FINA 465 Exam 2 UPDATED ACTUAL Questions And Correct Answers
C
Terms in this set (85)
Basics of Risk Management - Firms take risks to perform their "feats" of supplying goods and services
functions, but unfavorable outcomes can interfere with operations and cause
distress.
- Professional risk managers maximize shareholder value by:
o Measuring and assessing risks
o Screening, monitoring, and controlling risks efficiently
o Taking risks only that align with maximizing value
Deadweight Costs - Unproductive losses that reduce firm value without corresponding gains
- ex: loss of reputation and creditworthiness, costs of legal proceedings and
bankruptcy, valuable employees heading for the exits
Joint effort between banks and prudential authorities - Bank risk management is the outcome of dynamic and strategic interplay
between banks and prudential authorities- regulators and supervisors - with
shared and conflicting goals
- Shared goal: protecting banks from deadweight costs of financial and economic
distress
- Conflicting goals: moral hazard by banks, enforcement actions from authorities,
protecting the rest of society from bank financial distress
"Skinny Bundle" risk management strategy for banks - prioritizes capital ratios and liquid asset ratios
- conserves time and resources to efficiently create liquidity and mitigate risks for
customers
"Skinny Bundle +" - risk management strategy for banks with significant derivative exposures
- the "+" is also to monitor and prioritize the ratios of fair values of derivatives to
total assets in a similar fashion to equity capital and liquid asset ratios
Moral Hazard in Banking - banks take on excessive risks, expecting to be bailed out or protected
- enabled by: deposit insurance, government safety nets, inadequate risk pricing
Prudential Mechanisms - internal controls
- capital buffers
- diversification
- banks are more agile with these tools (customer-facing)
Certification Mechanisms - public confidence tools (ex: CAMELS ratings)
- external audits and regulatory stress tests
- authorities are better positioned to certify (independent verification)
, Why do Banks manage risk? - maximize shareholder equity value
- avoid losses of key employees, customers, and investors
- reduce costs of distress-related distractions from liquidity creation and risk
mitigation
Why do Authorities manage risk? - limit deadweight costs of bank distress
- protect value to society from bank activity
- ensure the ongoing provision of financial intermediation services during stress
Ways in which Prudential Authorities intervene - bailouts or bail-ins to prevent broader social losses
- arranged mergers or restructurings to minimize spillover effects
- dividend bans and other interventions that interfere with banks
Bank Prudential Mechanisms - interest rate risk, credit risk, operational risk
- capital and liquidity ratios
- strategies: skinny bundle, skinny bundle +
Certification and Prudential Overlap - prudential mechanisms double as certification tools
- help pass stress tests and build credibility with investors and supervisors
- ex: excellent loan files and records, demonstrating risk seriousness to examiners
Bank Certification Mechanisms - efforts include: publicizing safety, cooperating with supervisors
- limited effectiveness because: public sees banks as self-interested, long-
standing mistrust
- authorities must do real certification work
Authority Prudential Mechanisms - Before operations:
o Background checks.
o Banking experience requirements.
o Substantial equity capital investment.
- Before lending:
o Ban or limit junk bonds and leveraged loans.
o Legal lending limits to reduce concentration risk.
- Ongoing tools:
o CECL provisions.
o Enforcement actions.
o Focus on TBTF, TITF, TMTF banks.
Authority Certification Mechanisms - Certification is year-round:
o On-site inspections for large banks.
o Off-site monitoring via Call Reports.
- Stress tests: Joint preparation.
- Disclosure:
o Some results are published, others informally leaked.
- More trusted certifiers than banks.
Market Risks - potential financial losses due to changes in market prices
- ex: Interest rate risks, foreign exchange rate risks, commodity price risks
- risks can arise from mismatches between the characteristics of bank's asset,
liabilities, and off-balance sheet activities
C
Terms in this set (85)
Basics of Risk Management - Firms take risks to perform their "feats" of supplying goods and services
functions, but unfavorable outcomes can interfere with operations and cause
distress.
- Professional risk managers maximize shareholder value by:
o Measuring and assessing risks
o Screening, monitoring, and controlling risks efficiently
o Taking risks only that align with maximizing value
Deadweight Costs - Unproductive losses that reduce firm value without corresponding gains
- ex: loss of reputation and creditworthiness, costs of legal proceedings and
bankruptcy, valuable employees heading for the exits
Joint effort between banks and prudential authorities - Bank risk management is the outcome of dynamic and strategic interplay
between banks and prudential authorities- regulators and supervisors - with
shared and conflicting goals
- Shared goal: protecting banks from deadweight costs of financial and economic
distress
- Conflicting goals: moral hazard by banks, enforcement actions from authorities,
protecting the rest of society from bank financial distress
"Skinny Bundle" risk management strategy for banks - prioritizes capital ratios and liquid asset ratios
- conserves time and resources to efficiently create liquidity and mitigate risks for
customers
"Skinny Bundle +" - risk management strategy for banks with significant derivative exposures
- the "+" is also to monitor and prioritize the ratios of fair values of derivatives to
total assets in a similar fashion to equity capital and liquid asset ratios
Moral Hazard in Banking - banks take on excessive risks, expecting to be bailed out or protected
- enabled by: deposit insurance, government safety nets, inadequate risk pricing
Prudential Mechanisms - internal controls
- capital buffers
- diversification
- banks are more agile with these tools (customer-facing)
Certification Mechanisms - public confidence tools (ex: CAMELS ratings)
- external audits and regulatory stress tests
- authorities are better positioned to certify (independent verification)
, Why do Banks manage risk? - maximize shareholder equity value
- avoid losses of key employees, customers, and investors
- reduce costs of distress-related distractions from liquidity creation and risk
mitigation
Why do Authorities manage risk? - limit deadweight costs of bank distress
- protect value to society from bank activity
- ensure the ongoing provision of financial intermediation services during stress
Ways in which Prudential Authorities intervene - bailouts or bail-ins to prevent broader social losses
- arranged mergers or restructurings to minimize spillover effects
- dividend bans and other interventions that interfere with banks
Bank Prudential Mechanisms - interest rate risk, credit risk, operational risk
- capital and liquidity ratios
- strategies: skinny bundle, skinny bundle +
Certification and Prudential Overlap - prudential mechanisms double as certification tools
- help pass stress tests and build credibility with investors and supervisors
- ex: excellent loan files and records, demonstrating risk seriousness to examiners
Bank Certification Mechanisms - efforts include: publicizing safety, cooperating with supervisors
- limited effectiveness because: public sees banks as self-interested, long-
standing mistrust
- authorities must do real certification work
Authority Prudential Mechanisms - Before operations:
o Background checks.
o Banking experience requirements.
o Substantial equity capital investment.
- Before lending:
o Ban or limit junk bonds and leveraged loans.
o Legal lending limits to reduce concentration risk.
- Ongoing tools:
o CECL provisions.
o Enforcement actions.
o Focus on TBTF, TITF, TMTF banks.
Authority Certification Mechanisms - Certification is year-round:
o On-site inspections for large banks.
o Off-site monitoring via Call Reports.
- Stress tests: Joint preparation.
- Disclosure:
o Some results are published, others informally leaked.
- More trusted certifiers than banks.
Market Risks - potential financial losses due to changes in market prices
- ex: Interest rate risks, foreign exchange rate risks, commodity price risks
- risks can arise from mismatches between the characteristics of bank's asset,
liabilities, and off-balance sheet activities
