Financial System and Regulation
Final Exam
Course Introduction
This course explores the structure and functioning of financial systems, including the roles of financial institutions, markets, and instruments in facilitating economic activity. It examines the regulatory frameworks designed to ensure stability, transparency, and integrity within the financial sector, focusing on both domestic and international contexts. Key topics include banking supervision, securities regulation, systemic risk management, anti-money laundering measures, and the impact of recent financial crises. Through case studies and practical examples, students will develop an understanding of how regulation shapes financial system behavior and addresses emerging challenges in a dynamic global environment.
Recommended Textbook
Financial Institutions Management 5th Canadian Edition by Anthony Saunders
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) 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
Q2) The efficiency with which FIs provide payment services directly benefits the economy.
A)True
B)False
Answer: True
Q3) The purpose of guarantee funds in safety and soundness regulation is to protect claim-holders when an FI collapses or fails.
A)True
B)False
Answer: True
Q4) As a delegated monitor, an FI's actions reduce agency costs.
A)True
B)False
Answer: True
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Chapter 2: Deposit-Taking Institutions
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Sample Questions
Q1) Which of the following is the most important source of funds for credit unions?
A)Borrowings from the Bank of Canada.
B)Savings deposits from small consumers.
C)Repurchase agreements.
D)Interbank borrowing.
E)Wholesale deposits.
Answer: B
Q2) Compared to the average large Canadian bank, credit unions tend to have higher overhead expenses per dollar of assets.
A)True
B)False
Answer: True
Q3) Money market mutual funds have attracted large amounts of retail savings and retail time deposits from commercial banks in recent years.
A)True
B)False
Answer: True
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Chapter 3: Finance Companies
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Sample Questions
Q1) Finance companies charge different rates than do commercial banks which
A)tend to be higher than bank rates.
B)often reflect a more risky borrower.
C)causes some finance companies to be classified as subprime lenders.
D)must meet usury law guidelines.
E)All of these.
Answer: E
Q2) Finance companies have had no significant downturns in economic performance over the last two decades.
A)True
B)False
Answer: False
Q3) As of 2012, real estate loans dominated the assets of finance companies.
A)True
B)False
Answer: False
Q4) Personal credit institutions specialize in making equipment leases to consumers.
A)True
B)False
Answer: False
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Chapter 4: Securities, Brokerage, and Investment Banking
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Sample Questions
Q1) Pure arbitrage trading involves
A)buying blocks of securities in anticipation of some information release.
B)purchase of stock in a company being acquired and the sale of stock in the acquiring company.
C)exploitation of a difference between a company's current value and its estimated liquidation value.
D)buying an asset in one market at one price and selling it immediately in another market at a higher price.
E)simultaneous purchase and sale of similar shares in a single market.
Q2) Most securities firms are subject to large amounts of interest rate and market risk because of the large amount financial assets on the balance sheet.
A)True
B)False
Q3) 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
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6
Chapter 5: Mutual Funds, Hedge Funds, and Pension Funds
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Sample Questions
Q1) As of 2013, banks are not allowed to own or invest in mutual funds.
A)True
B)False
Q2) The type of abusive activity that involves cases where investors were able to buy or sell mutual fund shares long after the price had been set each day is
A)market timing.
B)late trading.
C)directed brokerage.
D)improper fee assessment.
E)None of these.
Q3) Mutual funds that are load funds use sales agents, and thus always have an up-front commission charge.
A)True
B)False
Q4) Equity mutual funds may contain common stock, but not preferred stock.
A)True
B)False
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Chapter 6: Insurance Companies
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Sample Questions
Q1) Annuities are the reverse of life insurance in that they are different means of liquidating a fund.
A)True
B)False
Q2) Annuities offered by life insurance companies are a financial contract that
A)is used to build up a fund.
B)pays only fixed returns to groups of employees.
C)is used to liquidate a fund.
D)pays only variable returns to individuals.
E)None of these.
Q3) What is essentially understood to be insurance for property & casualty insurance companies?
A)Policy reserves.
B)Conditional reserve funds.
C)Reinsurance.
D)Unearned premiums.
E)Surplus notes.
Q4) The policyholder can vary the premium payments on an endowment life policy. A)True
B)False
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Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) 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.
Q2) Technology risk is the uncertainty that economies of scale or scope will be realized from the investment in new technologies.
A)True
B)False
Q3) Because the economies of Canada and other countries have become more integrated, the risks of financial intermediation have decreased.
A)True
B)False
Q4) Returns from domestic and foreign investments may not be perfectly correlated because of different economic infrastructures and growth rates.
A)True
B)False
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) Can an FI immunize itself against interest rate risk exposure even though its maturity gap is not zero?
A)Yes, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities.
B)No, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities.
C)Yes, because the maturity model does not consider the timing of cash flows.
D)No, because the timing of cash flows is relevant to immunization against interest rate risk exposure.
E)No, because a representative bank will always have a positive maturity gap.
Q2) One reason to include demand deposits when estimating a bank's repricing gap is because rising interest rates could lead to high withdrawals.
A)True
B)False
Q3) A bank with a negative repricing (or funding) gap faces reinvestment risk.
A)True
B)False
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Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) The fact that the capital gain effect for rate decreases is greater than the capital loss effect for rate increases is caused by convexity in the yield-price relationship.
A)True
B)False
Q2) Managers can achieve the results of duration matching by using these to hedge interest rate risk.
A)Rate sensitive assets.
B)Rate sensitive liabilities.
C)Coupon bonds.
D)Consol bonds.
E)Derivatives.
Q3) As interest rates rise, the duration of a consol bond decreases.
A)True
B)False
Q4) For a given maturity fixed-income asset, duration decreases as the market yield increases.
A)True
B)False
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Chapter 10: Credit Risk: Individual Loans
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Sample Questions
Q1) The cumulative default probability of a borrower in a given time period is one minus the product of the marginal default probabilities for all time periods up to that time period.
A)True
B)False
Q2) The condition of no arbitrage profits implies that profits cannot be made without taking some risk.
A)True
B)False
Q3) How can discriminant analysis be used to make credit decisions?
A)By discriminating between good and bad borrowers.
B)By using statistical analysis to predict the default probabilities.
C)By using statistical analysis to isolate and weight factors to arrive at default risk classification of a commercial borrower.
D)By using statistical analysis to bypass qualitative credit decision making.
E)By updating FI bankruptcy experiences.
Q4) RAROC is a measure of a firm's cost of debt.
A)True
B)False
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Q1) In the Moody's Analytics portfolio model, the risk of a loan measures
A)the product of the estimated loss given default and risk-free rate on a security of equivalent maturity.
B)annual all-in-spread minus the loss given default.
C)annual all-in-spread minus the expected default frequency.
D)the product of the expected default frequency and the estimated loss given default.
E)the volatility of the loan's default rate around its expected value times the amount lost given default.
Q2) Included in the Moody's Analytics model are recovery rates on defaulted loans. A)True
B)False
Q3) The variance of returns of a portfolio of loans normally is equal to the arithmetic average of the variance of returns of the individual loans.
A)True
B)False
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Chapter 12: Liquidity Risk
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Sample Questions
Q1) Deposit-taking institutions generally rely on each other for cash and to meet their daily liquidity needs.
A)True
B)False
Q2) It is impossible for money market mutual fund share prices to fall below $1.00.
A)True
B)False
Q3) In the event of financial distress, open-ended mutual fund investors
A)have an incentive to cash in their shares quickly since they are paid on a first come, first served basis.
B)have an incentive to avoid a run since that will deplete the fund net asset value.
C)have an incentive to cash in their shares quickly since that will increase the fund's net asset value.
D)will switch into low risk bank deposits.
E)have an incentive to avoid a run since the Federal Reserve guarantees mutual fund holdings.
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Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) Which of the following FX trading activities is used to hedge FX risk?
A)The purchase and sale of foreign currencies for the purpose of profiting from forecasting or anticipating future movements in FX rates.
B)The purchase and sale of foreign currencies to allow customers to partake in and complete international commercial trade transactions.
C)The purchase and sale of foreign currencies for the purpose of offsetting customer exposure in any given currency.
D)The purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments.
E)None of these.
Q2) The greater the volatility of foreign exchange rates given any net exposure position, the greater the fluctuations in value of the foreign exchange portfolio.
A)True
B)False
Q3) Average daily turnover in the FX market has recently been over $4 trillion.
A)True
B)False
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Chapter 14: Sovereign Risk
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Sample Questions
Q1) A possible reason for the high systematic risk of VAREX in LCDs and EMs is
A)the tendency of world commodity prices to reflect non-similar economic conditions.
B)the sensitivity of this ratio to rising nominal and real interest rates in the developed, or lending, countries.
C)the tendency of prices and world demands for commodities to reflect simultaneously economic conditions.
D)the discretionary nature of money supply growth for LDC governments.
E)different demands for imports, and wide differences in the scale of vital imports across LDCs.
Q2) Traditional country risk analysis (CRA) that is based on discriminant statistical models often suffers from problems of using data that is not current.
A)True
B)False
Q3) Both the debt service ratio and the import ratio typically have low systematic risk elements in a CRA analysis.
A)True
B)False
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Chapter 15: Market Risk
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Sample Questions
Q1) In the Risk Metrics model, value at risk (VAR) is calculated as
A)the price sensitivity times an adverse daily yield move.
B)the dollar value of a position times the price volatility.
C)the dollar value of a position times the potential adverse yield move.
D)the price volatility times the ÖN.
E)VaR times the ÖN.
Q2) 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.
Q3) As securitization of assets continues to expand, the management of market risk will become more important to FIs.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) An up-front fee on a loan commitment rewards the FI for its willingness to stand ready to lend the commitment amount during some agreed upon time period.
A)True
B)False
Q2) Which of the following situations is similar to the externality effect?
A)Exercising an adverse material change in conditions clause as a last resort, thereby canceling or repricing a loan commitment.
B)Increase in the cost of funds above normal levels while many FIs scramble for funds to meet their commitments to customers during a credit crunch.
C)In a loan commitment, the borrower takes down only part of the funds over the specified time-period.
D)The buyer of a commercial letter of credit fails to perform as promised under a contractual obligation.
E)All of these.
Q3) Off-balance-sheet activities are an important source of fee income for many FIs.
A)True
B)False
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18
Chapter 17: Technology and Other Operational Risks
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Sample Questions
Q1) According to studies, which of the following may better explain cost differences and operating cost efficiencies among FIs?
A)Diseconomies of scale.
B)Economies of scale.
C)Economies of scope.
D)X-inefficiencies.
E)Diseconomies of scope.
Q2) What is float?
A)Overnight payments via the LVTS.
B)Encoding, endorsing, microfilming, and handling customers' checks.
C)Time it takes a check to clear at a bank.
D)Management of multiple currency and security portfolios for trading and investment purposes.
E)Interval between the dispatch of a bill and actual payment by the consumer.
Q3) Moving funds from accounts in several FIs into a few centralized accounts at one FI.
Q4) Coordinating the need for funds early in the day with a wire transfer to allow disbursement of the funds later in the day.
Q5) Encoding, endorsing, microfilming, and handling customers' checks.
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Chapter 18: Liability and Liquidity Management
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Q1) Demand deposits are a costless source of funds and have a high degree of withdrawal risk.
A)True
B)False
Q2) Which of the following is an outcome of a decrease in the reserve requirement ratio?
A)DTIs must hold more reserves against the transaction accounts on their balance sheets.
B)DTIs are able to lend a smaller percentage of their deposits.
C)Decreased credit availability in the economy.
D)A multiple contraction in deposits and a decrease in the money supply.
E)A multiplier effect on the supply of DTI deposits and thus, the money supply.
Q3) Recently banks have changed the liability structure towards instruments that have less withdrawal risk and higher explicit interest costs.
A)True
B)False
Q4) Excessive amounts of liquid asset holdings can penalize the earnings of a DTI.
A)True
B)False
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20
Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) The insured depositor transfer method of failure resolution
A)results in the closure of the failed bank.
B)results in the merger of the failed bank into a stronger entity.
C)keeps the failed bank operating for a short period of time.
D)minimizes the deposit insurers' out of pocket costs of resolving a failed DTI.
E)forces insured depositors to bear some losses.
Q2) The system of flat deposit insurance premiums:
A)enhances bank safety and soundness because it discourages bank risk taking.
B)reduces bank safety and soundness because it encourages bank risk taking.
C)has no impact on bank safety and soundness.
D)places banks that are considered "too big to fail" at a disadvantage.
E)provides unfair advantage to small banks.
Q3) Borrowing from the Bank of Canada as lender of last resort is a suitable substitute for deposit insurance and a possible method of preventing bank runs.
A)True
B)False
Q4) The risk of moral hazard increases when capital levels are low.
A)True
B)False
Page 21
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Chapter 20: Capital Adequacy
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Q1) Basel II attempts to encourage market discipline by having banks disclose capital structure, risk exposures, and capital adequacy in a systematic manner.
A)True
B)False
Q2) The determination of risk-adjusted on-balance-sheet assets under Basel III requires the segregation of assets into nine categories of credit risk exposure.
A)True B)False
Q3) Under historical accounting methods for the market value of capital, FIs
A)must write down the value of their assets to fully reflect market values.
B)have a great deal of discretion in timing the write downs of problem loans.
C)must conform to regulatory write-down schedules.
D)have an incentive to fully reflect problems in the asset portfolio as they become known.
E)invest in expensive computerized bookkeeping systems.
Q4) Banks likely would need additional capital to meet the new minimum standards.
Q5) Interest rate and liquidity risks are not yet included in the proposed Basel III plan.
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Page 22
Chapter 21: Product and Geographic Expansion
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Sample Questions
Q1) A fully integrated universal bank allows a bank to engage in securities activities only through a separately owned securities affiliate.
A)True
B)False
Q2) Firewalls are
A)barriers introduced to protect the bank against losses.
B)mechanisms to insure bank shareholders against loss.
C)regulations restricting the proliferation of Section 20 subsidiaries.
D)limitations on capital flows to the parent company.
E)safety codes required in tall skyscrapers.
Q3) Banks increasingly have been susceptible to nonbank competition on both sides of the balance sheet.
A)True
B)False
Q4) Expansion on a de novo basis implies the establishment and construction of a new office in a location where previously no office existed.
A)True
B)False
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Chapter 22: Futures and Forwards
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Sample Questions
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/£. Assume that the hedge was placed as indicated in a prior question, and that the BP futures contract is trading at $1.62/£. Assume the futures contract has some days remaining to maturity. What will be the gain or loss on the hedge if it is unwound at this price?
A)$4,280,000 loss.
B)$4,000,000 loss.
C)$4,280,000 gain.
D)$4,000,000 gain.
E)$6,400,000 gain.
Q2) When will the estimated hedge ratio be greater than one?
A)When spot rate changes are greater than futures rate changes.
B)When spot rate changes are less sensitive than futures price changes over time.
C)When spot rate changes are equally sensitive as futures price changes over time.
D)When basis risk is absent.
E)When the spot and future exchange rates are expected to move perfectly together.
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Chapter 23: Options, Caps, Floors, and Collars
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Q1) A naked option is an option written that has no identifiable underlying asset or liability position.
A)True B)False
Q2) Buying a call option on a bond ensures a bank that it will be able to sell the bond at a given point in time for a price at least equal to the exercise price of the option.
A)True B)False
Q3) Giving the purchaser the right to buy the underlying security at a prespecified price is a
A)put option.
B)call option.
C)naked option.
D)futures option.
E)credit spread call option.
Q4) The 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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Q1) The U.S. Wall Street Reform and Consumer Protection Act of 2010 established comprehensive regulation of over-the-counter (OTC) derivatives including swaps.
A)True
B)False
Q2) It is common to include
A)both the interest and principal payments in an interest rate swap.
B)only the interest payments in a currency swap.
C)both the interest and principal payments in a currency swap.
D)only the principal payments in an interest rate swap.
E)only the principal payments in a currency swap.
Q3) A contract that is a fixed-floating interest rate swap with a third party acting as an intermediary is known as
A)a pure credit swap.
B)a total return swap.
C)an off-market swap.
D)a plain vanilla swap.
E)an currency rate swap.
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Chapter 25: Loan Sales
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Q1) Loan assignments make up more than 90 percent of the Canadian and U.S. loan sale market because
A)they have lower capital requirements than other types of loan sales.
B)they are riskier than are other types of loan sales.
C)monitoring costs are reduced since all rights are transferred upon sale.
D)regulators prefer these transactions to loan participations.
E)there is no secondary market in loan participations.
Q2) Mutual funds are prohibited from purchasing/participating in the FI loan sales market by OSFI.
A)True
B)False
Q3) A type of company that specializes in distressed loans is
A)a bank loan mutual fund.
B)a domestic bank.
C)a foreign bank.
D)an investment bank.
E)a vulture fund.
Q4) The primary sellers of domestic loans are medium-sized credit unions.
A)True
B)False
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Chapter 26: Securitization Index
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Q1) Mortgage pools that are assumed to prepay at a rate of speed that is more rapid than the PSA model would indicate, are said to prepay at less than 100 percent PSA behavior because the mortgage life and balance will exist for a longer time.
A)True
B)False
Q2) A principal only (PO) mortgage-backed strip is attractive to investors who wish to speculate about decreasing interest rates.
A)True
B)False
Q3) A mortgage pass-through strip security is a special type of collateralized mortgage obligation (CMO).
A)True
B)False
Q4) On September 7, 2008, FNMA and FHLMC were placed under conservatorship and both are controlled by a U.S. federal government agency.
A)True
B)False
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