MaxMarkCh14QuestionsOnly.docx
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MaxMarkCh14QuestionsOnly.docx
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MaxMarkCh14QuestionsOnly
MaxMark—Viney
MenuItem14:
(Topic14)Interestrateriskmeasurement
Question1:
Interestrateriskcanbedescribedintwoforms:
priceriskandreinvestmentrisk.Whichofthefollowingiscorrect?
A:
reinvestmentriskisonlyconcernedwiththepossibilityofafallininterestrates
B:
priceriskisonlyaproblemifinterestratesareexpectedtorise
C:
priceriskandreinvestmentriskmayworkinthesamedirectionorinoppositedirections
D:
priceriskandreinvestmentriskalwaysworkinoppositedirections
Feedback:
Ifinterestratesrise,thecashinflowsreceivedfromaninterestbearinginvestmentcanbereinvestedatthenewhigherrate,butthevalueoftheassetwillfall.Conversely,ifinterestratesfell,thecashinflowswouldbereinvestedatlowerrates,butthevalueoftheassetwouldrise.Thus,priceriskandreinvestmentriskalwaysworkinoppositedirectionssoDiscorrect.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,pp.564–565.
Priceriskrelatestothevalueofbalance-sheetassetsandliabilitiesandthenetimpactonshareholdervalue.Thereisaninverserelationshipbetweeninterestratesandthepriceofasecurity.Forexample,ifacompanyhasissuedafixed-interestdebenture(bond)andinterestratesonsimilarsecuritieslaterfall,thevalueofthatexistinghigher-interestbondwillincrease.Thiswillresultinanincreaseinthevalueofequityoftheinvestor.Conversely,ifinterestrateshadrisen,thevalueofthebondwouldfall,withanegativeeffectonequity.
Question2:
Interestrateriskinvolvestheeffectofachangeininterestratesonthevaluesofassets,liabilitiesandfuturecashflows.Fromtheviewpointofaninvestorwhoholdsaportfolioofbonds,whichofthefollowingstatementsiscorrect?
A:
priceriskistheonlyimportantaspectofinterestraterisk
B:
reinvestmentriskismuchmoreimportantthanpricerisk
C:
priceriskandreinvestmentriskarebothimportant
D:
reinvestmentriskisonlyimportantiflong-termbondsareheld
Feedback:
Achangeininterestrateshastwoeffectsonaportfolioofbonds.Thepricesofexistingfixedcouponbondswillchange,aswilltheratesatwhichcouponpaymentsandtheproceedsofmaturingbondscanbereinvested.Inotherwords,aninvestmentinbondsisexposedtopriceriskandreinvestmentrisk.Bothoftheserisksareimportant,soCisthecorrectanswer.
MORE:
FinancialInstitutions,InstrumentsandMarkets5/e,pp.564–565.
Interestrateriskcanthereforebedescribedintwoforms:
∙reinvestmentrisk
∙
∙pricerisk.
∙
Reinvestmentriskrelatestoanorganisation’scashflows.Yieldsonassetsandliabilitiesmaychangeovertimeasinterestrateschange.Thiswillhaveanimpactoncashflows.Forexample,thecostoffundsonabusinessloanthathasafloatinginterestratewillmoveupordowndependingonchangesinmarketratesovertheperiodoftheloan.Thebankthathasgiventhefirmaloanwillalsobeaffected,inthatitisuncertainatwhatyielditwillbeabletoreinvesttheloanrepaymentsitreceivesfromthefirm.Ifthebankhadoriginallygiventhefirmaloanatarateof8percentperannumandmarketinterestratessubsequentlyfellto7.50percentperannum,thebankwouldbeabletoreinvestthosefundsonrepaymentoftheoriginalloanonlyatthecurrent7.50percentperannum.Allelsebeingequal,thechangeininterestrateswouldhavehadanegativeimpactonthebank’snetinterestmargin.
Inanotherexampleofreinvestmentrisk,afundsmanagerthatholdsabondinvestmentportfoliowillbeexposedtochangesintherateatwhichitisabletoreinvestinterestcouponsassociatedwiththebonds.Thiswillaffecttheyieldreceivedonthebondportfolioovertime.
Priceriskrelatestothevalueofbalance-sheetassetsandliabilitiesandthenetimpactonshareholdervalue.Thereisaninverserelationshipbetweeninterestratesandthepriceofasecurity.Forexample,ifacompanyhasissuedafixed-interestdebenture(bond)andinterestratesonsimilarsecuritieslaterfall,thevalueofthatexistinghigher-interestbondwillincrease.Thiswillresultinanincreaseinthevalueofequityoftheinvestor.Conversely,ifinterestrateshadrisen,thevalueofthebondwouldfall,withanegativeeffectonequity.
Question3:
Interestrateriskexposuresmaybedescribedasdirectorindirect.Whichofthefollowingisanexampleofindirectinterestraterisk?
A:
afterariseininterestrates,abank’scustomersrepaypartoftheirloans
B:
ariseininterestratescausesthevalueofbondstofall
C:
anincreaseininterestratesmeansthatcouponpaymentsreceivedcanbereinvestedatahigherrate
D:
afallininterestratescausesthevalueofbondstorise
Feedback:
Indirectinterestrateriskarisesfromchangesinbeha
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