Chapter2_PractiseQs

Chapter2_PractiseQs - 1 Using total assets as a measure of...

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Unformatted text preview: 1 Using total assets as a measure of size, the largest group of institutions in all major financial systems is: A) superannuation funds B) insurance companies C) commercial banks D) merchant banks Feedback: The banks’ share of the total assets of all financial institutions varies between countries and over time but, using Australia as an example, it is between 40 and 50 per cent which is clearly the largest share held by any of the institutions. See page 47. 2 Banks have progressively moved from asset management to liability management. Which of the following statementsthe loans portfolio is tailored to match the available deposit base A) best describes liability management? B) the ratio of debt to equity is managed to meet capital adequacy requirements Feedback: A bank C) the deposit on asset management mayfund loan demand that focuses base is managed in order to find that its lending is constrained if the growth of its deposits is not sufficient to fund all the loans that management wishes to make. Instead of declining profitable loan D) requests, a bank may adopt liability management whereby the bank will actively seek additional funds from deposit the deposit base and the funding for loans. A and B are fund loan demand C gives a description and non-deposit sources in order to meetotherdemandsources are managed toclearly and while and other commitments of liability management, it is incomplete in that it refers only to deposits as a source of funds. The description in D is more comprehensive, making it the answer. See page 48. 3 Banks and other depository institutions can raise funds from many sources. Which of the following are fund sourcesA) I, II, III, V utilised by banks? I call deposits II Statutory Reserve Deposits III term deposits IV Treasury notes V certificates of deposit VI loan capital B) I, III, V, VI C) I, III, IV, V Feedback: Of the six items listed, four are fund sources used by banks, namely call deposits, term deposits, D) III, IV, V, VI certificates of deposit and loan capital which includes subordinated notes. Statutory Reserve Deposits have been abolished but were deposits by banks with the Reserve Bank. Only the Commonwealth Government issues Treasury notes. See page 49. 4 An important distinction between current deposits and call deposits is: A) call deposits are more liquid than current deposits Feedback: For the B) only current deposit accounts have a cheque facility purpose of preparing official banking statistics a distinction is made between funds in accounts that have cheque facilities and those in other similar accounts without cheque facilities. Funds in accounts with C) only call deposit accounts pay interest to the depositor cheque facilities are known as ‘current deposits’. Deposits that can be withdrawn on demand from accounts without D) banks charge accounts) fees on current accounts but not Both deposit current cheque facilities (such as savings transaction are classified as ‘call deposits’.on callcall and accountsdeposit accounts can pay interest and incur transaction fees so C and D are . Given the ability to withdraw by cheque, current deposits are regarded as more liquid than call deposits so A is also . See page 49. 5 An important source of funding used by banks is the certificate of deposit (CD). Which of the following statements about CDsCDs differ from other bank deposits in that they are issued at a discount from face value A) is correct? B) while CDs are transferable, sales in the secondary market are rare Feedback: A CD isC) certificate issued by a bank undertaking to pay to the bearer the face value of the certificate at a a specified maturity date. CDs are discount securities and are short-term as most have initial terms to maturity of no CDs are essentially the same as retail term deposits except that larger amounts of money are involved more than 180 days. Each issue of a CD is a separate transaction so banks have the flexibility to vary the interest D) the yield offered to new CDs is the bank’s a weekly basis Based bank rates on CDs frequently in response on changes in reviewed onneed for funds.by eachon the above, A is accurate and both C and D are inaccurate. As stated in B, CDs are transferable but the market is very active so B is also . See page 50. 6 Which of the following does not represent a ‘use of funds’ by commercial banks? A) commercial bills B) credit cards C) certificates of deposit D) overdrafts Feedback: Feedback: Uses of funds by banks include discounting commercial bills, lending on credit cards and providing overdrafts. Issuing certificates of deposit is a source of funds, not a use of funds, so C is the answer. See page 50. 7 Lending to government by banks mainly takes the form of the purchase of government-issued securities. The reasonsA) I, II, III, Vinvest in these securities include: I regulations require banks to hold government securities II why banks government securities are a primary source of liquidity for banks III government securities may be used to raise B) II, III, IV, VI cleared funds for payments system settlements via repurchase agreements IV government securities provide C) are higher than the returns on other investments V government securities allow a bank to manage its yields that III, IV, V, VI D) II, III, V, VI nterest rate sensitivity VI government securities are —the low risk Feedback: iFeedback: Of the six ‘reasons’ listed, I and IVare of very regulations under which banks were required to hold government securities have been abolished and the yields on government securities are lower than the returns on most other investments.See page 57. 8 The main type of loan provided by Australian banks to commercial borrowers is: A) overdraft facilities B) fixed-term loans C) lease finance Feedback: Historically, Australian banks met the needs of businesses largely by providing overdraft facilities. D) bill rollover facilities However, providing overdrafts can be costly for banks which have discouraged their use by imposing higher interest rates and a range of additional fees. As an alternative to overdrafts, banks have encouraged commercial borrowers to use fixed-term loans and these now account for the majority of lending to businesses. See page 55. 9 In Australia, the largest form of bank lending to individuals is: A) credit card finance B) investment property finance C) loans for the purchase of owner-occupied housing D) fixed-term loans for the purchase of motor vehicles Feedback: All four types of bank lending are used by individuals in the Australian market but the total value of loans for home purchase is considerably greater than that of the other three types so C is the answer. See page 54. 10 Which of the following statements about bank term deposits is not correct? A) the interest rate on a term deposit is fixed for the period of the investment B) commercial banks typically offer term deposits for periods up to five years C) the interest rates on term deposits are usually lower than the rates on call deposits D) term deposits are usually attractive to conservative investors Feedback: The statements in A, B and D are accurate, but C is not accurate. Term deposits are less liquid than call deposits so a higher rate of interest is needed to compensate investors for the loss of liquidity. See page 50. 11 The off-balance-sheet business of banks is categorised below. Which category represents the most significant proportion of total off-balance-sheet business of the banks? A) direct credit substitutes B) trade and performance-related items C) commitments D) market rate-related transactions Feedback: Instruments such as interest rate swaps and foreign exchange contracts, both of which are in the marker rate-related category, dominate off-balance-sheet business. Accordingly, D is the answer. See page 61. 12 A basic principle of APRA’s approach to prudential supervision of banks is that: A) prudential supervision allows the regulator to control interest rates B) depositors’ funds are protected by a government guarantee C) the primary responsibility for a bank’s sound operation rests with its own management and directors Feedback: The RBA is responsible for controlling interest rates and that is quite separate from the prudential D) supervision carried out by APRA, so A is . Prudential supervision does not extend to providing a government prudential supervision . Bank regulation restricting the composition of banks’ balance sheets guarantee to protect deposits so B is alsocontinues to rely onused to involve controls on interest rates and restrictions on the composition of their assets but those restrictions have been removed so D is , leaving C as the answer. See page 63. 13 Which of the following statements best describes the regulatory structure of the Australian financial system A) the overall stability of the financial system and of individual institutions is the responsibility of the Reserve Bank B) APRA is responsible for the overall stability of the financial system and of individual institutions C) banks, superannuation funds and life insurance companies are each supervised by separate regulators Feedback: A and B are both because the Reserve Bank is responsible for the overall stability of the financial D) there are several regulators but each is responsible for C own distinct type the institutions listed system, while APRA supervises individual institutions within the system.its is also because of regulation are all supervised by APRA. As stated in D, the framework is based on the principle that only one regulator should be responsible for each type of regulation. See page 63 14 In the event of a threat to the stability of the Australian financial system, such as financial difficulties experienced by an individual bank: primary responsibility for dealing with the problem A) APRA has B) the Reserve Bank is obliged to provide emergency liquidity support Feedback: APRA is responsible for the prudential supervision of financial institutions. It is true that APRA takes the C) approach that the primary responsibility for each bank’s sound operation rests with emergency liquidity support the Reserve Bank will determine whether, and how, it might provide its own management and directors. This does not mean that regulators would refuse to intervene in a crisis, so D is . If difficulties experienced D) by an individual bank threatened the stability of the financial system, then the problem would become the management of the bank experiencing financial difficulties is responsibility in such a case, it is not responsibility of the Reserve Bank, so A is also . While the Reserve Bank has solely responsible for achieving a solution obliged to achieve a rescue—it could decide that the bank in difficulty should be allowed to fail. Hence B is and C is the answer. See page 63. 15 Prudential supervision of banks relies heavily on capital adequacy standards. The main reason for reliance on standards related to the level of bankfinancialis: A) the standards restrict the capital leverage of banks B) banks need to raise capital to generate profits Feedback: While several roles can be identified for bank capital, the primary reason for reliance on capital adequacy C) every business requires some shareholders’ funds (capital is that it provides an effective way of restricting financial leverage. A higher ratio of capital to assets means that the D) accounting principles require means that the risk be written off through an unexpected decline in ratio of liabilities to assets is lower. In turn, this that loan losses must of insolvency,against capital the value of assets, is lower if the ratio of capital to assets is ‘high’. The statements in B, C and D are all valid but none of these constitutes the main reason for reliance on capital adequacy standards. See page 64. 16 The Basel I capital accord which applied a standardised approach to the measurement of the capital adequacy of banks was all banks must have capital equal to version of per cent which ofassets A) later extended. Under the extended at least 8 Basel I, of their the following is the most accurate? B) the capital that each bank must have depends only on the credit risk of its on-balance sheet assets C) the capital base that each bank must have depends on the credit risk of its on- and off-balance-sheet assets D) I capital accord initially specified that banks must hold capital well as at least Feedback: The Baselthe capital required depends on a bank’s exposure to market risk asequal tocredit risk8 per cent of their risk-weighted assets, so the focus was on credit risk. Basel I was later extended to also include a bank’s exposure to market risk so D is the answer. See page 65. 17 The Basel II accord to be introduced in 2008 is regarded as a major extension of Basel I. Which of the following most accurately describes the way of which Basel II extends Basel I? A) it introduces a measure in the risk of off-balance-sheet business B) it introduces a measure of market risk C) it is more sensitive to the different levels of risk that may exist in an institution Feedback: A major criticism of the Basel I capital accord is that the risk weights applied to assets are based on D) it broad. For example, all on the risky assets that banks may hold categories that are toointroduces new restrictionloans to companies have a risk weight of 100 per cent regardless of the credit rating of the borrower. Basel II provides for the risk weights to be aligned more closely with the actual risk involved and this change is consistent with C as the answer. See page 65. 18 Mega Bank advances a loan of $5 million to a company that has a Standard and Poor’s credit rating of A+. How much ofA) $4 600 000 funded by liabilities? the loan can be B) $4 800 000 C) $200 000 Feedback: As shown in Table 2.3 (Chapter 2, page 69), a rating of A+ is classified as External rating grade 2, which D) $4 920 000 has a risk weight of 50 per cent. The amount of capital required is the book value of the loan × the risk weight × 8 per cent. In this case, the capital required is $5 000 000 × 0.5 × 0.08 = $200 000 so up to $4 800 000 can be funded by liabilities. See page 70. 19 A bank may choose to measure its market-related, off-balance-sheet capital requirements using a value at risk (VaR) model. APRA requires a VaR model to apply a confidence level such that, on average, trading losses from A) one in every 50 trading days market-related contracts will exceed the VaR estimate: B) one in every 100 trading weeks C) one in every 100 trading days Feedback: A VaR model may be used to estimate the maximum potential gains or losses that may occur with a D) over a given time period. in every 100 trading are specified probability between one and five timesWhere such modelsdaysused in relation to off-balance-sheet, marketrelated contracts, APRA requires a 99 per cent confidence level based on a one-day holding period, which corresponds to C. See page 75. 20 Banks may issue securities classed as ‘loan capital’. Which of the following statements about loan capital is correct?A) loan capital refers to instruments that have characteristics of both debt and equity B) subordinated debentures may be included in loan capital C) some types of perpetual loan capital are recognised by regulators as part of bank capital for capital adequacy purposes Feedback: In addition to raising funds by accepting deposits and by borrowing, banks can issue securities such as D) all debt above perpetual subordinatedof theand other hybrid securities. Such securities are classified as loan capital and are shown in Table 2.2 (Chapter 2, page 76). Some of these securities can be included in bank capital for regulatory purposes. Accordingly, the statements in A, B and C are all valid, making D the answer. See page 52. 21 Feedback: Several factors have contributed to growth in the all its profitable loans, the bank will usually raise of funds for If a bank’s deposits are not sufficient to fund importance of foreign currency liabilities as a source additional Australian banks. The funds by borrowing from the VI relevant factors include:than decliningof the foreign exchange some cases, a bank may A) I, III, IV, financial markets rather I deregulation requests for loans. In market II offshore funds are always B) needed funds borrowings III internationalisation of the banks’ corporate clients IV diversification be able to raise allless costly than localin the local market but many Australian banks have raised large amounts in of the III, IV, VI II, funding sources V avoidance of local bank regulations VI removal of controls on international capital flows offshore markets and these borrowings are generally denominated in a foreign currency. Of the six ‘reasons’ given, C) I, III, IV, V, VI all are valid except II and V. Offshore funds may be cheaper than local funds in some cases but if this was always so D) all of the raise then, logically, a bank should above all of its funds from the cheaper source, so II is not valid. Bank regulations in many countries are very similar and do not distinguish between local and foreign currency fund sources, so V is also invalid. See page 52. 22 Banks, in common with all organisations, must manage their day-to-day liquidity needs such as paying creditors and employees. However, banks face specialby regulators are difficult to meet reason for this is: A) the liquidity requirements imposed liquidity problems. One important B) future cash flows and hence liquidity requirements are uncertain Feedback: Banks and other financial intermediaries offer and liabilities are mismatched C) the maturity structures of bank assets short-term deposits while providing long-term loans. In other words, the term to maturity of their assets is greater than that of their liabilities – as stated in C. Banks face D) banks have high proportion of their funds invested in illiquid real assets such potential liquidity problems if anaunexpectedly high proportion of depositors seek to withdrawas premises andor their funds at, computers around, the same time. Regulatory requirements must be achievable, so A is . Future cash flows are, of course, uncertain but this is not peculiar to banking, so B is also . Finally, premises and computers are illiquid but they make up only a very small proportion of bank assets, so D is . See page 80. 23 Setting limits on maturity mismatches between assets and liabilities and access to wholesale markets for the issue of money market securities are both strategies that banks can use to: A) control credit risk B) manage liquidity C) meet capital requirements Feedback: The maturity mismatch between bank assets and liabilities is one reason for the potential liquidity problems faced byD) implement liability management banks. It follows that setting limits on the extent of the mismatch is one tool that can be used to manage bank liquidity. Another useful measure is to make arrangements in advance, whereby the bank can raise cash by accessing lines of credit or issuing securities. Accordingly, B is the answer. See page 81. 24 Which of the following statements about the off-balance-sheet business of Australian commercial banks is correct?A) the face value of off-balance-sheet business is similar to the total value of bank assets B) the face value of off-balance-sheet business is considerably larger than the total value of bank assets C) the face value of off-balance-sheet business is an unbiased measure of its significance relative to onbalance-sheet assets Feedback: Based on 2005 figures the face value of off-balance-sheet (OBS) business was about six times the total D) so A is . OBS business consists evenly of derivatives and their face values are value of bank assets off-balance-sheet business is fairly largely divided across the four main categories typically many times larger than the eventual cash flows, so C is . Market-rate related OBS business is far larger than the other three categories so D is also . See page 61. 25 Banks can be viewed as essentially passive receivers of deposits that are used mainly to fund loans. In Australia, this traditional view ofbeen valid A) has never banks: B) remains an accurate description Feedback: Accepting deposits and making loans (financial intermediation) continues to be a core activity of banks. C) applies to most, but not all, banks However, banks are not ‘passive’ and actively seek new business opportunities and funds from sources other than D) is inaccurate as a description of modern bank operations deposits. Modern banks are involved in foreign exchange transactions, insurance, funds management and derivatives as well as financial intermediation. In other words, they provide a full range of financial services so the description in the question is inaccurate making D the answer. See page 48. 26 XYZ Ltd requires a bank loan that will allow it to manage short-term and seasonal variations in its cash flows. The type of loan thatloan A) term is designed for this purpose is a: B) bill rollover facility C) overdraft Feedback: An overdraft provides the type of flexibility that is needed in this case. Once an overdraft facility has been D) lease established, the borrower can draw on additional funds as required (provided the approved limit is not exceeded). Also, cash inflows can be used to repay part of the loan at any time but there is no set repayment schedule to adhere to. See page 56. 27 In recent years, banks have undertaken an increased volume of business that is not recorded as assets and liabilities incommercial bill transactions business is generally known as: A) their accounts. This type of B) over-the-counter business C) exchange-traded contracts Feedback: Commercial bill transactions do give rise to assets and liabilities that appear on a bank’s balance sheet, so A is . Business D) off-balance-sheet businessnot recorded as assets and liabilities includes dealing in over the conducted by banks that is counter and exchange traded derivative contracts but the general term for all such business is ‘off-balance-sheet business’, so D is the answer. See page 58. 28 Bill acceptances are recorded as liabilities on the balance sheets of banks. These liabilities arise from: A) banks purchasing bills in the open market B) banks selling bills into the financial markets C) banks guaranteeing that the holder of a bill will be paid at maturity D) Feedback: When a bill of exchange is issued, it must be ‘accepted’ by a bank or other financial institution. The banks making a commitment paying the bills and of the customer holder on the maturity date. In acceptor takes on the primary responsibility for to purchase faceifvaluewhen a bill to the needs to issue them in the future other words, the acceptor provides a guarantee so that it is the credit rating of the acceptor that determines the risk of the bill, so C is the answer. See page 51. 29 The bank bill swap rate (BBSW) is most accurately described as: A) the interest rate on bank term deposits B) the interest rate on bank overdrafts C) the interest rate on fixed term loans Feedback: The interest rates on bank loans are typically set by adding a margin or premium to a base or ‘reference’ rate. In the case ofD) an important reference rate used to determineis adjusted at specified intervals loans on floating (variable) rate loans the interest rate the interest rate charged on bank based movements in the reference rate. For commercial loans in the Australian market, the most commonly used reference rate is the BBSW making D the answer. See page 55. 30 The largest providers of housing loans in the Australian market are: A) building societies B) banks C) mortgage originators Feedback: Most of the larger building societies that used to exist in Australia have converted to banks so the D) superannuation funds building society sector is now very small. While new entrants to the home loan market, such as Aussie Home Loans and RAMS (mortgage originators), have achieved a significant market share, banks have retained their dominant position in the market, making B the answer. See page 54. 1hapter 02no C 0 1 4070140898 2256362 qu 1 Using total assets as a measure of size, the largest group of institutions in all major financial systems is: A) superannuation funds B) insurance companies C) commercial banks D) merchant banks Feedback: The banks’ share of the total assets of all financial institutions varies between countries and over time but, using Australia as an example, it is between 40 and 50 per cent which is clearly the largest share held by any of the institutions. See page 47. 2 4 2 Banks have progressively moved from asset management to liability management. Which of the following statementsthe loans portfolio is tailored to match the available deposit base A) best describes liability management? B) the ratio of debt to equity is managed to meet capital adequacy requirements Feedback: A bank C) the deposit on asset management mayfund loan demand that focuses base is managed in order to find that its lending is constrained if the growth of its deposits is not sufficient to fund all the loans that management wishes to make. Instead of declining profitable loan D) requests, a bank may adopt liability management whereby the bank will actively seek additional funds from deposit the deposit base and the funding for loans. A and B are fund loan demand C gives a description and non-deposit sources in order to meetotherdemandsources are managed toclearly and while and other commitments of liability management, it is incomplete in that it refers only to deposits as a source of funds. The description in D is more comprehensive, making it the answer. See page 48. 3 4 3 Banks and other depository institutions can raise funds from many sources. Which of the following are fund sourcesA) I, II, III, V utilised by banks? I call deposits II Statutory Reserve Deposits III term deposits IV Treasury notes V certificates of deposit VI loan capital B) I, III, V, VI C) I, III, IV, V Feedback: Of the six items listed, four are fund sources used by banks, namely call deposits, term deposits, D) III, IV, V, VI certificates of deposit and loan capital which includes subordinated notes. Statutory Reserve Deposits have been abolished but were deposits by banks with the Reserve Bank. Only the Commonwealth Government issues Treasury notes. See page 49. 4 4 4 An important distinction between current deposits and call deposits is: A) call deposits are more liquid than current deposits Feedback: For the B) only current deposit accounts have a cheque facility purpose of preparing official banking statistics a distinction is made between funds in accounts that have cheque facilities and those in other similar accounts without cheque facilities. Funds in accounts with C) only call deposit accounts pay interest to the depositor cheque facilities are known as ‘current deposits’. Deposits that can be withdrawn on demand from accounts without D) banks charge accounts) fees on current accounts but not Both deposit current cheque facilities (such as savings transaction are classified as ‘call deposits’.on callcall and accountsdeposit accounts can pay interest and incur transaction fees so C and D are . Given the ability to withdraw by cheque, current deposits are regarded as more liquid than call deposits so A is also . See page 49. 5 4 5 An important source of funding used by banks is the certificate of deposit (CD). Which of the following statements about CDsCDs differ from other bank deposits in that they are issued at a discount from face value A) is correct? B) while CDs are transferable, sales in the secondary market are rare Feedback: A CD isC) certificate issued by a bank undertaking to pay to the bearer the face value of the certificate at a a specified maturity date. CDs are discount securities and are short-term as most have initial terms to maturity of no CDs are essentially the same as retail term deposits except that larger amounts of money are involved more than 180 days. Each issue of a CD is a separate transaction so banks have the flexibility to vary the interest D) the yield offered to new CDs is the bank’s a weekly basis Based bank rates on CDs frequently in response on changes in reviewed onneed for funds.by eachon the above, A is accurate and both C and D are inaccurate. As stated in B, CDs are transferable but the market is very active so B is also . See page 50. 6 4 6 Which of the following does not represent a ‘use of funds’ by commercial banks? A) commercial bills B) credit cards C) certificates of deposit D) overdrafts Feedback: Feedback: Uses of funds by banks include discounting commercial bills, lending on credit cards and providing overdrafts. Issuing certificates of deposit is a source of funds, not a use of funds, so C is the answer. See page 50. 7 7 4 Lending to government by banks mainly takes the form of the purchase of government-issued securities. The reasonsA) I, II, III, Vinvest in these securities include: I regulations require banks to hold government securities II why banks government securities are a primary source of liquidity for banks III government securities may be used to raise B) II, III, IV, VI cleared funds for payments system settlements via repurchase agreements IV government securities provide C) are higher than the returns on other investments V government securities allow a bank to manage its yields that III, IV, V, VI D) II, III, V, VI nterest rate sensitivity VI government securities are —the low risk Feedback: iFeedback: Of the six ‘reasons’ listed, I and IVare of very regulations under which banks were required to hold government securities have been abolished and the yields on government securities are lower than the returns on most other investments.See page 57. 8 4 8 The main type of loan provided by Australian banks to commercial borrowers is: A) overdraft facilities B) fixed-term loans C) lease finance Feedback: Historically, Australian banks met the needs of businesses largely by providing overdraft facilities. D) bill rollover facilities However, providing overdrafts can be costly for banks which have discouraged their use by imposing higher interest rates and a range of additional fees. As an alternative to overdrafts, banks have encouraged commercial borrowers to use fixed-term loans and these now account for the majority of lending to businesses. See page 55. 9 4 9 In Australia, the largest form of bank lending to individuals is: A) credit card finance B) investment property finance C) loans for the purchase of owner-occupied housing D) fixed-term loans for the purchase of motor vehicles Feedback: All four types of bank lending are used by individuals in the Australian market but the total value of loans for home purchase is considerably greater than that of the other three types so C is the answer. See page 54. 10 10 4 Which of the following statements about bank term deposits is not correct? A) the interest rate on a term deposit is fixed for the period of the investment B) commercial banks typically offer term deposits for periods up to five years C) the interest rates on term deposits are usually lower than the rates on call deposits D) term deposits are usually attractive to conservative investors Feedback: The statements in A, B and D are accurate, but C is not accurate. Term deposits are less liquid than call deposits so a higher rate of interest is needed to compensate investors for the loss of liquidity. See page 50. 11 11 4 The off-balance-sheet business of banks is categorised below. Which category represents the most significant proportion of total off-balance-sheet business of the banks? A) direct credit substitutes B) trade and performance-related items C) commitments D) market rate-related transactions Feedback: Instruments such as interest rate swaps and foreign exchange contracts, both of which are in the marker rate-related category, dominate off-balance-sheet business. Accordingly, D is the answer. See page 61. 12 12 4 A basic principle of APRA’s approach to prudential supervision of banks is that: A) prudential supervision allows the regulator to control interest rates B) depositors’ funds are protected by a government guarantee C) the primary responsibility for a bank’s sound operation rests with its own management and directors Feedback: The RBA is responsible for controlling interest rates and that is quite separate from the prudential D) supervision carried out by APRA, so A is . Prudential supervision does not extend to providing a government prudential supervision . Bank regulation restricting the composition of banks’ balance sheets guarantee to protect deposits so B is alsocontinues to rely onused to involve controls on interest rates and restrictions on the composition of their assets but those restrictions have been removed so D is , leaving C as the answer. See page 63. 13 13 4 Which of the following statements best describes the regulatory structure of the Australian financial system A) the overall stability of the financial system and of individual institutions is the responsibility of the Reserve Bank B) APRA is responsible for the overall stability of the financial system and of individual institutions C) banks, superannuation funds and life insurance companies are each supervised by separate regulators Feedback: A and B are both because the Reserve Bank is responsible for the overall stability of the financial D) there are several regulators but each is responsible for C own distinct type the institutions listed system, while APRA supervises individual institutions within the system.its is also because of regulation are all supervised by APRA. As stated in D, the framework is based on the principle that only one regulator should be responsible for each type of regulation. See page 63 14 14 4 In the event of a threat to the stability of the Australian financial system, such as financial difficulties experienced by an individual bank: primary responsibility for dealing with the problem A) APRA has B) the Reserve Bank is obliged to provide emergency liquidity support Feedback: APRA is responsible for the prudential supervision of financial institutions. It is true that APRA takes the C) approach that the primary responsibility for each bank’s sound operation rests with emergency liquidity support the Reserve Bank will determine whether, and how, it might provide its own management and directors. This does not mean that regulators would refuse to intervene in a crisis, so D is . If difficulties experienced D) by an individual bank threatened the stability of the financial system, then the problem would become the management of the bank experiencing financial difficulties is responsibility in such a case, it is not responsibility of the Reserve Bank, so A is also . While the Reserve Bank has solely responsible for achieving a solution obliged to achieve a rescue—it could decide that the bank in difficulty should be allowed to fail. Hence B is and C is the answer. See page 63. 15 15 4 Prudential supervision of banks relies heavily on capital adequacy standards. The main reason for reliance on standards related to the level of bankfinancialis: A) the standards restrict the capital leverage of banks B) banks need to raise capital to generate profits Feedback: While several roles can be identified for bank capital, the primary reason for reliance on capital adequacy C) every business requires some shareholders’ funds (capital is that it provides an effective way of restricting financial leverage. A higher ratio of capital to assets means that the D) accounting principles require means that the risk be written off through an unexpected decline in ratio of liabilities to assets is lower. In turn, this that loan losses must of insolvency,against capital the value of assets, is lower if the ratio of capital to assets is ‘high’. The statements in B, C and D are all valid but none of these constitutes the main reason for reliance on capital adequacy standards. See page 64. 16 16 4 The Basel I capital accord which applied a standardised approach to the measurement of the capital adequacy of banks was all banks must have capital equal to version of per cent which ofassets A) later extended. Under the extended at least 8 Basel I, of their the following is the most accurate? B) the capital that each bank must have depends only on the credit risk of its on-balance sheet assets C) the capital base that each bank must have depends on the credit risk of its on- and off-balance-sheet assets D) I capital accord initially specified that banks must hold capital well as at least Feedback: The Baselthe capital required depends on a bank’s exposure to market risk asequal tocredit risk8 per cent of their risk-weighted assets, so the focus was on credit risk. Basel I was later extended to also include a bank’s exposure to market risk so D is the answer. See page 65. 17 17 4 The Basel II accord to be introduced in 2008 is regarded as a major extension of Basel I. Which of the following most accurately describes the way of which Basel II extends Basel I? A) it introduces a measure in the risk of off-balance-sheet business B) it introduces a measure of market risk C) it is more sensitive to the different levels of risk that may exist in an institution Feedback: A major criticism of the Basel I capital accord is that the risk weights applied to assets are based on D) it broad. For example, all on the risky assets that banks may hold categories that are toointroduces new restrictionloans to companies have a risk weight of 100 per cent regardless of the credit rating of the borrower. Basel II provides for the risk weights to be aligned more closely with the actual risk involved and this change is consistent with C as the answer. See page 65. 18 18 4 Mega Bank advances a loan of $5 million to a company that has a Standard and Poor’s credit rating of A+. How much ofA) $4 600 000 funded by liabilities? the loan can be B) $4 800 000 C) $200 000 Feedback: As shown in Table 2.3 (Chapter 2, page 69), a rating of A+ is classified as External rating grade 2, which D) $4 920 000 has a risk weight of 50 per cent. The amount of capital required is the book value of the loan × the risk weight × 8 per cent. In this case, the capital required is $5 000 000 × 0.5 × 0.08 = $200 000 so up to $4 800 000 can be funded by liabilities. See page 70. 19 19 4 A bank may choose to measure its market-related, off-balance-sheet capital requirements using a value at risk (VaR) model. APRA requires a VaR model to apply a confidence level such that, on average, trading losses from A) one in every 50 trading days market-related contracts will exceed the VaR estimate: B) one in every 100 trading weeks C) one in every 100 trading days Feedback: A VaR model may be used to estimate the maximum potential gains or losses that may occur with a D) over a given time period. in every 100 trading are specified probability between one and five timesWhere such modelsdaysused in relation to off-balance-sheet, marketrelated contracts, APRA requires a 99 per cent confidence level based on a one-day holding period, which corresponds to C. See page 75. 20 20 4 Banks may issue securities classed as ‘loan capital’. Which of the following statements about loan capital is correct?A) loan capital refers to instruments that have characteristics of both debt and equity B) subordinated debentures may be included in loan capital C) some types of perpetual loan capital are recognised by regulators as part of bank capital for capital adequacy purposes Feedback: In addition to raising funds by accepting deposits and by borrowing, banks can issue securities such as D) all debt above perpetual subordinatedof theand other hybrid securities. Such securities are classified as loan capital and are shown in Table 2.2 (Chapter 2, page 76). Some of these securities can be included in bank capital for regulatory purposes. Accordingly, the statements in A, B and C are all valid, making D the answer. See page 52. 21 21 4 Feedback: Several factors have contributed to growth in the all its profitable loans, the bank will usually raise of funds for If a bank’s deposits are not sufficient to fund importance of foreign currency liabilities as a source additional Australian banks. The funds by borrowing from the VI relevant factors include:than decliningof the foreign exchange some cases, a bank may A) I, III, IV, financial markets rather I deregulation requests for loans. In market II offshore funds are always B) needed funds borrowings III internationalisation of the banks’ corporate clients IV diversification be able to raise allless costly than localin the local market but many Australian banks have raised large amounts in of the III, IV, VI II, funding sources V avoidance of local bank regulations VI removal of controls on international capital flows offshore markets and these borrowings are generally denominated in a foreign currency. Of the six ‘reasons’ given, C) I, III, IV, V, VI all are valid except II and V. Offshore funds may be cheaper than local funds in some cases but if this was always so D) all of the raise then, logically, a bank should above all of its funds from the cheaper source, so II is not valid. Bank regulations in many countries are very similar and do not distinguish between local and foreign currency fund sources, so V is also invalid. See page 52. 22 22 4 Banks, in common with all organisations, must manage their day-to-day liquidity needs such as paying creditors and employees. However, banks face specialby regulators are difficult to meet reason for this is: A) the liquidity requirements imposed liquidity problems. One important B) future cash flows and hence liquidity requirements are uncertain Feedback: Banks and other financial intermediaries offer and liabilities are mismatched C) the maturity structures of bank assets short-term deposits while providing long-term loans. In other words, the term to maturity of their assets is greater than that of their liabilities – as stated in C. Banks face D) banks have high proportion of their funds invested in illiquid real assets such potential liquidity problems if anaunexpectedly high proportion of depositors seek to withdrawas premises andor their funds at, computers around, the same time. Regulatory requirements must be achievable, so A is . Future cash flows are, of course, uncertain but this is not peculiar to banking, so B is also . Finally, premises and computers are illiquid but they make up only a very small proportion of bank assets, so D is . See page 80. 23 23 4 Setting limits on maturity mismatches between assets and liabilities and access to wholesale markets for the issue of money market securities are both strategies that banks can use to: A) control credit risk B) manage liquidity C) meet capital requirements Feedback: The maturity mismatch between bank assets and liabilities is one reason for the potential liquidity problems faced byD) implement liability management banks. It follows that setting limits on the extent of the mismatch is one tool that can be used to manage bank liquidity. Another useful measure is to make arrangements in advance, whereby the bank can raise cash by accessing lines of credit or issuing securities. Accordingly, B is the answer. See page 81. 24 24 4 Which of the following statements about the off-balance-sheet business of Australian commercial banks is correct?A) the face value of off-balance-sheet business is similar to the total value of bank assets B) the face value of off-balance-sheet business is considerably larger than the total value of bank assets C) the face value of off-balance-sheet business is an unbiased measure of its significance relative to onbalance-sheet assets Feedback: Based on 2005 figures the face value of off-balance-sheet (OBS) business was about six times the total D) so A is . OBS business consists evenly of derivatives and their face values are value of bank assets off-balance-sheet business is fairly largely divided across the four main categories typically many times larger than the eventual cash flows, so C is . Market-rate related OBS business is far larger than the other three categories so D is also . See page 61. 25 25 4 Banks can be viewed as essentially passive receivers of deposits that are used mainly to fund loans. In Australia, this traditional view ofbeen valid A) has never banks: B) remains an accurate description Feedback: Accepting deposits and making loans (financial intermediation) continues to be a core activity of banks. C) applies to most, but not all, banks However, banks are not ‘passive’ and actively seek new business opportunities and funds from sources other than D) is inaccurate as a description of modern bank operations deposits. Modern banks are involved in foreign exchange transactions, insurance, funds management and derivatives as well as financial intermediation. In other words, they provide a full range of financial services so the description in the question is inaccurate making D the answer. See page 48. 26 26 4 XYZ Ltd requires a bank loan that will allow it to manage short-term and seasonal variations in its cash flows. The type of loan thatloan A) term is designed for this purpose is a: B) bill rollover facility C) overdraft Feedback: An overdraft provides the type of flexibility that is needed in this case. Once an overdraft facility has been D) lease established, the borrower can draw on additional funds as required (provided the approved limit is not exceeded). Also, cash inflows can be used to repay part of the loan at any time but there is no set repayment schedule to adhere to. See page 56. 27 27 4 In recent years, banks have undertaken an increased volume of business that is not recorded as assets and liabilities incommercial bill transactions business is generally known as: A) their accounts. This type of B) over-the-counter business C) exchange-traded contracts Feedback: Commercial bill transactions do give rise to assets and liabilities that appear on a bank’s balance sheet, so A is . Business D) off-balance-sheet businessnot recorded as assets and liabilities includes dealing in over the conducted by banks that is counter and exchange traded derivative contracts but the general term for all such business is ‘off-balance-sheet business’, so D is the answer. See page 58. 28 28 4 Bill acceptances are recorded as liabilities on the balance sheets of banks. These liabilities arise from: A) banks purchasing bills in the open market B) banks selling bills into the financial markets C) banks guaranteeing that the holder of a bill will be paid at maturity D) Feedback: When a bill of exchange is issued, it must be ‘accepted’ by a bank or other financial institution. The banks making a commitment paying the bills and of the customer holder on the maturity date. In acceptor takes on the primary responsibility for to purchase faceifvaluewhen a bill to the needs to issue them in the future other words, the acceptor provides a guarantee so that it is the credit rating of the acceptor that determines the risk of the bill, so C is the answer. See page 51. 29 29 4 The bank bill swap rate (BBSW) is most accurately described as: A) the interest rate on bank term deposits B) the interest rate on bank overdrafts C) the interest rate on fixed term loans Feedback: The interest rates on bank loans are typically set by adding a margin or premium to a base or ‘reference’ rate. In the case ofD) an important reference rate used to determineis adjusted at specified intervals loans on floating (variable) rate loans the interest rate the interest rate charged on bank based movements in the reference rate. For commercial loans in the Australian market, the most commonly used reference rate is the BBSW making D the answer. See page 55. 30 30 4 The largest providers of housing loans in the Australian market are: A) building societies B) banks C) mortgage originators Feedback: Most of the larger building societies that used to exist in Australia have converted to banks so the D) superannuation funds building society sector is now very small. While new entrants to the home loan market, such as Aussie Home Loans and RAMS (mortgage originators), have achieved a significant market share, banks have retained their dominant position in the market, making B the answer. See page 54. no R <esult ¶st 1tables R yle= 4256362 epor ...
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