BIF 3

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Questions and Answers

What term describes the risks associated with an asset not being able to be sold at its value due to lack of buyers or significant price fluctuations?

Liquidity and Price Risk (correct)

Transaction Cost Services

Information Costs

Maturity Intermediation

Which term involves the channeling of funds from suppliers to users of funds?

Financial Intermediaries (FI) (correct)

Payment Services

Denomination Intermediation

Credit Allocation

What term refers to the ability of Financial Intermediaries to bear the risk associated with mismatched maturities of assets and liabilities?

Monetary Policy Transmission

Liquidity and Price Risk

Intergenerational Wealth Transfers

Maturity Intermediation (correct)

Which term involves directing funds to particular sectors considered crucial for economic development by Financial Intermediaries?

Credit Allocation Signup and view all the answers

What term is related to the reduction of costs in financial transactions by Financial Intermediaries due to economies of scale?

Transaction Cost Services Signup and view all the answers

Which term refers to services provided by depository institutions, crucial for the efficiency of the economy, such as check clearing?

Payment Services Signup and view all the answers

What is the role of FIs that act as monitors of borrower behavior on behalf of small investors?

Delegated Monitors Signup and view all the answers

Which service involves the creation of capital for other companies and governments?

Investment Banking Signup and view all the answers

What type of funds are used to finance new and high-risk ventures in exchange for equity?

Venture Capital Signup and view all the answers

What is the primary activity of creating a secondary market by providing liquidity and setting bid-ask spreads for securities known as?

Market Making Signup and view all the answers

Which service involves managing pooled assets like mutual or pension funds to beat performance benchmarks?

Investing Signup and view all the answers

What is the risk arising from changes in interest rates that affect a bank's earnings and capital called?

Interest Rate Risk Signup and view all the answers

Which formula evaluates the impacts of interest rate changes on net interest income?

$ ext{Spread Effect}$ Signup and view all the answers

What does 'Cumulative Gap' represent in interest rate sensitivity?

$ ext{Cumulative Gap (CGAP)}$ Signup and view all the answers

'Net Interest Margin (NIM)' is calculated as:

$ ext{NIM} = ( ext{Interest Earned} - ext{Interest Paid} ) / ext{Average Earning Assets}$ Signup and view all the answers

'Convexity' in finance refers to:

$ ext{Convexity}$ Signup and view all the answers

What does the Cost-Income Ratio measure?

Operating costs vs. total income Signup and view all the answers

How is Return on Equity (ROE) calculated?

Net Income divided by Shareholder's Equity Signup and view all the answers

What does Refinancing Risk refer to?

Rise in interest rates making refinancing more expensive Signup and view all the answers

Which formula assesses the effect of interest rate changes on net interest income?

$ ext{ΔNII} = ext{GAP} imes ext{ΔR}$ Signup and view all the answers

What does the Spread Effect refer to?

Effect of changing interest rates on spread between interest income and expense Signup and view all the answers

Which concept measures interest rate sensitivity relative to a bank's assets?

$ ext{Gap Ratio} = ext{CGAP} / ext{Total Assets}$ Signup and view all the answers

'Change in Net Interest Income (ΔNII)' is calculated using which formula?

$- Duration Gap × Assets × ΔR / (1 + R)$ Signup and view all the answers

Study Notes

Financial Intermediaries

Financial Intermediaries (FIs) are institutions that channel funds from suppliers of funds to users of funds.
They provide various services, including:
- Transaction Cost Services: reduction of costs due to economies of scale in financial transactions.
- Maturity Intermediation: the ability to bear the risk associated with mismatched maturities of assets and liabilities.
- Credit Allocation: directing of funds to particular sectors deemed important for economic development.
- Payment Services: services like check clearing, crucial for the economy's efficiency.
- Monetary Policy Transmission: how actions by a central bank are passed through depository institutions to the financial system and economy.
- Intergenerational Wealth Transfers: services allowing wealth to be passed from one generation to the next.
- Denomination Intermediation: allowing small investors to overcome the minimum denomination size of certain assets.

Financial Concepts and Ratios

Cost-Income Ratio (C/I): the ratio of a bank's operating costs to its total income. Formula: C/I = Non-interest Expenses / Total Operating Income.
Return on Assets (ROA): how efficiently a bank uses its assets to generate profits. Formula: ROA = Net Income / Total Assets.
Return on Equity (ROE): the amount of net income returned as a percentage of shareholders' equity. Formula: ROE = Net Income / Shareholder's Equity.
Equity Multiplier (EM): indicates the level of a bank's leverage. Formula: EM = Total Assets / Shareholder's Equity.

Interest Rate Risk Management

Interest Rate Risk: the risk to earnings or capital from the movement of interest rates.
Refinancing Risk: the risk of a rise in interest rates making it more expensive to refinance debt.
Reinvestment Risk: the risk of lower returns on reinvesting funds due to falling interest rates.
Market Value Risk: the risk that the market value of assets or liabilities decreases if interest rates rise.
Repricing Model: assesses the effect of interest rate changes on net interest income. Formula: ΔNII = GAP × ΔR.
Rate-Sensitive Assets (RSAs) and Liabilities (RSLs): assets and liabilities that will be repriced due to market rate changes within a specific timeframe.
Cumulative Gap (CGAP): the total gap between RSAs and RSLs across different maturity buckets. Formula: CGAP = Sum of GAPs across buckets.
Gap Ratio: measures interest rate sensitivity relative to the bank's assets. Formula: Gap Ratio = CGAP / Total Assets.
Duration: the weighted average time to receive cash flows from an asset or liability. Formula: Duration = Weighted average of time periods using present value of cash flows as weights.
Duration Gap: the difference between the duration of assets and the leveraged duration of liabilities. Formula: Duration Gap = Duration of Assets - (Liabilities/Assets) × Duration of Liabilities.
Net Interest Income (NII): income from interest-earning assets minus expenses on interest-bearing liabilities.
Change in Net Interest Income (ΔNII): the variation in NII due to a change in interest rates for a specific bucket. Formula: ΔNII = GAP × ΔR.
Change in Market Value (ΔMV): the change in value of assets or liabilities due to a change in interest rates. Formula: ΔMV = -Duration × MV × ΔR / (1 + R).
Net Worth Sensitivity: the sensitivity of an FI's equity to changes in interest rates. Formula: ΔEquity = -Duration Gap × Assets × ΔR / (1 + R).

Other Financial Concepts

Delegated Monitors: FIs that act as monitors of borrower behavior on behalf of small investors.
Asset and Maturity Transformers: FIs that transform the characteristics of assets to create better matches with investors' preferences.
Brokers: agents that arrange transactions between buyers and sellers for a commission.
Investment Banking: the segment of banking that deals with the creation of capital for other companies and governments.
Venture Capital: funds used to finance new and often high-risk ventures in exchange for equity.
Market Making: creating a secondary market by providing liquidity and setting bid-ask spreads for securities.
Trading: the act of buying and selling securities, either for clients or for the institution's own account.
Investing: managing pooled assets like mutual or pension funds to beat performance benchmarks.
Cash Management: services like check writing against mutual fund accounts offered by brokerage firms.
Mergers and Acquisitions (M&A): services involving the joining of two companies into one or the purchase of one company by another.

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Description

Test your knowledge of banking and finance terms with this quiz containing definitions and formulas related to financial intermediaries, information costs, liquidity, and price risk.