FINA 365 Final Exam Possible Chapter 12 Questions

MULTIPLE CHOICE. Choose the one alternative that best completes the statement or answers the question.

1) Which of the following is NOT a potential causes of liquidity risk for a DI?
A) An increase in requests by depositors to withdrawal large amounts of deposits.
B) A decrease in asset prices of securities held in the investment portfolio.
C) A decrease in the DI's stock price caused by market factors.
D) A decrease in the availability of short-term borrowed funds.
E) An increase in requests to fund large amounts of loan commitments.

2) Which type of financial intermediary is more highly exposed to liquidity risk?

A) Property-casualty insurance companies.
B) Depository institutions.
C) Mutual funds.
D) Life insurance companies.
E) Pension funds.

3) What is a fire-sale price?

A) Maximum price that will be received on sale of an asset irrespective of the time of sale.
B) Market value of an asset.
C) Replacement value of an asset.
D) Book value of an asset.
E) Price received for an asset that has to be liquidated immediately.

4) Which of the following is a condition for a DI to be growing?

A) Unused loan commitments is increasing.
B) Average deposit drain such that new deposit funds more than offset deposit withdrawals.
C) Net positive drain on deposits.
D) The liability side of its balance sheet is decreasing.
E) Peak of the net deposit drain probability distribution should lie at a point to the right of zero.

5) Which of the following balance sheet entries is not a tool used in purchased liquidity management?
A) Federal fund.
B) Demand deposit.
C) Subordinated note.
D) Bonds.
E) Repurchase agreement.

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 6) Which of the following observations is NOT true?
A) Today, many DIs rely on purchased liquidity management to deal with the risk of cash
shortfalls.
B) Purchased liquidity management and stored liquidity management are ways of managing a
drain on deposits.
C) Traditionally, DI managers have relied on purchased liquidity management as the primary
mechanism of liquidity management.
D) The largest banks with access to the money market and other nondeposit markets for funds rely
on purchased liquidity management to deal with the risk of cash shortfalls.
E) None of the above.

7) A disadvantage of using purchased liquidity management to manage a FI's liquidity risk is

A) the relatively high cost of purchased liabilities.
B) the accessibility of international money markets.
C) the resulting shrinkage of the FI's balance sheet.
D) tax considerations.
E) loss of flexibility as a result of dependence upon purchased liabilities.

8) 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) tax considerations.
C) the high cost of purchased liabilities.
D) loss of flexibility as a result of dependence upon purchased liabilities.
E) the accessibility of international money markets.

9) Which of the following statements is NOT true?

A) A DI sustains no cost under stored liquidity risk management.
B) DIs hold cash reserves in excess of the minimum required to meet liquidity drains.
C) When the DI uses its cash as the liquidity adjustment mechanism, both sides of its balance
sheet contract.
D) Traditionally DIs have stored cash reserves at the Federal Reserve and in their vaults to
overcome liquidity risk.
E) Stored liquidity management involves liquidation of assets.

10) Why have purchased liquidity management techniques become very popular in spite of its
limitations?
A) Because funds can be easily raised in the eventuality of a liquidity crunch.
B) Because the funds are covered by deposit insurance.
C) Because of decrease in the cost of funds during periods of high interest rate volatility.
D) Because the adjustment to the deposit drain occurs on the liability side of the balance sheet.
E) Because it insulates the assets of an FI from normal drains on liability liquidity.

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11) When banks use stored liquidity management, they
A) necessarily increase the asset side of the balance sheet.
B) must pay interest on the funds that are stored.
C) threaten the capital position of the institution.
D) store the funds at the U.S. Treasury.
E) may shrink the balance sheet if cash is used as the liquidity adjustment mechanism.

12) If purchased liquidity is used by a DI to fund an exercised loan commitment

A) there will be no effect on the balance sheet.
B) the balance sheet will decrease by the amount of the new loan.
C) only the liability side of the balance sheet will increase.
D) only the asset side of the balance sheet will increase.
E) the balance sheet will increase by the amount of the new loan.

13) If stored liquidity is used by a DI to fund an exercised loan commitment

A) only the liability side of the balance sheet will increase.
B) there will be no effect on the balance sheet.
C) the balance sheet will increase by the amount of the new loan.
D) only the asset side of the balance sheet will increase.
E) the balance sheet will decrease by the amount of the new loan.

14) What is the asset adjustment to a bank's balance sheet if the bank sold a five-year, 7 percent annual
coupon $100,000 bond acquired at par, but now yielding 8 percent? The bond was not in the
mark-to-market portfolio.
A) A $100,000 increase in assets.
B) A $100,000 reduction in assets.
C) A $96,007 reduction in assets.
D) A $96,007 increase in assets.
E) A $100,000 increase in liabilities.

15) An open-end bond mutual fund is holding a three-year, $1 million face value 5 percent annual
coupon bond selling at par. What is the impact on the total asset value of the fund of a 1 percent
decrease in interest rates?
A) A decrease of $10,000.
B) A decrease of $26,730.
C) An increase of $27,751.
D) An increase of $10,000.
E) The answer depends upon the number of mutual funds shares outstanding.

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16) What is the impact of a 50 basis point increase in interest rates on the net asset value of an open-end
bond mutual fund holding a seven year, $100 million face value 7 percent annual coupon bond
selling at par? The fund has 10 million shares.
A) A decrease of $0.05 per share.
B) An increase of $0.24 per share.
C) A decrease of $0.265 per share.
D) An increase of $0.265 per share.
E) An increase of $0.05 per share.

17) In the event of financial distress, open-ended mutual fund investors

A) have an incentive to cash in their shares quickly since that will increase the fund's net asset
value.
B) will switch into low risk bank deposits.
C) have an incentive to avoid a run since the Federal Reserve guarantees mutual fund holdings.
D) have an incentive to avoid a run since that will deplete the fund net asset value.
E) have an incentive to cash in their shares quickly since they are paid on a first come, first served
basis.

18) The surrender value of an insurance policy is

A) normally a portion of the contract's face value.
B) its holdup value.
C) the value of the junk bonds in the insurance company's portfolio.
D) its promised payoff.
E) its value upon bankruptcy.

19) Which intermediation function results in an FI's exposure to liquidity risk?

A) Asset transformation.
B) Brokering between funds deficit units and funds surplus units.
C) Lender of last resort.
D) Information production.
E) Conduit for monetary policy.

20) How does purchased liquidity management affect profitability?

A) By its impact on the interest rate sensitivity of liabilities.
B) By enhancing the liquidity of assets held.
C) By determining the default risk of investment securities.
D) By its impact on the interest rate sensitivity of assets.
E) By its impact on the cost of purchased funds.

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21) When comparing banks and mutual funds,
A) mutual funds have more liquidity risk than banks because all shareholders have the ability to
withdraw their money on a first-come first basis.
B) mutual funds have less liquidity risk than banks because all shareholders share the loss of value
on a pro rata basis.
C) mutual funds have more liquidity risk than banks because all shareholders share the loss of
value on a pro rata basis.
D) mutual funds have the same liquidity risk as banks because both shareholders and depositors
share the fall in the loss of value on a pro rata basis.
E) mutual funds have less liquidity risk than banks because all shareholders have the ability to
withdraw their money on a first-come first basis.

22) Which of the following is NOT a primary source of liquidity?

A) Excess cash reserves over and above regulatory reserve requirements.
B) Capital notes and other long-term financing alternatives.
C) Cash-type assets that can be sold with little price risk and low transaction costs.
D) Borrowings in the purchased funds market.
E) Borrowings in the money market.

23) Which of the following is NOT used as a method of measuring liquidity risk?
A) Liquidity index.
B) Liquidity coverage ratio.
C) Financing gap and financing requirement.
D) Peer group ratio comparison.
E) Current ratio.

24) What information does the net liquidity statement provide?

A) Sources and uses of liquidity.
B) A long-term focus on liquidity.
C) Liquidity index information.
D) Peer group ratio comparison.
E) Net asset value.

25) Which of the following is a measure of the potential losses an FI could suffer as the result of
fire-sale disposal of assets?
A) Peer group ratio.
B) Current ratio.
C) Liquidity index.
D) Financing gap and financing requirement.
E) Quick ratio.

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26) A DI has two assets: 50 percent in one-month Treasury bills 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 month'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 liquidation at the
end of one month will produce $92 per $100 of face value. The one-month liquidity index value for
this DI's asset portfolio is
A) .940. B) .973. C) 1.06. D) .979. E) 1.10.

27) For a DI, what does a high ratio of loans to deposits indicate?
A) High degree of loan commitments.
B) Liquidity concerns are at a bare minimum for the FI.
C) DI has large amounts of asset-side liquidity.
D) DI relies heavily on core deposits to fund loans.
E) DI relies heavily on the short-term money market to fund loans.

28) In terms of liquidity risk measurement, the financing gap is defined as

A) total deposits minus core deposits.
B) financing requirement plus liquid assets.
C) rate sensitive assets minus rate sensitive liabilities.
D) average loans minus average deposits.
E) total assets minus total liabilities.

29) In terms of liquidity risk measurement, the financing requirement is defined as

A) financing gap plus liquid assets.
B) average loans minus average deposits.
C) total assets minus total liabilities.
D) rate sensitive assets minus rate sensitive liabilities.
E) total deposits minus core deposits.

30) In a crisis, which of the following are more likely to withdraw funds quickly from banks and thrifts?
A) Individual depositors.
B) Foreign depositors.
C) Correspondent banks.
D) Small business corporations.
E) Mutual funds.

31) In a crisis, which of the following are relatively less likely to withdraw funds quickly from banks
and thrifts?
A) Correspondent banks.
B) Pension funds.
C) Individual depositors.
D) Small business corporations.
E) Mutual funds.

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32) Which of the following observations concerning the Fed's discount window is true?
A) Secondary credit is available only to depository institutions that are eligible for primary credit.
B) Eligible institutions for seasonal credit are big banks located in urban areas.
C) Primary credit is available to sound depository institutions on a very short-term basis.
D) Four lending programs are offered through the Fed's discount window.
E) The facility is provided to meet DIs' permanent liquidity needs.

33) What are the two major liquidity risk insulation devices available?
A) Financing gap and the financing requirement.
B) Deposit insurance and discount window.
C) Secondary credit and seasonal credit.
D) Liquidity planning and maturity ladder.
E) Scenario analysis and liquidity index.

34) What is the drawback of deposit insurance facility?

A) DIs are more likely to increase the liquidity risk on their balance sheets.
B) Deposit insurance does not deter contagious runs and panics.
C) Deposit holder's place in line affects his or her ability to obtain their funds.
D) Deposit holders are less likely to panic if there is a perceived bank solvency problem.
E) Even when the DI is in trouble, the deposit holder has no incentive to run.

35) Which of the following is NOT included as high-quality liquid assets when computing a liquidity
coverage ratio?
A) Central bank reserves.
B) Bank capital.
C) Sovereign debt.
D) Cash.
E) Government guaranteed mortgage-backed securities.

36) The liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) proposed by the Bank for
International Settlements are scheduled to take effect in
A) 2013 for LCR and 2016 for NSFR.
B) 2014 for both LCR and NSFR.
C) 2015 for LCR and 2018 for NSFR.
D) 2012 for both LCR and NSFR.
E) 2011 for LCR and 2014 for NSFR.

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37) Which of the following statements is true?
A) Open-end funds need not stand ready to buy back previously issued shares from investors at the
current market price for the fund's shares.
B) The number of outstanding shares of a closed-ended fund may change when the issuing fund
chooses to repurchase them.
C) At a given market price, the supply of open-end fund shares is perfectly inelastic.
D) Closed-end funds issue an unlimited number of shares as liabilities.
E) Open-end funds supply limited number of shares to investors.

38) Consider a mutual fund with 100 shareholders who each invested $10 for a total of $1,000. If the
assets of the mutual fund are worth $900, what is the net asset value for each one of the mutual fund
shares?
A) $0.10. B) $9. C) $10. D) $90. E) $0.9.

39) The price at which an open-end investment fund stands ready to redeem existing shares is the
A) face value.
B) net asset value.
C) net worth.
D) strike price.
E) book value.

40) If the bank's expected net deposit drain is +4 percent, what is the bank's expected liquidity
requirement?
A) $22,000. B) $16,000. C) $6,040. D) $14,760. E) $7,560.

41) What are the possible ways that the bank can meet an expected net deposit drain of +4 percent using
purchased liquidity management techniques?
A) Utilize further the Fed funds market.
B) Utilize repurchase agreements.
C) Liquidate all cash holdings.
D) All of the above.
E) Answers A and B only.

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 42) What are the possible ways that the bank can meet an expected net deposit drain of +4 percent using
stored liquidity management techniques?
A) Liquidate all cash and use more Fed funds.
B) Liquidate all cash holdings.
C) Liquidate some securities and/or loans.
D) Utilize further the Fed funds market.
E) All of the above are suitable techniques.

43) If the bank decides to cut down on interest expenses by reducing its dependence upon borrowed
funds, what policy must the bank follow?
A) Increase interest income by increasing securities holdings.
B) Manage liquidity risk exclusively through liability management.
C) Increase interest income by increasing lending.
D) Reduce the bank's dependence upon demand deposits.
E) Manage liquidity risk exclusively through reserve asset management.

44) If the bank experiences a $50,000 sudden liquidity drain caused by a loan commitment draw down,
what will be the impact on the balance sheet if stored liquidity management techniques are used?
A) A decrease in lending of $50,000.
B) A reduction in cash of $21,000 and an increase in demand deposits of $29,000.
C) A reduction in securities and/or current loans totaling $50,000.
D) A decrease in equity of $50,000.
E) A reduction in cash of $21,000 and a decrease in securities holdings of $29,000.

The average interest earned on the loans is 6 percent and the average cost of deposits is 5 percent. Rising interest
rates are expected to reduce the deposits by $3 million. Borrowing more debt will cost the bank 5.5 percent in the
short term.
45) What will be the size of the bank if a stored liquidity management strategy is adopted?
A) $15 million.
B) $9 million.
C) $14 million.
D) $11 million.
E) $12 million.

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 46) What will be the cost of using a strategy of reducing its asset base to meet the expected decline in
deposits? Assume that the bank intends to keep $2 million in cash as a liquidity precaution.
A) $40,000. B) $15,000. C) $50,000. D) $30,000. E) $10,000.

47) What will be the cost of using a strategy of purchased liquidity management to meet the expected
decline in deposits? Assume that the bank intends to keep $2 million in cash as liquidity precaution.
A) $50,000. B) $40,000. C) $10,000. D) $15,000. E) $30,000.

48) What will be the size of the bank if a purchased liquidity management strategy is adopted?
A) $15 million.
B) $12 million.
C) $14 million.
D) $9 million.
E) $11 million.

An FI has $5 million in cash reserves with the Fed in excess of its reserve requirements, $5 million in T-Bills,
and a credit line of $10 million to borrow in the repo market. It currently has lent $2 million in the Fed Funds
market and borrowed $1 million from the Federal discount window to meet its seasonal needs.
49) What are the bank's total available sources of liquidity?
A) $22 million.
B) $17 million.
C) $20 million.
D) $21 million.
E) $18 million.

50) What are the bank's current total uses of liquidity?

A) $3 million.
B) $10 million.
C) $8 million.
D) $1 million.
E) $15 million.

51) What is the net liquidity of the bank?

A) $17 million.
B) $22 million.
C) $12 million.
D) $7 million.
E) $21 million.

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52) Assume that the T-Bills can only be sold at a 10 percent discount, what is the net liquidity of the
bank given this information?
A) $21.5 million.
B) $6.5 million.
C) $11.5 million.
D) $20.5 million.
E) $16.5 million.

53) A bank's net deposit drain

A) is negative if deposits exceed withdrawals.
B) fluctuates unpredictably on any given day.
C) is positive if deposits exceed withdrawals.
D) in unaffected by holiday and vacation periods.
E) decreases during holiday and vacation periods.

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