13 - Chapter Thirteen Off-Balance-Sheet Activities Chapter...

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Unformatted text preview: Chapter Thirteen Off-Balance-Sheet Activities Chapter Outline Introduction Off-Balance-Sheet Activities and FI Solvency Returns and Risks of Off-Balance-Sheet Activities Loan Commitments Commercial Letters of Credit and Standby Letters of Credit Derivative Contracts: Futures, Forwards, Swaps, and Options Forward Purchases and Sales of When Issued Securities Loans Sold Nonschedule L Off-Balance-Sheet Risks Settlement Risk Affiliate Risk The Role of OBS Activities in Reducing Risk Summary 156 Solutions for End-of-Chapter Questions and Problems: Chapter Thirteen 1. Classify the following items as either (1) on-balance-sheet assets, (2) on-balance-sheet liabilities, (3) off-balance-sheet assets, (4) off-balance-sheet liabilities, or (5) capital account. Classification a. Loan commitments 3 b. Loan loss reserves 5 c. Letter of credit 2 d. Bankers acceptance 2 e. Rediscounted bankers acceptance 2 f. Loan sales without recourse None of the above. g. Loan sales with recourse 3 h. Forward contracts to purchase 3 I. Forward contracts to sell 4 j. Swaps 4 (for liability swaps) k. Loan participations 1 l. Securities borrowed 3 m. Securities lent 4 n. Loss adjustment expense account (PC insurers) 2 o. Net policy reserves 2 2. How does one distinguish between an off-balance-sheet asset and an off-balance-sheet liability? Off-balance-sheet activities or items are contingent claim contracts. An item is classified as an off-balance-sheet asset when the occurrence of the contingent event results in the creation of an on-balance-sheet asset. An example is a loan commitment. If the borrower decides to exercise the right to draw down on the loan, the bank will incur a new asset on its portfolio. Similarly, an item is an off-balance-sheet liability when the contingent event creates an on-balance-sheet liability. An example is a standby letter of credit (LC). In the event that the original payer of the LC defaults, then the bank is liable to pay the amount to the payee, incurring a liability on the right-hand side of its balance sheet. 3. Contingent Bank has the following balance sheet in market value terms (in millions of dollars): Assets Liabilities Cash $20 Deposits $220 Mortgages $220 Equity $20 Total Assets $240 Total Liabilities & Equity $240 In addition, the bank has contingent assets with $100 million market value and contingent liabilities with $80 million market value. What is the true stockholder net worth? What does the term contingent mean? 157 Net worth = (240-220) + (100-80) = $40 million. The term contingent means an event that may or may not happen. In financial economics, the term is used in conjunction with the result given that some event does occur....
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13 - Chapter Thirteen Off-Balance-Sheet Activities Chapter...

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