Introduction to Financial Services
Pre-Test Questions
Course Introduction
This course offers a comprehensive overview of the financial services sector, focusing on the key institutions, markets, and instruments that facilitate the flow of funds within an economy. Students will explore the roles of banks, insurance companies, investment firms, and other financial intermediaries, examining how these organizations help individuals and businesses manage risk, invest capital, and access credit. Fundamental concepts such as interest rates, time value of money, regulatory frameworks, and the impact of technology on financial services will be discussed. The course aims to equip students with a foundational understanding of the structure, functions, and evolving trends within the financial services industry.
Recommended Textbook
Financial Institutions Management 4th Edition by SAUNDERS
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Chapter 1: Why Are Financial Institutions Special
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Q1) FIs perform their intermediary function in two ways:
A)They specialise as brokers between savers and users and they directly control the quantity of outside money in the economy.
B)They serve as asset transformers by purchasing primary securities and issuing secondary securities and by purchasing secondary securities and issuing primary securities.
C)They serve as asset transformers by purchasing secondary securities and issuing primary securities and they directly control the quantity of outside money in the economy.
D)They specialise as brokers between savers and users and they serve as asset transformers by purchasing primary securities and issuing secondary securities. Answer: D
Q2) Which of the following statements is false?
A)A financial intermediary specialises in the production of information.
B)A financial intermediary reduces its risk exposure by pooling its assets.
C)A financial intermediary benefits society by providing a mechanism for payments.
D)A financial intermediary acts as a lender of last resort.
Answer: D
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Chapter 2: The Financial Service Industry: Depository
Institutions
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Q1) In response to the GFC and the global liquidity crisis the Australian government introduced the following measure in 2008:
A)a financial claims scheme that provided coverage to all depositors in any financial institution
B)a financial claims scheme that guaranteed bank deposits coverage to depositors up to a million dollars per depositor
C)a financial claims scheme that guaranteed bank deposits coverage to depositors up to a million dollars per depositor and provided a temporary wholesale funding guarantee
D)All of the listed options are correct.
Answer: C
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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Sample Questions
Q1) Private placement refers to a securities issue placed:
A)with one or a few large institutional investors
B)in private, that is, without announcing it to the public
C)by a private person
D)with one of the stock exchanges
Answer: A
Q2) Which of the following statements is true?
A)A term insurance policy has no savings element attached to it.
B)The maximum term of a term life insurance is 20 years.
C)The minimum term of a term life insurance is five years.
D)A term insurance policy has no savings element attached to it and the maximum term of a term life insurance is 20 years.
Answer: A
Q3) Reinsurance is insurance purchased by insurers from other insurers to limit the total loss an insurer would experience in case of a disaster.
A)True
B)False
Answer: True
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Chapter 4: Risks of Financial Institutions
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Q1) A letter of credit is:
A)a credit guarantee issued by an FI's customer to pay a predetermined amount of money to the FI at a future point in time
B)an on-balance-sheet transaction for the issuing FI
C)a credit guarantee issued by an FI on which payment is contingent on some future event occurring
D)None of the listed options are correct.
Q2) Which of the following may occur when a sufficient number of borrowers are unable to repay interest and principal on loans, thus causing an FI's equity to approach zero?
A)insolvency risk
B)sovereign risk
C)currency risk
D)liquidity risk
Q3) .... can be reduced by diversification.
A)Firm-specific credit risk
B)Systematic credit risk
C)Firm-specific and systematic credit risks
D)None of the listed options are correct.
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6
Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Q1) The repricing gap considers the timing and size of cash flows. A)True
B)False
Q2) Which of the following statements is true?
A)As opposed to the duration gap model, the repricing gap model captures the capital loss and capital gain effect.
B)The repricing gap model is a market-value based approach, while the duration model is a book-value based approach.
C)The repricing gap model does not consider the size and timing of cash flows.
D)The duration gap model focuses on the impact interest rate changes have on an FI's net interest income.
Q3) The term 'rate-sensitive assets' refers to assets with a particularly high interest rate. A)True B)False
Q4) Would you consider the repricing model to be a good and well-founded interest rate risk measurement and management tool? Why or why not?
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Chapter 6: Interest Rate Risk Measurement: the Duration
Model
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Q1) Which of the following statements most appropriately responds to the critique that duration matching is costly and time consuming?
A)The critique is valid; however, the speed has been eased and transaction costs of balance sheet restructuring have been lowered due to growth of purchased funds, asset securitisation and loan sales markets.
B)The critique is valid and FIs should spend funds in order to develop more efficient interest rate risk management tools.
C)The critique is valid, particularly because it is not possible for managers to get the same results of direct duration matching by taking positions in derivatives markets.
D)None of the listed options are correct.
Q2) In order to achieve a zero duration gap, an FI can:
A)change the duration of its assets only
B)change the duration of its liabilities only
C)change the duration of both, assets and liabilities
D)All of the listed options are correct.
Q3) Would you consider convexity of a fixed-income security to be desirable or undesirable for an FI? Explain your opinion.
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Page 8
Chapter 7: Managing Interest Rate Risk Using
Off-Balance-Sheet Instruments
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Q1) Which of the following are contracts that give the holder the right, but not the obligation, to buy or sell an underlying asset at a pre-specified price for a specified time period?
A)options
B)futures
C)forwards
D)swaps
Q2) Which of the following is a major difference between forwards and futures?
A)Forwards are marked to market, while futures are not.
B)Futures are tailor made, while forwards are standardised.
C)The default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards.
D)Forwards are marked to market, while futures are not, futures are tailor made, while forwards are standardised and the default risk of futures is significantly reduced by the futures exchange guaranteeing to indemnify counterparties against credit risk, while this is not the case for forwards.
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Chapter 8: Managing Interest Rate Risk Using Securitisation
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Q1) Which of the following is true concerning loans sold with recourse?
A)Most loans are sold in this manner.
B)The buyer cannot put the loan back to the selling FI.
C)The FI has no explicit liability if the loan eventually goes bad.
D)The FI that originated the loan retains a contingent credit risk liability.
Q2) Transferable mortgage is:
A)a mortgage contract that allows a change of asset to be sold
B)a mortgage contract that does not allow a change of asset to be mortgaged
C)a mortgage contract that allows a change of asset to be mortgaged
D)None of the listed options are correct.
Q3) Collateralised mortgage obligation (CMO) is a mortgage-backed bond issued in multiple classes or tranches.
A)True
B)False
Q4) 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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Chapter 9: Market Risk
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Sample Questions
Q1) Assume an FI holds three different positions.The following DEAR information is available for the positions.Position 1 is a five-year zero-coupon bonds with DEAR of $12 500, position 2 is a CHF spot contract with DEAR of $9500 and the third position are Australian equities with DEAR of $34 500.Which of the following statements is true in relation to these positions?
A)The DEAR of the portfolio can be calculated by simply adding up the individual DEARs.
B)The DEAR of the portfolio can be calculated by simply multiplying the individual DEARs.
C)The DEAR of the portfolio can be calculated by simply adding up the individual DEARs and adjusting the sum by an error factor gamma.
D)None of the listed options are correct.
Q2) VaR gives full information about the extent of possible losses, particularly when probability distributions are non-normal.
A)True
B)False
Q3) Describe the process of the fuller risk factor approach.
Q4) Why is market risk measurement important?
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Page 11
Chapter 10: Credit Risk I: Individual Loan Risk
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Q1) Consider the following data of a prospective borrower. \[\begin{array} { | l | r | }
\hline \text { Current assets } & \$ 120000 \\
\hline \text { Current liabilities } & \$ 60000 \\
\hline \text { Total assets } & \$ 500000 \\
\hline \text { Market value of equity } & \$ 50000 \\
\hline \text { Book value of equity } & \$ 60000 \\
\hline \text { Retained earnings } & \$ 12000 \\
\hline \text { Interest expense } & \$ 20000 \\
\hline \text { Profit before tax } & \$ 200000 \\
\hline \text { Sales revenue } & \$ 1000000 \\
\hline
\end{array}\] What is this company's Z-score ?
A)2.70
Q2) Explain the concept of RAROC and the major role RAROC models play in credit risk analysis.
Q3) What are the major ideas behind KMV's Credit Monitor model?
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Page 12
Chapter 11: Credit Risk II: Loan Portfolio and Concentration
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Q1) Assume that an FI's concentration limit on a particular sector is 15% and that the sector's loss rate is 25%.What is the maximum loss as a percentage of the FI's capital (round to two decimals)?
A)1.67%
B)0.60%
C)10.00%
D)3.75%
Q2) Using the Moody's Analytics model, the return on a loan can be calculated as the annual all-in-spread minus the loss in the event of default.
A)True
B)False
Q3) The return (Ri) on a loan can be measured as follows:
A)AISi - E(Li), whereby E(Li) = (EDFi * LGDi)
B)AISi - E(Li), whereby E(Li) = (EDFi / LGDi)
C)AISi + E(Li), whereby E(Li) = (EDFi * LGDi)
D)AISi + E(Li), whereby E(Li) = (EDFi / LGDi)
Q4) Explain the basic concept of loan loss ratio based models.
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Chapter 12: Sovereign Risk
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Questions
Q1) Which of the following statements is true in relation to the Institutional Investor Index?
A)The Institutional Investor Index rates country risk by combined economic and political risk on a maximum of 100 points scale.
B)The Institutional Investor Index is based on the spread in the Euromarket of the required interest rate on a country's debt over the LIBOR.
C)The Institutional Investor Index weighs subjective scores allocated by rating officers by the exposure of each bank to the country in question.
D)None of the listed options are correct.
Q2) All of the following are relevant determinants of sovereign risk exposure: the rate of domestic money supply growth; the variance of export revenue, and the size of the population.
A)True
B)False
Q3) Rescheduling is changing the contractual terms of a loan, such as the maturity and interest payments.
A)True
B)False
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Chapter 13: Foreign Exchange Risk
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Q1) In a currency swap it is usual to include both principal and interest payments as part of the swap agreement.
A)True
B)False
Q2) The case of the National Australia Bank shows that:
A)FX trading can result in significant losses for an FI
B)FX trading losses can result in reputational loss for an FI
C)the announcement of FX trading losses can lead to a fall in the share price of the FI at which the losses occurred
D)All of the listed options are correct.
Q3) The interest rate parity theorem implies that by hedging in the forward exchange rate market, an investor realises the same returns whether investing domestically or in a foreign country.
A)True
B)False
Q4) A net exposure is the degree to which a bank is net long (positive) or net short (negative) in a given currency.
A)True
B)False
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Chapter 14: Liquidity Risk
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Q1) Which of the following statements is true?
A)Under the BIS scenario analysis, an FI needs to assess its liquidity position in comparison to other FIs in the market based on different scenarios.
B)Under the BIS scenario analysis, an FI needs to estimate the size of cash flows for each type of asset and liability based on past experience.
C)Under the BIS scenario analysis, an FI needs to assign a timing of cash flows for each type of asset and liability by assessing the probability of behaviour of those cash flows under the scenario being examined.
D)None of the listed options are correct.
Q2) What are the possible ways that a bank can meet an expected net deposit drain of +4 per cent using purchased liquidity management techniques?
A)Utilise the interbank funds market and repurchase agreements.
B)Utilise repurchase agreements.
C)Liquidate all cash holdings.
D)All of the listed options are correct.
Q3) Discuss the components of liquidity position of the bank related to active liquidity planning
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Chapter 15: Liability and Liquidity Management
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Q1) Why do FIs face a return or interest earnings penalty by holding large amounts of assets such as cash, T-bills, and T-bonds to reduce liquidity risk?
A)These assets carry a reserve requirement tax.
B)These assets offer low returns.
C)These assets offer higher returns that reflect their risk.
D)Inflation increases the purchasing power value of these assets.
Q2) Which of the following statements is true?
A)Bank accepted bills classify as purchased liquidity.
B)Loans to short-term money market dealers classify as purchased liquidity.
C)Securities sold under agreements to repurchase classify as stored liquidity.
D)Certificates of deposits classify as stored liquidity.
Q3) What is the benefit of a regulatory guarantee or deposit insurance program for liability holders of FIs?
A)It decreases the likelihood contagious runs.
B)It increases concerns about the asset quality of FI.
C)It increases concerns about solvency of an FI.
D)It provides preference to those who are first in line to withdraw funds over those last in line.
Q4) What are the withdrawal risks and costs associated with the covered bonds?
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Chapter 16: Off-Balance-Sheet Activities
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Q1) Basis risk arises because loan rates and deposit rates are not perfectly correlated in their movements over time
A)True
B)False
Q2) Which of the following statements is true?
A)The variable spread between a lending rate and a borrowing rate, or between any two interest rates or prices is called basis risk.
B)The variable spread between a lending rate and a borrowing rate, or between any two interest rates or prices is called spread risk.
C)The variable spread between a lending rate and a borrowing rate, or between any two interest rates or prices is called interest spread risk.
D)The variable spread between a lending rate and a borrowing rate, or between any two interest rates or prices is called funding risk
Q3) Graphically explain the general set-up of a letter of credit transaction.In this context, explain why letters of credit are important
Q4) Briefly explain how off-balance-sheet transactions can affect an FI's solvency.
Q5) Discuss four major types of off-balance-sheet activities
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Page 18
Chapter 17: Technology and Other Operational Risks
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Q1) What are the advantages and disadvantages of technological advancements from the viewpoint of FIs? Use examples where appropriate.
Q2) Some of the most important retail payment product innovations are:
A)ATMs, EFTPOS and online banking
B)home banking, telephone banking and business-to-business ecommerce
C)online banking, smart cards and account reconciliation
D)All of the listed options are correct.
Q3) How can the operating income of an FI be increased by improved technological efficiency?
A)By improving the efficiency of management of information flows.
B)By obtaining access to low cost sources of funds.
C)By linking services to the quality of the FI's technology.
D)By innovating new interest-earning products.
Q4) There is little strong evidence that larger multi-product financial service firms enjoy cost advantages over smaller, more specialised firms.
A)True
B)False
Q5) Outline the main sources of operational risk and why operational risk gained prominence during the GFC.
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Chapter 18: Capital Management and Adequacy
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Q1) The leverage ratio is calculated as assets divided by core capital.
A)True
B)False
Q2) Which of the following is true?
A)Total capital is the sum of Tier I and Tier II capital less deductions.
B)Total capital must equal or exceed 8% of risk-weighted assets.
C)The total of Tier II capital is limited to 100% of Tier I capital.
D)All of the listed options are correct.
Q3) Which of the following elements is usually not included in the book value of capital?
A)the par value of shares
B)the FI's earnings
C)loan loss reserve
D)the surplus value of shares
Q4) Basel III has introduced the first set of global liquidity regulations.
A)True
B)False
Q5) What are the major differences between the Basel I and the Basel II approaches to capital regulation?
Q6) Why is a regulatory capital charge against operational risk necessary?
Page 20
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