MDIS

Course : Bsc (Hons) in Business and Marketing Bsc (Hons) in Entrepreneurship and Management Bsc (Hons) in Banking and Einance Risk Management in Banking Year 3 - Main Examination 27 May 2011 3 hours Module Name: Level Date Time : : :

Instructions: 1. 2. This examination paper consists of a total of three (3) pages. Section A: Answer ALL questions. This section is COMPULSORY. (50 Marks) Section B: Answer any TWO (2) out of 4 questions. (50 Marks) Non- Programmable calculators are allowed. Write all your answers in the answer booklet provided. Your answers must show the question numbers clearly. Start a new question on a fresh page and write the question number at the top of each page. Please write legibly and only on one side of a page.

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THIS PAPER IS TO BE RETURNED TO THE INVIGILATOR UPON COMPLETION

Section A: This section is COMPULSORY. Answer ALL the questions. Question 1

(50 marks)

Consider the following bank balance sheet and associated average interest rates. The time frame for rate sensitivity is one year. Assets Amount Rate Rate sensitive $3,300 7.3% Fixed-rate 1,400 8.7% Nonearning 500 Total $5.200 Liabilities&Equity Amount Rate sensitive $2,900 Fixed-rate 1,650 Nonpaying 650 Total " $5.200 Rate 3.8% 6.1%

a) Calculate the Bank's GAP, expected net interest income, and net interest margin if interest rates and portfolio composition remain constant during the year. This bank is positioned to profit if interest rates move in which direction? (12 marks) b) Calculate the change in expected net interest income and NIM (net interest margin) if the entire yield curve shifts 2 percent higher during the year. Is this consistent with the bank's static GAP? (6 marks) c) Suppose that, instead of the parallel shift in the yield curve in part (b), interest rates unevenly. Specifically, suppose that asset yields rise by 1 percent while liability rates rise by 1.75 percent. Calculate the change in net interest income and NIM. (8 marks) Is this uneven shift in rates more or less likely than a parallel shift? (2 marks) d) Suppose the bank converts $300 of rate-sensitive liabilities to fixed-rate liabilities during the year and interest rates remain constant. What would the bank's net interest income equal compared with the amount initially expected? (4 marks) Explain why there is a difference. (3 marks) e) What is the fundamental weakness of the GAP ratio compared with GAP as a measure of interest rate risk? (15 marks)

Risk Mimauement in Banking, Main: 27 May 2011

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Section B: Answer any two (2) out of the 4 questions below. Each question is worth 25 marks. (50 marks) Question 2 (25 marks)

Market risk is the current and potential risk to earnings and stockholders' equity resulting from adverse movements in market rates or prices. The three areas of market risk are: interest rate or reinvestment rate risk, equity or security price risk, and foreign exchange risk. Describe and explain how each of the three risks arising from its sources, contributes towards market risk. Question 3 (25 marks)

The traditional way of valuing fixed-income securities and yield-to-maturity (YTM) is too simplistic for investors, given the complexities of today's marketplace. Lets take bonds for instance. Bond price volatility focuses on the relationship between a security's market rate of interest, periodic interest payments, and maturity. Because maturity simply identifies how much time elapses until final payment, duration is a better measure of effective maturity. a. b. What are the complexities faced by investors of today? (20 marks) Explain the use of Duration and its importance to market participants over price volatility of securities. (5 marks) (25 marks)

Question 4 a. b.

Discuss the relative advantages and disadvantages of using futures versus forward contracts. (15 marks) Although FRAs ( Forward Rate Agreements) have attractive features, in practice there are problems using them. Explain. (10 marks)

Question 5

(25 marks)

Historically, bank regulators have limited the risks associated with banks owing securities. In the last two decades, an increasing number of banks have pursued active strategies in managing investments such as common stocks and debt instruments. Thus for accounting reasons, when banks buy securities they must indicate the underlying objective; which includes held-to-maturity, available-for-sale and trading purposes. The bank's investment porfolio differs markedly from the trading account. Give at least Six objectives for having an investment porfolio and answer as briefly as possible. ~ End of Paper ~
Risk Management in Banking, Main: 27 May 2011