Banking: Maturity Mismatch and Risks
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Questions and Answers

What risk arises for banks due to maturity mismatch between assets and liabilities?

  • Liquidity risk of insufficient funds for withdrawals (correct)
  • Credit risk of borrowers defaulting on loans
  • Operational risk of system failures
  • Market risk of asset value fluctuation

    • How does an increase in interest rates affect banks with long term assets and short term deposits?

  • Boosts the net interest income margin
  • Decreases the funding risk
  • Reduces the liquidity risk
  • Increases the spread between interest earned and interest paid (correct)

    • What is the primary source of net interest income for banks?

  • Service charges on customer transactions
  • Investment gains from trading activities
  • Interest received on bank assets (correct)
  • Fees from wealth management services

    • Why are banks vulnerable to changes in market conditions like interest rates?

    <p>Having long-term assets but mainly short-term deposits</p> Signup and view all the answers

    What is the main challenge for banks in ensuring they can meet short-term obligations while earning sufficient income?

    <p>Matching maturity dates of assets and liabilities</p> Signup and view all the answers

    Why do banks aim to match the maturity dates of assets and liabilities?

    <p>To mitigate liquidity and funding risks</p> Signup and view all the answers

    What is the formula for calculating the effective interest rate on retail deposits?

    <p>reffective = (F/P)^(1/t) - 1</p> Signup and view all the answers

    In the context of money market transactions, what formula is used to calculate future value with simple interest?

    <p>FV = PV(1 + (r x days/days in year))</p> Signup and view all the answers

    Which type of market are money market instruments traded in?

    <p>OTC market</p> Signup and view all the answers

    When an NCD is sold, how is the price (P) calculated?

    <p>PV = FV / (1 + (r x days/day in year))</p> Signup and view all the answers

    What is the main source of risk in OTC markets?

    <p>Credit risk</p> Signup and view all the answers

    What type of loan payments are calculated as an annuity in reducible loans?

    <p>Fixed-rate payments</p> Signup and view all the answers

    Who are the main dealers in the OTC money market?

    <p>Specialist investment banks</p> Signup and view all the answers

    What is the formula used to calculate the earned interest on Housing Loans?

    <p>$985 = $933 - PMT(1 + 0.06)</p> Signup and view all the answers

    What do dealers in the OTC market provide to clients due to their inventory of securities?

    <p>Immediacy</p> Signup and view all the answers

    What type of yield do dealers quote in the OTC market?

    <p>Simple interest yield</p> Signup and view all the answers

    How is the reflective value calculated in retail deposits?

    <p>(FX / PV) * t</p> Signup and view all the answers

    Which type of institutions trade on their behalf in making a market for wholesale clients?

    <p>Dealers</p> Signup and view all the answers

    What does the Negotiable Certificates of Deposit (NCDs) use in money market transactions?

    <p>Simple interest</p> Signup and view all the answers

    In which situation are loan payments that form an annuity calculated as fixed-rate payments?

    <p>Reducible loans</p> Signup and view all the answers

    What are some advantages offered by money market instruments like iShares Core Cash ETF and iShares Enhanced Cash ETF?

    <p>Liquidity, diversification, and ease of trading</p> Signup and view all the answers

    'AFMA' specifies trading protocols for which participants in the money market?

    <p>'AFMA' Dealers</p> Signup and view all the answers

    What benefit do borrowers gain by accessing ST funds with the endorsement of an established bank?

    <p>Lower cost loans</p> Signup and view all the answers

    In the context of Bill Acceptance Bills (BABs), what happens if a borrower is unable to honor the payment?

    <p>The bank steps in and accepts the payment</p> Signup and view all the answers

    What role does the accepting bank play in relation to the credit risk associated with Bill Acceptance Bills (BABs)?

    <p>It reduces credit risk for investors</p> Signup and view all the answers

    Why do borrowers typically pay an acceptance fee in relation to Bill Acceptance Bills (BABs)?

    <p>To obtain lower cost loans</p> Signup and view all the answers

    How does the process of BABs differ from traditional loans in terms of acquiring funds for borrowers?

    <p>Borrowers' funds are supplied by investors through BABs</p> Signup and view all the answers

    What happened to the numbers of Bill Acceptance Bills (BABs) sold after the Global Financial Crisis (GFC)?

    <p>They decreased notably</p> Signup and view all the answers

    What type of instrument is a BAB considered in terms of trading?

    <p>Unsecured instrument</p> Signup and view all the answers

    What is the primary purpose of a repurchase agreement (repo)?

    <p>To provide short-term financing for the seller of securities</p> Signup and view all the answers

    What type of securities are commonly used as collateral in repurchase agreements involving the Reserve Bank of Australia (RBA)?

    <p>Commonwealth government bonds</p> Signup and view all the answers

    How do repurchase agreements (repos) contribute to market liquidity and efficient trading of securities?

    <p>By enabling banks to use government bonds as collateral to access short-term funding</p> Signup and view all the answers

    What is the key difference between a repurchase agreement (repo) and a bond issued by a company?

    <p>Repos involve the sale and repurchase of securities, while bonds are debt instruments issued by companies</p> Signup and view all the answers

    What is the primary role of the Reserve Bank of Australia (RBA) in the repurchase agreement (repo) market?

    <p>To use repos to infer short-term interest rates and manage stability in the financial system</p> Signup and view all the answers

    Which of the following participants is NOT typically involved in repurchase agreements (repos)?

    <p>Retail investors</p> Signup and view all the answers

    What is the primary function of the 'repo rate' in a repurchase agreement (repo)?

    <p>It represents the interest rate paid by the buyer to the seller when the securities are repurchased</p> Signup and view all the answers

    How do repurchase agreements (repos) contribute to financial stability and liquidity in the Australian financial system?

    <p>By enabling a diverse range of participants to access short-term funding using government bonds as collateral</p> Signup and view all the answers

    What role do the main dealers play in the OTC money market?

    <p>Trade on their own behalf in making a market for wholesale clients</p> Signup and view all the answers

    What is the main source of risk associated with trading in OTC markets?

    <p>Credit risk</p> Signup and view all the answers

    What do dealers quote in the OTC market when trading money market instruments?

    <p>Bid and offer yields</p> Signup and view all the answers

    What is the primary role of AFMA in relation to money market instruments?

    <p>Specifying trading protocols for dealers</p> Signup and view all the answers

    Which sector primarily benefits from earning interest and trading income in the money market?

    <p>Main dealers</p> Signup and view all the answers

    What role do NCDs play in raising funds for banks?

    <p>Facilitating the sale of bank bills to investors</p> Signup and view all the answers

    What is the main function of money market securities issued by institutions such as governments and banks?

    <p>To diversify funding sources for issuing institutions</p> Signup and view all the answers

    Why is having a benchmark rate crucial in the financial market?

    <p>To ensure uniformity and comparability in the market</p> Signup and view all the answers

    How do investors earn a return from money market securities like NCDs?

    <p>By holding the securities until they reach their maturity date</p> Signup and view all the answers

    What is the primary purpose of The Bank Bill Swap rate (BBSW) in the Australian financial market?

    <p>To determine the price of money market securities</p> Signup and view all the answers

    What is the role of APRA in monitoring NCDs issued by banks in the money market?

    <p>Safeguarding the safety and stability of financial institutions</p> Signup and view all the answers

    How does the BBSW contribute to establishing fair practices in financial markets?

    <p>By providing a trustworthy and accurate benchmark</p> Signup and view all the answers

    What percentage of money market securities do Negotiable Certificates of Deposit (NCDs) represent?

    <p>Over 80%</p> Signup and view all the answers

    What relationship does BBSW have with BABs and NCDs?

    <p>It determines the transactional rates for BABs and NCDs</p> Signup and view all the answers

    Why are money market securities considered to have low credit risk despite being unsecured?

    <p>Due to the short-term nature of these investments</p> Signup and view all the answers

    In the context of Negotiable Certificates of Deposit (NCDs), what is the primary purpose of the formula used to calculate the price paid by an investor?

    <p>To establish the present value of the future cash flow</p> Signup and view all the answers

    What is the primary role of the acceptance fee charged by banks in relation to Bill Acceptance Bills (BABs)?

    <p>To compensate the bank for the credit risk assumed</p> Signup and view all the answers

    Which of the following statements best describes the role of money market instruments in the financial system?

    <p>They facilitate the transfer of short-term funds between lenders and borrowers</p> Signup and view all the answers

    In the context of risk management for banks, what is the primary concern associated with a maturity mismatch between assets and liabilities?

    <p>Liquidity risk</p> Signup and view all the answers

    Which of the following statements accurately describes the role of benchmark rates, such as the repo rate, in the money market?

    <p>They are used to determine the prices of money market instruments</p> Signup and view all the answers

    Which of the following best describes the primary role of fund managers in the Australian money market?

    <p>Participating in the wholesale money market to manage liquidity and interest rate risk</p> Signup and view all the answers

    What is the primary purpose of the Reserve Bank of Australia (RBA) in the repurchase agreement (repo) market?

    <p>To provide liquidity to the banking system and influence short-term interest rates</p> Signup and view all the answers

    Which of the following is the MAIN source of risk associated with trading in the over-the-counter (OTC) money market?

    <p>Exposure to credit risk of the counterparties involved</p> Signup and view all the answers

    How do banks typically aim to manage the risk of maturity mismatch between their assets and liabilities?

    <p>By matching the maturity dates of their assets and liabilities</p> Signup and view all the answers

    Which of the following is the MAIN benefit for borrowers in accessing short-term funding through Bill Acceptance Bills (BABs)?

    <p>Increased credit worthiness due to the endorsement of an established bank</p> Signup and view all the answers

    What is the main reason fund managers invest in Short Term (ST) term instruments in the money market?

    <p>To access Short Term gains and add liquidity to the portfolio</p> Signup and view all the answers

    How does the Global Financial Crisis (GFC) impact the financial markets according to the text?

    <p>Highlights the need for risk assessment and regulation due to market stability</p> Signup and view all the answers

    What is one of the key contributions of the money market to the Banking System according to the text?

    <p>Enables banks to meet their reserve requirements and provides a low-risk market for liquid reserves</p> Signup and view all the answers

    What type of agreements do banks use to sell securities mainly to the Reserve Bank of Australia (RBA) for Short Term (ST) funding?

    <p>Repurchase agreements (repos)</p> Signup and view all the answers

    How do repurchase agreements (repos) impact bank reserves according to the text?

    <p>Increase bank reserves by selling securities</p> Signup and view all the answers

    What is the primary role of the Reserve Bank of Australia (RBA) in the money market?

    <p>To participate in the money market as a buyer and seller of short-term securities, influencing monetary policy</p> Signup and view all the answers

    Which of the following is a common benchmark rate used in the Australian money market?

    <p>The Bank Bill Swap Rate (BBSW), which is the primary benchmark for pricing short-term debt securities in Australia</p> Signup and view all the answers

    What is the primary risk associated with trading in over-the-counter (OTC) markets, such as the money market?

    <p>Counterparty risk, as there is no central clearing mechanism to guarantee trades</p> Signup and view all the answers

    Which of the following statements best describes the role of fund managers in the money market?

    <p>Fund managers invest in money market instruments to generate short-term returns and maintain liquidity for their clients</p> Signup and view all the answers

    What is the primary role of the Australian Financial Markets Association (AFMA) in relation to the money market?

    <p>To establish trading protocols and standards for the issuance and trading of money market instruments</p> Signup and view all the answers

    What is the primary purpose of the Reserve Bank of Australia (RBA) conducting market operations like repos (buy and sell agreements) when the cash rate is changed?

    <p>To withdraw funds from the interbank market and increase the cash rate</p> Signup and view all the answers

    Which of the following is NOT one of the main short-term interest rates influenced by changes in the RBA's cash rate target?

    <p>Fixed Deposit Rates</p> Signup and view all the answers

    What is the primary aim of the Reserve Bank of Australia's monetary policy?

    <p>To keep inflation within a 2-3% target range over the medium term</p> Signup and view all the answers

    How do changes in the RBA's cash rate target influence short-term interest rates in the Australian financial system?

    <p>Changes to the cash rate have a gradual and indirect impact on short-term rates over a longer time period</p> Signup and view all the answers

    What is the primary role of repurchase agreements (repos) in the Australian financial system?

    <p>To allow the Reserve Bank of Australia to implement monetary policy by influencing short-term interest rates</p> Signup and view all the answers

    What is the primary role of the Bank Bill Swap Rate (BBSW) in the Australian financial market?

    <p>To serve as a reference rate for pricing and valuing a variety of money market instruments</p> Signup and view all the answers

    What is the primary function of negotiable certificates of deposit (NCDs) in the Australian money market?

    <p>To serve as a source of short-term funding for banks and corporations</p> Signup and view all the answers

    What is the primary risk associated with trading in over-the-counter (OTC) money markets?

    <p>Credit risk due to counterparty default</p> Signup and view all the answers

    What is the primary role of the Australian Financial Markets Association (AFMA) in relation to money market instruments?

    <p>To provide trading protocols and market conventions for participants</p> Signup and view all the answers

    How do repurchase agreements (repos) contribute to financial stability and liquidity in the Australian financial system?

    <p>Repos enable the RBA to inject or withdraw liquidity from the interbank market to maintain stability</p> Signup and view all the answers

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