VERSION B

FAMILY NAME: ___________________________

OTHER NAME(S): ___________________________

STUDENT ID: ___________________________

SIGNATURE: ___________________________

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UNSW Business School
SCHOOL OF BANKING AND FINANCE

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rs e FINS1613: Business
Semester Finance
1, 2017
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Semester 1 2015

FINS 3630: BANKTutorial Quiz 2MANAGEMENT

FINANCIAL
MID-SESSION EXAM
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Reproduction by Aaron On
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Name: Cindy Si Yun Li

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Student number: 5075327

1.! TIME ALLOWED – 2 HOURS
Tutorial:
2.! NO READING TIME ALLOWED Peter (H13A)
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3.! THIS EXAMINATION PAPER HAS 9 PAGES INCLUDING THE TITLE PAGE.
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4.! PLEASE INDICATE YOUR ANSWERS IN A SEPARATE GENERALISED ANSWER SHEET

Instructions:
IN 2B OR DARKER PENCILS. ANSWERS WRITTEN ELSEWHERE WILL NOT BE
1. You must complete a Generalised Answer Sheet for this exam.
GRADED.
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(a) Complete the top portion of the sheet, providing your family name,
5.! THIS IS A CLOSED-BOOK
initials, andEXAM.
student NO FORMULAE SHEET OR NOTE IS ALLOWED.
number.
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CANDIDATES
(b)MAY
If youBRING UNSW-APPROVED
are taking CALCULATORS
a quiz marked Extra, record the quizTO THE under
number
Other Data. If you are taking a quiz preprinted with your student
EXAMINATION.
information, leave Other Data blank.
6.! THIS PAPER (c)
MAY NOT all
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RETAINED usingBY
theCANDIDATES.
generalised answer sheet. Clearly fill in
the response oval using a 2B pencil.
NOTES: 2. You must not retain any part of this examination document. All examination
materials
!! There were including
45 questions butthis document
I don’t musteverything
remember be submitted
fromatthe
the completion
actual exam. of
the examination, otherwise your exam will not be marked.
!! Some questions do not have the exact figures so please do not memorise answers.
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 Question 1 IMPORTANT:
1.! Please correctly indicate the version of your exam paper in the provided answer sheet. Not
or incorrectly answering this question will result in incorrect grading of your paper and
subject to 1 mark penalty.
What is the version of your exam paper?
A. Version A
B. Version B
Please choose B for question 1 in the answer sheet.

2.! Which of the following is true?

A.! Adverse selection is the problem created by asymmetric information before the
transaction occurs
B.! Adverse selection in financial markets occurs when the potential borrowers who are the
most likely to pay back, the bad credit risk, are the ones who most actively seek out a

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loan and are thus most likely to be selected
C.! Moral hazard in financial markets is the risk (hazard) that the borrower might engage in

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activities that are undesirable (immoral) from the lender’s point of view, because they
make it less likely that the loan will be paid back

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D.! Options (A) and (C)
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E.! Options (A), (B), and (C)
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3.! Which of the following is true for the RBA?
A.! In the event of such threats, the RBA retains its discretionary role of ‘lender of last resort’
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(LOLR) for emergency liquidity support

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B.! The RBA has no obligation to protect the interests of bank depositors or other creditors of
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banks; rather, its task is to deal with threats to financial stability that have the potential to
spill over to economic activity and consumer and investor confidence
C.! The RBA, under the auspices of its Payments System Board, also has a mandate to
promote safety, competition and efficiency in the Australian payments system, and has
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the backing of strong regulatory powers

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D.! Options (A) and (B)

E.! Options (A), (B), and (C)
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4.! Which of the following is true for shadow banks?

A.! Credit intermediation involving entities and activities outside the regular banking system
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B.! Have facilitated the change from “Originate and Distribute” model of commercial
banking to “Originate and Hold” banking model
C.! Shadow banking includes Structured Investment Vehicles (SIV), Special Purpose
Vehicles (SPV), Asset Backed Commercial Paper (ABCP) conduits, Money Market
Mutual Funds (MMMFs), Credit Hedge Funds among others
D.! Options (A) and (C)
E.! Options (A), (B), and (C)

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 5.! What is the first layer of protection for safety and soundness regulation for FI?
A.! Minimum capital
B.! Deposit insurance
C.! Examination on and off site
D.! Diversification of assets
E.! None of the above

6.! The expected rate of return on this 1-year loan is 12.7% per annum. If the borrower defaults,
90% of the principal and interest payments are expected to be recovered. If the borrower is
expected to default with a 20% probability what is the contractually-promised return on this
loan?
A.! 0.15
B.! 0.127
C.! 0.12

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D.! 0.058

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E.! -0.08

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Questions 7 and 8 are related.

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7.! Bank ABC has a loan lent to firm DEF. The interest rate charged for this loan is 8% (5% for
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base rate, and 3% for risk premium). The compensating balance (b) is 5%, and there is 10%
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reserve requirement (RR). Assuming that firm DEF has a probability of 20% to default on this
loan, and once defaulted, the recovery rate is 90%, what is the expected rate of return on this
loan?
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A.! 0.0800
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B.! 0.0838
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C.! 0.0621
D.! 0.0900
E.! None of the above
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8.! Under Ceteris Paribas, suppose there is no compensating balance from question 6. Which of
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the following is true for the expected rate of return?

A.! The expected return without the compensating balance will be lower than the expected
return from question 7
B.! The expected return without the compensating balance will be higher than the expected
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return from question 7

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C.! The expected return without the compensating balance will be the same as the expected
return from question 7
D.! The expected return with the compensating balance will be the higher than the expected
return from question 7
E.! There is not enough information to determine this

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 9.! An FI wants to evaluate the credit risk of a $10 million loan with a duration of 4.3 years to a
AAA borrower. There are currently 500 publicly traded bonds in that class (i.e., bonds issued
by firms with a AAA rating). The current average level of rates (R) on AAA bonds is 8
percent. The largest increase in credit risk premiums on AAA loans, the 99 percent worst-case
scenario, over the last year was equal to 1.2 percent (i.e., only 6 bonds out of 500 had risk
premium increases exceeding the 99 percent worst case). The projected (one-year) spread on
the loan is 0.3 percent and the FI charges 0.25 percent of the face value of the loan in fees.
What is the the capital at risk and the RAROC on this loan?
A.! $3,185,185, 0.0725
B.! $477,778, 0.1151
C.! $3,185,185, 0.0725
D.! $477,778, 0.1151
E.! None of the above

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Please use the following information for the next two questions:

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A bank develops the following linear discriminant model of the credit quality (i.e., a higher Z

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means a better credit quality) based on their own loan database:

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Z = β1X1 + β2X2 + 2.0X3

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where X1 is debt to asset ratio (long-term debts/total assets), X2 is return on asset (net
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income/total assets), and X3 is earnings retention ratio (retained earnings/total assets). Based on
the estimates of coefficients provided the bank's risk management team, the coefficients of X1
and X2 are either 2 or -1.5. For one of its potential borrower, X1 = 30%, X2 = 20%, and X3 =
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90%.
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10.! What should be the value of coefficients of X1 and X2 respectively?

β1 β2
A.! 2 -1.5
B.! -1.5 -2
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C.! -1.5 -1.5

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D.! 2 2
E.! None of the above
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11.! Assuming the two critical values of Zs for loan decisions (approval or rejection) are 1.85 and
2.99, should the bank approve the loan for this client?
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A.! Yes, because the Z-score for this client is higher than the cut-off value 2.99.
B.! Yes, because the Z-score for this client is lower than the cut-off value 2.99.
C.! No, because the Z-score for this client is higher than the cut-off value 1.85.
D.! No, because the Z-score for this client is lower than the cut-off value 1.85.
E.! The client’s case is indecisive.

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 12.! The current term structure for Treasury and corporate debt is

Spot 1 year Spot 2 years

Treasury 3.5 percent 4.25 percent
BBB corporate debt 8.2 percent 10.45 percent

The cumulative probability of repayment of the BBB corporate debt over the next 2 years is
A.! 0.8910
B.! 0.1121
C.! 0.9440
D.! 0.9970
E.! None of the above

13.! Any model that seeks to estimate an efficient frontier for loans, and thus the optimal

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proportions in which to hold loans made to different borrowers, needs to determine and

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measure:

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A.! the expected return on a loan to borrower

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B.! the risk of a loan to borrower

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C.! the correlation of default risks between loans made to borrowers
D.! only A and B rs e
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E.! all of A, B and C

14.! Matrix Bank has compiled the following migration matrix on consumer loans. Which of the
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following statements accurately summarizes this data?

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Risk Grade at End of Year

1 2 3 4
Risk grade 1 0.88 0.08 0.02 0.02
at beginning 2 0.10 0.84 0.03 0.02
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of year 3 0.02 0.09 0.78 0.11

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A.! Grade one loans have a higher probability of downgrade than grades two or three
B.! Grade three loans have a higher probability of upgrade than grade two loans
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C.! Grade three loans have a higher probability of downgrade than grade two loans
D.! Options (A) and (B)
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E.! Options (A), (B), and (C)

15.! Which of the following statements is false?

A.! A positive repricing gap (RSA>RSL) exposes the bank to reinvestment risk in that a
drop in interest rates would lower the FI’s NII
B.! Reinvestment risk is the risk that the returns on funds to be reinvested will fall below
the cost of the funds
C.! When there are different changes in interest rates on RSAs and RSLs, this introduces
the spread effect
D.! The spread effect is negatively related to the changes in net interest income.
E.! None of the above

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 c. The duration of all rate-sensitive assets minus the duration of rate-sensitive
liabilities.
d. The duration of the bank's liabilities minus the duration of its assets.
e. The duration of all rate-sensitive liabilities minus the duration of rate-
sensitive assets.
Answer: b
16.! What is the essential difference between the repricing model and duration model?
A.! 68.
Repricing
Which ofmodel and duration
the following model
allows measurescash
a security's the flows
changes in net firm
to change income
when and net
interest
firm value respectively
rates change?
B.! a.Repricing modelduration
Modified looks at the difference between assets and liabilities whereas duration
looks
b. at the sensitivity of price with interest rates
Macaulay's duration
C.! c.Repricing modelduration
Effective looks at book values whereas duration model looks at equity values
D.! d.Repricing model doesduration
Balance sheet not take into account of the size and timing of cash flows whereas
e.duration does statement duration
Income
E.! None
Answer: c of the above

17.! Use
Consider the following
the following bank bank information.
information for questions 69 – 73.

Liabilities
Market Duration and Market Duration

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Assets Value Rate (Years) Equity Value Rate (Years)

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Time

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Cash $ 200 Deposits $ 600 2.0% 1.500

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Loans $ 800 8.0% 3.750 CDs $ 500 4.5% 3.125
T-Bonds $ 250 4.0% 7.250 Equity $ 150

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Total $ 1,250 $ 1,250
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69. What
If interest is rise
rates the weighted
1% for allaverage duration
assets and of assets?
liabilities, what is the approximate expected change
a. 2.56 years
in the economic value of equity?
A.! b.-$2.56
3.85 years
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c.
B.! $5.844.85 years
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C.! d.-$5.84
5.00 years
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e. 7.5 years
D.! $22.19
Answer:
E.! -$22.19b
(800/1,250)*3.75 years + (250/1,250)*7.25 years = 3.85 years
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18.! Consider a consol bond with an annual interest rate of 10% and coupon rate of 8%. What is
70. What is the bank’s duration gap?
its duration?
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A.! a.11 0.53

years
B.! b.12.5
0.73
years
c. 0.91
C.! 13.5 years
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D.! d.14.75
1.88years
e.
E.! None 4.58
of the above
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Answer: d
19.! Step 1 four different bonds with the same face value and yield to maturity. Bond A pays
Consider
annual coupons at 8%, Bond B pays semi annual coupons at 4%, Bond C pays semi annual
coupons at 5% and Bond D pays annual coupons at 10%. Which bond has the shortest
duration?
A.! Bond A
B.! Bond B
C.! Bond C
D.! Bond D
E.! Not enough information

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 Please use the following information for the next two questions:
The numbers provided are in thousands of dollars.

Treasury bill $ 90 Time deposits $1,100

Treasury notes $ 55 Fed funds sold $ 230
Treasury bonds $ 176 Demand deposits $2,500
Loans $4,679 Equity $1,170

Notes: All Treasury bills have six months until maturity. One-year Treasury notes are priced at
par and have a coupon of 7 percent paid semiannually. Treasury bonds have an average duration
of 4.5 years and the loan portfolio has a duration of 7 years. Time deposits have a 1-year duration
and the Fed funds duration is .003 years.

20.! What is the bank’s leverage adjusted duration gap?

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A.! 6.73 years
B.! 0.29 years

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C.! -6.44 years
D.! 6.51 years

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E.! 0 years
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21.! If all interest rates fall by 100 basis points, what is the impact on the bank's market value of
equity using the duration approximation?
A.! The bank's market value of equity increases by $325,450
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B.! The bank's market value of equity decreases by $325,450

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C.! The bank's market value of equity increases by $336,500

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D.! The bank's market value of equity decreases by $336,500

E.! There is no change in the bank's market value of equity

22.! A DI has two assets: 40 percent in one-month Treasury bills and 60 percent in real estate
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loans. If the DI must liquidate its T-bills today, it receives $98 per $100 of face value; if it
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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
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one-month liquidity index value for this DI’s asset portfolio is

A.! 0.973
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B.! 0.940
C.! 0.979
D.! 0.998
E.! 1

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 Please use the following balance sheet (values in thousands) for the next two questions:

Assets Liabilities and Equity

Cash Required Reserves $2 million Deposits $8 million
Loans $10 million Long-term Debt $2 million
Equity $2 million
Total $12 million Total $12 million

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.

23.! 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

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liquidity precaution.
A.! $10,000

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B.! $15,000
C.! $30,000

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D.! $40,000
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E.! None of the above
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24.! What will be the cost of using a strategy of stored liquidity management to meet the
expected decline in deposits? Assume that the bank intends to keep $2 million in cash as
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liquidity precaution.
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A.! $10,000
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B.! $15,000
C.! $30,000
D.! $40,000
E.! None of the above
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25.! When comparing banks and mutual funds,

A.! mutual funds have more liquidity risk than banks because all shareholders share the loss
of value on a pro rata basis
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B.! mutual funds have less liquidity risk than banks because all shareholders share the loss
of value on a pro rata basis
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C.! mutual funds have more liquidity risk than banks because all shareholders have the
ability to withdraw their money on a first-come first basis
D.! mutual funds have less liquidity risk than banks because all shareholders have the
ability to withdraw their money on a first-come first basis
E.! 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.

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 26.! Same question from problem set 03, question 2 with ρ12 = -0.25 with weights of 0.4 and 0.6.

27.! Under Ceteris Paribas, what happens when you change weights to 0.2 and 0.8 etc?

28.! One question of cumulative gaps and runoffs.

29.! Maturity and immunization.

30.! Liquidity risk.

(Rest were true, false statements and few more calculations similar to the problem sets)

______________________________________________________________________________

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ANSWERS:

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1. B, 2. D, 3. E, 4. D, 5. D, 6. A, 7. C, 8. A, 9. B, 10. E, 11. D, 12. A, 13. E, 14. E, 15. D, 16. D,

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17. D, 18. A, 19. C, 20. D, 21. A, 22. C, 23. B, 24. C, 25. B

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