FIN 480 UPDATED QUESTIONS AND SOLUTIONS
GUARANTEE A+
✔✔Foreign Exchange Risk - ✔✔comes from holding assets denominated in one
currency & liabilities denominated in another
✔✔Managing Foreign Exchange Risk - ✔✔- work to attract deposits that are
denominated in same currency as their loans, matching assets to liabilities
- use foreign exchange futures and swaps to hedge risk
✔✔???
A rumor starts that says a bank has suffered significant losses and may not be able to
honor its promises to depositors. This causes most of the depositors to one up in front
of the bank the next morning wanting to withdraw their deposits. This is an example of: -
✔✔liquidity risk
✔✔???
Interest rate risk arises because: - ✔✔a bank's liabilities tend to be more interest rate
sensitive than its assets
✔✔???
Credit risk is a bigger problem for: - ✔✔smaller banks because they tend to have less
diversified markets
✔✔Five Major Categories of Non-depository Institutions - ✔✔- Insurance companies
- Pension funds
- Securities firms (including brokers, mutual-fund companies, investment banks)
- Finance companies
- Govt. sponsored enterprises
✔✔Insurance Companies Specializations - ✔✔specialize in 3 of 5 function performed by
intermediaries:
- pool small premiums & make large investments with them
- diversify risks across a large population
- screen & monitor policyholders to mitigate the problem of asymmetric info
✔✔Insurance Companies - Balance Sheet - ✔✔- promises to policyholders show up as
liabilities
- asset side... insurance companies hold a combination of stocks & bonds
- assets = reserves against sudden claims, must be liquid
✔✔Insurance Companies - Adverse Selection & Moral Hazard - ✔✔- adverse selection:
a person with terminal cancer has an incentive to buy life insurance for the largest
amount possible
, - moral hazard: without fire insurance, people would have more fire extinguishers in
their house
✔✔Reinsurance Companies - ✔✔some risks are too big for insurance companies...
insure insurance companies against really big risks (earthquakes, hurricanes)
✔✔Catastrophe Bonds - ✔✔allow investors to share some of this risk
- if there is NO catastrophe, they pay a high return (LIBOR+spread)
- if a specific event (described in bond) occurs, they pay nothing... principal goes to
bond issuer to pay for damages
- ex: willing to pay 12% a year (high rate) for 5 years if nothing bad happens
✔✔Pension Fund - ✔✔offers people the ability to make premium payments today in
exchange for promised payments under certain future circumstances... provide an easy
way to make sure that a worker saves & has sufficient resources in old age, help savers
diversify risks
- pools savings of many small investors to spread the risk
✔✔Types of Loans - ✔✔most finance companies specialize in one type of loan
- consumer loans
- business loans
- sales loans
- commercial & home mortgages
✔✔Consumer Finance - ✔✔firms provide small installment loans to individual consumer
✔✔Business Finance - ✔✔companies provides loans to businesses, also provide both
inventory loans & accounts receivable loans
✔✔Sales Finance - ✔✔companies specialize in larger loans for major purchases
(automobiles)
✔✔Broad Class of Securities Firms - ✔✔intermediaries all help link savers/investors
with people who need access to capital
- brokerages
- investment banks
- mutual fund companies
✔✔Government-Sponsored Enterprises - ✔✔hybrid corporate form known as a GSE is
chartered by the govt. as a corporation with a public purpose
✔✔???
Insurance companies perform all of the following functions performed by financial
intermediaries except:
a. transferring risk
GUARANTEE A+
✔✔Foreign Exchange Risk - ✔✔comes from holding assets denominated in one
currency & liabilities denominated in another
✔✔Managing Foreign Exchange Risk - ✔✔- work to attract deposits that are
denominated in same currency as their loans, matching assets to liabilities
- use foreign exchange futures and swaps to hedge risk
✔✔???
A rumor starts that says a bank has suffered significant losses and may not be able to
honor its promises to depositors. This causes most of the depositors to one up in front
of the bank the next morning wanting to withdraw their deposits. This is an example of: -
✔✔liquidity risk
✔✔???
Interest rate risk arises because: - ✔✔a bank's liabilities tend to be more interest rate
sensitive than its assets
✔✔???
Credit risk is a bigger problem for: - ✔✔smaller banks because they tend to have less
diversified markets
✔✔Five Major Categories of Non-depository Institutions - ✔✔- Insurance companies
- Pension funds
- Securities firms (including brokers, mutual-fund companies, investment banks)
- Finance companies
- Govt. sponsored enterprises
✔✔Insurance Companies Specializations - ✔✔specialize in 3 of 5 function performed by
intermediaries:
- pool small premiums & make large investments with them
- diversify risks across a large population
- screen & monitor policyholders to mitigate the problem of asymmetric info
✔✔Insurance Companies - Balance Sheet - ✔✔- promises to policyholders show up as
liabilities
- asset side... insurance companies hold a combination of stocks & bonds
- assets = reserves against sudden claims, must be liquid
✔✔Insurance Companies - Adverse Selection & Moral Hazard - ✔✔- adverse selection:
a person with terminal cancer has an incentive to buy life insurance for the largest
amount possible
, - moral hazard: without fire insurance, people would have more fire extinguishers in
their house
✔✔Reinsurance Companies - ✔✔some risks are too big for insurance companies...
insure insurance companies against really big risks (earthquakes, hurricanes)
✔✔Catastrophe Bonds - ✔✔allow investors to share some of this risk
- if there is NO catastrophe, they pay a high return (LIBOR+spread)
- if a specific event (described in bond) occurs, they pay nothing... principal goes to
bond issuer to pay for damages
- ex: willing to pay 12% a year (high rate) for 5 years if nothing bad happens
✔✔Pension Fund - ✔✔offers people the ability to make premium payments today in
exchange for promised payments under certain future circumstances... provide an easy
way to make sure that a worker saves & has sufficient resources in old age, help savers
diversify risks
- pools savings of many small investors to spread the risk
✔✔Types of Loans - ✔✔most finance companies specialize in one type of loan
- consumer loans
- business loans
- sales loans
- commercial & home mortgages
✔✔Consumer Finance - ✔✔firms provide small installment loans to individual consumer
✔✔Business Finance - ✔✔companies provides loans to businesses, also provide both
inventory loans & accounts receivable loans
✔✔Sales Finance - ✔✔companies specialize in larger loans for major purchases
(automobiles)
✔✔Broad Class of Securities Firms - ✔✔intermediaries all help link savers/investors
with people who need access to capital
- brokerages
- investment banks
- mutual fund companies
✔✔Government-Sponsored Enterprises - ✔✔hybrid corporate form known as a GSE is
chartered by the govt. as a corporation with a public purpose
✔✔???
Insurance companies perform all of the following functions performed by financial
intermediaries except:
a. transferring risk
