the following FIs does not provide a business lending function?
A)Depository institutions.
B)Insurance companies.
C)Finance companies.
D)Pension funds.
E)Mutual funds.
Answer: E
Q3) An FI is exposed to liquidity risk because the average maturity of assets and the average maturity of liabilities are often different on the FIs balance sheet.
A)True
B)False
Answer: False
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Page 4
Chapter 3: Financial Services: Finance Companies
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Sample Questions
Q1) Finance companies have enjoyed very high rates of growth because they
A)are willing to lend to riskier customers than commercial banks.
B)charge higher rates on lower risk loans.
C)do not have ties or affiliations with manufacturing firms.
D)face very high levels of regulation,which assures their success.
Answer: A
Q2) A company that specializes in making loans to the customers of a particular retailer or manufacturer would best be categorized as a A)sales finance institution.
B)personal credit institution.
C)business credit institution.
D)lease finance company.
Answer: A
Q3) Business loans represent 50% of the loan portfolio of finance companies.
A)True
B)False
Answer: False
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Page 5
Chapter 4: Financial Services: Securities Firms and Investment Banks
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Sample Questions
Q1) How much money does Rochester Industries receive?
A)$15,000,000.
B)$84,000,000.
C)$76,200,000.
D)$82,200,000.
Q2) Discount brokers
A)are securities firms focused on providing research support for customers.
B)conduct trades for customers but do not offer investment advice.
C)allow customers to receive investment advice at very low rates.
D)complete trades for customers on- or offline while offering investment advice.
Q3) Initial public offerings (IPOs)are first-time issues of firms whose equity has not previously traded in an organized market.
A)True
B)False
Q4) Investment banks specialize in the origination,underwriting,and distribution of new securities issued by corporations or governments.
A)True
B)False
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Chapter 5: Financial Services: Mutual Fund and Hedge Fund Companies
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Sample Questions
Q1) In 2015 there were approximately _______ exchange traded funds (ETFs)in existence with combined assets valued at _______.
A)510;$1.20 trillion
B)1,550;2.0 trillion
C)860;$294 billion
D)1,220;$960 billion
Q2) Regarding the relative asset size and asset growth rate of mutual fund sectors between 1980 and 2015,
A)long-term funds had more assets at the end of 2015,but short-term funds had grown at a faster rate since 1980.
B)long-term funds had more assets at the end of 2015,and long-term funds had grown at a faster rate since 1980.
C)short-term funds had more assets at the end of 2015,but long-term funds had grown at a faster rate since 1980.
D)short-term funds had more assets at the end of 2015,and short-term funds had grown at a faster rate since 1980.
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Chapter 6: Financial Services: Insurance Companies
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Sample Questions
Q1) Calculate the annual cash flows of a $2 million,10-year fixed-payment deferred annuity earning a guaranteed 8 percent per year if annual payments are to begin at the end of the sixth (6<sup>th</sup>)year.
A)$218,973.21.
B)$202,752.97.
C)$343,321.86.
D)$405,505.95.
E)$437,946.42.
Q2) Insurance companies have resisted the investment in technology that banks and other financial service firms have pursued.
A)True
B)False
Q3) The largest liability category on the balance sheet of U.S.life insurance companies as of 2015 was
A)net policy reserves.
B)policy claims.
C)premium and deposit funds.
D)commission,taxes and expenses.
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8
Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) FIs that actively trade assets and liabilities are exposed to market risk.
A)True
B)False
Q2) Systematic credit risk can be reduced significantly by diversification.
A)True
B)False
Q3) The asset transformation function potentially exposes the FI to
A)foreign exchange risk.
B)technology risk.
C)operational risk.
D)trading risk.
E)interest rate risk.
Q4) Credit risk stems from non-repayment or delays in repayment of either principal or interest on FI assets.
A)True
B)False
Q5) Effective use of diversification principles allows an FI to reduce the total default risk in a portfolio.
A)True
B)False
Page 9
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) What is the weighted average maturity of assets?
A)5.50 years.
B)6.40 years.
C)5.00 years.
D)4.60 years.
Q2) An FI finances a $250,000 2-year fixed-rate loan with a $200,000 1-year fixed-rate
CD.Use the repricing model to determine (a)the FI's repricing (or funding)gap using a 1-year maturity bucket,and (b)the impact of a 100 basis point (0.01)decrease in interest rates on the FI's annual net interest income?
A)$0;$0.
B)-$200,000;+$2,000.
C)-$200,000;-$2,000.
D)+$50,000;-$500.
Q3) A bank with a negative repricing (or funding)gap faces refinancing risk.
A)True
B)False
Q4) When the Fed finds it necessary to slow economic activity,it allows interest rates to fall.
A)True
B)False
Page 10
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Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) What is the price of the bond if market interest rates are 4 percent?
A)$105,816.44.
B)$105,287.67.
C)$105,242.14.
D)$100,000.00.
Q2) What is the duration of the liabilities?
A)0.708 years.
B)0.354 years.
C)0.350 years.
D)0.955 years.
Q3) What conclusions can you draw from the duration gap in your answer to the previous question?
A)The market value of the dealer's equity decreases slightly if interest rates fall.
B)The market value of the dealer's equity becomes negative if interest rates rise.
C)The market value of the dealer's equity decreases slightly if interest rates rise.
D)The market value of the dealer's equity becomes negative if interest rates fall.
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Chapter 10: Credit Risk: Individual Loan Risk
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Sample Questions
Q1) A borrower's reputation is an example of a market-specific factor in the credit decision.
A)True
B)False
Q2) Which of the following statements does not reflect a borrower-specific factor often used in qualitative default risk models?
A)Reputation is an implicit contract regarding borrowing and repayment that extends beyond the formal explicit legal contract.
B)A borrower's leverage ratio is positively related to the probability of default over all levels of debt.
C)Firms with high earnings variance are less attractive credit risks than those firms that have a history of stable earnings.
D)Loans can be collateralized or uncollateralized.
Q3) Equity holders of a levered corporation have no incentive to invest the borrowed funds in risky capital investments.
A)True
B)False
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Q1) Which of the following observations concerning concentration limits is not true?
A)Limits are set by assessing the borrower's current portfolio,its operating unit's business plans,its economists' economic projections,and its strategic plans.
B)FIs set concentration limits to reduce exposures to certain industries and increase exposures to others.
C)When two industry groups' performances are highly correlated,an FI may set an aggregate limit of less than the sum of the two individual industry limits.
D)FIs may set aggregate portfolio limits or combinations of industry and geographic limits.
E)Bank regulators in recent years have limited loan concentrations to individual borrowers to a maximum of 30 percent of a bank's capital.
Q2) In applying the loan loss ratio models,the loss rate "\(\beta\)" for the whole loan portfolio is
A)0.
B)0.5.
C)1.
D)2.
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) Hedge funds are not susceptible to liquidity risk or a liquidity crisis.
A)True
B)False
Q2) Why have purchased liquidity management techniques become very popular in spite of its limitations?
A)Because it insulates the assets of an FI from normal drains on liability liquidity.
B)Because funds can be easily raised in the eventuality of a liquidity crunch.
C)Because of decrease in the cost of funds during periods of high interest rate volatility.
D)Because the funds are covered by deposit insurance.
Q3) The price at which an open-end investment fund stands ready to redeem existing shares is the
A)strike price.
B)face value.
C)book value.
D)net asset value.
Q4) Most demand deposits stay at DIs for periods of two years or more.
A)True
B)False
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Page 14
Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Your U.S.bank issues a one-year U.S.CD at 5 percent annual interest to finance a C $1.274 million (Canadian dollar)investment in two-year,fixed rate Canadian bonds selling at par and paying 7 percent annually.You expect to liquidate your position in one year.Currently,spot exchange rates are U.S.$0.78493 per Canadian dollar.
What is the end-of-year profit or loss to the bank if in one year Canadian bond rates increase to 7.538 percent? (Assume no change in either current U.S.interest rates or current exchange rates,U.S.$0.78493/C $1. )
A)Loss of U.S.$5,000.
B)Profit of U.S.$15,000.
C)Loss of C $119,000.
D)Profit of C $50,000.
Q2) FX trading income is derived only from profit (or loss)on the FI's speculative currency positions.
A)True
B)False
Q3) The foreign exchange market in Tokyo is the largest FX trading market.
A)True
B)False
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Page 15
Chapter 14: Sovereign Risk
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Sample Questions
Q1) In exchange for the loss of some present value of the interest and principal on a loan after a rescheduling,the lender avoids the permanent loss that would result from a default.
A)True
B)False
Q2) The larger the import ratio of a country;the higher is the probability that the country will have to schedule its debt payments.
A)True
B)False
Q3) The statistical results of the country risk analysis models
A)may have limited usefulness if parameters are unstable.
B)are not subject to estimation error.
C)cannot be extrapolated to influence financial decision making.
D)are theoretical depictions of underlying relationships.
Q4) One advantage of swapping a sovereign loan for a bond is the capability to sell the bond in the secondary market.
A)True
B)False
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Chapter 15: Market Risk
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Sample Questions
Q1) The RiskMetrics model generally prefers using the present value of cash flow changes as the price-sensitivity weights.
A)True
B)False
Q2) A disadvantage of the historic or back simulation model for quantifying market risk includes
A)calculation of a standard deviation of returns is not required.
B)calculation of the correlation between asset returns is not required.
C)estimates of past returns used in the model may not be relevant to the current market returns.
D)it accounts for non-standard return distributions.
Q3) The portfolio of a bank that contains assets and liabilities that are relatively illiquid and held for longer holding periods
A)is the trading portfolio.
B)is the investment portfolio.
C)contains only long term derivatives.
D)is subject to regulatory risk.
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) Interest rate risk is part of the loan commitment contingent risk because of the uncertainty of changes in interest rates before the borrower exercises his option to borrow.
A)True
B)False
Q2) One way to completely protect the lender against interest rate risk on a loan commitment is for the lender to price the loan at a variable rate against some index.
A)True
B)False
Q3) The effect to an FI of default by the counterparty to a derivative contract is LEAST serious with A)options contracts.
B)futures contracts. C)swap agreements.
D)forward contracts.
Q4) If an FI enters into a loan commitment,it is essentially entering into a forward contract.
A)True B)False
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Chapter 17: Technology and Other Operational Risks
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Sample Questions
Q1) Daylight overdrafts occur when
A)FIs in different time zones clear transactions.
B)FI debits exceed credits during the day.
C)FI credits exceed debits during the day.
D)the sum of all debits transmitted over the system exceed the sum of all credits during the day.
Q2) Which of the following observations is NOT true?
A)The use of electronic methods of payment is far higher in major developed countries other than the United States.
B)E-money payments are virtually nonexistent in the United States.
C)Money stored in e-money accounts and cards is covered by deposit insurance.
D)U.S.FIs have been slow in adopting and using online banking and electronic payment methods extensively.
Q3) New retail products and services based heavily on technology often are risky because of the high usage rate necessary to make them positive net present value projects.
A)True
B)False
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19
Chapter 18: Liability and Liquidity Management
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Sample Questions
Q1) Michelle has maintained an average balance of $300 per month for the first three months of the year,$800 per month for the next three months,and $1,000 per month for the final six months of the year in a NOW account.It requires a minimum balance of $500 to be maintained if annual interest of 5 percent is to be earned.She writes an average of 25 checks per month but the account does not have a service charge for checks although it costs the bank 10 cents to process each check.
What is the average return (explicit and implicit)earned by her if the bank pays interest only on the amounts in excess of the required minimum of $500?
A)9.01%.
B)7.56%.
C)6.93%.
D)5.97%.
Q2) The Fed discount window is an appropriate place to borrow reserve shortfalls because of its lower than market rates.
A)True
B)False
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Page 20
Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Sample Questions
Q1) Insured depositors can be covered for much more than $250,000 at any given FI under current FDIC regulations.
A)True
B)False
Q2) How can the regulators reduce the effects of moral hazard in the absence of depositor discipline?
A)By allowing DIs to undertake high-risk high-return asset investments.
B)By basing deposit insurance premiums on a DI's deposit size.
C)By charging explicit deposit insurance premiums and implicit premiums on DIs.
D)By exhibiting excessive capital forbearance.
Q3) During the 1980s,a high proportion of brokered deposits at a DI became an early warning signal of its risk for failure.
A)True
B)False
Q4) FDICIA imposed additional regulatory discipline as a substitute for increased stockholder and depositor discipline.
A)True
B)False
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Chapter 20: Capital Adequacy
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Sample Questions
Q1) During the financial crisis of 2008-2009,the FASB provided guidance on asset valuation that allowed
A)DI management to use internal cash flow models and assumptions to estimate fair value when there is limited market data available.
B)regulatory capital of banks to deviate from industry norms.
C)excess reserves with the Fed to be included as regulatory capital.
D)DIs to choose either book value treatment or market value treatment of asset valuation.
Q2) The concept of prompt corrective action refers to the requirement
A)that bank managers must address problems in the loan portfolio when they are first identified.
B)that regulators must take specific actions when bank capital levels fall outside the well-capitalized category.
C)that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent.
D)that regulators must take specific actions when bank capital levels fall outside the well-capitalized category and that a receiver must be appointed when a bank's book value of capital to assets falls below 2 percent.
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Chapter 21: Product and Geographic Expansion
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Sample Questions
Q1) The economic value of narrowly defined bank franchises has declined because A)product line restrictions inhibit the ability of an FI to optimize the set of financial services it can offer.
B)product restrictions limit the ability of FI managers to adjust to shifts in the demand for financial products.
C)product restrictions limit the ability of FI managers to adjust to shifts in costs due to technology and related innovations.
D)All of the options.
Q2) In order to achieve a more stable revenue stream in a merger,the asset and liability portfolios of the two institutions should have similar credit,interest rate,and liquidity characteristics.
A)True
B)False
Q3) Offices of foreign banks may be examined by the Federal Reserve under the FBSEA of 1991.
A)True
B)False
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Page 23
Chapter 22: Futures and Forwards
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Sample Questions
Q1) A U.S.bank issues a 1-year,$1 million U.S.CD at 5 percent annual interest to finance a C $1.274 million investment in 2-year fixed-rate Canadian bonds selling at par and paying 7 percent annually.You expect to liquidate your position in 1 year upon maturity of the CD.Spot exchange rates are U.S.$0.78493 per Canadian dollar.
What is the end-of-year profit or loss on the bank's cash position if in one year the exchange rate falls to U.S.$0.765/C $1? Assume there is no change in interest rates.(Choose the closest answer)
A)Loss of U.S.$75,000.
B)Profit of C $274,000.
C)Loss of U.S.$7,000.
D)Profit of C $9,000.
Q2) A perfect hedge,or perfect immunization,seldom occurs.
A)True
B)False
Q3) A forward contract has only one payment cash flow that occurs at the time of delivery.
A)True
B)False
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Page 24
Chapter 23: Options, Caps, Floors, and Collars
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Q1) Giving the purchaser the right to sell the underlying security at a prespecified price is a
A)put option.
B)call option.
C)naked option.
D)futures option.
Q2) Identify a problem associated with using the Black-Scholes model to value bond options.
A)It assumes short-term interest rates are constant.
B)It assumes that commissions are charged.
C)It assumes fluctuating variance of returns on the underlying asset.
D)It assumes that the variance of bond prices is constant over time.
Q3) Selling an interest rate call option may hedge an FI when rates rise and bond prices fall.
A)True
B)False
Q4) The potential gain to a buyer of bond call options is unlimited,even if interest rates decrease to zero.
A)True
B)False
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Chapter 24: Swaps
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Sample Questions
Q1) In the derivatives markets,the instrument with the longest potential maturity is A)options.
B)futures.
C)forwards.
D)swaps.
Q2) A bank with a strong positive leverage adjusted duration gap can hedge their exposure to interest rate increases by entering into
A)a currency swap agreement to receive the fixed rate payment.
B)an interest rate swap agreement to make the fixed-rate payment side of the swap.
C)a credit swap agreement to receive the floating rate payment.
D)a commodity swap agreement to make the fixed-rate payment side of the swap.
Q3) Which of the following is true of the "netting" process in the swap market?
A)It decreases or mitigates the credit risk on swaps.
B)Both parties make payments to each other as a consequence.
C)It implies that the default exposure of the in-the-money party is the total fixed or floating payment.
D)It does not happen across contracts.
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Chapter 25: Loan Sales
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Q1) The definition of a highly leveraged transaction is any transaction that involves a buyout,acquisition or recapitalization.
A)True
B)False
Q2) Banks began selling short-term loans only since the passage of the Financial Services Modernization Act in 1999.
A)True
B)False
Q3) A loan made to finance a merger and acquisition that usually results in a high leverage ratio for the borrower is a
A)loan sold without recourse.
B)highly leveraged transaction loan.
C)loan sold with recourse.
D)loan assignment transaction.
Q4) Vulture funds are
A)management consulting firms that employ turn-around specialists.
B)portfolios consisting of stakes in distressed companies.
C)mutual funds that grow by acquiring their competitors.
D)mutual funds that invest only in highly-leveraged transactions.
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Chapter 26: Securitization
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Q1) FNMA securitizes conventional mortgage loans as well as FHA/VA insured loans.
A)True
B)False
Q2) Investors in GNMA pass-through securities are exposed to the risk that the originating bank may fail,and the risk that the trustee may mismanage monthly interest and principal payments collected.
A)True B)False
Q3) Overseas bank is pooling 50 similar and fully amortized mortgages into a pass-through security.The face value of each mortgage is $100,000 paying 180 monthly interest and principal payments at a fixed rate of 9 percent per annum.
What is the monthly payment received by investors of the mortgage pass-through if the FI deducts a 50 basis points servicing fee?
A)$49,237.
B)$50,713.
C)$50,459.
D)$51,200.
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