Chapter+17+Answers+to+end-of-chapter+questions

Chapter+17+Answers+to+end-of-chapter+questions - CHAPTER 17...

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CHAPTER 17 CAPITAL ADEQUACY Chapter outline The Cost of Equity Capital as a Funding Source Capital and Insolvency Risk Capital The Market Value of Capital Market Value of Capital and Credit Risk Market Value of Capital and Interest Rate Risk The Book Value of Capital Book Value of Capital and Credit Risk Book Value of Capital and Interest Rate Risk The Discrepancy between the Market and Book Values of Equity Arguments against Market Value Accounting Capital Adequacy: Australia’s Authorised Depository Institutions The Capital–Assets Ratio (Or Leverage Ratio) Risk-Based Capital Ratios Capital Tier I Capital Tier II Capital Credit Risk-adjusted Assets Calculating Risk-Based Capital Ratios Credit risk adjusted on-balance-sheet assets under Basel I Credit risk adjusted on-balance-sheet assets under Basel II Credit risk adjusted off-balance-sheet activities Credit risk adjusted asset value of off-balance-sheet derivative instruments with netting Interest rate risk, market risk and risk-based capital Operational risk and risk-based capital Criticisms of the Risk-Based Capital Ratio Appendix 17A: Internal Ratings-based Approach to Measuring Credit Risk Adjusted Assets Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, 1
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Answers to end-of-chapter questions QUESTIONS AND PROBLEMS 1. Identify and briefly discuss the importance of the five functions of an FI’s capital. Capital serves as a primary cushion against operating losses and unexpected losses in the value of assets (such as the failure of a loan). FIs need to hold enough capital to provide confidence to uninsured creditors that they can withstand reasonable shocks to the value of their assets. In addition, the FDIC, which guarantees deposits, is concerned that sufficient capital is held so that their funds are protected, because they are responsible for paying insured depositors in the event of a failure. This protection of the FDIC funds includes the protection of the FI owners against increases in insurance premiums. Finally, capital also serves as a source of financing to purchase and invest in assets. 2. Why are regulators concerned with the levels of capital held by an FI compared to a non-financial institution? Regulators are concerned with the levels of capital held by an FI because of its special role in society. A failure of an FI can have severe repercussions for the local or national economy, unlike non-financial institutions. Such externalities impose a burden on regulators to ensure that these failures do not impose major negative externalities on the economy. Higher capital levels will reduce the probability of such failures. 3.
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This note was uploaded on 08/21/2009 for the course FINS 3630 taught by Professor Yip during the Three '09 term at University of New South Wales.

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Chapter+17+Answers+to+end-of-chapter+questions - CHAPTER 17...

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