FIM - Sample Examination
Sample Examination Pape
FINANCIAL INSTITUTIONS MANAGEMENT II
Exam response Time : XXXXXXXXXXmins
Submission time : 15 mins
Grace period : XXXXXXXXXX5 mins
Total Duration 190 mins
Instructions to Candidate:
1. Answer ALL questions in Sections A, B and C
2. This is an Open Book examination.
3. Please allocate your time according to the percentage contribution of the questions.
PLEASE SEE NEXT PAGE
FIM - Sample Examination
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SECTION A: Multiple Choice
Each question is worth 1 mark- select the answer you believe most co
ect. Mark your
answers on the answer sheet provided.
A1. Which of the following is a method that may overcome weaknesses in the historic or back
simulation model in measuring market risk?
(a) The use of smaller sample sizes to estimate return distributions.
(b) Weight sample size observations so that the more recent observations contribute a larger
amount to the model.
(c) Decrease the number of assets in the trading portfolio so that past returns will provide more
accuracy to the model.
(d) Increase the number of assets in the trading portfolio in order to benefit from higher levels
of diversification.
(e) The weaknesses in the model cannot be overcome.
A2. Which of the following statements is NOT true?
(a) Stored liquidity management involves liquidation of assets.
(b) Traditionally Depository Institutions have stored cash reserves at the Central bank and in
their vaults to overcome liquidity risk.
(c) When a Depository Institution uses its cash to fund a net deposit drain, both sides of its
alance sheet contract.
(d) DIs hold cash reserves in excess of the minimum required to meet liquidity drains.
(e) Bank sustains no cost under stored liquidity risk management.
A3. Which of the following statements best describes the treatment of adjusting for credit risk of
off-balance-sheet activities under Basel risk based capital ratio ?
(a) All OBS activities are treated equally in making credit-risk adjustments.
(b) Standby letter of credit guarantees issued by banks to back commercial paper have a 0
percent conversion factor.
(c) The credit or default risk of over-the-counter contracts is approximately zero.
(d) The treatment of forward, option, and swap contracts differs from the treatment of
contingent or guarantee contracts.
(e) None of the given answers
A4. A disadvantage of using stored liquidity management to manage a FI's liquidity risk is
(a) the resulting shrinkage of the FI's balance sheet.
(b) the high cost of purchased liabilities.
(c) the accessibility of international money markets.
(d) tax considerations.
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(e) loss of flexibility as a result of dependence upon purchased liabilities.
A5. Assume the dollar market value of an FI’s position is $200,000 and the calculated price
volatility is 1.25%. What is the VAR of the position if the FI is required to hold the position
for 6 days (round to two decimals)?
(a) $2,683.28.
(b) $6,123.72.
(c) $200,000.00.
(d) $489,897.95.
(e) None of the above answers
A6. Assume the interest rate in the market for one-year zero-coupon government bonds is i = 8%
and the rate for one-year zero-coupon grade BBB bonds is k = 10.2%. What is the implied
probability of repayment on the corporate bond (round to two decimals)?
(a) 2.00%.
(b) 5.04%.
(c) 97.96%.
(d) 98.00%.
(e) 90%
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A7. The following are the net cu
ency positions of a US Financial Institution (stated in US
dollars).
Note: Net cu
ency positions are foreign exchange bought minus foreign exchange sold
estated in US dollar terms.
How would you characterise the FI's risk exposure to fluctuations in the Euro to dollar
exchange rate?
(a) The Financial Institution is net short in the Euro and therefore faces the risk that the Euro
will rise in value against the U.S. dollar.
(b) The Financial Institution is net short in the Euro and therefore faces the risk that the Euro
will fall in value against the U.S. dollar.
(c) The Financial Institution is net long in the Euro and therefore faces the risk that the Euro
will fall in value against the U.S. dollar.
(d) The Financial Institution is net long in the Euro and therefore faces the risk that the Euro
will rise in value against the U.S. dollar.
(e) The Financial Institution has a balanced position in the Euro.
A8. The repricing gap does not accurately measure FI interest rate risk exposure because
(a) FIs cannot accurately predict the magnitude change in future interest rates.
(b) FIs cannot accurately predict the direction of change in future interest rates.
(c) accounting systems are not accurate enough to allow the calculation of precise gap
measures.
(d) it does not recognize timing differences in cash flows within the same maturity grouping.
(e) equity is omitted.
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A9. ABC Bank is charging a 10 percent interest rate on a $10,000,000 loan. The bank has a cost
of funds of 7 percent. The bo
ower has a ten percent chance of default, and if default occurs,
the bank expects to recover 85 percent of the principal and interest. What is the expected
eturn on the loan using the KMV model?
(a) 6.5 percent.
(b) 0.5 percent.
(c) 3.5 percent.
(d) 1.5 percent
(e) None of the given answers
A10. The Basel capital requirements are based upon the premise that
(a) banks with riskier assets should have higher capital ratios.
(b) banks with riskier assets should have lower capital ratios.
(c) banks with riskier assets should have lower absolute amounts of capital.
(d) banks with riskier assets should have higher absolute amounts of capital.
(e) there is no relationship between asset risk and capital.
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Section B (2 questions)
(Answer all questions, each question is worth 5 marks)
B1. ABC Bank has a $1 million position in a five-year, zero-coupon bond with a face value of
$ XXXXXXXXXXThe bond is trading at a yield to maturity of 7.00 per cent. The historical mean
change in daily yields is 0.0 per cent, and the standard deviation is 12 basis points.
(a) What is the maximum adverse daily yield move given that we desire no more than a 5 per
cent chance that yield changes will be greater than this maximum?
Potential adverse move in yield at 5 per cent = 1.65 = 1.65 x 0.0012 = XXXXXXXXXX
(b) What are the daily earnings at risk for this bond?
MD = 5 ÷ (1.07) = XXXXXXXXXXyears
Price volatility = -MD x potential adverse move in yield
= XXXXXXXXXXx .00198 = XXXXXXXXXXor XXXXXXXXXXper cent
DEAR = ($ value of position) x (price volatility)
= $ XXXXXXXXXXx XXXXXXXXXX = $9252
(c) What is meant by value at risk (VAR)? What would be the VAR for the bond held by ABC
Bank for a 10-day period?
Value at risk or VAR is the cumulative DEARs over a specified period of time and is given by
the formula VAR = DEAR x [N]½.
VAR is a more realistic measure if it requires a longer period to unwind a position, that is if
markets are less liquid.
The value for VAR is $9252 x 3.1623 = $ XXXXXXXXXX.
B2. XYZ Bank issues a six-month, $1 million Eurodollar deposit at an annual interest rate of 6.5
per cent. It invests the funds in a six-month British pound (GBP) bond paying 7.5 per cent per
year. The cu
ent spot rate is $0.18/GBP.
(a) The six-month forward rate on the pound is being quoted at $0.1810/GBP. What is the net
spread earned on this investment if the bank covers its foreign exchange exposure using
the forward market?
Interest plus principal expense on six-month CD = $1m x XXXXXXXXXX/2) = $ XXXXXXXXXX
Principal of UK bond = $ XXXXXXXXXX/0.18 = GBP XXXXXXXXXX
Interest and principal = GBP XXXXXXXXXXx XXXXXXXXXX/2) = GBP XXXXXXXXXX
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Interest and principal in dollars if hedged: GBP XXXXXXXXXXx 0.1810 = $ XXXXXXXXXX
Spread = $ XXXXXXXXXX500 = $ XXXXXXXXXX/1 million = XXXXXXXXXXper semi annual, or
2.15 per cent p.a.
(b) Explain how forward and spot rates will both change in response to the increased spread?
If FIs are able to earn higher spreads in other countries and guarantee these returns by using
the forward markets, these are equivalent to risk-free investments (except for default risk). As
a result, in part (a) there will be an increase in demand for the UK pound in the spot market
and an increase in sale of the forward GBP as more banks engage in this kind of lending. This
esults in an appreciation of the spot GBP and a depreciation of the forward GBP until the
spread is zero for securities of equal risk.
(c) Why will the financial institution still be able to earn a spread of 1 per cent knowing that
interest rate parity usually eliminates a
itrage opportunities created by differential rates?
The FI is still able to earn a spread of 1 per cent because the risk of the securities is not equal.
Thus, the 1 per cent spread reflects credit or default risk. If the FI were to invest in securities
of equal credit risk in the UK, a
itrage would ensure that the spread is zero.
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Section C (3 questions)
(Answer all questions, each question is worth 10 marks)
C1