FIN 470 EXAM #1 QUESTIONS WITH ACCURATE
ANSWERS
A bank invested $50 million in a one-year asset paying 10 percent interest per
year and simultaneously issued a $50 million, two-year liability paying 8 percent
interest per year to pay for it.
Is the bank short funded or long funded?
What is the bank's net interest income in year one?
What will be the bank's net interest income in year two if at the end of the first
year all interest rates have decreased by 1.5 percent (150 basis points)? correct
answer The bank is long funded because the liability is for over a year.
NII in year 1 = $1,000,000=
($5,000,000 - $4,000,000)
NII in year 2 = $250,000
A bank manager is quite certain that interest rates are going to fall within the next
six months. • Will the bank want a positive or negative 6-month repricing gap to
take advantage of the fall? • What if the manger believes rates will rise in the next
six months? correct answer If interest rates fall you want a negative GAP; if rates
rise you want a positive GAP
A U.S. insurance company borrows £1,000,000 to invest in a private placement of
US bonds. Each bond pays $300 in interest per year for 20 years.
-If the current exchange rate is £0.874/$, what is the nature of the US insurance
company's exchange rate risk (net long or net short)?
,-What type of exchange rate movement in the $ (appreciate or depreciate) will
cause the insurance company to lose money? correct answer -Net short
-A depreciation of the USD concerns the insurance company
ABC, Inc. has issued 1.25 million new shares of stock. An investment bank agrees
to underwrite these shares on a firm commitment basis. The investment bank
pays $50 per share, and it sets the IPO price to $75 per share.
A)How much money does ABC receive?
B)What is the profit to the investment bank?
C)What is the stock price of ABC? correct answer ABC receives $62,500,000=
(1,250,000 * 50)
IB receives $31,250,000=
(1,250,000 * (75-50))
Price = $75
Adverse Selection: correct answer If the insurance company only insures risky
people, they are going to pay too much in premiums. They need to attract less
risky people because they are what pays for the most risky ones
Assets:
$300M in USD
$700M in GBP
Liabilities and Equity:
,$800M in USD
$200M in GBP
Country. US UK
Deposit Rate 6% 7%
LendingRate. 8% 9%
-Is this bank net short or net long?
-What is the net interest income (NII) if the value of the £ appreciates to $1.65?
-What is the net interest margin (NIM) if the value of the £ depreciates to $1.15?
correct answer -Net Long
-NII = +$117.6786M;
-NIM = -7.77%
Assume that a US bank has assets located in London worth £150 million on which
it earns an average of 8% per year. The bank has £100 million in liabilities on
which it pays an average of 6% per year. The current spot rate is £1 = $1.50
-If the exchange rate at the end of the year is £1 = $1.25, will the US dollar have
appreciated or depreciated against the pound?
-Is the bank net short or net long? Given the change in the exchange rate, will the
bank make money or lose money? correct answer -Appreciated
-Net Long; Lose money because the pound depreciated
Assume that as part of the asset transformation process a bank takes in short
term deposits with a maturity less than one year and "transforms" it into a 30
year mortgage loan to a customer.
, -Is this example considered to be short funded or long funded?
-Would the bank be exposed to refinancing risk or reinvestment risk?
-What movement in interest rates will negatively impact the bank? correct
answer The bank would be short funded because the maturity of the liability is
less than one year and the maturity of the asset is thirty years.
The bank would be exposed to refinancing risk.
A increase in interest rates will negatively impact the bank.
Auction Information Ranking correct answer 1. English Auction:
Price depends on all losing bids
2. 2nd Price Sealed: Bid
Price depends on the information of the highest losing bidder
3. 1st Price Sealed: Bid/Dutch Auction
Price depends exclusively on your own information
Auction Theory: correct answer -English Auction
-Dutch Auction
-First Price Sealed Bid
-Second Price Sealed Bid
Bank Underwriting correct answer Value and assessing the risk on loans
What is the likelihood the person pays back and pays back at the stated interest
rate?
ANSWERS
A bank invested $50 million in a one-year asset paying 10 percent interest per
year and simultaneously issued a $50 million, two-year liability paying 8 percent
interest per year to pay for it.
Is the bank short funded or long funded?
What is the bank's net interest income in year one?
What will be the bank's net interest income in year two if at the end of the first
year all interest rates have decreased by 1.5 percent (150 basis points)? correct
answer The bank is long funded because the liability is for over a year.
NII in year 1 = $1,000,000=
($5,000,000 - $4,000,000)
NII in year 2 = $250,000
A bank manager is quite certain that interest rates are going to fall within the next
six months. • Will the bank want a positive or negative 6-month repricing gap to
take advantage of the fall? • What if the manger believes rates will rise in the next
six months? correct answer If interest rates fall you want a negative GAP; if rates
rise you want a positive GAP
A U.S. insurance company borrows £1,000,000 to invest in a private placement of
US bonds. Each bond pays $300 in interest per year for 20 years.
-If the current exchange rate is £0.874/$, what is the nature of the US insurance
company's exchange rate risk (net long or net short)?
,-What type of exchange rate movement in the $ (appreciate or depreciate) will
cause the insurance company to lose money? correct answer -Net short
-A depreciation of the USD concerns the insurance company
ABC, Inc. has issued 1.25 million new shares of stock. An investment bank agrees
to underwrite these shares on a firm commitment basis. The investment bank
pays $50 per share, and it sets the IPO price to $75 per share.
A)How much money does ABC receive?
B)What is the profit to the investment bank?
C)What is the stock price of ABC? correct answer ABC receives $62,500,000=
(1,250,000 * 50)
IB receives $31,250,000=
(1,250,000 * (75-50))
Price = $75
Adverse Selection: correct answer If the insurance company only insures risky
people, they are going to pay too much in premiums. They need to attract less
risky people because they are what pays for the most risky ones
Assets:
$300M in USD
$700M in GBP
Liabilities and Equity:
,$800M in USD
$200M in GBP
Country. US UK
Deposit Rate 6% 7%
LendingRate. 8% 9%
-Is this bank net short or net long?
-What is the net interest income (NII) if the value of the £ appreciates to $1.65?
-What is the net interest margin (NIM) if the value of the £ depreciates to $1.15?
correct answer -Net Long
-NII = +$117.6786M;
-NIM = -7.77%
Assume that a US bank has assets located in London worth £150 million on which
it earns an average of 8% per year. The bank has £100 million in liabilities on
which it pays an average of 6% per year. The current spot rate is £1 = $1.50
-If the exchange rate at the end of the year is £1 = $1.25, will the US dollar have
appreciated or depreciated against the pound?
-Is the bank net short or net long? Given the change in the exchange rate, will the
bank make money or lose money? correct answer -Appreciated
-Net Long; Lose money because the pound depreciated
Assume that as part of the asset transformation process a bank takes in short
term deposits with a maturity less than one year and "transforms" it into a 30
year mortgage loan to a customer.
, -Is this example considered to be short funded or long funded?
-Would the bank be exposed to refinancing risk or reinvestment risk?
-What movement in interest rates will negatively impact the bank? correct
answer The bank would be short funded because the maturity of the liability is
less than one year and the maturity of the asset is thirty years.
The bank would be exposed to refinancing risk.
A increase in interest rates will negatively impact the bank.
Auction Information Ranking correct answer 1. English Auction:
Price depends on all losing bids
2. 2nd Price Sealed: Bid
Price depends on the information of the highest losing bidder
3. 1st Price Sealed: Bid/Dutch Auction
Price depends exclusively on your own information
Auction Theory: correct answer -English Auction
-Dutch Auction
-First Price Sealed Bid
-Second Price Sealed Bid
Bank Underwriting correct answer Value and assessing the risk on loans
What is the likelihood the person pays back and pays back at the stated interest
rate?
