Font size
WorksheetsChapter 01 Testbank - Multiple Choice (Part 1)
Total questions: 150
Worksheet time: 1hrs 15mins
Repricing gap refers to the:
difference between rate-sensitive assets and rate-sensitive liabilities.
sum of rate-sensitive assets and rate-sensitive liabilities.
difference between rate-sensitive liabilities and rate-sensitive assets.
difference between rate-insensitive assets and rate-insensitive liabilities.
The term rate-sensitive assets refers to assets:
whose interest rate will be repriced over some future period.
with a particularly high interest rate.
with a particularly low interest rate.
for which demand is highly dependent on the level of interest rates.
Which of the following statements is true regarding regulatory use of the repricing gap method?
APRA requires smaller Australian financial institutions (FIs) to use the repricing gap method to estimate interest rate exposures in their banking book for capital adequacy.
Australian FIs are only required to use the repricing gap method if they are listed on a US stock exchange.
APRA does not require Australian FIs to use the repricing gap method to estimate interest rate exposures in their banking book for capital adequacy.
Australian FIs are only required to use the repricing gap if they are internationally active.
What is meant by spread effect in interest rate risk management?
Periodic cash flow of interest and principal amortisation payments on long-term assets that can be reinvested at market rates.
The effect that a change in the spread between rates on rate-sensitive assets and rate-sensitive liabilities has on net interest income as interest rates change.
The effect of mismatch of asset and liabilities within a maturity bucket.
The premium paid to compensate for the future uncertainty in a security's value.
The cumulative gap over the whole balance sheet by definition:
must be greater than zero.
must be lower than zero.
must equal zero.
can take any value.
Which of the following statements is true about net interest income (NII) sensitivity?
A negative gap indicates that a rise in interest rates would lower the bank's net interest income.
A positive gap indicates that a rise in interest rates would lower the bank's net interest income.
A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
None of the listed options are correct.
Which of the following statements is true about the sign of the gap and rate changes?
A negative gap indicates that a rise in interest rates would increase the bank's net interest income.
A negative gap indicates that a fall in interest rates would increase the bank's net interest income.
A positive gap indicates that a fall in interest rates would increase the bank's net interest income.
None of the listed options are correct.
Consider the repricing schedule shown in the table. If the overnight interest rate decreased by 100 basis points, what is the annualised change in the bank's future net interest income?
−$700
$700
−$7000
$7000
Using the repricing buckets in the table provided, what is the annualised change in the bank's future net interest income if the overnight interest rate increased by 100 basis points?
−$700
$700
−$7000
$7000
Consider the repricing buckets and gaps shown. If the average rate change for assets and liabilities that can be repriced within one year is an increase of 100 basis points, what is the annualised change in the bank's future net interest income?
$17,000
−$17,000
$13,000
−$13,000
Using the same repricing schedule, if the average rate change for assets and liabilities that can be repriced within one year is a decrease of 100 basis points, what is the annualised change in the bank's future net interest income?
$17,000
−$17,000
$13,000
−$13,000
Refer to the repricing schedule with cumulative gap reported. If the average rate change for assets and liabilities that can be repriced over five years is an increase of 50 basis points, what is the annualised change in the bank's future net interest income?
$7500
$7500
$0
Not enough information to answer the question.
In repricing gap analysis, which bucket(s) contribute to interest rate risk over the next year?
Only the 1-day bucket because other buckets are fixed.
All buckets up to 12 months because they can be repriced within the year.
Only the 6 to 12 months bucket because it is closest to one year.
Only the over-5-years bucket because it is the longest.
If an FI has a positive cumulative gap over the next year and market rates rise, the most likely effect on net interest income is:
Increase in net interest income as more assets than liabilities reprice upwards.
Decrease in net interest income as more liabilities than assets reprice upwards.
No effect because cumulative gap always equals zero within one year.
Ambiguous effect because cumulative gap ignores interest rate changes.
Which statement best characterizes the repricing gap model in terms of accounting basis and analysis focus?
It is a market-value accounting cash flow analysis of the repricing gap between interest revenue on assets and interest paid on liabilities over some period.
It is a book value accounting cash flow analysis of the repricing gap between interest revenue on assets and interest paid on liabilities over some period.
It is a market-value accounting analysis of capital gains and losses from interest rate changes on assets and liabilities.
It is a duration-based measure of present value changes in net worth.
Compared to the duration model, which statement about the repricing gap model is true?
The repricing gap model is a market-value based approach.
The repricing gap model is a book-value based approach.
The capital loss effect is captured by the repricing model.
None of the listed options are correct.
Term core deposits are best described as deposits that:
Act as long-term sources of funds for the financial institution.
Reflect the true or core nature of the FI’s operations.
Support the core of the FI’s operations.
None of the listed options are correct.
Which of the following are rate-sensitive assets?
Short-term consumer loans, cheque accounts and three-month Treasury notes.
Ten-year fixed rate mortgages, short-term consumer loans and long-term consumer loans.
Short-term consumer loans, ten-year fixed rate mortgages and one-year term deposits.
Short-term consumer loans, six-month Treasury notes and three-year Treasury bonds.
Which of the following are rate-sensitive liabilities?
Short-term consumer loans, cheque accounts and three-month Treasury notes.
Three-month term deposits, three month bankers’ acceptances, six-month negotiable certificates of deposit and one-year term deposits.
Short-term consumer loans, six-month negotiable certificates of deposit and one-year term deposits.
Short-term consumer loans, six-month Treasury notes and three-year Treasury bonds.
In interest rate risk analysis, the term ‘runoffs’ refers to:
One-off cash flow of interest and principal amortisation payments on long-term assets.
Periodic cash flow of interest and principal amortisation payments on long-term assets.
One-off cash flow of interest and principal amortisation payments on short-term assets.
Periodic cash flow of interest and principal amortisation payments on short-term assets.
Which statement about cheque accounts and interest sensitivity is true?
Cheque accounts are a type of interest-sensitive asset.
Cheque accounts are a type of interest-sensitive liability.
There are strong arguments for and against including cheque accounts as a type of interest-sensitive asset.
There are strong arguments for and against including cheque accounts as a type of interest-sensitive liability.
Which statement about cheque accounts’ inclusion in interest-sensitive liabilities is false?
A major reason for inclusion is that the majority of these accounts are core deposits.
Cheque accounts should be treated as interest-sensitive liabilities because if interest rates rise, deposits might be withdrawn and replaced by higher-yielding deposits.
The final decision whether or not to include cheque accounts as rate-sensitive liabilities must be made after an analysis of actual deposit history.
None of the listed options are correct.
Which statement about excluding cheque accounts from interest-sensitive liabilities is true?
A major reason for exclusion is that the majority of these accounts are core deposits.
Cheque accounts should be treated as interest-sensitive liabilities because if interest rates fall, deposits might be withdrawn and replaced by higher-yielding deposits.
The final decision must be made by predicting depositors’ behaviours.
None of the listed options are correct.
Which statement about expressing the cumulative repricing gap is true?
It can be expressed as a percentage of liabilities.
It can also be expressed as a percentage of equity.
It can be expressed as a percentage of assets.
None of the listed options are correct.
Which statement about interpreting the repricing gap as a percentage is true?
Expressing the repricing gap as a percentage of assets tells us the direction of the interest rate exposure.
Expressing the repricing gap as a percentage of liabilities tells us the scale of the interest rate exposure.
Expressing the repricing gap as a percentage of equity tells us the scale of the interest rate exposure.
Expressing the repricing gap as a percentage of liabilities tells us the direction of the interest rate exposure.
If a financial institution (FI) has a positive repricing gap, which expectation regarding interest rates is correct?
The FI expects interest rates to remain stable.
The FI expects interest rates to rise.
The FI expects interest rates to remain fall.
The FI has no particular expectations regarding interest rate movements.
If a financial institution has a negative repricing gap, which expectation regarding interest rates is correct?
The FI expects interest rates to remain stable.
The FI expects interest rates to rise.
The FI expects interest rates to remain fall.
The FI has no particular expectations regarding interest rate movements.
Which statement about an FI with a repricing gap of zero is true?
It is unsure about interest rate movements.
It expects interest rates to rise.
It expects interest rates to remain fall.
It does not measure and manage its interest rate exposures.
As a manager expecting interest rates to increase, how should you structure your balance sheet using the repricing gap model?
Create a positive gap.
Create a negative gap.
Create a neutral gap.
Choose based on current profitability.
Which statement comparing repricing gap and duration gap models is true?
Unlike the duration gap model, the repricing gap captures capital loss and gain effects.
The repricing gap model is market-value based, while the duration model is book-value based.
The repricing gap model does not consider the size and timing of cash flows.
The duration gap model focuses on the impact of interest rate changes on net interest income.
An FI with a positive on-balance-sheet gap and a negative off-balance-sheet gap is most likely:
Unsure about interest movements.
Making a mistake in hedging its interest rate risk.
Using its off-balance-sheet position to hedge its on-balance-sheet position.
None of the listed options are correct.
What is a commonly cited problem with the repricing gap approach?
Over-aggregation: dollar values of asset-sensitive liabilities and assets within a bucket may be the same, but repricing timing within the bucket can differ.
Over-aggregation: managers cannot make informed decisions about interest rate movements.
Advantage: information provided in the buckets is precise.
None of the listed options are correct.
Regarding bucket gap ranges in repricing analysis, which statement is true?
The size of the range does not matter, as the repricing gap will always lead to exact results.
The shorter the range over which bucket gaps are calculated, the greater the potential error.
The shorter the range over which bucket gaps are calculated, the smaller the potential error.
None of the listed options are correct.
Which statement about the runoff component is true?
The runoff component is rate-sensitive.
The runoff component is rate-insensitive.
It refers to interest payments on long-term liabilities that need to be refinanced at market rates.
It refers to interest payments on short-term liabilities that need to be refinanced at market rates.
Consider the following runoff table for assets and liabilities (values in millions).Assetslessthanoneyearrunofftotals 175 and more than one year runoff totals 132.Liabilitieslessthanoneyearrunofftotals 88 and more than one year runoff totals $54. What is the one-year gap adjusted for runoffs? Choose the best answer.
$43
$87
$121
$78
Which statement correctly identifies the major focus of the repricing gap approach?
The major focus is the capital loss effect.
The major focus is the capital gains effect.
It focuses equally on capital gains, capital loss, and interest income effects.
The major focus is the interest income effect.
How should you interpret the position of a financial institution (FI) that has a positive on-balance-sheet gap and a negative off-balance-sheet gap?
The FI uses its on-balance-sheet activities to hedge its off-balance-sheet activities.
The FI uses its off-balance-sheet activities to hedge its on-balance-sheet activities.
The FI believes that interest rates will increase and made a mistake in setting its gap for off-balance-sheet activities.
The FI believes that interest rates will increase and made a mistake in setting its gap for on-balance-sheet activities.
When repricing all interest sensitive assets and all interest sensitive liabilities in a balance sheet, what is the cumulative gap?
zero
one
greater than one
a negative value
In the repricing gap approach, how are gaps in each maturity bucket calculated?
current assets from the current liabilities
long-term liabilities from the fixed assets
rate sensitive assets from the total assets
rate sensitive liabilities from the rate sensitive assets
A bank has a positive repricing gap. Is it exposed to interest rate increases or decreases, and why?
Interest rate increases, because the interest income on its assets will rise more than the interest expenses on its liabilities and net interest income will rise.
Interest rate increases, because the interest income on its assets will fall more than the interest expenses on its liabilities and net interest income will fall.
Interest rate decreases, because the interest income on its assets will rise more than the interest expenses on its liabilities and net interest income will rise.
Interest rate decreases, because the interest income on its assets will fall more than the interest expenses on its liabilities and net interest income will fall.
A bank has a negative repricing gap. Is it exposed to interest rate increases or decreases, and why?
Interest rate increases, because the interest income on its assets will rise more than the interest expenses on its liabilities and net interest income will rise.
Interest rate increases, because the interest income on its assets will rise by less than the interest expenses on its liabilities and net interest income will fall.
Interest rate decreases, because the interest income on its assets will rise more than the interest expenses on its liabilities and net interest income will rise.
Interest rate decreases, because the interest income on its assets will rise by less than the interest expenses on its liabilities and net interest income will fall.
Consider the runoff table. Assets less than one year runoff: 5, 5, 5, 15, 5, 25, 20(total 80). Liabilities less than one year runoff: 0, 20, 10, 5, 10, 5, 17, 13 (total $80). An increase in the average one-year interest rate of 50 basis points occurs. How does this affect the FI’s future net interest income (NII)?
The NII will not change.
The NII will increase by $50.
The NII will increase by $5.
The NII will decrease by $50.
Consider the following runoff table for assets and liabilities. Assets with runoff in less than one year total 175andinmorethanoneyeartotal 132. Liabilities with runoff in less than one year total 88andinmorethanoneyeartotal 54. If the average one-year interest rate decreases by 50 basis points, what happens to the FI’s future net interest income (NII)?
The NII decreases by $0.435.
The NII increases by $0.435.
The NII remains constant.
The NII decreases by $0.39.
Using the runoff-adjusted gap table where assets maturing in less than one year sum to 175andliabilitiesmaturinginlessthanoneyearsumto 88, what is the one-year gap adjusted for runoffs?
$0
$50
$55
$5
The Reserve Bank of Australia’s monetary policy can reduce a financial institution’s interest rate risk primarily by which mechanism?
By smoothing or targeting interest rates it increases unexpected rate shocks and volatility.
By smoothing or targeting the level of interest rates it decreases unexpected rate shocks and volatility.
By letting rates find their own level it increases interest volatility.
All of the listed options are correct.
Following the global financial crisis, the RBA used open market operations to enhance market stability. Which action describes this approach?
Increasing the maturity of repos to reduce money pressure in the money market over the longer term.
Increasing RBA holdings of non-government securities for use with repos due to the shortage of government securities.
Increasing the supply of deposits held by banks and other ADIs in their exchange settlement accounts with the RBA.
All of the listed options are correct.
In the repricing model, which limitation arises because it ignores the distribution of assets and liabilities within maturity buckets?
Market value effect.
Over-aggregation.
Runoffs and pre-payments.
Off-balance sheet activities.
If an FI’s repricing gap is less than zero, which implication is most accurate?
It is deficient in its required reserves.
It is deficient in its capital ratio requirement.
Its liability costs are more sensitive to changing market interest rates than are its asset yields.
Its liability costs are less sensitive to changing market interest rates than are its asset yields.
Given the balance sheet: Rate-sensitive assets 35,000,000at10 21,000,000 at 9%; Non-earning assets 4,000,000.Rate−sensitiveliabilities 40,000,000 at 8%; Fixed-rate liabilities 12,000,000at7 8,000,000. If interest rates do not change, what is the FI’s year-end net interest income?
$3.20 million
$5.39 million
$1.89 million
$1.35 million
Which function of financial intermediaries primarily addresses the problem that small investors cannot efficiently screen and monitor borrowers?
Denomination intermediation through pooling small deposits.
Delegated monitoring that reduces agency costs.
Maturity intermediation by transforming short deposits into long loans.
Provision of payment services to improve liquidity.
Which benefit of diversification best explains why a bank holds a wide mix of loans across sectors and regions?
It increases expected return by concentrating on the riskiest sector.
It reduces unsystematic risk by spreading exposures across uncorrelated assets.
It guarantees elimination of all market risk.
It maximizes liquidity by lengthening all asset maturities.
Agency costs in finance arise primarily due to which underlying issue?
Perfect information between lenders and borrowers.
Conflicts of interest and asymmetric information between principals and agents.
Guaranteed alignment of incentives via regulation.
Absence of monitoring expenses in intermediated lending.
Which statement best characterizes liquidity provision by financial intermediaries?
They offer investors only illiquid assets with long maturities.
They transform illiquid loans into liquid claims such as deposits that can be withdrawn on demand.
They eliminate the need for cash reserves completely.
They increase withdrawal risk by tying deposits to fixed long-term rates only.
Maturity intermediation allows an FI to:
Match long-term investors with long-term borrowers directly without transformation.
Convert short-term liabilities into long-term assets, bearing interest rate risk.
Avoid any exposure to interest rate changes by perfectly hedging maturities.
Set deposit rates independently of market forces.
When interest rates unexpectedly rise and an FI has a positive repricing gap (RSA > RSL), the most likely immediate effect on net interest income is:
NII increases because asset yields reprice faster than liability costs.
NII decreases because liability costs rise more than asset yields.
NII is unchanged because fixed-rate items dominate.
NII becomes negative regardless of gap size.
A bank faces potential prepayments on mortgages and early withdrawals on time deposits. In gap analysis, these are best treated as:
Runoffs and prepayments that adjust the effective repricing bucket sizes.
Off-balance sheet exposures that do not affect buckets.
Capital adequacy adjustments only.
Pure market value effects unrelated to NII.
Using the following table, compute the repricing gap (RSA − RSL) for the financial institution. Rate-sensitive assets: 35,000,000at10 21,000,000 at 9%. Non-earning assets: 4,000,000.Rate−sensitiveliabilities: 40,000,000 at 8%. Fixed-rate liabilities: 12,000,000at7 8,000,000. Choose the closest value.
$0
$5,000,000
$9,800,000
−$5,000,000
Which is a weakness of the repricing model used to measure interest rate risk?
Potential for over-aggregation of assets and liabilities within each maturity bucket.
It ignores how changes in interest rates affect the market value of assets and liabilities.
It ignores the reinvestment of interest and principal at current market rates and omits off-balance-sheet rate-sensitive items.
All of the listed options are correct.
According to the unbiased expectations theory of the term structure of interest rates, which statement is most accurate?
Long-term rates are an arithmetic average of short-term rates.
The yield curve reflects the market’s current expectations of future short-term interest rates.
Forward rates are perfect predictors of future interest rates.
Risk premiums increase uniformly with maturity.
According to the liquidity premium theory of the term structure, which statement best characterizes long-term rates?
Investors will hold long-term maturity assets only if compensated by a premium for long-term uncertainty.
Long-term rates equal an arithmetic average of short-term rates plus a liquidity premium.
Forward rates are perfect predictors of future rates.
Risk premiums increase uniformly with maturity.
The market segmentation theory of the term structure of interest rates assumes which of the following?
Investors will hold long maturities if there is a sufficient premium for uncertainty.
The yield curve reflects current expectations of future short-term rates.
Market rates are determined by supply and demand within fairly distinct time or maturity buckets.
Investors and borrowers readily shift between maturities to exploit changing yields.
True or False: The repricing gap considers the timing and size of cash flows.
True
False
Cannot be determined from given data
True or False: The repricing gap focuses on the interest income effect.
True
False
Only under static gap assumptions
True or False: An FI with a positive repricing gap expects interest rates to decrease.
True
False
Only if liabilities reprice faster than assets
True or False: An FI with a neutral repricing gap in its three- to six-month bucket is hedged against interest rate changes at all points in time.
True
False
Only for parallel yield curve shifts
True or False: The repricing gap is a book-value-based approach.
True
False
Only when market values are unavailable
True or False: Over-aggregation and runoffs are major problems associated with the repricing gap.
True
False
Only in the longest maturity buckets
True or False: Convexity is the major problem associated with the repricing gap.
True
False
Only for zero-coupon assets
True or False: The cumulative repricing gap for an extended period equals the sum of the gaps over the subperiod buckets within that horizon.
True
False
Only if rates remain constant
True or False: An FI with a negative gap of 20millionwillseenetinterestincomefallby 0.2 million if interest rates decrease by 1%.
True
False
Only if equity is unchanged
True or False: An FI with a positive gap of 30millionsuffersa 0.15 million decrease in net interest income if interest rates increase by 0.5%.
True
False
Only if prepayment risk is zero
True or False: Because the repricing model ignores market value effects of changing rates, it is an incomplete measure of an FI’s true interest rate risk exposure.
True
False
Only during steep yield curves
True or False: If the spread between rate-sensitive assets and rate-sensitive liabilities increases for a bank, future interest rate changes will lead to an increase in net interest income.
True
False
Only if non-earning assets shrink
ABC Bank reports the following repricing buckets (amounts in millions): 1 day: RSA 50,RSL 100; 1 day to 3 months: RSA 120,RSL 25; 3 to 6 months: RSA 35,RSL 100; 6 to 12 months: RSA 65,RSL 75; 1 to 5 years: RSA 70,RSL 40; Over 5 years: RSA 60,RSL 60. What is the cumulative gap through 6 months?
−$20
$80
−$20 through 6 months, then turns positive after 1 year
$0
Suppose the yield of a consol bond is 10%. What is its duration?
5 years
10 years
11 years
15 years
Suppose the yield of a five-year zero-coupon bond is 10%. What is its duration?
5 years
10 years
11 years
15 years
Suppose the yield of a five-year bond with an 8% coupon is 10%. What is its duration most likely to be?
Less than 5 years
Exactly 5 years
From 5 to 10 years
More than 10 years
With increasing maturity of a fixed-income asset or liability, how does its duration generally change?
Increases, but at a decreasing rate
Decreases
Increases at an increasing rate
Increases at a constant rate
How does a lower coupon or interest payment on a security affect its duration?
Lowers its duration
Has no impact on duration
Raises its duration
None of the listed options are correct
Duration is a direct measure of interest rate sensitivity. Which statement is most accurate?
Smaller duration means greater price sensitivity
Larger duration means less price sensitivity
Larger duration means greater price sensitivity
None of the listed options are correct
As interest rates increase, the price of an asset or liability generally:
Remains constant
Decreases
Increases
Increases and it increases at a faster rate
As interest rates decrease, the price of an asset or liability generally:
Remains constant
Decreases
Increases
Increases and it increases at a faster rate
The duration gap can be used to measure how changes in the interest rate affect an FI’s:
Net worth
Maturity gap strategy
Liquidity strategy
All of the listed options are correct
The leverage-adjusted duration gap measures:
The change in an FI’s net worth if interest rates change
The degree of duration mismatch in an FI’s profit and loss statement
The degree of duration mismatch in an FI’s balance sheet
All of the listed options are correct
The larger an FI’s absolute leverage-adjusted duration gap:
The less exposed the FI is to interest rate shocks
The more exposed the FI is to interest rate shocks
The lower the FI’s net worth
None of the listed options are correct
The effect of interest rate changes on the market value of an FI’s net worth breaks into three elements. Which combination is correct?
Size of the FI and the reputation of the FI
Size of the FI and the size of the interest rate shock
Reputation of the FI and the size of the interest rate shock
Size of the FI and the direction of the interest rate changes
Which statement best responds to the critique that duration matching is costly and time consuming?
The critique is valid; however, restructuring has become faster and cheaper due to purchased funds, securitisation, and loan sales markets
The critique is valid and FIs should spend funds to develop more efficient tools
The critique is valid because derivative positions cannot achieve similar results to direct matching
None of the listed options are correct
The statement that a portfolio is immunised using duration matching is:
It means the FI is entirely hedged against interest rate risks
Misleading, as duration matching is dynamic and only hedges against instantaneous interest rate changes
Misleading, as duration matching only hedges against rate changes within a month
None of the listed options are correct
Immunising the balance sheet to protect equity holders from the effects of interest rate risk occurs when:
The maturity gap is zero
The repricing gap is zero
The duration gap is zero
The effect of interest rate changes on asset values exactly offsets the effect of the same changes on liabilities
Using the duration gap to measure the change in an FI’s net worth in case of large interest rate shocks:
Produces exact results
Only produces exact results if rates change instantaneously
Produces approximate results only due to concavity
Produces approximate results only due to convexity
Duration is a less accurate predictor for the change in an FI’s net worth in case of large interest rate shocks because it assumes a:
Linear relationship between price change and interest rate change, while the true relationship is convex
Linear relationship while the true relationship is concave
Convex relationship while the true relationship is linear
Concave relationship while the true relationship is linear
Convexity is defined as:
The degree of curvature of the price–yield curve around some maturity level
The degree of curvature of the price–yield curve around some price level
The degree of curvature of the price–yield curve around some interest rate level
None of the listed options are correct
Which objective best describes technological expansion by financial institutions?
Adopting new systems to improve service delivery and efficiency
Reducing branch staff through layoffs without investing in systems
Focusing solely on regulatory capital optimization
Eliminating all third-party technology providers
Off-balance-sheet risk primarily arises from which activity by a financial institution?
Holding excess cash reserves in vaults
Issuing long-term fixed-rate deposits
Engaging in contingent commitments such as guarantees and derivatives
Purchasing only government bonds for liquidity
Economies of scale occur when a bank’s average cost per unit falls as it
expands into unrelated business lines
increases output while using similar processes
switches from retail to wholesale clients
outsources customer service to a third party
Economies of scope are best illustrated when a financial institution
produces multiple services more cheaply together than separately
reduces average cost by doubling the volume of a single product
raises fees to match competitors’ prices
cuts technology spending to meet quarterly targets
Which source is most closely aligned with operational risk at financial institutions?
Unexpected changes in benchmark interest rates
Breakdowns in internal processes, people, or systems
Deterioration in borrower credit quality
Movements in foreign exchange rates
A bank deploys a new mobile app to shorten loan approvals and reduce manual errors. This initiative most directly targets which objective of technological expansion?
Regulatory arbitrage
Cost efficiency and service speed
Market speculation
Balance sheet deleveraging
Which off-balance-sheet item exposes a bank to risk without immediately changing reported assets or liabilities?
Standby letter of credit
Certificate of deposit
Treasury bill holding
Owned branch real estate
If a bank experiences economies of scale, which outcome is most likely as transaction volume grows using the same platform?
Unit processing costs fall
Total costs remain fixed
Unit processing costs rise
Average costs become unrelated to output
A financial conglomerate cross-sells payments, lending, and wealth management using a shared data platform. This primarily exemplifies
economies of scope through joint production and shared inputs
economies of scale from higher single-product volume
regulatory risk reduction through compliance outsourcing
pure market risk hedging using derivatives
Identify the scenario that reflects operational risk rather than market or credit risk.
Losses from a trading desk due to interest rate spikes
Client default on an unsecured loan
System outage delaying payments and causing penalties
Foreign currency depreciation affecting asset values
Which statement best contrasts economies of scope and economies of scale?
Scope reduces average cost by producing more varieties together; scale reduces average cost by producing more of the same product
Scope and scale both require product diversification to reduce average cost
Scale lowers cost only when technology changes; scope does not
Scope relates to risk management; scale relates only to marketing
Why can off-balance-sheet exposures be difficult for stakeholders to assess?
They are always hedged perfectly and thus irrelevant
They involve contingent obligations that become realized under specific events
They are recorded at historical cost like fixed assets
They are prohibited by regulation and therefore rare
Which technological expansion risk most directly increases operational risk?
Vendor concentration leading to single points of failure
Improved straight-through processing
Better data governance and access controls
Automated reconciliation reducing manual entries
A bank scales its cloud-based payments engine from 10,000 to 1,000,000 daily transactions with minimal added cost per transaction. Which efficiency concept is demonstrated?
Economies of scope
Economies of scale
Regulatory capital efficiency
Credit risk transfer
A bank holds foreign assets denominated in euros while its liabilities are in U.S. dollars. Which risk primarily arises from movements in the EUR/USD exchange rate?
Credit risk
Foreign exchange risk
Sovereign risk
Operational risk
An FI lends to a foreign government that later imposes capital controls preventing repayment in the agreed currency. Which risk most accurately describes the FI’s exposure?
Liquidity risk
Sovereign risk
Market risk
Reputational risk
Which statement best distinguishes credit risk from insolvency risk for a financial institution?
Credit risk is the likelihood of borrower default; insolvency risk is the chance the FI’s asset value falls below liabilities.
Credit risk is the chance of currency depreciation; insolvency risk is the risk of rising interest rates.
Credit risk is the variability of market prices; insolvency risk is the possibility of trading losses.
Credit risk is the risk of liquidity shortage; insolvency risk is the risk of operational failure.
High inflation in the domestic economy most directly increases which type of risk for an FI holding long-duration fixed-rate assets?
Foreign exchange risk because domestic prices rise
Interest rate risk due to upward pressure on discount rates
Sovereign risk because the government borrows more
Operational risk due to higher transaction volumes
Consider a security with a face value of $100,000 to be repaid at maturity in three years. The coupon rate is 9% per annum with semi-annual payments. The current discount rate is 12% per annum. What is the security’s price (rounded to two decimals)?
$127,000.00
$100,000.00
$76,046.08
$92,624.01
A $100,000 security with 9% annual coupon paid semi-annually and three years to maturity has a current discount rate of 12% per annum. What is the security’s duration (round to two decimals)?
2.68 years
2.68 half-years
3 years
0.38 years
An FI has financial assets of 800andequityof 50. If the duration of assets is 1.21 years and the duration of liabilities is 0.25 years, what is the leverage-adjusted duration gap (LADG)?
0.9000 years
0.9600 years
0.9756 years
0.8844 years
How can a negative duration gap of 0.21 years be interpreted?
The FI is exposed to decreasing interest rates because it has a negative duration gap of 0.21 years.
The FI is exposed to increasing interest rates because it has a negative duration gap of 0.21 years.
The FI is not exposed to interest rate changes since it is running a matched book.
The FI’s exposure will depend on its maturity gap.
Consider a consol bond with a required yield to maturity of 9%. What is the consol’s duration (rounded to two decimals)?
Infinite as the bond has no maturity
0 years
9.33 years
12.11 years
If the required yield to maturity on a consol bond increases from 6% to 12%, what happens to the consol bond’s duration?
There are no intervening cash flows, so duration always equals maturity.
As interest rates rise, the duration of consol bonds falls.
As interest rates rise, the duration of consol bonds rises.
There will be no impact on the bond’s duration.
Consider an asset with current market value 250,000andduration3.3years.Itispartiallyfundedthroughzero−couponbondscurrentlysellingfor 225,000 with maturity 4 years. The current discount rate is 15%. Calculate the duration gap for this scenario.
-0.3 years
0.3 years
-0.7 years
0.7 years
Using the scenario of an asset worth 250,000withduration3.3yearsfundedbyzero−couponbondssellingfor 225,000 with maturity 4 years at a 15% discount rate, which statement is true?
The FI is benefiting from increasing interest rates as it has a negative duration gap of 0.3 years.
The FI is exposed to increasing interest rates as it has a negative duration gap of 0.3 years.
The FI is exposed to increasing interest rates as it has a positive duration gap of 0.3 years.
The FI is exposed to decreasing interest rates as it has a positive duration gap of 0.3 years.
For the same position (asset 250,000,duration3.3years;fundingzero−couponbonds 225,000, maturity 4 years; discount rate 15%) and an interest rate increase of 150 basis points, which statement is true?
The current net worth of the position is $25,000 and if interest rates increase the net worth will not be affected.
The current net worth of the position is $25,000 and if interest rates increase the net worth will increase, too.
The current net worth of the position is $25,000 and if interest rates increase the net worth will decrease.
The current net worth of the position cannot be determined; however, if interest rates increase the net worth will increase, too.
To achieve a zero duration gap, an FI can:
change the duration of its assets only
change the duration of its liabilities only
change the duration of both assets and liabilities
None of the listed options are correct
It is not possible to measure the duration of a perpetuity because a perpetuity has no maturity. True or False?
True
False
Only true for zero-coupon perpetuities
True if the yield is above 10%
Using the leverage-adjusted duration gap, it is possible to measure the effect of changing interest rates on an FI’s net worth. True or False?
True
False
True only when duration is zero
False unless liabilities are zero-duration
Calculating modified duration involves which operation on Macaulay duration?
Dividing the value of duration by the change in the market interest rate
Dividing the value of duration by 1 plus the interest rate
Dividing the value of duration by discounted change in interest rates
Multiplying the value of duration by discounted change in interest rates
An FI has a leverage-adjusted duration gap of 1.21 years, 60millioninassets,7 100 of assets?
+$336 111
−$0.605
−$336 111
+$0.605
Which of the following statements is incorrect regarding immunization strategies?
Investing in a zero-coupon asset with a maturity equal to the desired investment horizon is one method of immunising against changes in interest rates.
Investing in a zero-coupon asset with a maturity equal to the desired investment horizon removes interest rate risk from the investment management process.
Buying a fixed-rate asset whose duration is exactly equal to the desired investment horizon immunises against interest rate risk.
Using a fixed-rate bond to immunise a desired investment horizon means that the reinvested coupon payments are not affected by changes in market interest rates.
Which of the following statements is incorrect about convexity and price–yield relationships for fixed-income assets?
Convexity is a desirable effect to a portfolio manager because it is easy to measure and price.
All fixed-income assets exhibit convexity in their price–yield relationships.
The greater is convexity, the more insurance a portfolio manager has against interest rate increases and the greater potential gain from rate decreases.
The fact that the capital gain effect for rate decreases is greater than the capital loss effect for rate increases is caused by convexity in the yield–price relationship.
For small changes in interest rates, market prices of bonds move in an inversely proportional manner according to the size of which measure?
Equity
Asset value
Liability value
Duration value
In simple terms, duration measures the average life of an asset or liability. Select the best answer.
True
False
Only for zero-coupon bonds
The duration of a zero-coupon bond is always smaller than its maturity. Choose the correct statement.
True
False
Only when interest rates are zero
The maturity of a fixed-income security is always smaller than its duration. Choose the correct statement.
True
False
Only when coupons are reinvested
A portfolio manager wants more protection against rate increases and greater upside when rates fall. Which characteristic should be higher to achieve this?
Convexity of the portfolio
Coupon frequency of the bonds
Current yield of the bonds
Time to next coupon date
A bank has a negative maturity gap. Based on this condition, is the bank more exposed to interest rate increases or decreases, and why? Choose the best explanation.
Interest rate increases because the value of its assets will rise more than its liabilities.
Interest rate increases because the value of its assets will fall more than its liabilities.
Interest rate decreases because the value of its assets will rise less than its liabilities.
Interest rate decreases because the value of its assets will fall more than its liabilities.
A high numerical value of duration for an asset most directly indicates which of the following?
low sensitivity of the asset price to interest rate shocks
high interest inelasticity of a bond
high sensitivity of the asset price to interest rate shocks
lack of sensitivity of the asset price to interest rate shocks
Which statement about leverage-adjusted duration gap is true?
It is equal to the duration of the assets minus the duration of the liabilities.
The larger the gap in absolute terms, the more exposed the financial institution is to interest rate shocks.
It reflects the degree of maturity mismatch in a financial institution's balance sheet.
It indicates the dollar size of the potential net worth and its value is equal to duration divided by (1+R).
Complete the idea: The larger the size of a financial institution, the larger the ______ from any given interest rate shock.
duration mismatch
immunisation effect
net worth exposure
net interest income
When does duration become a less accurate predictor of expected changes in security prices?
As interest rate shocks increase in size.
As interest rate shocks decrease in size.
When maturity distributions of an FI’s assets and liabilities are considered.
As inflation decreases.
Duration matching is a desirable interest rate risk management tool because it captures changes in interest rates over long periods of time. Evaluate this statement.
True, because duration fully accounts for long-horizon interest rate paths.
True, because duration tracks both level and convexity effects precisely over time.
False, because duration approximates small rate changes around the current yield and is not designed to capture long-term path changes.
False, because duration only applies to equities, not fixed income.
An FI’s portfolio is immunised when the weighted-average duration of the bond portfolio exactly equals the FI’s desired investment horizon. Assess this claim.
True, because matching portfolio duration to the horizon neutralises small parallel rate shifts on value at the horizon.
True, because matching duration eliminates all forms of market risk permanently.
False, because immunisation requires matching maturity, not duration.
False, because immunisation is unrelated to duration or horizon.
An FI’s portfolio is immunised when the weighted-average duration of the bond portfolio exactly equals the weighted-average maturity of the bond portfolio. Judge this statement.
True, because duration and maturity are interchangeable measures of interest rate risk.
False, because immunisation relates duration to the investment horizon, not to maturity.
True, because equal maturity ensures identical cash flow timing.
False, because immunisation requires convexity matching only.
Consider the following assertion: The larger the numerical value of the duration of an asset or liability, the less sensitive its price is to changes in the interest rate. Select the best evaluation.
True, because higher duration dampens price volatility for a given rate change.
False, because higher duration implies greater price sensitivity to rate changes.
True, because duration measures cash flow timing only, not sensitivity.
False, because duration is unrelated to price changes.
As interest rates increase (decrease) the value of an asset or a liability decreases (increases). Decide whether this proposition is correct.
True, reflecting the inverse relationship between price and yield.
False, because most assets’ values rise with rate increases.
True only for assets, not liabilities.
False unless convexity is negative.
Greater convexity provides what effect for a portfolio manager facing rate increases and potential gains from rate decreases?
More insurance against rate increases and larger potential gains from rate decreases.
Less insurance against rate increases and smaller gains from rate decreases.
No change in protection; convexity affects only coupon income.
More insurance against rate increases but smaller gains from rate decreases.
A proposed immunisation tactic states: To reduce a positive leverage-adjusted duration gap for a typical depository institution, increase the duration of assets and decrease the duration of liabilities. How should this be evaluated?
True, because raising asset duration and lowering liability duration reduces the positive gap toward zero.
False, because the gap is unaffected by changes in durations.
True, but only if maturity also increases by the same amount.
False, because immunisation requires increasing both asset and liability durations.
Which description best characterises maturity gap versus duration gap in measuring interest rate risk for an FI?
Maturity gap compares book-value maturities; duration gap measures sensitivity-weighted timing of cash flows.
Both are identical because they measure the same horizon.
Maturity gap accounts for convexity, while duration gap ignores timing.
Duration gap looks only at coupon rate, whereas maturity gap looks at yield volatility.
If an FI’s leverage-adjusted duration gap is zero, what is the primary implication for small parallel shifts in the yield curve?
The market value of equity is immunised against small parallel shifts.
Asset prices will always rise when rates rise.
Net interest income is fixed regardless of rate changes.
Convexity effects become infinite.
Which action would most directly decrease a negative duration gap (make it less negative) for a depository institution?
Shorten asset duration and lengthen liability duration.
Lengthen asset duration or shorten liability duration.
Increase convexity while holding durations constant.
Reduce the size of the balance sheet without changing durations.
Why does duration become less accurate for predicting price changes as interest rate shocks grow larger?
Because duration is a first-order linear approximation that ignores convexity effects for large changes.
Because duration only applies when coupon rates are zero.
Because duration overstates the impact of convexity for tiny changes.
Because duration measures only default risk, not interest rate risk.
Which statement best distinguishes duration from maturity for a bond with interim cash flows?
Duration equals maturity when coupons are paid.
Duration is typically less than maturity when there are intervening cash flows between issue and maturity.
Duration exceeds maturity whenever coupons are level.
Duration and maturity are unrelated by definition.
For a zero-coupon bond held to maturity with no interim cash flows, which relationship holds between duration and maturity?
Duration equals maturity.
Duration is greater than maturity.
Duration is less than maturity.
Duration is undefined.
Despite perpetuities such as consols having no finite maturity, what is true about their duration?
Duration cannot be defined for perpetuities.
Duration can be calculated even though maturity is infinite.
Duration always equals maturity for perpetuities.
Duration is equal to the time to the first coupon only.
