Reference no: EM133188043

Question 1. What is the difference between firm-­-specific credit risk and systemic credit risk? How can an FI alleviate firm-­-specific credit risk?

Question 2. What is liquidity risk? What routine operating factors allow FIs to deal with this risk in times of normal economic activity? What market reality can create severe financial difficulty for an FI in times of extreme liquidity crises?

Question 3. What is the process of asset transformation performed by a financial institution? Why does this process often lead to the creation of interest rate risk? What is interest rate risk?

Question 4. How can interest rate risk adversely affect the economic or market value of an FI?

Question 5. A money market mutual fund bought $1,000,000 of two-­-year Treasury notes six months ago. During this time, the value of the securities has increased, but for tax reasons the mutual fund wants to postpone any sale for two more months. What type of risk does the mutual fund face for the next two months?

Question 6. Characterize the risk exposure(s) of the following FI transactions by choosing one or more of the following:

a. Credit risk
b. Interest rate risk
c. Off-­-balance-­-sheet risk
d. Foreign exchange rate risk
e. Country/sovereign risk
f. Technology risk

(1) A bank finances a $10 million, six-­-year, fixed-­-rate commercial loan by selling one-­-year certificates of deposit.
(2) An insurance company invests its policy premiums in a long-­-term municipal bond portfolio.
(3) A French bank sells two-­-year fixed-­-rate notes to finance a two-­-year fixed-­-rate loan to a British entrepreneur.
(4) A Japanese bank acquires an Austrian bank to facilitate clearing operations.
(5) A mutual fund completely hedges its interest rate risk exposure using forward contingent contracts.
(6) A bond dealer uses his own equity to buy Mexican debt on the less developed countries (LDC) bond market.
(7) A securities firm sells a package of mortgage loans as mortgage-­-backed securities.

Question 7. Consider the following income statement for WatchoverU Savings Inc. (in millions):

          Assets                                                              Liabilities

Floating-rate mortgages (currently 10% annually) 30-year fixed-rate loans (currently 7% annually)

$50 NOW accounts (currently 6% annually) 50 Time deposits (currently 6% annually)

$70 20

                                                                Equity 10
Total                                                             $100                                                        $100

a. What is WatchoverU's expected net interest income at year-­-end?
b. What will be the net interest income at year-­-end if interest rates increase by 2 percent?

Question 8. If a bank invested $50 million in a two-­-year asset paying 10% interest per year and simultaneously issued a $50 million one-­-year liability paying 8% interest per year, what would be the impact on the bank's net interest income if, at the end of the first year, all interest rates increased by 1% point?