Question 1 IMPORTANT:

1. Please correctly indicate the version of your exam paper in the provided answer sheet. Not or incorrectly answering this question will result in incorrect grading of your paper and subject to 1 mark penalty.

What is the version of your exam paper?

A. Version A B. Version B

Please choose A for question 1 in the answer sheet.

Specialness of Financial Intermediaries and Regulation

2. What is the most important factor driving the change in Australian financial service regulation framework from industry-based to function-based?

A. Banking industry became relatively more important than other financial industries B. Banking industry became relatively less important than other financial industries

C. The distinction between the activities of different types of financial industry institutions became blurred

D. The financial industry needed a stronger regulation. E. None of the above.

3. Financial intermediaries could address the agency costs associated with investments better than individual households, because agglomerating funds of individual households helps: A. To avoid free-rider problem.

B. To reduce costs of information collection and monitoring.

C. To develop new secondary securities to more effectively monitor owners/managers of invested companies.

D. Both A and B. 

E. All of A, B and C. 

4. FIs perform their intermediary function via

A. Transforming assets by purchasing primary securities and issuing secondary securities.

B. Transforming assets by making efficient transactions.

C. Transforming assets by purchasing secondary securities and issuing primary securities. 

D. Specializing as brokers between households and corporations by purchasing primary securities and issuing secondary securities.

E. Specializing as brokers between households and corporations by purchasing secondary securities and issuing primary securities.

5. Which of the following statements is true?

A. APRA is responsible for market integrity and consumer protection across the financial system.

B. RBA is responsible for market integrity and consumer protection across the financial system.

C. ASIC is responsible for prudential supervision. 

D. APRA is responsible for prudential supervision. 

E. ASIC is responsible for monetary policies. 

6. Which of the following is (are) reason(s) for the specialness of financial intermediaries? A. Lower average information costs.

B. Lower average transaction costs.

C. Lower price risk and superior liquidity attributes of financial claims to household savers. 

D. Only A and C.

E. All of A, B and C.

Credit Risk

7. Bank ABC has a loan lent to firm DEF. The interest rate charged for this loan is 8% per annum. The bank also charges various fees which amount to 2% of the loan amount per annum. The compensating balance (b) is 5%, and there is 10% reserve requirement (RR). What is the contractually promised rate of return on this loan (rounded to the closest basis points, i.e., 0.01%)?

A. 8.38% 

B. 8% 

C. 6.70% 

D. 10.48% 

E. 1.68% 

8. The contractually-promised return on a 1-year loan is 15% per annum. If the borrower defaults, 90% of the principal and interest payments are expected to be recovered. If the borrower is expected to default with a 20% probability, what is the expected rate of return on this loan?

A. 15% 

B. 12.7% 

C. 12% 

D. 5.8% 

E. -8% 

9. Which of the following statements does NOT reflect credit decisions at the retail level? 

A. Loans are typically of small size.

B. The financial institutions usually control the credit risk by limiting the quantity of loans made available to retail borrowers and credit rationing.

C. The financial institutions rely mainly on the pricing tool, i.e., setting a higher interest rate for riskier borrowers, to address credit risk.

D. It is economically inefficient to collect detailed information about borrowers’ credit quality. 

E. Usually a standard loan rate is charged.

10. What is/are the problem(s) with the linear discriminant model for default risk?

A. Factors included in the model may vary over time and across types of loans considered.

B. Weights of factors may vary over time and across types of loans considered.

C. Factors included in the model must be quantified.

D. A centralized database of loans is normally not available for the model development.

E. All of above.

11. What should be the value of coefficients of X1 and X2, β1 and β2 respectively?

  

β1

β2

 

A. 2

-1.5

 

B. -1.5

2

 

C. -1.5

-1.5

 

D. 2

2

E. None of the above

12. Assuming the two critical values of Zs for loan decisions (approval or rejection) are 1.85 and 2.99, should the bank approve the loan for this client?

A. Yes, because the Z-score for this client is higher than the cut-off value 2.99. 

B. Yes, because the Z-score for this client is lower than the cut-off value 2.99. 

C. No, because the Z-score for this client is higher than the cut-off value 1.85. 

D. No, because the Z-score for this client is lower than the cut-off value 1.85. 

E. This client’s case is indecisive.

13. A regression of sectoral loan losses against total loans losses, both measured as a percentage of loans, of a bank results in the following beta coefficients for the real estate (RE) and commercial (CL) loan variables: RE = 1.2, CL = 1.6. The intercept for both regressions is zero. According to the Modern Portfolio Theory, the results indicate that for the bank

A. both sectors have the same degree of systematic default risk and benefit of diversification. 

B. the real estate loans have a higher systematic default risk and thus lower benefit of diversification.

C. the real estate loans have a higher systematic default risk and thus higher benefit of diversification.

D. the commercial loans have a higher systematic default risk and thus higher benefit of diversification.

E. the commercial loans have a higher systematic default risk and thus lower benefit of diversification.

Use the following to answer the next three questions:

The current term structure for Treasury and corporate debt is

  

Spot 1 year

Spot 2 years

 

Treasury

3.5 percent

4.25 percent

 

BBB Corporate Debt

8.2 percent

10.45 percent

14. Using the term structure of default probability, the implied default probability for BBB corporate debt during the first year is

A. 0.39 percent 

B. 2.25 percent 

C. 3.50 percent 

D. 4.34 percent 

E. 6.87 percent

15. Using the term structure of default probability, the implied default probability for BBB corporate debt during the second year is

A. 0.39 percent 

B. 2.25 percent 

C. 3.50 percent 

D. 4.34 percent 

E. 6.87 

16. The cumulative probability of repayment of the BBB corporate debt over the next 2 years is 

A. 89.1 percent

B. 93.1 percent 

C. 94.4 percent 

D. 95.7 percent 

E. 99.7 percent 

17. What is the essential idea behind RAROC?

A. Evaluating the actual or contractually promised annual ROA on a loan.

B. Analyzing historic or past default risk experience.

C. Balancing expected interest and fee income less the cost of funds against the loan’s expected risk.

D. Extracting expected default rates from the current term structure of interest rates.

E. Dividing net interest and fees by the amount lent.

18. If a bank’s concentration limit (as a percent of capital) is 20 percent, and its expected recovery from defaulted loans is 30 percent, what is the maximum loss it permits to affect its capital in the event of a default?

A. 6 percent.

B. 14 percent.

C. 24 percent.

D. 29 percent.

E. 67 percent. 

19. A bank charges an interest rate of 8% per annum on a loan, and there is no other fee charged. Its cost of obtaining the funding for this loan is 5% per annum. According to the historical data, 50% of borrowers with similar characteristics defaulted when there was an adverse credit scenario, and typically the lenders were able to recover only 60% of loan amount on average once borrowers defaulted in those adverse credit scenarios. What is the Risk-Adjusted-Return-on-Capital of this loan if we use historical loan loss under the adverse credit scenario as the estimate of loan risk?

A. 40% 

B. 25% 

C. 15% 

D. 10% 

E. 3% 

20. As follows is the information about loan allocation of Bank A:

  

National Benchmark

Bank A

 

 

Consumer   Loans

50   percent

35 percent

 

Commercial   Loans

50   percent

65 percent

What is the standard deviation of Bank A’s asset allocation proportions relative to the national benchmark.

A. 40.44 percent

B. 34.32 percent

C. 29.89 percent

D. 21.21 percent

E. 15.00 percent

21. What is the expected return of the whole portfolio of loans made to both sectors? A. 4 percent

B. 4.8 percent 

C. 5 percent 

D. 5.2 percent 

E. 6 percent 

22. What is the risk of the whole portfolio of loans made to both sectors?

A. 2 percent

B. 2.08 percent

C. 2.40 percent

D. 2.5 percent

E. 4.00 percent

23. Any model that seeks to estimate an efficient frontier for loans, and thus the optimal proportions in which to hold loans made to different borrowers, needs to determine and measure: A. the expected return on a loan to borrower.

B. the risk of a loan to borrower.

C. the correlation of default risks between loans made to borrowers. D. only A and B.

E. all of A, B and C 

24. LNW Bank is charging a 15 percent interest rate on a $3,000,000 loan. The bank also charged $50,000 in fees to originate the loan. The bank has a cost of funds of 8 percent. The borrower has a seven percent chance of default, and if default occurs, the bank expects to recover 85 percent of the principal and interest.

What is the expected return on the loan using the Moody’s Analytics Portfolio Manager model?

A. 2.72 percent.

B. 5.95 percent.

C. 7.62 percent.

D. 10.72 percent.

E. 15.62 percent. 

25. OZ Bank earns a 6% annual all-in-spread (the spread of interest income plus fees over the funding cost) on a loan. The borrower has a 20 percent chance of default, and if default occurs, the bank expects to lose 20% of loans. What is the risk of the loan using the Moody’s Analytics Portfolio Manager model?

A. 27 percent 

B. 20 percent 

C. 16 percent 

D. 8 percent 

E. 4 percent 

26. In making credit decisions, which of the following items is (are) considered as market-specific factor(s)?

A. Whether the reputation of the borrower is sufficient to create an implicit contract B. Whether property can be pledged as collateral

C. Whether the position of the economy in the business cycle phase would affect the probability of borrower default.

D. Whether tight monetary policies and high interest rates affect the ability of borrowers to seek alternative funding.

E. Both C and D 

Sovereign risk

27. Loans made to borrowers in a foreign country with the following characteristics are more likely to have a high probability of rescheduling:

A. High variance of export revenue (VAREX) 

B. Low domestic money supply growth (MG) 

C. Low import ratio (IR)

D. High debt service ratio (DSR) 

E. Both A and D

28. What are major mechanisms to deal with sovereign risk exposure?

A. Debt-for-equity swap

B. Loan sales

C. Multi-year restructuring of loans

D. Loan-for-bond swap

E. All of the above

29. Which of the following makes international loan rescheduling more likely than bond rescheduling?

A. The inclusion of cross-default provisions in loan contracts.

B. A smaller number of FIs in an international loan compared with an international bond.

C. The same group of FIs have been involved in more international loan syndicates since World War II.

D. The tendency of the governments to bail out those lending FIs.

E. All of the above.

30. High rates of domestic inflation impact the credit scoring model of sovereign country risk exposure through which of the following variables?

A. The rate of growth of the domestic money supply 

B. The import ratio

C. The investment ratio 

D. The debt service ratio

E. The variance of export revenue 

Liquidity risk

31. Which of the following are potentially direct causes of liquidity risk for a DI? A. The decrease in the DI’s stock price caused by market factors.

B. Requests to fund large amounts of loan commitments.

C. Requests by depositors to withdraw large amounts of deposits. 

D. All of a, b and c will cause liquidity problems.

E. Only b and c above are considered causes of liquidity risk. 

32. What are the possible ways that the bank can meet an expected net deposit drain using stored liquidity management techniques?

A. Borrowing heavily in the short-term money markets. B. Issue commercial paper.

C. Utilize repurchase agreements.

D. Liquidate some liquid securities and/or loans. 

E. All of the above.

33. What are the possible ways that the bank can meet an expected net deposit drain using purchased liquidity management techniques?

A. Issue commercial paper.

B. Utilize repurchase agreements. 

C. Liquidate all cash holdings. 

D. Only a and b of the above.

E. All of a, b and c. 

34. A DI has two assets: 50 percent in 1-year Treasury bonds and 50 percent in real estate loans. If the DI must liquidate its T-bills today, it receives $98 per $100 of face value; if it can wait to liquidate them on maturity (in one year’s time), it will receive $100 per $100 of face value. If the DI has to liquidate its real estate loans today, it receives $90 per $100 of face value. For every $100 face value of real estate loans, the DI will receive $90 if it liquidates them at the end of one month, and $95 if liquidating at the end of one year. The one-year liquidity index value for this DI’s asset portfolio is

A. 0.940

B. 0.964

C. 0.979

D. 1.06

E. 1.10 

35. Among the following funding sources: retail CDs, wholesale CDs, demand deposits, repurchase agreement, and interbank funds, which one has the highest withdrawal risk? 

A. retail CDs

B. wholesale CDs 

C. demand deposits

D. repurchase agreement 

E. interbank funds 

36. Among the following funding sources: demand deposits, interest-bearing checking (NOW) accounts, passbook savings, short-term certificates of deposit (short-term CDs), and interbank funds, which one has the highest funding cost?

A. NOW accounts 

B. passbook savings 

C. demand deposits 

D. short-term CDs 

E. interbank funds 

37. Which of the following observations is NOT true of a liquid asset?

A. It can be turned into cash quickly

B. It helps reduce the liquidity risk.

C. It typically bears low returns or interest rates.

D. It will be typically sold at a big discount to its fair value if liquidated.

E. None of the above.

38. What is the fundamental reason why depository institutions are subjected to bank run risk? 

A. DIs typically have high leverage.

B. DIs typically take excessive risks.

C. Deposit contract typically implies a ‘first come, first served’ principle.

D. Depositors are typically paid based on the value of the bank and their shares in the total deposits.

E. None of the above.

39. Which statement regarding the deposit insurance is NOT true? 

A. A well designed deposit insurance scheme can prevent bank runs.

B. Insured depositors lack incentives to differentiate between good vs bad banks.

C. Deposit insurance will encourage the management and shareholders of banks to manage liquidity risk more prudently.

D. All of A, B and C 

E. None of A, B and C