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WEEK 42023 Solution

This document contains the solutions to 10 questions from an assignment on credit risk management tools, credit rationing, interest rate risk, off-balance sheet activities, customer relationships, and the "market for lemons" concept. The key points covered are that collateral is a credit risk management tool, credit rationing occurs when lenders restrict credit, an increase in interest rates can reduce bank profits if liabilities are more sensitive than assets, selling CDs does not generate fee income, long customer relationships reduce information costs and improve screening, financial engineering develops new products, urban cooperative banks operate locally, SBI is the largest commercial bank in India, and the "market for lemons" predicts quality deterioration due to information asymmetry between buyers and sellers

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Arunim Yadav
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30 views3 pages

WEEK 42023 Solution

This document contains the solutions to 10 questions from an assignment on credit risk management tools, credit rationing, interest rate risk, off-balance sheet activities, customer relationships, and the "market for lemons" concept. The key points covered are that collateral is a credit risk management tool, credit rationing occurs when lenders restrict credit, an increase in interest rates can reduce bank profits if liabilities are more sensitive than assets, selling CDs does not generate fee income, long customer relationships reduce information costs and improve screening, financial engineering develops new products, urban cooperative banks operate locally, SBI is the largest commercial bank in India, and the "market for lemons" predicts quality deterioration due to information asymmetry between buyers and sellers

Uploaded by

Arunim Yadav
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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Week 4: Assignment 4 (Solutions)

Q1. Credit risk management tools include


A) deductibles.
B) collateral.
C) interest rate swaps.
D) duration analysis.
Answer: B
Explanation: It serves as a risk management tool in credit transactions because if the borrower
defaults on the loan, the lender can seize the collateral to recover the outstanding debt.

Q2. When a lender refuses to make a loan, although borrowers are willing to pay the stated
interest rate or even a higher rate, the bank is said to engage in
A) coercive bargaining.
B) strategic holding out.
C) credit rationing.
D) collusive behavior.
Answer: C
Explanation: Credit rationing occurs when a lender restricts the amount of credit available to
borrowers, even if they are willing to pay the stated interest rate or a higher rate. This can
happen due to various reasons such as asymmetric information or concerns about the borrower's
creditworthiness.

Q3. All else the same, if a bankʹs liabilities are more sensitive to interest rate fluctuations than
are its assets, then ________ in interest rates will ________ bank profits.
A) an increase; increase
B) an increase; reduce
C) a decline; reduce
D) a decline; not affect
Answer: B
Explanation: If a bank's liabilities (such as deposits) are more sensitive to interest rate
fluctuations compared to its assets (such as loans), an increase in interest rates will lead to
higher interest expenses on liabilities and a smaller increase in interest income on assets. This
imbalance can reduce the bank's profits.

Q4. All of the following are examples of off-balance sheet activities that generate fee income
for banks except
A) foreign exchange trades.
B) guaranteeing debt securities.
C) back-up lines of credit.
D) selling negotiable CDs.
Answer: D
Explanation: When a bank sells negotiable CDs to investors, it is creating a liability that doesn't
appear on the balance sheet as a loan or debt but can still have an impact on the bank's financial
condition.

Q5. Long-term customer relationships ________ the cost of information collection and make
it easier to ________ credit risks.
A) reduce; screen
B) increase; screen
C) reduce; increase
D) increase; increase
Answer: A
Explanation: Long-term customer relationships can help reduce the cost of information
collection for banks with deeper understanding of the customer's financial behavior, repayment
history, and creditworthiness over time. This accumulated knowledge allows the bank to better
assess the customer's credit risk. As a result, the bank can more effectively screen and evaluate
the customer's creditworthiness.

Q6. ________ is the process of researching and developing profitable new products and
services
by financial institutions.
A) Financial engineering
B) Financial manipulation
C) Customer manipulation
D) Customer engineering
Answer: A
Explanation: Based on definition

Q7. Urban Cooperative Banks are also called as?


A. Short-term co-operatives
B. Secondary Cooperative Banks
C. Primary Cooperative Banks
D. Long-term co-operatives
Answer: C
Explanation: These banks operate at the grassroots level and provide financial services to urban
and semi-urban areas.

Q8. Which is the largest commercial bank in India?


A. Bank of India
B. Axis Bank
C. State Bank of India
D. HDFC
Answer: C

Q9. Which of the following is not true for financial structure throughout the world?
A. Stocks are not most important source of external finance for businesses.
B. Business do not primarily finance their operations by marketable securities.
C. Financial Intermediaries are the most importance source of finance for businesses.
D. Direct finance is more important than indirect finance.
Answer: D
Explanation: The statement "Direct finance is more important than indirect finance" is not true
for financial structures throughout the world. In reality, financial systems around the world tend
to rely more on indirect finance.

Q10. The ‘Market for lemons’ predicts quality deterioration in the used car market
because
A. used cars require increasing maintenance.
B. suppliers and demanders have different information about cars’ quality.
C. used cars are generally of a lower quality than new cars.
D. people will usually buy new cars if they are available.
Answer: B
Explanation: Answer: B) Suppliers and demanders have different information about cars’
quality.

Explanation: The "Market for lemons" is a concept from economics that refers to a situation in
which sellers (suppliers) and buyers (demanders) have asymmetric information about the
quality of a product being sold, such as used cars. In this scenario, sellers may have more
information about the true quality of the product than buyers do. This can lead to a situation
where higher quality goods are driven out of the market, as buyers are reluctant to pay a
premium for quality due to the presence of lower quality goods (lemons). This phenomenon
can result in an overall decrease in the average quality of products in the market.

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