Banking and Finance Exam Questions

Balance Sheet Analysis

1. Complete all three parts of this question.

a. Suppose KPM Bank has the following balance sheet (in billions of dollars):

If net profit of this bank is $2 billion, then what is the return on assets (ROA) and the return on equity (ROE)? Demonstrate that ROE = ROA x EM.

b. A bank has $105 billion of assets with average duration of 5 years and $80 billion of liabilities with average duration of 6 years. Conduct a duration analysis for the bank, and show what will happen to the net worth of the bank if interest rates fall by 1%. What action should the bank take to reduce interest rate risk?

c. A bank has $80 billion of fixed-rate liabilities, $25 billion of rate-sensitive liabilities, $10 billion of fixed-rate assets, and $95 billion of rate-sensitive assets. Conduct a gap analysis for the bank, and show what will happen to the bank profits if interest rates fall by 1%. What action should the bank take to reduce interest rate risk

2. Suppose that currency in circulation is $1 trillion, the amount of chequable deposits is $1.2 trillion, excess reserves are $20 billion, and the desired reserve ratio is 10%.

a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the money multiplier.

b. If the central bank conducts an unusually large open market purchase of bonds of $1.4 trillion following a sharp contraction in the economy, what is the impact on the money supply?

c. If the central bank conducts the same policy as in part (b), except chartered banks hold all of these proceeds as excess reserves rather than loan them out, what happens to the amount of excess reserves, the excess reserve ratio, the money supply, and the money multiplier?

d. Following the financial crisis in 2008, the Federal Reserve injected massive amounts of liquidity in the U.S. banking system but very little lending occurred. As a result, the M1 money multiplier was below 1 for most of the time from October 2008 through 2011. How does this relate to your answer to part (c) above?

3. Describe the large value transfer system (LVTS), and list the major reasons for adopting the system. 

Discuss how in the LVTS environment, government deposit shifting is affected by auctions of government balances. 

4. Indicate how each of the following international transactions is entered into the Canadian balance of payments with double-entry bookkeeping. Your records should include a description of the transaction being recorded, which specific account is affected (e.g., export, home financial account asset, etc.), and the accompanying credit/debit entry.

Duration Analysis and Interest Rate Risk

Example: A Canadian airplane manufacturer imports $5 million in parts from a U.S. firm. It uses a Canadian bank account to pay for the parts.

Example Answer:

a. An Italian tourist charges $450 to his Mastercard (issued by an Italian bank) for a hotel room in Jasper, Alberta, Canada.

b. A Chinese catering company purchases $200,000 worth of helium tanks from a Canadian welding firm. The Chinese catering company uses deposits from a bank in China.

c. A French firm forgives a $250,000 loan to a firm located in in the town of Lac-Mégantic, Quebec, following a deadly rail accident.

d. Canada donates $10 million in medical and food supplies to Ukraine following a month-long war.

5. Suppose the spot foreign exchange rate of the Canadian dollar is $US 1.53, while its 12-month forward rate is $US 1.58. One-year interest rates are 6% in Canada and 10% in the United States. Are there quick profits to be made from foreign currency arbitrage here? If so, show the sequence of purchases and sales, using $Can. 100,000 as your starting point.

6. Briefly describe each of the following terms:

a. Eurocurrency markets 

b. international debt crises

c. purchasing power parity 

d. currency arbitrage 

e. interest-rate parity condition

7. Suppose that the pension you are managing is expecting an inflow of funds of $1 billion next year and you want to make sure you will earn the current interest rate of 5% when you invest the incoming funds in long-term bonds.

a. How would you use the options market to do this?

b. How would you use the futures market to do this? 

c. What are the advantages and disadvantages of using a futures contract rather than an option contract 

8. Complete all three parts of this question.

a. Why does a lower exercise price mean a call option will have a higher premium and a put option a lower premium?

b. Suppose you buy a put option on a $1 million Canada bond futures contract with an exercise price of 100 and the price of the Canada bond is 110 at expiration.

(i) Is the contract in the money, out of the money, or at the money? 

(ii) What is your profit or loss on the contract if the premium was $50,000

Suppose you buy a call option on a $1 million Canada bond futures contract with an exercise price of 150 for a premium of $20,000. If on expiration the futures contract has a price of 155, what is your profit or loss on the contract?