chap007金融机构课后题答案.docx

chap007金融机构课后题答案.docx

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chap007金融机构课后题答案

ChapterSeven

RisksofFinancialIntermediation

ChapterOutline

Introduction

InterestRateRisk

MarketRisk

CreditRisk

Off-Balance-SheetRisk

TechnologyandOperationalRisk

ForeignExchangeRisk

CountryorSovereignRisk

LiquidityRisk

InsolvencyRisk

OtherRisksandtheInteractionofRisks

Summary

SolutionsforEnd-of-ChapterQuestionsandProblems:

ChapterSeven

1.Whatistheprocessofassettransformationperformedbyafinancialinstitution?

Whydoesthisprocessoftenleadtothecreationofinterestraterisk?

Whatisinterestraterisk?

AssettransformationbyanFIinvolvespurchasingprimaryassetsandissuingsecondaryassetsasasourceoffunds.TheprimarysecuritiespurchasedbytheFIoftenhavematurityandliquiditycharacteristicsthataredifferentfromthesecondarysecuritiesissuedbytheFI.Forexample,abankbuysmedium-tolong-termbondsandmakesmedium-termloanswithfundsraisedbyissuingshort-termdeposits.

Interestrateriskoccursbecausethepricesandreinvestmentincomecharacteristicsoflong-termassetsreactdifferentlytochangesinmarketinterestratesthanthepricesandinterestexpensecharacteristicsofshort-termdeposits.Interestrateriskistheeffectonprices（value）andinterimcashflows（interestcouponpayment）causedbychangesinthelevelofinterestratesduringthelifeofthefinancialasset.

2.Whatisrefinancingrisk?

Howisrefinancingriskpartofinterestraterisk?

IfanFIfundslong-termfixed-rateassetswithshort-termliabilities,whatwillbetheimpactonearningsofanincreaseintherateofinterest?

Adecreaseintherateofinterest?

Refinancingriskistheuncertaintyofthecostofanewsourceoffundsthatarebeingusedtofinancealong-termfixed-rateasset.ThisriskoccurswhenanFIisholdingassetswithmaturitiesgreaterthanthematuritiesofitsliabilities.Forexample,ifabankhasaten-yearfixed-rateloanfundedbya2-yeartimedeposit,thebankfacesariskofborrowingnewdeposits,orrefinancing,atahigherrateintwoyears.Thus,interestrateincreaseswouldreducenetinterestincome.Thebankwouldbenefitiftheratesfallasthecostofrenewingthedepositswoulddecrease,whiletheearningrateontheassetswouldnotchange.Inthiscase,netinterestincomewouldincrease.

3.Whatisreinvestmentrisk?

Howisreinvestmentriskpartofinterestraterisk?

IfanFIfundsshort-termassetswithlong-termliabilities,whatwillbetheimpactonearningsofadecreaseintherateofinterest?

Anincreaseintherateofinterest?

Reinvestmentriskistheuncertaintyoftheearningrateontheredeploymentofassetsthathavematured.ThisriskoccurswhenanFIholdsassetswithmaturitiesthatarelessthanthematuritiesofitsliabilities.Forexample,ifabankhasatwo-yearloanfundedbyaten-yearfixed-ratetimedeposit,thebankfacestheriskthatitmightbeforcedtolendorreinvestthemoneyatlowerratesaftertwoyears,perhapsevenbelowthedepositrates.Also,ifthebankreceivesperiodiccashflows,suchascouponpaymentsfromabondormonthlypaymentsonaloan,theseperiodiccashflowswillalsobereinvestedatthenewlower（orhigher）interestrates.Besidestheeffectontheincomestatement,thisreinvestmentriskmaycausetherealizedyieldsontheassetstodifferfromtheaprioriexpectedyields.

4.Thesalesliteratureofamutualfundclaimsthatthefundhasnoriskexposuresinceitinvestsexclusivelyinfederalgovernmentsecuritiesthatarefreeofdefaultrisk.Isthisclaimtrue?

Explainwhyorwhynot.

Althoughthefund'sassetportfolioiscomprisedofsecuritieswithnodefaultrisk,thesecuritiesremainexposedtointerestraterisk.Forexample,ifinterestratesincrease,themarketvalueofthefund'sTreasurysecurityportfoliowilldecrease.Further,ifinterestratesdecrease,therealizedyieldonthesesecuritieswillbelessthantheexpectedrateofreturnbecauseofreinvestmentrisk.Ineithercase,investorswholiquidatetheirpositionsinthefundmaysellataNetAssetValue（NAV）thatislowerthanthepurchaseprice.

5.Whatiseconomicormarketvaluerisk?

InwhatmanneristhisriskadverselyrealizedintheeconomicperformanceofanFI?

Economicvalueriskistheexposuretoachangeintheunderlyingvalueofanasset.Asinterestratesincrease（ordecrease）,thevalueoffixed-rateassetsdecreases（orincreases）becauseofthediscountedpresentvalueofthecashflows.Totheextentthatthechangeinmarketvalueoftheassetsdiffersfromthechangeinmarketvalueoftheliabilities,thedifferenceisrealizedinthemarketvalueoftheequityoftheFI.Forexample,formostdepositoryFIs,anincreaseininterestrateswillcauseassetvaluestodecreasemorethanliabilityvalues.Thedifferencewillcausethemarketvalue,orshareprice,ofequitytodecrease.

6.Afinancialinstitutionhasthefollowingbalancesheetstructure:

AssetsLiabilitiesandEquity

Cash$1,000CertificateofDeposit$10,000

Bond$10,000Equity$1,000

TotalAssets$11,000TotalLiabilitiesandEquity$11,000

Thebondhasa10-yearmaturityandafixed-ratecouponof10percent.Thecertificateofdeposithasa1-yearmaturityanda6percentfixedrateofinterest.TheFIexpectsnoadditionalassetgrowth.

a.Whatwillbethenetinterestincome（NII）attheendofthefirstyear?

Note:

Netinterestincomeequalsinterestincomeminusinterestexpense.

Interestincome$1,000$10,000x0.10

Interestexpense600$10,000x0.06

Netinterestincome（NII）$400

b.Ifattheendofyear1marketinterestrateshaveincreased100basispoints（1percent）,whatwillbethenetinterestincomeforthesecondyear?

IsthechangeinNIIcausedbyreinvestmentriskorrefinancingrisk?

Interestincome$1,000$10,000x0.10

Interestexpense700$10,000x0.07

Netinterestincome（NII）$300

Thedecreaseinnetinterestincomeiscausedbytheincreaseinfinancingcostwithoutacorrespondingincreaseintheearningsrate.Thus,thechangeinNIIiscausedbyrefinancingrisk.Theincreaseinmarketinterestratesdoesnotaffecttheinterestincomebecausethebondhasafixed-ratecouponfortenyears.Note:

thisanswermakesnoassumptionaboutreinvestingthefirstyear’sinterestincomeatthenewhigherrate.

c.Assumingthatmarketinterestratesincrease1percent,thebondwillhaveavalueof$9,446attheendofyear1.WhatwillbethemarketvalueoftheequityfortheFI?

AssumethatalloftheNIIinpart（a）isusedtocoveroperatingexpensesorisdistributedasdividends.

Cash$1,000Certificateofdeposit$10,000

Bond$9,446Equity$446

Totalassets$10,446Totalliabilitiesandequity$10,446

d.Ifmarketinterestrateshaddecreased100basispointsbytheendofyear1,wouldthemarketvalueofequitybehigherorlowerthan$1,000?

Why?

Themarketvalueoftheequitywouldbehigher（$1,600）becausethevalueofthebondwouldbehigher（$10,600）andthevalueoftheCDwouldremainunchanged.

e.Whatfactorshavecausedthechangeinoperatingperformanceandmarketvalueforthisfirm?

Theoperatingperformancehasbeenaffectedbythechangesinthemarketinterestratesthathavecausedthecorrespondingchangesininterestincome,interestexpense,andnetinterestincome.Thesespecificchangeshaveoccurredbecauseoftheuniquematuritiesofthefixed-rateassetsandfixed-rateliabilities.Similarly,theeconomicmarketvalueofthefirmhaschangedbecauseoftheeffectofthechangingratesonthemarketvalueofthebond.

7.Howdoesthepolicyofmatchingthematuritiesofassetsandliabilitieswork（a）tominimizeinterestrateriskand（b）againsttheasset-transformationfunctionforFIs?

Apolicyofmaturitymatchingwillallowchangesinmarketinterestratestohaveapproximatelythesameeffectonbothinterestincomeandinterestexpense.Anincreaseinrateswilltendtoincreasebothincomeandexpense,andadecreaseinrateswilltendtodecreasebothincomeandexpense.Thechangesinincomeandexpensemaynotbeequalbecauseofdifferentcashflowcharacteristicsoftheassetsandliabilities.Theasset-transformationfunctionofanFIinvolvesinvestingshort-termliabilitiesintolong-termassets.Maturitymatchingclearlyworksagainstsuccessfulimplementationofthisprocess.

8.Corporatebondsusuallypayinterestsemiannually.Ifacompanydecidedtochangefromsemiannualtoannualinterestpayments,howwouldthisaffectthebond’sinterestraterisk?

Theinterestrateriskwouldincreaseasthebondsarebeingpaidbackmoreslowlyandthereforethecashflowswouldbeexposedtointerestratechangesforalongerperiodoftime.Thusanychangeininterestrateswouldcausealargerinversechangeinthevalueofthebonds.

9.Two10-yearbondsarebeingconsideredforaninvestmentthatmayhavetobeliquidatedbeforethematurityofthebonds.Thefirstbondisa10-yearpremiumbondwithacouponratehigherthanitsrequiredrateofreturn,andthesecondbondisazero-couponbondthatpaysonlyalump-sumpaymentafter10yearswithnointerestoveritslife.Whichbondwouldhavemoreinterestraterisk?

Thatis,whichbond’spricewouldchangebyalargeramountforagivenchangeininterestrates?

Explainyouranswer.

Thezero-couponbondwouldhavemoreinterestraterisk.Becausetheentirecashflowisnotreceiveduntilthebondmatures,theentirecashflowisexposedtointerestratechangesovertheentirelifeofthebond.Thecashflowsofthecoupon-payingbondarereturnedwithperiodicregularity,thusallowinglessexposuretointerestratechanges.Ineffect,someofthecashflowsmaybereceivedbeforeinterestrateschange.Theeffec