Choice Multiple Questions (20%; 0.5% for each question) 1. A. B. C. D.

The risk that an investor will be forced to place earnings from a loan or security into a lower yielding investment is known as liquidity risk. reinvestment risk. credit risk. foreign exchange risk. 2. A. B. C. D. Risk management for financial intermediaries deals with controlling the overall size of the institution. controlling the scope of the institution's activities. limiting the geographic spread of the institution's offices. limiting the mismatches on the institution's balance sheet. 3. A. B. C. D. When repricing all interest rate sensitive assets and liabilities in a balance sheet, the cumulative gap will be zero. one. greater than one. a negative value. 4. A. B. C. D. The earnings at risk for an FI is a function of the time necessary to liquidate assets. the potential adverse move in yield. the price sensitivity of the position. all of the above. 5. If interest rates decrease 40 basis points for an FI that has a cumulative gap of -$25 million, the expected change in net interest income is +$100,000. -$100,000. -$625,000. -$625,000. A. B. C. D. 1 6. A. B. C. D.

7. A. B. C. D. 8. A. B. C. D. 9. A. B. C. D. Which of the following observations concerning floating-rate loans is not true ? They are less credit risky than fixed-rate loans. They better enable FIs to hedge the cost of rising interest rates on liabilities. They pass the risk of interest rate changes onto borrowers. In rising interest rate environments, borrowers may find themselves unable to pay the interest on their floating-rate loans. Can an FI immunize itself against interest rate risk exposure even though its maturity gap is not zero ? 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. 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. Yes, because the maturity model does not consider the timing of cash flows. No, because the timing of cash flows is relevant to immunization against interest rate risk exposure. Consider a 6-year maturity, $100,000 face value bond that pays a 5% fixed coupon annually, what is the price of the bond if market interest rates are 6% ? $95,082.68 $95,769.55 $95,023.00 $96,557.87 (I) Prices of longer-maturity bonds respond less dramatically to changes in interest rates. (II) Prices & returns for long-term bonds are less volatile than those for shorter-term bonds. (I) is true, (II) is false (I) is false, (II) is true Both are true Both are false 2 10. Compensating balances : A. are a particular form of collateral commonly required on commercial loans B. are the required minimum amount of funds that a borrower must keep in a checking account at the bank C. allow banks to monitor firms check payment practices which can yield information about the borrowers financial conditions D. all of the above 11. Sumitomo Banks risk manager has estimated that the DEARs of two of its major assets in its trading portfolio, foreign exchange and bonds, are -$150,000 and -$250,000, respectively. What is the total DEAR of Sumitomos trading portfolio if the correlation among assets is assumed to be 1.0 ? A. -$100,000 B. $291,548 C. -$380,789 D. -$400,000 12. Which of the following factors affect the promised return an FI achieves on any loan ? A. The collateral backing of the loan. B. Any fees relating to the loan. C. The interest rate & risk premium on the loan. D. All of the above. 13. According to Altmans credit scoring model, which of the following Z scores would indicate a low default risk firm ? A. less than 1 B. between 1 and 1.81 C. between 1.81 and 2.99 D. greater than 2.99 3 14. What does cumulative default probability refer to ? A. Probability that a borrower will default over a specified multiyear period. B. Expected maximum change in the loan rate due to a change in the risk factor on the loan. C. The historic default rate experience of a bond or loan. D. Expected maximum change in the loan rate due to a change in the credit premium.

15. Choose the best statement from below. The longer the duration of the loan, ceteris paribus, A. and the lower the current level of interest rates, the higher the RAROC. B. and the lower the expected change in risk premium, the lower the RAROC. C. and the higher the expected change in risk premium, the higher the RAROC. D. and the higher the loan amount, the lower the RAROC. 16. A negative net exposure position implies that the FI is A. net long in a currency and exposed to depreciation currency. B. net short in a currency and exposed to depreciation currency. C. net long in a currency and exposed to appreciation currency. D. net short in a currency and exposed to appreciation currency. of the foreign of the foreign of the foreign of the foreign 17. FX risk exposure of an FI essentially relates to this type of activity. A. Purchase and sale of foreign currencies to allow customers to participate in and complete international commercial trade transactions. B. Purchase and sale of foreign currencies to allow customers to take positions in foreign real and financial investments. C. Purchase and sale of foreign currencies for hedging purposes to offset customer exposure in any given currency. D. Purchase and sale of foreign currencies for speculative purposes through forecasting or anticipating future movements in FX rates. 4 18. Which of the following is a problem encountered while using more observations in the Back Simulation approach ? A. Past observations become decreasingly relevant in predicting VAR in the future. B. Calculations become highly complex. C. Need to assume a symmetric (normal) distribution for all asset returns. D. Requirement for calculating the correlations of asset returns. 19. Which of the following is NOT true ? A. FI bearing the credit risk of a loan is often different from the FI that issued the loan. B. The buyer of a credit swap makes periodic payments to the seller until the end of the life of the swap. C. Banks are more willing than the insurance companies to bear credit risk. D. The settlement of the swap in the event of a default involves either physical delivery of the bonds or a cash payment. 20. How can we define market risk in absolute terms ? A. As a dollar exposure amount or as a relative amount against some benchmark. B. As the gap between promised cash flows from loans and securities and realized cash flows. C. As the change in value of an FIs assets and liabilities denominated in Nondomestic currencies. D. As the cost incurred by an FI when its technological investments do not produce anticipated cost savings. 21. does What marginal default probability refer to ? A. The probability that a borrower will default over a specified multiyear period. B. The marginal increase in the default probabililty due to a change in credit premium. C. The probability that a borrower will default in any given year. D. Expected maximum change in the loan rate due to a change in the credit premium. 5 22. A. B. C. D. An FI's net interest income reflects its asset-liability structure. the riskiness of its loans and investments. the cost of its deposit and non-deposit sources of funds. all of the above. 23. What is spread effect ? A. Periodic cash flow of interest and principal amortization payments on longterm assets that can be reinvested at market rates. B. The effect that a change in the difference between rates on RSAs and RSLs has on net interest income as interest rates change. C. The effect of mismatch of asset and liabilities within a maturity bucket. D. The premium paid to compensate for the future uncertainty in a securitys value. 24. Which of the following statements about leverage adjusted duration gap is true ? A. It is equal to the duration of the assets minus the duration of the liabilities. B. Larger the gap in absolute terms, the more exposed the FI is to interest rate shocks. C. It reflects the degree of maturity mismatch in an FIs balance sheet. D. It indicates the dollar size of the potential net worth. 25. A bank that finances long-term fixed-rate mortgages with short-term deposits is exposed to : A. increases in net interest income and decreases in the market value of equity when interest rates fall. B. decreases in net interest income and decreases in the market value of equity when interest rates increase. C. decreases in net interest income and increases in the market value of equity when interest rates increase. D. increases in net interest income and increases in the market value of equity when interest rates increase.

26. If the chosen maturity buckets are too long, the repricing model may produce inaccurate results because : A. as the time to maturity increases, the price volatility increases. B. price changes will be overestimated. C. there may be large differentials in the time to repricing for different securities within each maturity bucket. D. the FI will be unable to accurately measure the quantity of rate sensitive assets & liabilities. 27. Managers can achieve the results of duration matching by using __________ to hedge interest rate risk. A. Rate sensitive assets B. Rate sensitive liabilities C. Coupon bonds D. Derivatives 28. Which theory of term structure posits that long-term rates are a geometric average of current and expected short-term interest rates ? A. The unbiased expectations theory B. The liquidity premium theory C. The loanable funds theory D. The market segmentation theory 29. Credit rationing : A involves restricting the quantity of loans made available to individual borrowers. B. results from a monotonic 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. 7 Use the following information to answer Questions 30 - 32. Suppose that the financial ratios of a potential borrower took the following values : X 1 = 0.3, X2 = 0, X3 = -0.30, X4 = 0.15, X5 = 2.1 30. Using the Altmans credit scoring model, the Z score for the firm would be : A. 1.64 B. 1.56 C. 2.10 D. 3.54 31. According to Altmans credit scoring model, this firm should be considered : A. a high default risk firm. B. an indeterminant default risk firm. C. a low default risk firm. D. a lowest risk customer. 32. Suppose X3 = 0.2 instead of -0.30. According to Altmans credit scoring model, the firm would fall under which default risk classification ? A. A high default risk firm. B. An indeterminant default risk firm. C. A low default risk firm. D. A medium default risk firm. 33. According to the market segmentation theory of the term structure, A. The interest rate for bonds of one maturity is determined by supply & demand for bonds of that maturity. B. Bonds of one maturity are not substitutes for bonds of other maturities; therefore, interest rates on bonds of different maturities do not move together over time. C. Investors strong preference for short-term relative to long-term bonds explains why yield curves typically slope upward. D. All of the above. 8 34. Immunization of a portfolio implies that changes in _____ will not affect the value of the portfolio. A. book value of assets B. maturity C. interest rates D. duration Questions 35-36 are based on an 18-month, 8 percent (semiannual) coupon Treasury note selling at par. 35. A. B. C. D. What is the duration of this Treasury note ? 1.500 years 1.371 years 1.443 years 2.882 years 36. If interest rates increase by 20 basis points (i.e., R = 20 basis points), use the duration approximation to determine the approximate price change. A. $0.2775 per $100 face value. B. $2.775 per $100 face value. C. $0.2672 per $100 face value. D. $2.672 per $100 face value. 37. A. B. C. D. The convexity adjustment overestimates price decreases. underestimates price increases. approximates the curvature of the nonlinear price valuation function. is less accurate for large interest rate changes because of its nonlinearity. 38. The portfolio of a bank that contains assets and liabilities that are relatively illiquid and held for longer holding periods A. is the trading portfolio. B. is the investment portfolio. C. contains only long term derivatives. D. is subject to regulatory risk. 9 39. A. B. C. D. Price volatility is calculated as the price sensitivity times an adverse daily yield move. the dollar value of a position times the price volatility. the dollar value of a position times the potential adverse yield move. the price volatility times the N.

40. If foreign currency exchange rates are highly positively correlated, how can a FI reduce its exchange rate risk exposure ? A. B. C. D. By taking net long positions in all currencies. By taking net short positions in all currencies. By taking opposing net short and net long positions in different currencies. By taking opposing net long and net short positions in same currency. *** THE END OF THE PAPER *** 10 Multiple Choice Questions (20%; 0.5% for each question) Question No. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Answer Question No. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. Answer B D A D A A C A D D Question No. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. Answer Question No. Answer D D D A D D D A C A A C D C C A C B A C 11 Question No. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. Answer Question No. Answer C D B B B C D A A B