Fire Sale Price

Chapter 14 Testbank

1.

Fire-sale price refers to the price received for:



A. an asset that has to be sold at half price
B. a liability that has to be sold at half price
C. an asset that has to be sold immediately
D. a liability that has to be sold immediately

2.

Net deposit drains refer to the amount by which cash withdrawals:



A. are less than additions-this is a cash outflow
B. are less than additions-this is a cash inflow
C. exceed additions-this is a cash outflow
D. exceed additions-this is a cash inflow

3.

An FI’s financing gap is the difference between an FI’s:



A. average core deposits and average loans
B. average loans and average core deposits
C. assets and liabilities
D. liabilities and assets

4.

Which of the following statements is true?



A. The financing requirement is the financing gap plus an FI’s liquid assets.
B. The financing requirement is the financing gap minus an FI’s liquid assets.
C. The financing requirement is the financing gap multiplied by an FI’s liquid assets.
D. The financing requirement is the financing gap divided by an FI’s liquid assets

5.

Which of the following statements is true?



A. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay shareholders immediately.
B. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to finance new loan demand.
C. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay fully and promptly all maturing liabilities.
D. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay all short-term liabilities immediately.

6.

Which of the following statements is true?



A. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the Christmas effect.
B. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called seasonal liquidity.
C. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the January effect.
D. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called the four seasons liquidity gap.

7.

Trend liquidity needs are liquidity needs that relate to the:



A. trends occurring in the community where, for example, loan growth exceeds deposits growth.
B. trends occurring in the community where, for example, deposit growth exceeds loan growth.
C. demand for liquidity that fluctuates with seasonal factors.
D. demand for liquidity that fluctuates with seasonal factors within a community

8.

Cyclical liquidity needs are those which vary with the:



A. seasonal cycle
B. business cycle
C. weather cycle, for example influencing droughts
D. FI’s maturity cycle

9.

Contingent liquidity needs refers to the liquidity needs necessary to:



A. fund contingent assets
B. fund assets
C. meet an unforeseen event
D. meet a foreseen event

10.

A bank run refers to a sudden:



A. but expected increase in deposit withdrawals from an FI
B. and unexpected increase in deposit withdrawals from an FI
C. and unexpected increase in customers that wish to undertake business with the FI
D. but expected increase in customers that wish to undertake business with the FI

11.

Bank panic refers to a contagious run on the deposits of:



A. banking institutions in particular suburbs
B. the big four banks
C. all branches of a particular institution.
D. the banking industry as a whole.

12.

Which of the following statements is true?



A. Open market operations are interventions in the short-term money market by APRA to affect the cash interest rate.
B. Open market operations are interventions in the short-term money market by the RBA to affect the cash interest rate.
C. Open market operations are interventions in the long-term capital market by APRA to affect long-term interest rates.
D. Open market operations are interventions in the long-term capital market by the RBA to affect long-term interest rates.

13.

An investment fund that sells a fixed number of shares in the fund to outside investors is called:



A. open-end fund
B. closed-end fund
C. fixed fund
D. fixed number fund

14.

An open-end fund is defined as an investment fund that sells:



A. an elastic number of shares to outside investors
B. a fixed number of shares to an elastic number of outside investors
C. an elastic number of shares to outside investors, but that never buys back any of these shares
D. a fixed number of shares to an elastic number of outside investors, but that never buys back any of these shares

15.

Net asset value is the:



A. product of the price at which a managed fund’s shares are sold and the number of outstanding shares
B. price at which a managed fund’s shares are sold
C. value of an investor’s holding in managed fund’s shares
D. None of the listed options are correct.

16.

Which of the following statements is true?



A. The net asset value equals the total market value of the assets of the fund.
B. The net asset value equals the total market value of the assets of the fund divided by the number of shares in the funds outstanding.
C. The net asset value equals the number of shares in the funds outstanding divided by the total market value of the assets of the fund.
D. The net asset value equals the total market value of the assets of the fund multiplied by the number of shares in the funds outstanding.

17.

Which of the following statements is true?



A. In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
B. In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
C. In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.
D. In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.

18.

Which of the following items may expose an FI to liquidity risk?



A. $500 000 in demand deposits and $100 000 in overnight deposits made by another FI
B. $500 000 in demand deposits and $50 000 in credit line facilities
C. $500 000 in demand deposits, $100 000 in loan commitments and $50 000 in short-term securities
D. $500 000 in demand deposits, $100 000 in overnight deposits made by another FI and $50 000 in credit line facilities

19.

Which of the following statements is true?



A. An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.
B. Traditionally, FI managers have relied on stored liquidity management as the primary mechanism of liquidity management.
C. Today, there is a higher reliance on purchased liquidity management.
D. All of the listed options are correct.

20.

Purchased liquidity management is:



A. a liability-side adjustment to the balance sheet to cover a deposit drain
B. an asset-side adjustment to the balance sheet to cover a deposit drain
C. an equity-side adjustment to the balance sheet to cover a deposit drain
D. All of the listed options are correct.

21.

Stored liquidity management is:



A. a liability-side adjustment to the balance sheet to cover a deposit drain
B. an asset-side adjustment to the balance sheet to cover a deposit drain
C. an equity-side adjustment to the balance sheet to cover a deposit drain
D. All of the listed options are correct.

22.

Which of the following statements is true?



A. A net liquidity statement focuses on the sources of liquidity and thus provides a measure of an FI’s available liquidity.
B. A net liquidity statement list focuses on the uses of liquidity and thus provides a measure of an FI’s liquidity needs.
C. A net liquidity statement lists sources and uses of liquidity and thus provides a measure of an FI’s net liquidity position.
D. None of the listed options are correct.

23.

Which of the following is a way in which an FI can raise liquidity?



A. selling liquid assets
B. borrowing funds in money markets
C. using excess cash reserves over and above the amount held in its exchange settlement account with the RBA
D. All of the listed options are correct.

24.

Which of the following statements is true?



A. The liquidity index compares the liquidity of a single institution with the industry average and thus measures the liquidity risk of that particular institution.
B. The liquidity index provides guidance for FIs on how much liquidity they should hold on a seasonal basis.
C. The liquidity index measures the potential losses an FI could suffer if new market entrants take away market share from the existing institutions.
D. The liquidity index measures the potential losses an FI could suffer from a sudden disposal of assets compared to the mount it would receive at a fair market value established under normal sales conditions.

25.

Consider the following hypothetical data:

What is the FI’s net liquidity position?


A. ($12 500 + $500) - ($3000 + $22 000 + $1000) = -$13 000
B. ($3000 + $22 000 + $1000) - ($12 500 + $500) = $13 000
C. ($12 500 - $500) = $13 000
D. ($3000 + $22 000 + $1000) = $26 000

26.

Which of the following statements is true in the context of the liquidity index?



A. The greater the difference between immediate fire-sale asset prices and fair market value prices, the more liquid is the FI’s portfolio of assets.
B. The greater the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI’s portfolio of assets.
C. The smaller the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI’s portfolio of assets.
D. None of the listed options are correct.

27.

Consider the following situation: an FI holds two assets in equal proportions, these being liquid securities with a fair market value of $200 and housing loans with a fair market value of $800. Further assume that in case of immediate liquidation, the FI would receive $185 for its liquid securities and $700 for its housing loans. What is the FI’s liquidity index (round to two decimals)?



A. I = (185/200) + (700/800) = 1.80
B.

I = (185/200) ´ (700/800) = 0.81


C.

I = 0.5 ´ (185/200) + 0.5 ´ (700/800) = 0.90


D.

I = [0.5 ´ (185/200)] ´ [0.5 ´ (700/800)] = 0.20

28.

Consider the following situation: an FI holds 40 per cent of its assets in liquid securities with a fair market value of $100 and the remaining 60 per cent of its assets in housing loans with a fair market value of $500. Further assume that in case of immediate liquidation, the FI would receive $90 for its liquid securities and $450 for its housing loans. What is the FI’s liquidity index (round to two decimals)?



A. 0.19
B. 0.54
C. 0.67
D. 0.90

29.

Which of the following equations correctly defines an FI’s financing requirements?



A.

Average loans – average deposits


B.

Average deposits – average loans


C.

Average loans – average deposits + liquid assets


D.

Financing gap – liquid assets

30.

Assume that an FI’s average loan value is $500 and the average value of deposits is $450. The FI has liquid assets of $50. What is the FI’s financing gap?



A.

$500 – $450 – $50 = $0


B.

$450 – $500 = –$50


C.

$500 – $450 = $50


D.

$500 – $450 + $50 = $100

31.

Which of the following statements is true?



A. A positive financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
B. A negative financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
C. A positive financing gap means that the FI has excess liquidity.
D. A negative financing gap means that the FI is in need of liquidity.

32.

Assume the value of an FI’s average loans is $300 and the value of its average deposits is $400. The FI has liquid assets of $100. What is the FI’s financing requirement?



A.

$400 – $300 – $100 = $0


B.

$300 – $400 – $100 = –$200


C.

$400 – $300 + $100 = $200


D.

$300 – $400 + $100 = $0

33.

Which of the following statements is true?



A. Under the BIS scenario analysis, an FI needs to assess its liquidity position in comparison to other FIs in the market based on different scenarios.
B. Under the BIS scenario analysis, an FI needs to estimate the size of cash flows for each type of asset and liability based on past experience.
C. Under the BIS scenario analysis, an FI needs to assign a timing of cash flows for each type of asset and liability by assessing the probability of behaviour of those cash flows under the scenario being examined.
D. None of the listed options are correct.

34.

A disadvantage of using liability management to manage an FI’s liquidity risk is:



A. the resulting shrinkage of the FI’s balance sheet
B. the high cost of purchased liabilities
C. the accessibility of international money markets
D. loss of flexibility as a result of dependence upon purchased liabilities

35.

Which of the following statements is false?



A. It is difficult to isolate which part of past deposits and loan fluctuations is due to cyclical liquidity.
B. Forecasting future liquidity needs based on past patterns is always risky due to changes in seasonal patterns, regulation and economic conditions.
C. Liquidity planning tools typically ignore cyclical liquidity needs and liquidity needs due to FI confidence crises.
D. None of the listed options are correct.

36.

Which of the following is false?



A. Appropriate liquidity planning can lower the cost of funds of an FI and thus increase its profitability.
B. Appropriate liquidity planning can maximise the amount of excess cash reserves.
C. Appropriate liquidity planning can limit an FI’s liquidity risk.
D. None of the listed options are correct.

37.

What are typical reasons for abnormal deposit drains?



A. Concerns about an FI’s solvency relative to other FIs.
B. Failure of a related FI leading to heightened depositor concerns about the solvency of other FIs.
C. Sudden changes in investor preferences regarding holding non-bank financial assets relative to deposits.
D. All of the listed options are correct.

38.

Which of the following statements is true?



A. In case of a liquidity crisis, depositors do not need to worry as the RBA will pay out any deficit balances.
B. In case of a liquidity crisis, any available balances will be divided equally among depositors.
C. In case of a liquidity crisis, any available balances will be divided proportionally to each depositor’s investment.
D. In case of a liquidity crisis, the ‘first comes, first served’ principle holds.

39.

Which of the following statements is true?



A. In Australia, depositors received preference over other liability holders in the event of a liquidation of an FI.
B. In Australia, depositors receive preference over other liability holders in the event of a liquidation of an FI being replaced by a financial claims scheme to protect deposit accounts.
C. In Australia, only customers of the major banks are covered by deposit insurance.
D. Australia has had a well-developed deposit insurance system for decades that has protected depositors without a bank failure for over a century.

40.

Which of the following is not a potential cause of liquidity risk for a DI?



A. a decrease in the DI’s stock price caused by market factors
B. an increase in requests to fund large amounts of loan commitments
C. a decrease in the availability of short-term borrowed funds
D. an increase in requests by depositors to withdrawal large amounts of deposits

41.

A disadvantage of using asset management to manage an FI’s liquidity risk is:



A. the resulting shrinkage of the FI’s balance sheet
B. the high cost of purchased liabilities
C. the accessibility of international money markets
D. loss of flexibility as a result of dependence upon purchased liabilities

42.

What are the possible ways that a bank can meet an expected net deposit drain of +4 per cent using purchased liquidity management techniques?



A. Utilise the interbank funds market and repurchase agreements.
B. Utilise repurchase agreements.
C. Liquidate all cash holdings.
D. All of the listed options are correct.

43.

What are the two main liquidity facilities available to Australian FIs to prevent financial disturbances occurring?



A. deposit insurance and the discount window
B. intra-day repurchase agreement and overnight repurchase agreement
C. financing gap and the financing requirement
D. secondary credit and seasonal credit

44.

When comparing banks and mutual funds, mutual funds have:



A. more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis
B. less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis
C. more liquidity risk than banks because all shareholders have the ability to withdraw their money on a ‘first come first served’ basis
D. the same liquidity risk as banks because both shareholders and depositors share the fall in the loss of value on a pro rata basis

45.

Consider a mutual fund with 100 shareholders who each invested $10 for a total of $1000. If the assets of the mutual fund are worth $900, what is the net asset value for each one of the mutual fund shares?



A. $0.9
B. $9
C. $90
D. $10

46.

The Reserve Bank of Australia (RBA) took a number of temporary actions during the global financial crisis to provide liquidity and avert financial system disturbance. Which of the following were not actions supplied by the RBA?



A. Extension of collateral eligible for open market operations.
B. Longer term repos offered daily that provided funding for six-month and one-year terms.
C. Residential mortgage-backed securities and asset-backed commercial paper.
D. A foreign exchange swap facility to address the global shortage of euro in financial markets.

47.

As part of the Basel III liquidity reforms the RBA will establish a secure committed liquidity facility.



A. This is necessary due to the shortage of capital required to be held by FIs.
B. This is necessary due to the shortage of Australian government debt, T-bonds and T-notes, used in open market operations.
C. This is necessary due to the shortage of international funds to purchase repos.
D. All of the listed options are correct.

48.

Use the following balance sheet (values in thousands of dollars) to answer the question.

If the bank experiences a $50 000 sudden liquidity drain caused by a loan commitment drawdown, what will be the impact on the balance sheet if stored liquidity management techniques are used?


A. a reduction in cash of $21 000 and an increase in demand deposits of $29 000
B. a reduction in securities and/or current loans totalling $50 000
C. a reduction in cash of $21 000 and a decrease in securities holdings of $29 000
D. a decrease in equity of $50 000

49.

Use the following balance sheet (values in thousands of dollars) to answer the question.

If the bank experiences a $50 000 sudden liquidity drain caused by withdrawal of their demand deposits, what will be the impact on the balance sheet if purchased liquidity management techniques are used?


A. a reduction in cash of $21 000 and a decrease in demand deposits of $29 000
B. a reduction in securities and/or current loans totalling $50 000
C. a reduction in demand deposits of $50 000 and an increase in interbank borrowings of $50 000
D. a decrease in equity of $50 000

50.

Which of the following is not a component of liquidity planning?



A. A summary of the size of potential net deposit drains over various time horizons.
B. Detailed list of funds providers who have seasonal patterns of funds usage.
C. A calculation of the value of assets at fire-sale prices relative to the fair market value of those assets.
D. A detailed itemisation of managerial responsibilities

51.

Which type of financial intermediary is more highly exposed to liquidity risk?



A. property-casualty insurance companies
B. life insurance companies
C. mutual funds
D.

depository institutions

52.

Fire-sale price refers to the price received for an asset that has to be sold immediately.



True False

53.

Fire-sale price refers to the price received for an asset that has to be sold at half price.



True False

54.

Core deposits are those deposits that provide a DI with a long-term funding source



True False

55.

In 2010, the Bank for International Settlements (BIS) developed two new liquidity ratios to be maintained by DIs, namely, the liquidity coverage ratio (LCR) and a net stable funds ratio (NSFR)



True False

56.

Available unencumbered assets are important as they have the potential to be used as collateral to raise additional secured funding in secondary markets and also possible at the RBA, and as such, may potentially be additional sources of liquidity for the DI



True False

57.

Australia has recently developed a market for deposit insurance guarantee that protects deposit accounts.



True False

58.

The aim of open market transactions is to influence the level of liquidity in the market.



True False

59.

Liquidity risk can only arise on the asset side of an FI’s balance sheet as this means that the FI does not hold enough liquid assets such as cash or liquid securities.



True False

60.

In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts knows that normally only a small proportion of these deposits will be withdrawn on any given day.



True False

61.

An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.



True False

62.

Purchased liquidity management is a liability-side adjustment to the balance sheet to cover a deposit drain



True False

63.

Stored liquidity management is an asset-side adjustment to the balance sheet to cover a deposit drain



True False

64.

Stored liquidity management is a liability-side adjustment to the balance sheet to cover a deposit drain



True False

65.

Purchased liquidity management is an asset-side adjustment to the balance sheet to cover a deposit drain



True False

66.

The liquidity index will always lie between -1 and +1.



True False

67.

The maturity ladder model allows a comparison of cash inflows and cash outflows over a series of specified time periods.



True False

68.

The Bank for International Settlements requires FIs to measure their liquidity positions under normal market conditions only.



True False

69.

Trend liquidity planning calculates an FI’s liquidity need as the simple difference between the FI’s liquid assets and its volatile sources of funds.



True False

70.

APRA requires every FI to hold sufficient liquid assets to meet a name crisis situation.



True False

71.

Liquidation of a mutual fund causes assets to be liquidated and funds received to the dispersed to shareholders on a first come, first served basis.



True False

72.

A contagious run, or bank panic, differs from a run on a bank in that a contagious run involves loss of faith in the entire banking system as opposed to just one bank.



True False

73. Distinguish between liquidity risk arising from the asset side and the liability side of the balance sheet.

74. Discuss the advantages and disadvantages of stored liquidity management and purchased liquidity management. In your opinion, which is the better approach for a DI to adopt?

75. What are the main components of a liquidity plan? Discuss the vital role such a plan plays in reducing liquidity risk.

76. Discuss the components of liquidity position of the bank related to active liquidity planning


Chapter 14 Testbank Key

1.

Fire-sale price refers to the price received for:



A. an asset that has to be sold at half price
B. a liability that has to be sold at half price
C. an asset that has to be sold immediately
D. a liability that has to be sold immediately


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.

2.

Net deposit drains refer to the amount by which cash withdrawals:



A. are less than additions-this is a cash outflow
B. are less than additions-this is a cash inflow
C. exceed additions-this is a cash outflow
D. exceed additions-this is a cash inflow


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

3.

An FI’s financing gap is the difference between an FI’s:



A. average core deposits and average loans
B. average loans and average core deposits
C. assets and liabilities
D. liabilities and assets


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

4.

Which of the following statements is true?



A. The financing requirement is the financing gap plus an FI’s liquid assets.
B. The financing requirement is the financing gap minus an FI’s liquid assets.
C. The financing requirement is the financing gap multiplied by an FI’s liquid assets.
D. The financing requirement is the financing gap divided by an FI’s liquid assets


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

5.

Which of the following statements is true?



A. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay shareholders immediately.
B. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to finance new loan demand.
C. Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay fully and promptly all maturing liabilities.
D.

Immediate liquidity obligations refer to the liquidity required of an FI so that it has sufficient funds to repay all short-term liabilities immediately.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

6.

Which of the following statements is true?



A. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the Christmas effect.
B. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called seasonal liquidity.
C. The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is referred to as the January effect.
D.

The liquidity required of an FI to enable it to meet the demand for liquidity that fluctuates with seasonal factors is called the four seasons liquidity gap.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

7.

Trend liquidity needs are liquidity needs that relate to the:



A. trends occurring in the community where, for example, loan growth exceeds deposits growth.
B. trends occurring in the community where, for example, deposit growth exceeds loan growth.
C. demand for liquidity that fluctuates with seasonal factors.
D. demand for liquidity that fluctuates with seasonal factors within a community


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

8.

Cyclical liquidity needs are those which vary with the:



A. seasonal cycle
B. business cycle
C. weather cycle, for example influencing droughts
D. FI’s maturity cycle


AACSB: Analytic
Bloom's: Application
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

9.

Contingent liquidity needs refers to the liquidity needs necessary to:



A. fund contingent assets
B. fund assets
C. meet an unforeseen event
D. meet a foreseen event


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

10.

A bank run refers to a sudden:



A. but expected increase in deposit withdrawals from an FI
B. and unexpected increase in deposit withdrawals from an FI
C. and unexpected increase in customers that wish to undertake business with the FI
D. but expected increase in customers that wish to undertake business with the FI


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

11.

Bank panic refers to a contagious run on the deposits of:

A. banking institutions in particular suburbs
B. the big four banks
C. all branches of a particular institution.
D. the banking industry as a whole.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

12.

Which of the following statements is true?



A. Open market operations are interventions in the short-term money market by APRA to affect the cash interest rate.
B. Open market operations are interventions in the short-term money market by the RBA to affect the cash interest rate.
C. Open market operations are interventions in the long-term capital market by APRA to affect long-term interest rates.
D. Open market operations are interventions in the long-term capital market by the RBA to affect long-term interest rates.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

13.

An investment fund that sells a fixed number of shares in the fund to outside investors is called:



A. open-end fund
B. closed-end fund
C. fixed fund
D. fixed number fund


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

14.

An open-end fund is defined as an investment fund that sells:



A. an elastic number of shares to outside investors
B. a fixed number of shares to an elastic number of outside investors
C. an elastic number of shares to outside investors, but that never buys back any of these shares
D. a fixed number of shares to an elastic number of outside investors, but that never buys back any of these shares


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

15.

Net asset value is the:



A. product of the price at which a managed fund’s shares are sold and the number of outstanding shares
B. price at which a managed fund’s shares are sold
C. value of an investor’s holding in managed fund’s shares
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

16.

Which of the following statements is true?



A. The net asset value equals the total market value of the assets of the fund.
B. The net asset value equals the total market value of the assets of the fund divided by the number of shares in the funds outstanding.
C. The net asset value equals the number of shares in the funds outstanding divided by the total market value of the assets of the fund.
D. The net asset value equals the total market value of the assets of the fund multiplied by the number of shares in the funds outstanding.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

17.

Which of the following statements is true?



A. In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
B. In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out that amount by liquidating an equivalent amount of asset on any banking day.
C. In theory, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.
D. In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts must stand ready to pay out half of that amount by liquidating an equivalent amount of asset on any banking day.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

18.

Which of the following items may expose an FI to liquidity risk?



A. $500 000 in demand deposits and $100 000 in overnight deposits made by another FI
B. $500 000 in demand deposits and $50 000 in credit line facilities
C. $500 000 in demand deposits, $100 000 in loan commitments and $50 000 in short-term securities
D. $500 000 in demand deposits, $100 000 in overnight deposits made by another FI and $50 000 in credit line facilities


AACSB: Analytic
Bloom's: Application
Difficulty: Hard
Est time: 1-3
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

19.

Which of the following statements is true?



A. An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.
B. Traditionally, FI managers have relied on stored liquidity management as the primary mechanism of liquidity management.
C. Today, there is a higher reliance on purchased liquidity management.
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

20.

Purchased liquidity management is:



A. a liability-side adjustment to the balance sheet to cover a deposit drain
B. an asset-side adjustment to the balance sheet to cover a deposit drain
C. an equity-side adjustment to the balance sheet to cover a deposit drain
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

21.

Stored liquidity management is:



A. a liability-side adjustment to the balance sheet to cover a deposit drain
B. an asset-side adjustment to the balance sheet to cover a deposit drain
C. an equity-side adjustment to the balance sheet to cover a deposit drain
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

22.

Which of the following statements is true?



A. A net liquidity statement focuses on the sources of liquidity and thus provides a measure of an FI’s available liquidity.
B. A net liquidity statement list focuses on the uses of liquidity and thus provides a measure of an FI’s liquidity needs.
C. A net liquidity statement lists sources and uses of liquidity and thus provides a measure of an FI’s net liquidity position.
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

23.

Which of the following is a way in which an FI can raise liquidity?



A. selling liquid assets
B. borrowing funds in money markets
C. using excess cash reserves over and above the amount held in its exchange settlement account with the RBA
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

24.

Which of the following statements is true?



A. The liquidity index compares the liquidity of a single institution with the industry average and thus measures the liquidity risk of that particular institution.
B. The liquidity index provides guidance for FIs on how much liquidity they should hold on a seasonal basis.
C. The liquidity index measures the potential losses an FI could suffer if new market entrants take away market share from the existing institutions.
D. The liquidity index measures the potential losses an FI could suffer from a sudden disposal of assets compared to the mount it would receive at a fair market value established under normal sales conditions.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Hard
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

25.

Consider the following hypothetical data:

What is the FI’s net liquidity position?


A. ($12 500 + $500) - ($3000 + $22 000 + $1000) = -$13 000
B. ($3000 + $22 000 + $1000) - ($12 500 + $500) = $13 000
C. ($12 500 - $500) = $13 000
D. ($3000 + $22 000 + $1000) = $26 000


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

26.

Which of the following statements is true in the context of the liquidity index?



A. The greater the difference between immediate fire-sale asset prices and fair market value prices, the more liquid is the FI’s portfolio of assets.
B. The greater the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI’s portfolio of assets.
C. The smaller the difference between immediate fire-sale asset prices and fair market value prices, the less liquid is the FI’s portfolio of assets.
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

27.

Consider the following situation: an FI holds two assets in equal proportions, these being liquid securities with a fair market value of $200 and housing loans with a fair market value of $800. Further assume that in case of immediate liquidation, the FI would receive $185 for its liquid securities and $700 for its housing loans. What is the FI’s liquidity index (round to two decimals)?



A. I = (185/200) + (700/800) = 1.80
B.

I = (185/200) ´ (700/800) = 0.81


C.

I = 0.5 ´ (185/200) + 0.5 ´ (700/800) = 0.90


D.

I = [0.5 ´ (185/200)] ´ [0.5 ´ (700/800)] = 0.20


AACSB: Analytic
Bloom's: Application
Difficulty: Hard
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

28.

Consider the following situation: an FI holds 40 per cent of its assets in liquid securities with a fair market value of $100 and the remaining 60 per cent of its assets in housing loans with a fair market value of $500. Further assume that in case of immediate liquidation, the FI would receive $90 for its liquid securities and $450 for its housing loans. What is the FI’s liquidity index (round to two decimals)?



A. 0.19
B. 0.54
C. 0.67
D. 0.90


AACSB: Analytic
Bloom's: Application
Difficulty: Hard
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

29.

Which of the following equations correctly defines an FI’s financing requirements?



A.

Average loans – average deposits


B.

Average deposits – average loans


C.

Average loans – average deposits + liquid assets


D.

Financing gap – liquid assets


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

30.

Assume that an FI’s average loan value is $500 and the average value of deposits is $450. The FI has liquid assets of $50. What is the FI’s financing gap?



A.

$500 – $450 – $50 = $0


B.

$450 – $500 = –$50


C.

$500 – $450 = $50


D.

$500 – $450 + $50 = $100


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

31.

Which of the following statements is true?



A. A positive financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
B. A negative financing gap means that the FI must fund it by using its cash and liquid assets or by raising funds in the money market.
C. A positive financing gap means that the FI has excess liquidity.
D. A negative financing gap means that the FI is in need of liquidity.


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

32.

Assume the value of an FI’s average loans is $300 and the value of its average deposits is $400. The FI has liquid assets of $100. What is the FI’s financing requirement?



A.

$400 – $300 – $100 = $0


B.

$300 – $400 – $100 = –$200


C.

$400 – $300 + $100 = $200


D.

$300 – $400 + $100 = $0


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

33.

Which of the following statements is true?



A. Under the BIS scenario analysis, an FI needs to assess its liquidity position in comparison to other FIs in the market based on different scenarios.
B. Under the BIS scenario analysis, an FI needs to estimate the size of cash flows for each type of asset and liability based on past experience.
C. Under the BIS scenario analysis, an FI needs to assign a timing of cash flows for each type of asset and liability by assessing the probability of behaviour of those cash flows under the scenario being examined.
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

34.

A disadvantage of using liability management to manage an FI’s liquidity risk is:



A. the resulting shrinkage of the FI’s balance sheet
B. the high cost of purchased liabilities
C. the accessibility of international money markets
D. loss of flexibility as a result of dependence upon purchased liabilities


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

35.

Which of the following statements is false?



A. It is difficult to isolate which part of past deposits and loan fluctuations is due to cyclical liquidity.
B. Forecasting future liquidity needs based on past patterns is always risky due to changes in seasonal patterns, regulation and economic conditions.
C. Liquidity planning tools typically ignore cyclical liquidity needs and liquidity needs due to FI confidence crises.
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Hard
Est time: 1-3
Learning Objective: 14.5 Discover the importance of liquidity planning to a DI.
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

36.

Which of the following is false?



A. Appropriate liquidity planning can lower the cost of funds of an FI and thus increase its profitability.
B. Appropriate liquidity planning can maximise the amount of excess cash reserves.
C. Appropriate liquidity planning can limit an FI’s liquidity risk.
D. None of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

37.

What are typical reasons for abnormal deposit drains?



A. Concerns about an FI’s solvency relative to other FIs.
B. Failure of a related FI leading to heightened depositor concerns about the solvency of other FIs.
C. Sudden changes in investor preferences regarding holding non-bank financial assets relative to deposits.
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

38.

Which of the following statements is true?



A. In case of a liquidity crisis, depositors do not need to worry as the RBA will pay out any deficit balances.
B. In case of a liquidity crisis, any available balances will be divided equally among depositors.
C. In case of a liquidity crisis, any available balances will be divided proportionally to each depositor’s investment.
D. In case of a liquidity crisis, the ‘first comes, first served’ principle holds.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

39.

Which of the following statements is true?



A. In Australia, depositors received preference over other liability holders in the event of a liquidation of an FI.
B. In Australia, depositors receive preference over other liability holders in the event of a liquidation of an FI being replaced by a financial claims scheme to protect deposit accounts.
C. In Australia, only customers of the major banks are covered by deposit insurance.
D. Australia has had a well-developed deposit insurance system for decades that has protected depositors without a bank failure for over a century.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

40.

Which of the following is not a potential cause of liquidity risk for a DI?



A. a decrease in the DI’s stock price caused by market factors
B. an increase in requests to fund large amounts of loan commitments
C. a decrease in the availability of short-term borrowed funds
D. an increase in requests by depositors to withdrawal large amounts of deposits


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

41.

A disadvantage of using asset management to manage an FI’s liquidity risk is:



A. the resulting shrinkage of the FI’s balance sheet
B. the high cost of purchased liabilities
C. the accessibility of international money markets
D. loss of flexibility as a result of dependence upon purchased liabilities


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

42.

What are the possible ways that a bank can meet an expected net deposit drain of +4 per cent using purchased liquidity management techniques?



A. Utilise the interbank funds market and repurchase agreements.
B. Utilise repurchase agreements.
C. Liquidate all cash holdings.
D.

All of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

43.

What are the two main liquidity facilities available to Australian FIs to prevent financial disturbances occurring?



A. deposit insurance and the discount window
B. intra-day repurchase agreement and overnight repurchase agreement
C. financing gap and the financing requirement
D. secondary credit and seasonal credit


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

44.

When comparing banks and mutual funds, mutual funds have:



A. more liquidity risk than banks because all shareholders share the loss of value on a pro rata basis
B. less liquidity risk than banks because all shareholders share the loss of value on a pro rata basis
C. more liquidity risk than banks because all shareholders have the ability to withdraw their money on a ‘first come first served’ basis
D. the same liquidity risk as banks because both shareholders and depositors share the fall in the loss of value on a pro rata basis


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

45.

Consider a mutual fund with 100 shareholders who each invested $10 for a total of $1000. If the assets of the mutual fund are worth $900, what is the net asset value for each one of the mutual fund shares?



A. $0.9
B. $9
C. $90
D. $10


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

46.

The Reserve Bank of Australia (RBA) took a number of temporary actions during the global financial crisis to provide liquidity and avert financial system disturbance. Which of the following were not actions supplied by the RBA?



A. Extension of collateral eligible for open market operations.
B. Longer term repos offered daily that provided funding for six-month and one-year terms.
C. Residential mortgage-backed securities and asset-backed commercial paper.
D. A foreign exchange swap facility to address the global shortage of euro in financial markets.


AACSB: Reflective thinking
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

47.

As part of the Basel III liquidity reforms the RBA will establish a secure committed liquidity facility.



A. This is necessary due to the shortage of capital required to be held by FIs.
B. This is necessary due to the shortage of Australian government debt, T-bonds and T-notes, used in open market operations.
C. This is necessary due to the shortage of international funds to purchase repos.
D. All of the listed options are correct.


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

48.

Use the following balance sheet (values in thousands of dollars) to answer the question.
If the bank experiences a $50 000 sudden liquidity drain caused by a loan commitment drawdown, what will be the impact on the balance sheet if stored liquidity management techniques are used?


A. a reduction in cash of $21 000 and an increase in demand deposits of $29 000
B. a reduction in securities and/or current loans totalling $50 000
C. a reduction in cash of $21 000 and a decrease in securities holdings of $29 000
D. a decrease in equity of $50 000


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

49.

Use the following balance sheet (values in thousands of dollars) to answer the question.

If the bank experiences a $50 000 sudden liquidity drain caused by withdrawal of their demand deposits, what will be the impact on the balance sheet if purchased liquidity management techniques are used?


A. a reduction in cash of $21 000 and a decrease in demand deposits of $29 000
B. a reduction in securities and/or current loans totalling $50 000
C. a reduction in demand deposits of $50 000 and an increase in interbank borrowings of $50 000
D. a decrease in equity of $50 000


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

50.

Which of the following is not a component of liquidity planning?



A. A summary of the size of potential net deposit drains over various time horizons.
B. Detailed list of funds providers who have seasonal patterns of funds usage.
C. A calculation of the value of assets at fire-sale prices relative to the fair market value of those assets.
D. A detailed itemisation of managerial responsibilities


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.5 Discover the importance of liquidity planning to a DI.

51.

Which type of financial intermediary is more highly exposed to liquidity risk?



A. property-casualty insurance companies
B. life insurance companies
C. mutual funds
D.

depository institutions


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: 1-3
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.
Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

52.

Fire-sale price refers to the price received for an asset that has to be sold immediately.



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.

53.

Fire-sale price refers to the price received for an asset that has to be sold at half price.



FALSE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.

54.

Core deposits are those deposits that provide a DI with a long-term funding source



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

55.

In 2010, the Bank for International Settlements (BIS) developed two new liquidity ratios to be maintained by DIs, namely, the liquidity coverage ratio (LCR) and a net stable funds ratio (NSFR)



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

56.

Available unencumbered assets are important as they have the potential to be used as collateral to raise additional secured funding in secondary markets and also possible at the RBA, and as such, may potentially be additional sources of liquidity for the DI



TRUE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

57.

Australia has recently developed a market for deposit insurance guarantee that protects deposit accounts.



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

58.

The aim of open market transactions is to influence the level of liquidity in the market.



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

59.

Liquidity risk can only arise on the asset side of an FI’s balance sheet as this means that the FI does not hold enough liquid assets such as cash or liquid securities.



FALSE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

60.

In practice, an FI that has 15 per cent of its liabilities in demand deposits and other transaction accounts knows that normally only a small proportion of these deposits will be withdrawn on any given day.



TRUE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

61.

An FI can manage a drain on deposits or an exercise of a loan commitment in two major ways, these being purchased liquidity management and stored liquidity management.



TRUE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

62.

Purchased liquidity management is a liability-side adjustment to the balance sheet to cover a deposit drain



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

63.

Stored liquidity management is an asset-side adjustment to the balance sheet to cover a deposit drain



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

64.

Stored liquidity management is a liability-side adjustment to the balance sheet to cover a deposit drain



FALSE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

65.

Purchased liquidity management is an asset-side adjustment to the balance sheet to cover a deposit drain



FALSE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Easy
Est time: <1
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

66.

The liquidity index will always lie between -1 and +1.



FALSE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

67.

The maturity ladder model allows a comparison of cash inflows and cash outflows over a series of specified time periods.



TRUE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

68.

The Bank for International Settlements requires FIs to measure their liquidity positions under normal market conditions only.



FALSE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

69.

Trend liquidity planning calculates an FI’s liquidity need as the simple difference between the FI’s liquid assets and its volatile sources of funds.



FALSE


AACSB: Analytic
Bloom's: Knowledge
Difficulty: Medium
Est time: <1
Learning Objective: 14.5 Discover the importance of liquidity planning to a DI.

70.

APRA requires every FI to hold sufficient liquid assets to meet a name crisis situation.



TRUE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.5 Discover the importance of liquidity planning to a DI.

71.

Liquidation of a mutual fund causes assets to be liquidated and funds received to the dispersed to shareholders on a first come, first served basis.



FALSE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

72.

A contagious run, or bank panic, differs from a run on a bank in that a contagious run involves loss of faith in the entire banking system as opposed to just one bank.



TRUE


AACSB: Analytic
Bloom's: Application
Difficulty: Medium
Est time: <1
Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

73. Distinguish between liquidity risk arising from the asset side and the liability side of the balance sheet.

Liquidity risk occurs because of situations that develop from economic and financial transactions that are reflected on either the asset side of the balance sheet or the liability side of the balance sheet of a DI.
Asset side risk arises from transactions that result in a transfer of cash to some other asset, such as the exercise of a loan commitment or a line of credit. When a borrower draws on the loan commitment, the DI must fund the loan on the balance sheet immediately; this creates a demand for liquidity. Another type of asset side liquidity risk arises from the DI’s investment portfolio.
Liability side risk arises from transactions whereby a creditor, depositor, or other claim holder demands cash in exchange for the claim. The withdrawal of funds from a bank is an example of such a transaction. When liability holders demand cash by withdrawing deposits, the FI needs to borrow additional funds or sell assets to meet the withdrawal. The most liquid asset is cash; DIs use this asset to pay claimholders who seek to withdraw funds. However, DIs tend to minimise their holdings of cash reserves as assets because those reserves pay no interest. To generate interest revenues, most DIs invest in less liquid and/or longer maturity assets. While most assets can be turned into cash eventually, for some assets may be liquidated only at low fire-sale prices if the asset must be liquidated immediately, thus threatening the solvency of the DI.


AACSB: Communication
Bloom's: Comprehension
Difficulty: Hard
Est time: 10-15
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.
Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

74. Discuss the advantages and disadvantages of stored liquidity management and purchased liquidity management. In your opinion, which is the better approach for a DI to adopt?

If the DI has a net deposit drain, it needs to either increase its liabilities (by borrowing funds or issuing equity, i.e. purchased liquidity management) or reduce its assets (i.e. stored liquidity management). An institution can reduce its assets by drawing down on its cash reserves, selling securities, or calling back (or not renewing) its loans. It can increase liabilities by borrowing funds from competitor banks through the interbank market and other institutional investors such as life insurance companies, issuing fixed-maturity wholesale certificates of deposit or even sell some longer dated notes and bonds, or by issuing new issues of equity.
The advantage of purchased liquidity management is that it allows the DI to maintain its overall balance sheet size without disturbing the size and composition of the asset side of its balance sheet; that is, the complete adjustment to the purchased liquidity management can insulate the asset side of the balance sheet from normal drains on the liability side of the balance sheet.
However, this process of addressing a net deposit drain does not come without costs. On the asset side, liquidating assets may occur only at fire-sale prices that will result in realised losses of value, or asset-mix instability. Further, not renewing loans may result in the loss of profitable relationships that could have negative effects on profitability in the future. On the liability side, entering the borrowed funds market normally requires paying market interest rates that are above those rates that it had been paying on low interest deposits.
While stored liquidity management and purchased liquidity management are alternative strategies for meeting deposit drains or exercise of loan commitments, a DI can, and usually does, combine the two methods by using some purchased liquidity management and some stored liquidity management to meet liquidity needs.


AACSB: Analytic
Bloom's: Analysis
Difficulty: Hard
Est time: 10-15
Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.
Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

75. What are the main components of a liquidity plan? Discuss the vital role such a plan plays in reducing liquidity risk.

A liquidity plan requires forward planning so that an optimal mix of funding can be implemented to reduce costs and unforeseen withdrawals. In general, a plan could incorporate the following:
1. The delineation of managerial details and responsibilities: assigning a team that will take charge in the event of a liquidity crisis.
2. A detailed list of fund providers who are most likely to withdraw, as well as the pattern of fund withdrawals: identifying the account holders that will most likely withdraw funds in the event of a crisis.
3. The identification of the size of potential deposit and fund withdrawals over various future time horizons: estimating the size of the runoffs and the sources of borrowing to stem the runoffs.
4. The setting of internal limits on separate subsidiaries' and branches' borrowings as well as bounds for acceptable risk premiums to pay in each market (interbank, repo, certificate of deposits, etc.).
5. A sequencing of assets for disposal in anticipation of various degrees or intensities of deposit/ fund withdrawals.
Liquidity planning is a key component in measuring (and being able to deal with) liquidity risk and its associated costs. Specifically, liquidity planning allows DI managers to make important borrowing priority decisions before liquidity problems arise. Such planning can lower the cost of funds (by determining an optimal funding mix) and can minimise the amount of excess reserves that a DI needs to hold. This is very important for firms that rely on deposits or short-term funds as a source of borrowing because of the difficulty in rolling over debt in periods of crisis.


AACSB: Analytic
Bloom's: Comprehension
Difficulty: Hard
Est time: 10-15
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

76. Discuss the components of liquidity position of the bank related to active liquidity planning

Immediate liquidity obligations : Occur in both contractual and relationship form. For, contractual liquidity obligations the DI must have sufficient funds to repay in full all maturing liabilities. Relationship liquidity obligations relate to the strength of the customer-base relationship and satisfying the liquidity requirements of those customers through the provision of funds for new legitimate loan demand which meets the DI’s credit standards.

Seasonal short-term liquidity needs : Classified as predictable or unpredictable and may arise: Predictable events include increased deposit withdrawals during December and Easter holiday periods and in a farming community in spring (planting and fertilisation) when loan demand rises and deposits fall and in summer when deposits rise (sale of harvest), Unpredictable needs can arise from large depositors and large borrowers that may influence short-term liquidity needs of a DI disproportionately.

Trend liquidity needs : Determined over a longer time span. Trend liquidity needs are likely to be associated with a DI’s particular customer base. For example, a large proportion of age pensioners bank with the CBA and, as such, the CBA’s liquidity increases significantly on pensioner payment day and drops gradually over the next two weeks until the next pensioner payment.

Cyclical liquidity needs : Much more difficult to predict and are usually out of the control of any individual DI. Liquidity needs vary with the business cycle; for example, in boom economic conditions DIs have high liquidity needs as loan demand grows rapidly and deposits decline as consumers spend more and save less. By contrast, during recessions deposits tend to grow and loan demand shrinks.

Contingent liquidity needs : Caused by events that are difficult, if not impossible, to predict, such as unexpected deposit outflow due to a loss of confidence in the DI. By their very nature, contingent liquidity needs are impossible to forecast accurately and are difficult to meet, as typically contingent liquidity needs arise at the worst possible time for the DI. It is because of such events that regulators, in order to avoid system risk, impose liquidity regulations.


AACSB: Analytic
Bloom's: Comprehension
Difficulty: Hard
Est time: 10-15
Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.


Chapter 14 Testbank Summary

Category

# of Questions

AACSB: Analytic

74

AACSB: Communication

1

AACSB: Reflective thinking

1

Bloom's: Analysis

1

Bloom's: Application

33

Bloom's: Comprehension

3

Bloom's: Knowledge

39

Difficulty: Easy

16

Difficulty: Hard

9

Difficulty: Medium

51

Est time: 1-3

44

Est time: 10-15

4

Est time: <1

28

Learning Objective: 14.1 Discover what is liquidity risk and what are its sources.

8

Learning Objective: 14.2 Learn how a depository institution (DI) can utilise either stored liquidity or purchased liquidity.

15

Learning Objective: 14.3 Learn how liquidity risk arises on both the liability side and asset side of the balance sheet of a DI.

10

Learning Objective: 14.4 Learn how to measure a DI’s liquidity risk and determine its liquidity needs.

19

Learning Objective: 14.5 Discover the importance of liquidity planning to a DI.

4

Learning Objective: 14.6 Understand why liquidity risk is generally more critical for DIs than for other FIs.

10

Learning Objective: 14.7 Discover the main reasons why depositors of DIs which are perceived to be in trouble may have very strong incentives to engage in bank runs.

5

Learning Objective: 14.8 Understand the ways in which the Australian government, the RBA and APRA support liquidity in the Australian financial system.

10

Learning Objective: 14.9 Understand liquidity risk in life insurance companies, general insurers and managed funds.

5

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