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1 Jan 2018

4. What is insolvency risk? How can liquidity risk and credit risk cause insolvency? What actions can a financial institution take to best protect itself against insolvency? (25 points)

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Beverley Smith
Beverley SmithLv2
2 Jan 2018
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Related questions

1. True or False? If false, justify your answer.

a. The Dodd Frank Act increased the regulation of derivatives.

b. The McFadden Act of 1927 imposed a rigid separation between commercial and investment banks.

c. A Section 20 Affiliate is a securities subsidiary of a bank holding company through which a banking organization can engage in investment banking activities.

d. In the early 1980s, low interest rates led to disintermediation.

e. Liquidity risk is the risk that the promised cash flows from loans and securities held by FIs may not be paid in full.

f. Wholesale banking is business oriented while retail banking is consumer oriented.

g. Insolvency risk is the risk that a financial institution may not have enough capital to offset a sudden decline in the value of its assets relative to its liabilities.

Choose the best multiple choice:

When considering both their assets and their liabilities many institutions try to immunize their portfolios against interest rate risk. Which of the following is a true statement:

a) When an institution matches the durations of its assets and liabilities, price risk is eliminated but reinvestment risk continues to be a potential problem.

b) When an institution matches the durations of its assets and liabilities, reinvestment risk is eliminated but price risk continues to be a potential problem.

c) Assuming interest rates do not change, if an institution begins by strictly matching the durations of their assets and liabilities they won’t need to rebalance later, even if the durations of their assets and liabilities change over time at different rates.

d) When significant market interest rates changes occur, convexity differences between an institution’s asset and liability positions can create a need to rebalance a previously immunized portfolio.

4) A mortgage banker had made loan commitments for $20 million in 3 months. How many contracts on Treasury bonds futures must the banker write or buy? 5) Duration is defined as the weighted average time to maturity of a financial instrument. Explain how this knowledge can help protect against interest rate risk.

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