Bank MGMT Exam C

• Your bank has need for liquidity and has an excess of auto loans. You decide to pool $500M of these loans and sell units of ownership of these loans to the public in the way of asset-backed securities. What is the fundamental financial effect of this transaction?

  (a) change a type of liability to asset

  (b) change a type of asset to a liability

  (c) transform a type of asset into another type of asset

  (d) transform a type of liability into another type of liability

  (c)
• Could mighty big banks securitize its sub-prime mortgage assets en masse, selling the ABS to retail investors who may undervalue the risk the individual mortgages comprising the portfolio causing a catastrophic banking crisis and recession? Briefly explain

  Yes, this caused the 2008 financial crisis
• What is a credit derivative?

  Contracts that allow for risk transfer related to creditworthiness (Credit Risk) off the balance sheet. It enables the creditor to transfer some or all of the risk of a debtor defaulting to a third party. The third party accepts this risk in return for a payment, known as the premium
• Most homeowners make monthly mortgage payments to a finance company that does not even have their mortgage. What are such firms called?

  Mortgage Banking (not a depository)
• Standby Letters of Credit are typically used in ____.

  (a) construction loans

  (b) international trade

  (c) insuring employees who handle large sums of money do not embezzle

  (d) the gap between when a credit card application is approved and the card is received?

  (b)
• As bank president, you are hiring an investment portfolio manager. What will the person in this post provide your bank? [List at least three.]

  -Portfolio Management (Diversification)

  -Reduce Tax Exposure

  -Hedge against interest rate
• If you are managing the investment portfolio of your bank and are concerned about a sudden increase in inflation, would you rather have the maturity of your asset portfolio front-loaded (shorter duration) or back-loaded (longer duration)? Briefly explain

  Front-loaded: because the portfolio’s cash flows occur sooner. This means the bank will receive its returns and principal earlier, reducing the time during which inflation can erode the value of those returns.
• Explain to your non-finance friend the economic justification of lenders to build into auto loans and mortgages with discount points a prepayment penalty:

  Lenders include prepayment penalties in auto loans and mortgages with discount points to protect themselves from potential financial losses if borrowers pay off the loans early. When borrowers repay loans ahead of schedule, lenders miss out on expected interest income. Prepayment penalties serve as a form of compensation for this lost income and help lenders manage their risks
• What is business risk to a bank? Give an example

  financial loss resulting from factors inherent in its operations or the broader economic environment. An example of business risk for a bank could be a downturn in the economy leading to increased loan defaults
• What is liquidity risk to a bank? Give an example

  risk that it may not be able to meet its short-term financial obligations due to an inability to convert assets into cash quickly without incurring significant losses. An example of liquidity risk for a bank could be a sudden surge in customer withdrawals exceeding the bank's available cash reserves
• Which type of risk is most-managed by banks using derivatives?

  interest-rate risk
• When a bank takes a position on a forward contract, it typically appears ____ and when it closes the position, the result appears ____.

  (a) on the balance sheet; on the balance sheet

  (b) off balance sheet; on the income statement

  (c) on the income statement; off balance sheet

  (d) off balance sheet; on the income statement

  (b)
• Which of the following is a feature of a futures contract?

  (a)counterparty risk

  (b) customization of the type/amount of asset

  (c) asset valuation marked to market daily

  (d) requires no cash down

  (c)
• Secured Overnight Financing Rate (SOFR) will be replacing LIBOR soon. Why does this matter to US banks and many mortgage borrowers?

  SOFR is expected to provide a more reliable and transparent benchmark for setting interest rates on various financial products, including mortgages. However, it may also lead to changes in the interest rates paid by borrowers, particularly those with adjustable-rate loans
• Describe how you, as a savings institution’s mortgage lender, might use a plain vanilla interest rate swap to manage the interest rate risk of your FRM versus ARM originations.

  FRMs -> Interest Rates Fall -> Refinance Risk

  • Hedge: Pay fixed rate, receive floating rate in swap

  AMR -> Interest Rates Rise -> Cost of Funds Increase

  • Hedge: Pay floating rate, receive fixed rate
• OCC is not funded by taxes. Banks pay to be regulated by the OCC
• The OCC is an agency that charters, regulated and supervises national banks
• Reason for the founding of the OCC?

  Every bank had their own currency (North/South and State to State). In 1863, the OCC was established to solve this currency issue
• The main mission of the OCC: Make sure banks do not fail
• CAMELS: Capital, Asset, Management, Earnings, Liquidity, Sensitivity to market risk
• ITCC: information Tech, Trust, Consumer Compliance, Community reinvestment Act (public rating)
• interest rate risk: the risk that a change in interest rates will cause a change in the value of a firm's asset. Relevant now because of how quick and violent the rates recently rose.
• Dual Mandate of the Fed: Unemployment and Inflation
• Liquidity Risk: The risk that a firm will not be able to meet its obligations as they fall due.
• Credit Risk: Refinance Risk
• What is the difference between OCC and FDIC?

  FDIC insures, OCC is concerned with safety
• The OCC will observe and approve the process of Shotgun Mergers
• When UBS merged with Credit Suisse, the OCC focused on charter in states (national level) not international
• Camels: Assets

  Quality of Loans
• Camels: MGMT

  Are they strong
• Camels: Earnings

  Profitable?
• Camels: Liquidity

  Assets and Liabilities
• Camels: Sensitivity

  Interest rate risk
• ITCC: Trust?

  Fiduciary activities
• Camels and ITCC have a 5 point rating, 1 being the best
• Gambling is an artificial event creating winers and losers
• Futures: agreement to deliver a security at a future date (off-balance sheet)
• in "spot" or "cash" markets, sellers deliver within a customary time
• Foward agreements have counter party risk
• futures are not custom made, standardized, nightly delivery (no counter party risk)