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Question: What is a collateralized mortgage obligation (CMO)?


What is a collateralized mortgage obligation (CMO)? How is it similar to a pass-through security? How does it differ? In what way does the creation of a CMO use market segmentation to redistribute prepayment risk?


> What are some of the main features of the Foreign Bank Supervision Enhancement Act of 1991?

> Calculate the following: a. What is the amount of the annuity purchase required if you wish to receive a fixed payment of $240,000 for 20 years? Assume that the annuity will earn 7 percent per year. b. Calculate the annual cash flows from a $2.5 million,

> How have the International Banking Act of 1978 and the FDICIA of 1991 been detrimental to foreign banks in the United States?

> Identify the five zones of capital adequacy and explain the mandatory regulatory actions corresponding to each zone.

> How is the Tier I leverage ratio for an FI defined under Basel III?

> Under Basel III, what four capital ratios must DIs calculate and monitor?

> What is the significance of prompt corrective action as specified by the FDICIA legislation?

> If the reserve computation period extends from May 18 through May 31, what is the corresponding reserve maintenance period? What accounts for the difference?

> What is the capital conservation buffer? What is the countercyclical capital buffer?

> Under Basel III, how are risk weights for sovereign exposures determined?

> Under Basel III, how are residential one- to four-family mortgages assigned to a credit risk class?

> What forms of protection and regulation are imposed by regulators of CBs to ensure their safety and soundness?

> A property–casualty insurer brings in $5.55 million in premiums on its homeowners multiple line of insurance. The line’s losses amount to $3,962,700, expenses are $1,526,250, and dividends are $333,000. The insurer earns $349,650 in the investment of its

> Under the Federal Deposit Insurance Reform Act of 2005, how is a Category I deposit insurance premium determined?

> How does a bank’s asset size affect its financial ratios?

> How does a bank’s choice of market niche affect its financial ratios?

> What is the difference between the net interest margin and the spread?

> A bank has an ROA of 1.0 percent. The industry average ROA is 1.5 percent. How can ratio analysis help the firm’s managers identify the reasons for this difference?

> What are the definitional differences between Common Equity Tier I, Tier I, and Tier II capital?

> A security analyst calculates the following ratios for two banks. How should the analyst evaluate the financial health of the two banks? Bank A Bank B Return on equity 22% 24% Return on assets 2% 1.5% 11x Equity multiplier Profit margin 16x 15% 14%

> What is the likely relationship between the interest income ratio and the noninterest income ratio?

> How does the asset utilization ratio for a bank compare to that of a retail company? How do the equity multipliers compare?

> How might the use of an end-of-the-year balance sheet bias the calculation of certain ratios?

> A property–casualty insurer brings in $6.25 million in premiums on its homeowner’s MP line of insurance. The line’s losses amount to $4,343,750, expenses are $1,593,750, and dividends are $156,250. The insurer earns $218,750 in the investment of its prem

> What is the difference between Basel I, Basel II, and Basel III?

> What are the major categories of off-balance-sheet activities?

> How do core deposits differ from purchased funds?

> How does a retail CD differ from a wholesale CD?

> How does a NOW account differ from a demand deposit?

> Repurchase agreements are listed as both assets and liabilities in Table 12–1. How can an account be both an asset and a liability? Table 12–1: Heartland Bank and Trust Bank of America Assets 1. Vault cash 2. Ixp

> What is shadow banking? How does the shadow banking system differ from the traditional banking system?

> What insurance activities are permitted for U.S. commercial bank holding companies?

> A Section 20 subsidiary of a major U.S. bank is planning to underwrite corporate securities and expects to generate $5 million in revenues. It currently underwrites U.S. Treasury securities and general obligation municipal bonds and earns annual fees of

> How has the separation of commercial banking and investment banking activities evolved through time? How does this differ from banking activities in other countries?

> Calculate the following: a. What is the amount of the annuity purchase required if you wish to receive a fixed payment of $200,000 for 20 years? Assume that the annuity will earn 10 percent per year. b. Calculate the annual cash flows (annuity payments)

> How does a bank’s report of condition differ from its report of income?

> What are the three levels of regulatory taxes faced by FIs when making loans? How does securitization reduce the levels of taxation?

> In addition to managing credit risk, what are some other reasons for the sale of loans by FIs?

> Who are the buyers and sellers of U.S. loans? Why do they participate in this activity?

> What are highly leveraged transactions? What constitutes the federal regulatory definition of an HLT?

> What is the difference between loan participations and loan assignments?

> Why are yields higher on loan sales than they are for similar maturity and issue size commercial paper issues?

> What are some of the key features of short-term loan sales?

> What is the difference between loans sold with recourse and without recourse from the perspective of both sellers and buyers?

> Can all assets and loans be securitized? Explain your answer.

> What is the capital conservation buffer? How would this buffer affect your answers in Problem 6? Data from Problem 6: National Bank has the following balance sheet (in millions) and has no off-balance-sheet activities. a. What is the CET1 risk-based

> Why do buyers of Class C tranches of collateralized mortgage obligations (CMOs) receive a lower return than purchasers of Class A tranches?

> How do FIs use securitization to manage their interest rate, credit, and liquidity risks?

> What are the differences between CMOs and MBBs?

> What is prepayment risk? How does prepayment risk affect the cash flow stream on a fully amortized mortgage loan? What are the two primary factors that cause early payment?

> What specific changes occur on the balance sheet at the completion of the securitization process? What adjustments occur to the risk profile of the FI?

> Why have FIs been very active in loan securitization issuance of pass-through securities while they have reduced their volume of loan sales? Under what circumstances would you expect loan sales to dominate loan securitization?

> Answer the following: a. What are the two ways to use call and put options on T-bonds to generate positive cash flows when interest rates decline? b. When and how can an FI use options on T-bonds to hedge its assets and liabilities against interest rate

> What is basis risk? What are the sources of basis risk?

> What are the differences between a microhedge and a macrohedge for an FI? Why is it generally more efficient for FIs to employ a macrohedge than a series of microhedges?

> The following net transaction accounts have been documented by a bank for the computation of its reserve requirements (in millions). The average daily reserves at the Fed for the 14-day reserve maintenance period have been $22.7 million per day, and th

> An insurance company owns $50 million of floating-rate bonds yielding LIBOR plus 1 percent. These loans are financed with $50 million of fixed-rate guaranteed investment contracts (GICs) costing 10 percent. A finance company has $50 million of auto loans

> Suppose that you purchase a Treasury bond futures contract at $95 per $100 of face value. a. What is your obligation when you purchase this futures contract? b. If an FI purchases this contract, in what kind of hedge is it engaged? c. Assume that the Tre

> What is a naive hedge? How does a naive hedge protect an FI from risk?

> Why is the credit risk on a swap lower than the credit risk on a loan?

> How does a pure credit swap differ from a total return swap?

> What is a total return swap?

> Explain the similarity between a swap and a forward contract.

> How can caps, floors, and collars be used to hedge interest rate risk?

> Suppose that an FI manager writes a call option on a T-bond futures contract with an exercise price of 114 at a quoted price of 0-55. What type of opportunities or obligations does the manager have?

> In each of the following cases, identify what risk the manager of an FI faces and whether the risk should be hedged by buying a put or a call option. a. A commercial bank plans to issue CDs in three months. b. An insurance company plans to buy bonds in t

> How does hedging with options differ from hedging with forward or futures contracts?

> An FI has purchased a $200 million cap of 9 percent at a premium of 0.65 percent of face value. A $200 million floor of 4 percent is also available at a premium of 0.69 percent of face value. a. If interest rates rise to 10 percent, what is the amount re

> What are some of the major differences between futures and forward contracts?

> What are two ways a DI can offset the effects of asset-side liquidity risk, such as the drawing down of a loan commitment?

> What are two ways a DI can offset the liquidity effects of a net deposit drain of funds? How do the two methods differ? What are the operational benefits and costs of each method?

> How is a DI’s distribution pattern of net deposit drains affected by the following? a. The holiday season. b. Summer vacations. c. A severe economic recession. d. Double-digit inflation.

> What are core deposits? What role do core deposits play in predicting the probability distribution of net deposit drains?

> The probability distribution of the net deposit drain of a DI has been estimated to have a mean of 2 percent. a. Is this DI increasing or decreasing in size? Explain. b. If a DI has a net deposit drain, what are the two ways it can offset this drain of

> What are the two reasons liquidity risk arises? How does liquidity risk arising from the liability side of the balance sheet differ from liquidity risk arising from the asset side of the balance sheet? What is meant by fire-sale prices?

> How is the liquidity problem faced by investment funds different from the liquidity problem faced by DIs and insurance companies?

> What is the greatest cause of liquidity exposure that property–casualty insurers face?

> Why does deposit insurance deter bank runs?

> A mutual fund plans to purchase $10 million of 20-year T-bonds in two months. The bonds are yielding 7.68 percent. These bonds have a duration of 11 years. The mutual fund is concerned about interest rates changing over the next two months and is conside

> Describe the unprecedented steps the Federal Reserve took with respect to the discount window operations during the financial crisis.

> What is a bank run? What are some possible withdrawal shocks that could initiate a bank run? What feature of the demand deposit contract provides deposit withdrawal momentum that can result in a bank run?

> What are the several components of a DI’s liquidity plan? How can such a plan help a DI reduce liquidity shortages?

> Define each of the following four measures of liquidity risk. Explain how each measure would be implemented and utilized by a DI. a. Financing gap and financing requirement. b. Sources and uses of liquidity. c. Peer group ratio comparisons. d. Liquidity

> Why should a credit officer be concerned if a mid-market business borrower’s liquidity ratios differ from the industry norm?

> How does ratio analysis help answer questions about the production, management, and marketing capabilities of a prospective borrower?

> Why must an account officer be well versed in the FI’s credit policy before talking to potential mid-market business borrowers?

> What are some of the special risks and considerations when lending to small businesses rather than large businesses?

> In what ways does the credit analysis of a mid-market borrower differ from that of a small-business borrower?

> How does an FI evaluate its credit risks with respect to consumer and small-business loans?

> An FI has a $200 million asset portfolio that has an average duration of 6.5 years. The average duration of its $160  million in liabilities is 4.5 years. Assets and liabilities are yielding 10 percent. The FI uses put options on T-bonds to hedge against

> What are the purposes of credit-scoring models? How do these models assist an FI manager to better administer credit?

> What are the primary considerations used by FIs to evaluate mortgage loans?

> Explain how modern portfolio theory can be applied to lower the credit risk of an FI’s portfolio.

> Consider the coefficients of Altman’s Z score. Can you tell by the size of the coefficients which ratio appears most important in assessing the creditworthiness of a loan applicant? Explain.

> Why is an FI’s bargaining strength weaker when dealing with large corporate borrowers than mid-market business borrowers?

> What are conditions precedent?

> Why is credit risk analysis an important component of FI risk management?

> The sales literature of a mutual fund claims that the fund has no risk exposure since it invests exclusively in default risk free federal government securities. Is this claim true? Why or why not?

> What is reinvestment risk? How is reinvestment risk part of interest rate risk? If an FI funds short-term assets with long-term liabilities, what will be the impact on earnings of a decrease in the rate of interest? An increase in the rate of interest?

> What is refinancing risk? How is refinancing risk part of interest rate risk? If an FI funds long-term fixed-rate assets with short-term liabilities, what will be the impact on earnings of an increase in the rate of interest? A decrease in the rate of in

2.99

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