Multiple-Choice Questions on Banking and Finance

Part A Multiple-Choice Questions

Part A Multiple-Choice Questions

Select the best answer for each of the following questions. Answer each of these items by circling or highlight the letter of your choice. If more than one answer is given for a question, that question will not be marked. Incorrect answers will be marked as zero. Marks will not be awarded for explanations.

1.____ of the following is used to refer to the risk that the decline in interest rates leads to loans being paid off earlier.

a)Credit risk

b)Interest rate risk

c)Market risk

d)Prepayment risk

2.____ of the following is TRUE about a bank’s trading book.

a)It includes all the contracts the bank enters into as part of its trading operations.

b)It includes the market values of the bank’s assets.

c)It includes the loans made to individuals and corporations.

d)It includes the log of the trading transactions of the clients of the investment bank.

3.Bank holding companies were allowed to acquire branches in different states by ________.

a)Bank Holding Act

b)McFadden Act

c)Riegel-Neal Act

d)Sarbanes-Oxley Act

4._____ of the following refers to a health insurance company’s strategy of pricing the insurance fees based on its estimates of the average yearly medical expenditures of a certain age category. 

a)Risk aggregation

b)Risk assessment

c)Risk averaging

d)Risk decomposition

5.The reason(s) why a bank trades securities is(are) ____________.

(i)To meet the needs of its counterparties

(ii)To reduce its own risk exposure

(iii)To take a speculative position

a)(i)

b)(ii)

c)(iii)

d)(i) and (ii)

e)(i) and (iii)

f)(ii) and (iii)

g)(i), (ii), and (iii)

6.______ of the following is TRUE about the differences between operational risk and credit risk in the context of banks and financial institutions.

a)Operational risk is relatively easier to avoid as compared to credit risk.

b)Operational risk-taking activities are usually performed by a larger group of employees than credit-risk taking activities.

c)Operational risk is likely to have a much smaller impact as compared to credit risk.

d)Operational risk is relatively easier to track as compared to credit risk.

7.COSO defines ___ of the following risk response, of which a typical example is hedging losses using derivatives and other contracts. 

a)Acceptance

b)Avoidance

c)Reduction 

d)Sharing 

8.The following statements are true about the internal auditors’ role in ERM EXCEPT ___.

a)They play a primary role in evaluating the ERM.

b)They play a primary role in implementing the ERM.

c)They play a primary role in monitoring the ERM.

d)None of the above (that is, ALL statements are true)

Select the best answer for each of the following questions

9.A mutual fund manager wants to attract clients, but she also does not want to overexpose her employer, so she is trying to find the optimal yield that she should promise her clients. This activity of finding an optimal point is an example of _____ of the following ERM implementation factors defined by COSO.

a)Communicating risk results

b)Determining risk appetite

c)Monitoring 

d)Performing risk assessment

10.According to COSO, ___ of the following is an example of the risk-reduction response.

a)Dealing with multiple suppliers (instead of one) to ensure the availability of raw material

b)Deciding not to invest in projects with high level of uncertainty

c)Hiring an experienced manager

d)Outsourcing some of the production processes

11.Smaller investors are attracted to invest in mutual funds by ____ of the following key advantage. 

a)Mutual funds provide access to foreign capital markets.

b)Mutual funds provide a higher level of diversification.

c)Mutual funds provide broader access to the capital market.

d)Mutual funds provide portfolio management services.

12.If a fund has equal dollar amounts in long and short positions, it is called _____________.

a)A dollar-neutral fund

b)A factor-neutral fund

c)A matched fund

d)A short-long balanced fund

13.How would increases in longevity affect annuity contracts and life insurance contracts?

a)Increases in longevity affect the profitability of annuity contracts positively and the profitability of life insurance contracts negatively.

b)Increases in longevity affect the profitability of annuity contracts negatively but have no effect on the profitability of life insurance contracts.

c)Increases in longevity affect the profitability of annuity contracts negatively and the profitability of life insurance contracts positively.

d)Increases in longevity affect both the profitability of annuity contracts and the profitability of life insurance contracts negatively.

14.The following are some type of annuity contract EXCEPT __________.

a)Deferred annuity

b)Fixed annuity

c)Perpetual annuity

d)None of the above (that is, ALL are a type of annuity contract)

15.____ of the following group of options traders is expected to be positively affected by the stock price drop after one of the company’s factories was damaged by floods. 

a)Investors who hold a long position in an American put option on the stock

b)Investors who hold a short position in an American put option on the stock

c)Investors who hold a long position in an American call option on the stock

d)None of the above 

16.In __ of the following cases, an American put option on a certain asset with a strike (exercise) price of $10 would be worth the most to its buyer.   

Question 1: Interest rate risk

a)If the current price of the underlying asset is $11.

b)If the current price of the underlying asset is $9.

c)If the current price of the underlying asset is $8.

d)If the current price of the underlying asset is $12.

17.The initial and maintenance margin for a stock put option written in the U.S. is _______.

(i)100% of the value of the option plus 20% of the underlying share price minus the amount (if any) by which the option is out-of-the-money

(ii)100% of the value of the option plus 10% of the exercise price

(iii)100% of the value of the option plus 10% of the share price

a)The greater of (i) and (ii) 

b)The greater of (i) and (iii)

c)The greater of (ii) and (iii)

d)The greater of (i), (ii), and (iii)

18.The following are the characteristics of futures contracts EXCEPT __________.

a)They are standardized contracts.

b)They bear relevant credit risk.

c)They are traded on exchanges.

d)They are marked-to-market daily.

19.__ of the following options provides a payoff based on the average price of an underlying asset over a specified period.

a)Asian option

b)Binary option

c)Compound option

d)Look back option

20.__ of the following is a likely option transaction now for someone who holds some shares of a company’s stock but is planning to sell in two months.

a)Buying a call on the stock

b)Writing a call on the stock 

c)Buying a put on the stock

d)Writing a put on the stock

1.Given the following table of the annual returns on Canada’s small and emerging companies (represented by the TSX Venture stock index) during the 13-year period from 2002-2014. If you invest in these Venture stocks, what is the approximate probability that your return will be less than 51.51% in a given year? What range of returns would you expect to see 95% of the time? 99% of the time? Assuming that the returns on Canada’s small and emerging company stocks are roughly normally distributed.

Year S&P/TSX Venture Composite

2002 +3.66%

2003 +63.24%

2004 +4.4%

2005 +22.62%

2006 +33.59%

2007 –4.94%

2008 –71.93%

2009 +90.8%

2010 +50.45%

2011 –35.07%

2012 – 16.88%

2013 –21.8%

2014 –25%

2.Fill in the missing information assuming a correlation of –0.1.

Portfolio Weights Estimated

Return Standard

Deviation

 Stock A  Stock B

100%      13%     31%

80%

60%

40%

20%

0%       16%      42%

Discuss the diversification of this 2-stock portfolio and illustrate in a graph the risk-return trade-off. 

Question 2: Bank’s trading book

3.Company FANG wants to sell 1,000,000 shares using a Dutch auction. The resulting bids are summarized in the table below:

Bidder Size of bid (Shares) Bid Price per share

A 100,000 $75

B 250,000 $70

C 150,000 $80

D 500,000 $55

E 300,000 $90

F 450,000 $72

Answer:

a)Did every bidder end up with some shares? Who ended up getting how many shares?

b)What was the price paid by investors? How much financing did FANG raise? 

c)Briefly discuss the attraction of a Dutch auction over the normal procedure for an IPO.

4. a)Bank A, with a BI component of 500 million euros, has suffered 10 operational risk losses of 15 million euros in the past 10 years. What is the operational risk regulatory capital for Bank A under SMA? 

b)A fund affiliated with Bank B has a risk appetite, which is such that it wants to be 95% certain that it will not lose more than 15% in any year. Using the performance of the S&P 500 between 1997 and 2016 (see Table 27.2 on p.606), determine the beta the fund should have. Assume a risk-free rate of 3.5% per annum.

5. Use Table 3.1 on p.54 to calculate the minimum premium an insurance company should charge for a $10 million three-year term life insurance contract issued to a man aged 41. Assume that the premium is paid at the beginning of each year and death always takes place halfway through a year. The risk-free interest rate is 5% per annum (with semi-annual compounding).

6. You are investing in a mutual fund, which charges 1 plus 15%. The mutual fund invests its money equally among 4 hedge funds each of which charges 2 plus 20%. The hedge funds’ incentive fees are calculated on the return after management fees. The mutual fund’s incentive fee is calculated on the net (after management fees and incentive fees) average return of the hedge funds in which it invests and after its own management fee has been subtracted. If the four hedge funds earn -10%, 2%, 10%, and 20%, what is the overall return on the investments? How is it divided between the mutual fund, the hedge funds, and you, the investor? 

7. Your aunt is celebrating her 45th birthday today and wants to start saving for her anticipated retirement at age 65. She wants to be able to withdraw $100,000 from her savings account on each birthday for 25 years following her retirement; the first withdrawal will be on her 66th birthday. Your aunt intends to invest her money in a mutual fund, which offers 10% return per year. She wants to make equal annual payments on each birthday into the mutual fund for her retirement fund. If she starts making these deposits on her 46th birthday and continues to make deposits until she is 65 (the last deposit will be on her 65th birthday), what amount must she deposit annually to be able to make the desired withdrawals at retirement?