Risk Management in Financial Institutions
Exam Preparation
Guide
Course Introduction
Risk Management in Financial Institutions explores the fundamental principles, techniques, and regulatory frameworks used to identify, assess, and mitigate various risks faced by banks, insurance companies, and investment firms. The course covers market risk, credit risk, operational risk, and liquidity risk, emphasizing both quantitative and qualitative approaches to risk measurement and control. Students learn how financial institutions structure their risk management processes, comply with international regulations such as Basel Accords, and use instruments like derivatives and insurance for hedging purposes. Real-world case studies and current events are analyzed to provide practical insights into risk management strategies, emerging risks, and best practices in the evolving landscape of global finance.
Recommended Textbook
Financial Institutions Management 3rd Edition by Lange
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18 Chapters
1157 Verified Questions
1157 Flashcards
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Page 2
Chapter 1: Why Are Financial Institutions Special
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Sample Questions
Q1) Which of the following statements is true?
A)Primary securities are securities issued by corporations and backed by the real assets of those corporations.
B)Secondary securities are securities issued by corporations and backed by the real assets of those corporations.
C)Dominant securities are securities issued by corporations and backed by the real assets of those corporations.
D)Preliminary securities are securities issued by corporations and backed by the real assets of those corporations.
Answer: A
Q2) The risk that the sale price of an asset will be less than the purchase price of an asset is called liquidity risk.
A)True
B)False
Answer: False
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Chapter 2: The Financial Services Industry: Depository
Institutions
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Sample Questions
Q1) Which of the following statements is true?
A)APRA is responsible for market integrity and consumer protection across the financial system.
B)The RBA is responsible for prudential supervision.
C)ASIC is responsible for monetary policy and for overall financial system stability.
D)None of the listed options are correct.
Answer: D
Q2) Which of the following statements is true?
A)Credit unions are mutual cooperative organisations.
B)Credit unions provide deposit facilities, personal and housing loans and payments services to their members.
C)In case of credit unions the depositors are also members of the society.
D)Credit unions are mutual cooperative organisations that provide deposit facilities, personal and housing loans and payments services to their members.
Answer: D
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Chapter 3: The Financial Services Industry: Other Financial Institutions
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56 Flashcards
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Sample Questions
Q1) Which of the following statements is true?
A)Life insurance allows individuals and their beneficiaries to protect against loss in income through premature death.
B)Life insurance allows individuals and their beneficiaries to protect against loss in income through premature retirement.
C)Life insurance allows individuals and their beneficiaries to protect against loss in income through unforeseen accidents.
D)Life insurance allows individuals and their beneficiaries to protect against loss in income through premature death and life insurance allows individuals and their beneficiaries to protect against loss in income through premature retirement.
Answer: D
Q2) 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.
Answer: A
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Chapter 4: Risk of Financial Institutions
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Sample Questions
Q1) If an FI is long-funded it means that the:
A)maturity of assets equals the maturity of liabilities.
B)bank holds more long-term assets than short-term assets.
C)maturity of liabilities is less than the maturity of assets.
D)maturity of liabilities is longer than the maturity of its assets.
Q2) Why are depository institutions and life insurance companies more exposed to credit risk than, for instance, money market managed funds and general insurance companies?
A)Because the average maturities of their assets are longer than those of money market managed funds/general insurance companies.
B)Because the average maturities of their assets are shorter than those of money market managed funds/general insurance companies.
C)They are not exposed to more risk.
D)Because they are not specialised in credit risk management.
Q3) Which of the following are typical operational risk sources?
A)employee fraud
B)back-office failures
C)general technological glitches
D)All of the listed options are correct.
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Page 6
Chapter 5: Interest Rate Risk Measurement: The Repricing Model
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Sample Questions
Q1) An FI with a negative gap of $20 million suffers a $0.2 million decrease in its net interest income if interest rates decrease by 1 per cent.
A)True
B)False
Q2) Which of the following statements is true?
A)The size of the range over which bucket gaps are calculated does not matter as the repricing gap will always lead to exact results.
B)The shorter the range over which bucket gaps are calculated, the greater the potential error.
C)The shorter the range over which bucket gaps are calculated, the smaller the potential error.
D)None of the listed options are correct.
Q3) When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, the cumulative gap will be:
A)zero.
B)one.
C)greater than one.
D)a negative value.
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Chapter 6: Interest Rate Risk Measurement: The Duration
Model
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64 Flashcards
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Sample Questions
Q1) An FI has financial assets of $800 and equity of $50.If the duration of assets is 1.21 years and the duration of all liabilities is 0.25 years, what is the leverage-adjusted duration gap?
A)0.9000 years
B)0.9600 years
C)0.9756 years
D)0.8844 years
Q2) Which of the following statements are incorrect?
A)Investing in a zero-coupon asset with a maturity equal to the desired investment horizon is one method of immunising against changes in interest rates.
B)Investing in a zero-coupon asset with a maturity equal to the desired investment horizon removes interest rate risk from the investment management process.
C)Buying a fixed-rate asset whose duration is exactly equal to the desired investment horizon immunises against interest
D)Using a fixed-rate bond to immunisea desired investment horizon means that the reinvested coupon payments are not affected by changes in market interest rates.
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8
Chapter 7: Managing Interest Rate Risk Using Off Balance
Sheet Instruments
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Sample Questions
Q1) Off-market swaps are swaps that are have non-standard terms that require one party to compensate another so the swap can be tailored to the needs of the transacting parties, compensation is usually in the form of an upfront fee or payment.
A)True
B)False
Q2) Which of the following is an example of microhedging asset-side portfolio risk?
A)When an FI, attempting to lock in cost of funds to protect itself against a rise in short-term interest rates, takes a short position in futures contracts on CDs.
B)FI manager trying to pick a futures contract whose underlying deliverable asset is not matched to the asset position being hedged.
C)When an FI hedges a cash asset on a direct dollar-for-dollar basis with a forward or futures contract.
D)When an FI manager wants to insulate the value of the institution's bond portfolio fully against a rise in interest rates.
Q3) Forwards are on-balance-sheet transactions.
A)True
B)False
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Page 9
Chapter 8: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) Banks have been partially responsible for big corporate collapses such as Enron.
A)True
B)False
Q2) When current mortgage rates fall sufficiently low that the present value savings of refinancing outweigh the cost of prepayment penalties(and other fees and costs), the mortgage holders are said to have a valuable:
A)put option.
B)call option.
C)forward agreement.
D)futures contract.
Q3) Benefits of securitisation include:
A)increased liquidity of bank loans
B)enhanced ability to manage the duration gap.
C)if off-balance-sheet, the issuer saves on reserve requirements, deposit insurance premiums and capital adequacy requirements.
D)All of the listed options are correct.
Q4) What is prepayment risk? How does prepayment risk affect the cash flow stream on a fully amortised mortgage loan? What are the two primary factors that cause early payment?
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Chapter 9: Market Risk
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Sample Questions
Q1) Assume that the dollar market value of a position is $100 000 and the price volatility is 1.50 per cent.What are the daily earnings at risk for this position (round to two decimals)?
A)$150.00
B)$1500.00
C)$15 000.00
D)Not enough information to solve the question.
Q2) Reasons why market risk measurement is important include:
A)management information.
B)resource allocation.
C)performance evaluation.
D)All of the listed options are correct.
Q3) Which of the following statements is true?
A)Unsystematic risk is specific to a particular firm.
B)Unsystematic risk is specific to a particular industry.
C)Unsystematic risk is specific to a particular geographical area.
D)Unsystematic risk relates to the whole market.
Q4) Why is market risk measurement important?
Q5) Explain the basic concept of the RiskMetric model.What are the major disadvantages? How can the major disadvantages be addressed?
Page 11
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Chapter 10: Credit Risk I: Individual Loan Risk
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Sample Questions
Q1) Models of credit risk measurement include:
A)term structure of credit risk approach.
B)mortality rate approach
C)RAROC and option models.
D)All of the listed options are correct.
Q2) Which of the following statements is true?
A)A line of credit facility is a credit facility with a maximum size and a minimum period of time over which the borrower can withdraw funds.
B)A line of credit facility is a credit facility with a minimum size and a minimum period of time over which the borrower can withdraw funds.
C)A line of credit facility is a credit facility with a maximum size and a maximum period of time over which the borrower can withdraw funds.
D)A line of credit facility is a credit facility with a minimum size and a maximum period of time over which the borrower can withdraw funds.
Q3) Explain the major concept of Altman's linear discriminant model.What would you consider to be the major disadvantages of this model?
Q4) What are the major ideas behind KMV's Credit Monitor Model?
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Chapter 11: Credit Risk II: Loan Portfolio and Concentration
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Sample Questions
Q1) Assume that the maximum loss as a percentage of capital is 12 per cent of an FI's capital to a particular sector.The FI's concentration limit on this sector 35 per cent.What is the sector's loss rate (round to two decimals)?
A)4.20 per cent
B)23.00 per cent
C)34.29 per cent
D)2.92 per cent.
Q2) The term 'transition matrix' refers to a matrix that provides a measurement of the probability of a loan:
A)being upgraded over some period.
B)being downgraded over some period.
C)defaulting over some period.
D)All of the listed options are correct.
Q3) The concentration limit for a loan portfolio is calculated as the expected default frequency of the borrower multiplied by (one divided by the loss rate).
A)True
B)False
Q4) Explain the basic concept of loan loss ratio based models.
Page 13
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Chapter 12: Sovereign Risk
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Sample Questions
Q1) In accordance with the Heritage Foundation, which of the following definitions best represents the term 'economic freedom'?
A)The absence of government coercion or constraint on the production, distribution or consumption of goods and services at all costs to protect and maintain liberty itself.
B)The absence of government coercion or constraint on the production, distribution or consumption of goods and services beyond the extent necessary for citizens to protect and maintain liberty itself.
C)The absence of government coercion or constraint on the consumption of goods and services at all costs to protect and maintain liberty itself.
D)The absence of government coercion or constraint on the production and distribution or consumption of goods and services at all costs to protect and maintain liberty itself.
Q2) Debt repudiations were more common before WWII compared to now.
A)True
B)False
Q3) What are the costs and benefits of rescheduling for the lenders and for the borrowers?
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14
Chapter 13: Foreign Exchange Risk
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Sample Questions
Q1) On-balance-sheet hedging involves taking positions in forward or other derivative securities to hedge FX risk.
A)True
B)False
Q2) 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
Q3) An FI that holds more foreign currency liabilities than assets has a net long position.
A)True
B)False
Q4) Which of the following is the largest market for FX?
A)Tokyo
B)London
C)New York
D)Berlin.
Q5) Explain the concept of the interest rate parity theorem (IRPT) and its implications for FIs?
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Chapter 14: Liquidity Risk
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Sample Questions
Q1) Trend liquidity needs are liquidity needs that relate to the:
A)trends occurring in the community where, for example, loan growth exceeds deposits growth.
B)trends occurring in the community where, for example, deposit growth exceeds loan growth.
C)demand for liquidity that fluctuates with seasonal factors.
D)demand for liquidity that fluctuates with seasonal factors within a community.
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) Contingent liquidity needs refers to the liquidity needs necessary to:
A)fund contingent assets.
B)fund assets.
C)meet an unforeseen event.
D)meet a foreseen event.
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Chapter 15: Liability and Liquidity Management
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Sample Questions
Q1) Which of the following statements is true?
A)Treasury bonds are short-term instruments.
B)Corporate promissory notes are long-term instruments.
C)Corporate bonds are long-term instruments.
D)Semi-government bonds are short-term instruments.
Q2) Basel III liquidity reforms:
A)will strengthen global illiquidity rules with the key aim of promoting a resilient global sector.
B)introduce the need for adequate high-quality liquid assets that meet the available stable funding (ASF) requirement
C)introduce the need for adequate high-quality liquid assets that meet the net stable funding ratio (NSFR).
D)introduce the need for adequate high-quality liquid assets that meet the liquidity coverage ratio (LCR).
Q3) Funding costs generally are positively related to the period of time the liability remains on the balance sheet.
A)True
B)False
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Chapter 16: Off-Balance-Sheet Activities
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Sample Questions
Q1) Which of the following statements is true?
A)When issued trading can expose FIs to future interest rate risk.
B)When issued trading can expose FIs to future credit risk.
C)When issued trading can expose FIs to future liquidity risk.
D)When issued trading can expose FIs to future default risk.
Q2) In the early 1980s:
A)banks increased their off-balance-sheet activities to avoid regulatory taxes.
B)banks decreased their off-balance-sheet activities to avoid regulatory costs.
C)banks decreased their off-balance-sheet activities to avoid competition from nonbank banks.
D)banks increased their off-balance-sheet activities to avoid competition from nonbank banks.
Q3) Redraw facilities are included in the category 'commitments and other non-market related items'.
A)True
B)False
Q4) The delta of an option is always greater than one.
A)True
B)False
Q5) Briefly explain how off-balance-sheet transactions can affect an FI's solvency.
Page 18
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Chapter 17: Technology and Other Operational Risk
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Sample Questions
Q1) Which of the following statements is false?
A)Regulations can affect the profitability of technological innovations.
B)Regulations can hinder the rate and types of innovations.
C)Typical regulations include caps on loan rates such as usury ceilings.
D)Regulations are predominantly implemented to enhance FIs' profitability.
Q2) Which of the following statements is false?
A)Large-scale investments may result in excess capacity problems.
B)Large-scale investments may result in integration problems.
C)Large-scale investments may result in problems of capacity constraints.
D)Large-scale investments may result in cost overruns.
Q3) 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.
Q4) Which of the following are potential benefits of technology for an FI?
A)Service quality, especially for customers of large banks.
B)The rate of innovation of new products has increased.
C)FIs can more easily cross-market new and existing products to customers.
D)All of the listed options are correct.
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Chapter 18: Capital Management and Adequacy
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Sample Questions
Q1) Basel II established minimum capital requirements, procedures to ensure that sound internal process are used to assess capital adequacy and set targets that were commensurate with the risk profile and environment in an endeavour to protect solvency of individual FIs.Basel III introduced liquidity and higher capital levels to protect the financial system in general.
A)True
B)False
Q2) Consider an FI with the following off-balance-sheet items: A two-year loan commitment with a face value of $120 million, a standby letter of credit with a face value of $20m and trade-related letters of credit with a face value of $70 million.What is the total credit equivalent amount?
A)$63 million
B)$94 million
C)$105 million
D)$310 million
Q3) Basel III has introduced the first set of global liquidity regulations.
A)True
B)False
Q4) Why is a regulatory capital charge against operational risk necessary?
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