Lab Test: Financial institutions · RiskAtoms Academy

How it works

Seven problems from inside the institutions of this module: a bank treasurer, an underwriter, an insurer, a saver, a pension trustee, a CCP risk analyst and a supervisor. Most need two or three steps, and some draw on more than one lesson. Answer each part, press Check, then walk through the worked solution. Use a calculator. All firms and figures are illustrative.

Problem 1The bank treasurer and the rate rise

L1.2.01 · L1.2.08

A euro area bank holds €500m of fixed-rate mortgages at 4%, €300m of business loans at the policy rate + 2 points, and €100m of reserves paid the policy rate. It funds itself with €750m of deposits, paid 50% of the policy rate, €100m of wholesale funding at the policy rate + 0.5 points, and €50m of equity. The policy rate is 3%, and the central bank is expected to raise it by one point. Simple annual rates.

(a)What is the bank's net interest income today, in € millions?
€m
(b)By how much does NII change after the one-point rise, in € millions? (Use a minus sign for a fall.)
€m
(c)Below what deposit pass-through, in %, would the rate rise increase NII?
%

Problem 2The underwriter's difficult week

L1.2.02

A bank syndicate underwrites a listing of 20 million shares at $15 on a firm commitment, with a gross spread of 5.5%. Demand is weaker than hoped: it sells 14 million shares at the offer price, but the rest only at $13.80 after the price slips. Ignore the greenshoe and costs.

(a)How much does the company receive, in $ millions?
$m
(b)What is the syndicate's actual profit, in $ millions?
$m
(c)Had the deal been done on a best-efforts basis instead, who would have borne the weak demand?
AThe syndicate, exactly as beforeBThe company, which would have raised less moneyCThe stock exchangeDThe investors who bought at the offer price

Problem 3The motor insurer and claims inflation

L1.2.03

A UK motor insurer earns £2,000m of premiums a year, with a loss ratio of 74% and an expense ratio of 28%. Claims are paid 1.5 years after the premium on average, and the float earns 4% a year. Take the float as claims × years held.

(a)What is its combined ratio, in %?
%
(b)What is its operating result (underwriting plus investment income), in £ millions?
£m
(c)Repair costs jump and claims cost 10% more, with premiums unchanged. What is the operating result now, in £ millions?
£m

Problem 4The saver choosing a fund

L1.2.04

A saver in Madrid invests €20,000 for 25 years. She expects 6% a year before fees. An index ETF charges 0.2% a year; an active mutual fund charges 1.4%. Annual compounding, with the fee taken off each year's return.

(a)What will the ETF holding be worth, to the nearest euro?
€
(b)How much less will the active fund be worth, to the nearest euro?
€
(c)The fund manager goes out of business. What happens to her savings in either fund?
AThey are lost, because the manager owned themBThey are safe in principle, because a separate depositary holds the fund's assets for its investorsCThey are converted into shares of the managerDOnly the ETF is protected

Problem 5The pension trustee and the hedge

L1.2.05 · L1.2.06

A UK defined benefit scheme must pay £20m a year for 20 years. It values the promise at a 4% discount rate (annual payments, annual compounding) and is 90% funded. It hedges 40% of its liabilities against interest rate moves; the rest of its assets are in shares, which do not move in this problem.

(a)Long-term rates fall by 1 point. What is the new funding ratio, in % (one decimal)?
%
(b)A consultant proposes a 120% hedge built with repo and swaps. Starting from today, if rates instead rise 1.5 points in a week, how much cash collateral would that hedge need, in £ millions?
£m
(c)Which is riskier, and why?
AThe 40% hedge, because a bigger hedge always means less riskBThe 120% leveraged hedge: it steadies the funding ratio but adds liquidity risk, since rising rates bring cash calls that may force salesCThey are equally risky, because both hold bondsDNeither has any risk, because pension schemes cannot fail

Problem 6The CCP risk analyst

L1.2.07

Four clearing members owe each other the following (€m): W owes X 120; X owes Y 90; Y owes W 70; Z owes X 40; Y owes Z 30.

Later, a different member defaults. Closing out its portfolio costs €610m. It had posted €380m of initial margin and €60m to the default fund. The CCP has €30m of skin in the game, and 10 surviving members have each paid €60m into the default fund.

(a)After multilateral netting through the CCP, what is the total that members must pay in, in € millions?
€m
(b)How much does each surviving member lose from its default fund contribution, in € millions?
€m
(c)A member argues the CCP should cut initial margin to win business. What happens to the risk?
AIt disappears, because the CCP guarantees everythingBMore of any default loss falls on the surviving members' default fund, so mutualised risk risesCOnly the defaulter's risk risesDNothing, because margin is not part of the waterfall

Problem 7The supervisor's in-tray

L1.2.09 · L1.2.08 · L1.2.03

You join a team that tracks how rules travel from global bodies to firms. A large bank reports US$400bn of risk-weighted assets and US$26bn of CET1 capital. Basel III requires a CET1 ratio of 4.5% plus a 2.5% conservation buffer.

(a)What is the bank's CET1 ratio, in %?
%
(b)What follows from that ratio?
ANothing: it is above the minimum, so there are no consequencesBIt is inside the buffer: dividends and bonuses are restricted until it rebuilds capitalCIt is below the minimum and must be resolved at onceDThe Basel Committee will fine the bank
(c)A Singapore insurer and a Japanese bank each want to know their main supervisor. Who are they?
AThe IAIS and the BCBSBThe Monetary Authority of Singapore and Japan's Financial Services AgencyCThe FSB for bothDThe Bank of England's PRA for both

Score 0 / 210 of 7 problems checked