Describe the risk exposure(s) in the following financial transactions. Identify
ID: 2652326 • Letter: D
Question
Describe the risk exposure(s) in the following financial transactions. Identify which transactions are influenced by interest rates or interest income. (CAUTION: Some can be influenced by both!)
Risk Types: Interest rate risk, Credit risk, Technology risk, Foreign exchange rate risk, Country or sovereign risk
Financial Transactions
Risk Type
Describe and justify risk type
Interest Rate or Interest Income?
A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.
An insurance company invests its policy premiums in a long-term municipal bond portfolio.
A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur.
A Japanese bank acquires an Austrian bank to facilitate clearing operations.
A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market.
A securities firm sells a package of mortgage loans as mortgage-backed securities.
Describe the features of the method you would choose to measure the interest risks identified.
Financial Transactions
Risk Type
Describe and justify risk type
Interest Rate or Interest Income?
A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.
An insurance company invests its policy premiums in a long-term municipal bond portfolio.
A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur.
A Japanese bank acquires an Austrian bank to facilitate clearing operations.
A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market.
A securities firm sells a package of mortgage loans as mortgage-backed securities.
Describe the features of the method you would choose to measure the interest risks identified.
Explanation / Answer
Financial Transactions
Risk Type
Describe and justify risk type
Interest Rate or Interest Income?
A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.
Interest rate risk & credit risk
Interest rate risk because Change in the value of the fixed rate assets and change in the interest rate.
Interest Rate and Interest Income
An insurance company invests its policy premiums in a long-term municipal bond portfolio.
Interest rate risk & credit risk
Because of the moment or changes in the interest rate return on the portfolio may rise or down.
Interest Rate and Interest Income
A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur.
Credit risk, foreign exchange risk, country risk
This is a foreign exchange risk (FER) because it involved many currency (multi-currency) transaction for ex. Euro. It also have credit risk because the loan not be repay.
Interest Rate
A Japanese bank acquires an Austrian bank to facilitate clearing operations.
Interest rate risk, Credit risk, Off-balance-sheet risk, Technology risk, Foreign exchange rate risk, Country or sovereign risk
Acquiring of the bank (multinational or MNC bank) is foreign exchange risk (FER) because the involvement of many or multiple currency, but in this transaction many risk also associated like country risks, technology risks and credit risks as well as interest rate risks.
Interest Rate
A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market.
Interest rate risk, Credit risk, Foreign exchange rate risk, Country or sovereign risk
This transaction has interest rate risk because in this transaction there is huge exposure in debt whose interest (rate) fluctuate.
Interest Rate and Interest Income
A securities firm sells a package of mortgage loans as mortgage-backed securities.
Interest rate risk, Credit risk, Technology risk
Interest rate risk (because loan interest rate change) and credit risk (loan may not be repaid).
Interest Rate and Interest Income
Describe the features of the method you would choose to measure the interest risks identified.
Solution-
The method for bank is Duration Gap. This method helps in measured the risk and compares’ the price sensitivity of its total liabilities with the price sensitivity of a bank's total assets to know the overall impact of that changes in interest rate on stockholder equity.
Financial Transactions
Risk Type
Describe and justify risk type
Interest Rate or Interest Income?
A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.
Interest rate risk & credit risk
Interest rate risk because Change in the value of the fixed rate assets and change in the interest rate.
Interest Rate and Interest Income
An insurance company invests its policy premiums in a long-term municipal bond portfolio.
Interest rate risk & credit risk
Because of the moment or changes in the interest rate return on the portfolio may rise or down.
Interest Rate and Interest Income
A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur.
Credit risk, foreign exchange risk, country risk
This is a foreign exchange risk (FER) because it involved many currency (multi-currency) transaction for ex. Euro. It also have credit risk because the loan not be repay.
Interest Rate
A Japanese bank acquires an Austrian bank to facilitate clearing operations.
Interest rate risk, Credit risk, Off-balance-sheet risk, Technology risk, Foreign exchange rate risk, Country or sovereign risk
Acquiring of the bank (multinational or MNC bank) is foreign exchange risk (FER) because the involvement of many or multiple currency, but in this transaction many risk also associated like country risks, technology risks and credit risks as well as interest rate risks.
Interest Rate
A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market.
Interest rate risk, Credit risk, Foreign exchange rate risk, Country or sovereign risk
This transaction has interest rate risk because in this transaction there is huge exposure in debt whose interest (rate) fluctuate.
Interest Rate and Interest Income
A securities firm sells a package of mortgage loans as mortgage-backed securities.
Interest rate risk, Credit risk, Technology risk
Interest rate risk (because loan interest rate change) and credit risk (loan may not be repaid).
Interest Rate and Interest Income
Describe the features of the method you would choose to measure the interest risks identified.
Solution-
The method for bank is Duration Gap. This method helps in measured the risk and compares’ the price sensitivity of its total liabilities with the price sensitivity of a bank's total assets to know the overall impact of that changes in interest rate on stockholder equity.
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