M24_MISH1438_06_IM_C24

M24_MISH1438_06_IM_C24 - Part VII The Management of...

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Part VII The Management of Financial Institutions
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Chapter 24 Risk Management in Financial Institutions Managing Credit Risk Screening and Monitoring Long-Term Customer Relationships Loan Commitments Collateral Compensating Balances Credit Rationing Managing Interest-Rate Risk Income Gap Analysis Duration Gap Analysis Example of a Nonbanking Financial Institution Some Problems with Income and Duration Gap Analysis The Practicing Manager: Strategies for Managing Interest-Rate Risk Overview and Teaching Tips Risk management has become a major concern for managers of financial institutions in recent years. This chapter provides an introduction to this subject which is useful for business students who will not take jobs in the financial institutions industry, but which will also provide a solid grounding for students who will go on to pursue more advanced courses in risk management in financial institutions. The section on managing credit risk is an excellent application of the basic concepts of adverse selection and moral hazard to explain managerial practices in the financial institutions industry. The section on managing interest rate risk introduces students to how interest-rate risk is measured and then uses a Practicing Manager application to outline strategies for how to manage interest-rate risk. If duration GAP analysis is covered, then it is necessary that the Practicing Manager application in Chapter 3 on duration be covered earlier in the course. This chapter is really one big application of concepts introduced earlier in the course. Not only does it help solidify students’ understanding of these concepts, but it shows how these concepts are useful for solving managerial problems that business students are likely to encounter in the real world.
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136 Mishkin/Eakins • Financial Markets and Institutions, Sixth Edition Answers to End-of-Chapter Questions 1. Yes. By warning borrowers that they will not be able to get future loans if they engage in risky activities, borrowers will be less likely to engage in these activities in order to have access to loans in the future. 2. Secured loans are an important method of lending for financial institutions because if the borrower defaults, the financial institution can take title to the collateral, sell it off, and use the proceeds to offset any losses on the loan. Thus the financial institution can worry less about the adverse selection problem because it has some protection even if the borrower was a bad credit risk. 3. Uncertain. In some cases, raising rates may generate more income and thus increase profits. However, the higher interest rates do increase adverse selection in which the risk-prone borrowers are more likely to seek out the loans. Thus the rate of default might go up and bank profits could suffer. 4.
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This note was uploaded on 10/17/2011 for the course ECON 317 taught by Professor Guidry during the Spring '11 term at Nicholls State.

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M24_MISH1438_06_IM_C24 - Part VII The Management of...

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