Introduction to Financial Institutions
Exam Review
Course Introduction
Introduction to Financial Institutions provides students with a foundational understanding of the various types of financial institutions and their roles within the economy. The course covers key topics such as the structure and functions of commercial banks, investment banks, insurance companies, mutual funds, and credit unions. Students will explore the regulatory environment governing these institutions, the products and services they offer, and their impact on financial markets and economic stability. Through case studies and real-world examples, the course highlights current trends, challenges, and technological innovations shaping the financial services industry.
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) Why do households prefer to use FIs as intermediaries to invest their surplus funds?
A)Transaction costs are low to the household since FIs are more efficient in monitoring and gathering investment information.
B)To receive the benefits of diversification that households may not be able to achieve on their own.
C)The FI has can benefit from combining funds and negotiating lower asset prices and transactions costs.
D)The FI can provide insurance at relatively low cost that will protect funds under management.
E)All of these.
Answer: E
Q2) Pension and mutual funds have a lower correlation between the maturities of their assets and liabilities than do commercial banks and credit unions.
A)True
B)False
Answer: False
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Chapter 2: Deposit-Taking Institutions
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Sample Questions
Q1) The credit union industry avoided much of the financial distress of the 1980s because of the short maturity and relatively lower credit risk of their assets.
A)True
B)False
Answer: True
Q2) Commercial banks that have invested in Internet and mobile banking services and products have significantly outperformed those banks that have chosen to avoid these markets.
A)True
B)False
Answer: False
Q3) The movement of an off-balance-sheet asset or liability to an on-balance-sheet item is dependent on the occurrence of a contingent event.
A)True
B)False
Answer: True
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Chapter 3: Finance Companies
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Sample Questions
Q1) Ally Financial [formerly General Motors Acceptance Corporation (GMAC)]
A)is a wholly owned subsidiary of General Motors.
B)only provides financing to purchasers of automobiles built by General Motors.
C)had its Canadian assets purchase by Royal Bank of Canada in 2013.
D)did not participate in U.S. federal bailout funds during the financial crisis because of their financial strength.
E)is the largest finance company in the U.S.
Answer: C
Q2) As the economic expansion continued in Canada and the U.S. through the 1990s, the demand for finance company loans increased.
A)True
B)False
Answer: True
Q3) Securitized mortgage assets are used as collateral backing secondary market securities.
A)True
B)False
Answer: True
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Chapter 4: Securities, Brokerage, and Investment Banking
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Sample Questions
Q1) Which of the following is most typical of broker-dealers?
A)They assist in underwriting of new securities.
B)They assist in trading of existing securities.
C)They assist in issuing new securities.
D)They assist in underwriting and distribution of new securities.
E)All of these.
Q2) The revision of the Bank Act and other regulatory changes have been the cause of the increase in interindustry mergers of investment banks and securities firms since 1987.
A)True
B)False
Q3) Offering bank deposit-like accounts to individual customers by a securities firm involves
A)the function of investing.
B)the function of cash management.
C)the function of market making.
D)the function of trading.
E)the function of investment banking.
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Chapter 5: Mutual Funds, Hedge Funds, and Pension Funds
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Sample Questions
Q1) Open-end mutual funds
A)require that NAV consider the amount of discount or premium in the share value.
B)calculate the NAV based on the total value of assets held divided by the number of fund shares outstanding.
C)may experience fluctuations in the number of shares outstanding on a daily basis.
D)All of these.
E)calculate the NAV based on the total value of assets held divided by the number of fund shares outstanding and may experience fluctuations in the number of shares outstanding on a daily basis
Q2) Since 2002, the amount of assets invested in load funds have exceeded those invested in no-load funds.
A)True
B)False
Q3) Historical evidence indicates that load funds perform better than no-load funds. A)True
B)False
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Chapter 6: Insurance Companies
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Sample Questions
Q1) Insurance policy benefits are classified on an insurance company's balance sheet as A)liabilities, because the insurance company may have to pay out the benefits.
B)assets, because policy benefits are valuable to the company.
C)liabilities, because customers may fall behind on their premium payments.
D)assets, because policy benefits are fully covered by premium payments.
E)liabilities, because insurance companies must maintain a capital base to cover the payments of benefits.
Q2) Property & casualty underwriting risk only exists when the premiums generated on a given insurance line are less than the claims (losses) on the line.
A)True B)False
Q3) Pension fund management is a relatively small portion of the life insurance industry.
A)True B)False
Q4) Assuris is administered by CDIC.
A)True
B)False
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8
Chapter 7: Risks of Financial Institutions
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Sample Questions
Q1) An FI that finances a euro ( ) loan with Canadian dollar ($) deposits is exposed to A)technology risk.
B)interest rate risk.
C)credit risk.
D)foreign exchange risk.
E)off-balance-sheet risk.
Q2) This risk of default is associated with general economy-wide or macro conditions affecting all borrowers.
A)Systematic credit risk.
B)Firm-specific credit risk.
C)Refinancing risk.
D)Liquidity risk.
E)Sovereign risk.
Q3) An FI is net long in foreign assets if it holds more foreign liabilities than foreign assets.
A)True
B)False
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Chapter 8: Interest Rate Risk I
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Sample Questions
Q1) Which of the following is a weakness of the repricing model to measure interest rate risk?
A)Potential for overaggregation of assets and liabilities within each maturity bucket.
B)It ignores how changes in interest rates affect the market value of assets and liabilities.
C)It ignores the reinvestment of loan interest and principal payments that are reinvested at current market rates.
D)It fails to recognize off-balance-sheet activities that may be rate sensitive.
E)All of these.
Q2) Which theory of term structure argues that individual investors have specific maturity preferences?
A)The unbiased expectations theory.
B)The liquidity premium theory.
C)The loanable funds theory.
D)The market segmentation theory.
E)None of these.
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10
Chapter 9: Interest Rate Risk II
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Sample Questions
Q1) Calculate the duration of a two-year corporate bond paying 6 percent interest annually, selling at par. Principal of $20,000,000 is due at the end of two years.
A)2 years.
B)1.91 years.
C)1.94 years.
D)1.49 years.
E)1.75 years.
Q2) The economic meaning of duration is the interest elasticity of a financial assets price.
A)True
B)False
Q3) Consider a five-year, 8 percent annual coupon bond selling at par of $1,000. What is the duration of this bond?
A)5 years.
B)4.31 years.
C)3.96 years.
D)5.07 years.
E)Not enough information to answer.
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11
Chapter 10: Credit Risk: Individual Loans
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Sample Questions
Q1) Revolving loans are credit lines
A)that allow the borrower to borrow the repeat credit only after the first loan is repaid.
B)that specify a maximum size and a maximum period of time over which the borrower can withdraw funds.
C)whose interest rate adjusts with movements in an underlying market index interest rate.
D)on which a borrower can both draw and repay many times over the life of the loan contract.
E)that include new and used automobile loans, mobile home loans, and fixed-term consumer loans.
Q2) Credit rationing by an FI
A)involves restricting the quantity of loans made available to individual borrowers.
B)results from a positive linear relationship between interest rates and expected loan returns.
C)is not used by FIs at the retail level.
D)involves rationing consumer loans using price or interest rate differences.
E)is only relevant to banks.
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Chapter 11: Credit Risk: Loan Portfolio and Concentration
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Sample Questions
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) Included in the Moody's Analytics model are recovery rates on defaulted loans.
A)True
B)False
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13
Chapter 12: Liquidity Risk
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Sample Questions
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) What is a fire-sale price?
A)Market value of an asset.
B)Price received for an asset that has to be liquidated immediately.
C)Maximum price that will be received on sale of an asset irrespective of the time of sale.
D)Replacement value of an asset.
E)Book value of an asset.
Q3) Which of the following statements is NOT true?
A)Stored liquidity management involves liquidation of assets.
B)Traditionally DTIs have stored cash reserves at the Federal Reserve and in their vaults to overcome liquidity risk.
C)When the DTI uses its cash as the liquidity adjustment mechanism, both sides of its balance sheet contract.
D)DTIs hold cash in excess of the minimum required to meet liquidity drains.
E)A DTI sustains no cost under stored liquidity risk management.
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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 US$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, US$0.78493/C$1.)
A)Loss of US$5,000.
B)Profit of US$15,000.
C)Loss of C$119,000.
D)Profit of C$50,000.
E)Loss of C$50,000.
Q2) FX trading risk exposure continues into the night until all FI operations are closed.
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) Sellers of LDC debt in secondary markets include small FIs wishing to disengage themselves from the LDC market.
A)True
B)False
Q2) FIs that lend to foreign entities often need to make provisions to their loan loss reserves.
A)True
B)False
Q3) Sovereign country risk is largely independent of the credit standing of the foreign borrower.
A)True
B)False
Q4) Which is NOT a key economic ratio in credit scoring models to estimate sovereign country risk exposure?
A)The debt service ratio.
B)The import ratio.
C)The variance of export revenue.
D)The discount on rescheduled debt.
E)Domestic money supply growth.
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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) The dollar value of a foreign exchange portfolio equals the FX position times the spot exchange rate.
A)True
B)False
Q3) In the BIS standardized framework model, the specific risk charge attempts to measure the decline in the liquidity or credit risk quality of the trading portfolio over the holding period.
A)True
B)False
Q4) In the BIS framework, vertical offsets are charges that reflect the modified duration and interest rate shocks for each maturity.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Risk
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Sample Questions
Q1) Which of the following refers to the fee charged on the unused balance of a loan commitment.
A)Up-front fee.
B)Facility fee.
C)Compensating balance.
D)Commitment fee.
E)Closing costs.
Q2) All call options are eventually exercised and the underlying asset must be delivered.
A)True
B)False
Q3) The aggregate commitment funding risk can increase the cost of funds above normal levels.
A)True
B)False
Q4) The use of an up-front fee by a bank eliminates the contingent risk on a loan commitment.
A)True
B)False
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Page 18
Chapter 17: Technology and Other Operational Risks
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Sample Questions
Q1) The initial steps of cross selling financial products can easily occur with computer technology.
A)True
B)False
Q2) Which of the following implies that small FIs are more cost efficient than large FIs, and that in a freely competitive environment for financial services, small FIs may outperform their larger counterparts?
A)Economies of scale.
B)Diseconomies of scale.
C)Economies of scope.
D)Diseconomies of scope.
E)Constant returns to scale.
Q3) Funds transferred on the LVTS are settled immediately.
A)True
B)False
Q4) Usury ceilings place caps on interest rates that FIs can charge on certain types of loans and are established by OSFI.
A)True
B)False
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Chapter 18: Liability and Liquidity Management
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Q1) One reason FIs such as deposit-taking institutions and life insurance companies are exposed to liquidity risk is the relatively illiquid nature of their liabilities.
A)True
B)False
Q2) Reliance on purchased or borrowed funds will largely eliminate the liquidity risk faced by a bank.
A)True
B)False
Q3) A liquid asset can be converted to cash quickly, but will require a discount from market value.
A)True
B)False
Q4) In most countries, assets used to satisfy the liquid assets ratio may include liquid government securities.
A)True B)False
Q5) Savings accounts are less liquid than demand deposit accounts.
A)True
B)False
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Chapter 19: Deposit Insurance and Other Liability
Guarantees
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Q1) The adverse effects of a contagious run include the restrictions on the ability of individuals to transfer wealth through time and a negative impact on the level or rate of savings.
A)True
B)False
Q2) The use of the option pricing model to determine the actuarially fair premium is difficult to apply in practice because the asset values and risks are difficult to determine.
A)True
B)False
Q3) Moral hazard provides an incentive for bank owners to accept greater asset risks because they have less to lose, and potentially more to gain.
A)True
B)False
Q4) If regulators provide more protection against bank runs, the incidence of moral hazard is likely to increase.
A)True
B)False
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Chapter 20: Capital Adequacy
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Q1) Which of the following statements best describes the treatment of adjusting for credit risk of off-balance-sheet activities?
A)All OBS activities are treated equally in making credit-risk adjustments.
B)Standby letter of credit guarantees issued by banks to back commercial paper have a 50 percent conversion factor.
C)The credit or default risk of over-the-counter contracts is approximately zero.
D)The current exposure component of the credit equivalent amount of OBS derivative contracts reflects the credit risk if the contract counterparty defaults.
E)The treatment of interest rate forward, option, and swap contracts differs from the treatment of contingent or guarantee contracts.
Q2) Basel III capital ratios will become fully effective for Canadian banks in 2016. A)True
B)False
Q3) Under Basel II (2006), operational risk can be measured by four different approaches.
A)True
B)False
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Chapter 21: Product and Geographic Expansion
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Sample Questions
Q1) An organization form that establishes bank subsidiaries rather than branches to expand is
A)an unit bank.
B)a multibank holding company.
C)a one-bank holding company.
D)a representative office.
E)a nonbank bank.
Q2) Banks typically have faced few restrictions in expanding their businesses, while securities firms and insurance companies have faced complex rules regarding expansion.
A)True
B)False
Q3) Research on bank mergers for the decade of the 1990s found that improved performance of the merged bank occurred because of both revenue enhancements and cost reduction.
A)True
B)False
Q4) The use of inside information about customers or rivals that can be useful in setting securities prices or distributing securities offerings.
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Chapter 22: Futures and Forwards
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Q1) The covariance of the change in spot exchange rates and the change in futures exchange rates is 0.6606, and the variance of the change in futures exchange rates is 0.6060. The variance of the change in spot exchange rates is 0.9090. What is the degree of hedging effectiveness?
A)0.61.
B)0.90.
C)0.87.
D)0.82.
E)0.79.
Q2) Corporations
A)Net buyer (typically)
B)Net seller (typically)
Q3) An adjustment for basis risk with a value of "br" less than one means that the percent change in the spot rates is greater than the change in rate in the deliverable bond in the futures market.
A)True B)False
Q4) A perfect hedge, or perfect immunization, seldom occurs.
A)True
B)False
24
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Chapter 23: Options, Caps, Floors, and Collars
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Q1) 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.
E)All of these.
Q2) The payoffs on bond call options move symmetrically with changes in interest rates.
A)True
B)False
Q3) All else equal, the value of an option increases with an increase in the variance of returns in the underlying asset.
A)True
B)False
Q4) A digital default option pays a stated amount in the event that a portion of the loan is not paid.
A)True
B)False
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25
Chapter 24: Swaps
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Q1) 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 yield on assets for the credit union?
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.
Q2) An existing swap can be effectively hedged against interest rate risk by
A)selling out to another party.
B)entering into another swap agreement that is the mirror image of the original swap.
C)setting interest sensitive assets equal to interest sensitive liabilities.
D)setting asset duration equal to liability duration.
E)defaulting to the swap intermediary.
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Chapter 25: Loan Sales
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Sample Questions
Q1) 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.
Q2) Which of the following is NOT a key characteristic of loans sold in the short-term loan sale market?
A)Issued as a secured loan.
B)Loans to investment grade borrowers or better.
C)Issued with a fixed rate.
D)Sold in units of $1 million and up.
E)Issued for 90 days or less.
Q3) Besides reducing credit risks, an FI has an incentive to sell loans it originates for all of the following reasons EXCEPT to:
A)geographically diversify.
B)decrease core deposits.
C)lower reserve requirements.
D)lower capital requirements.
E)generate reinvestment income.
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Chapter 26: Securitization Index
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Q1) 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
Q2) One hundred identical mortgages are pooled together into a pass-through security. Each mortgage has a $150,000 principal, a fixed annual interest rate of 8 percent (paid monthly), and is fully amortized over a term of 30 years. What is the present value of the mortgage pass-through if the entire pool is repaid after two months and there is no change in interest rates?
A)$14,989,935.
B)$15,089,868.
C)$15,000,000.
D)$15,110,065.
E)$14,889,935.
Q3) CMHC helps create pass-through asset-backed securities by providing timing insurance.
A)True
B)False
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