Question

1. Which of the following statements is true about EVE (economic value of equity) interest rate risk models?
2. 1. They express risk in terms of cumulative gap.
   2. They only reflect risk over a short horizon, such as a year.
   3. They express interest rate risk in terms of potential change in the theoretical value of the bank.

2. Which of the following statements is true regarding capital requirements for banks?
3. 1. Lower capital levels reduce the risk of bank failures.
   2. Higher capital levels reduce risk of bank failures and taxpayer-funded bailouts, but they also reduce shareholder profitability ratios, such as ROE.
   3. Higher capital requirements benefit smaller banks in relation to larger banks, because small banks have better access to sources of capital.

3. Your bank owns a significant amount of mortgage-backed securities. If mortgage interest rates drop substantially, which of the following would be likely to happen?
4. 1. The yield on the investment portfolio would rise.
   2. The duration of the investment portfolio would increase.
   3. The yield on the investment portfolio would decline.

Answer 1

Answers-

Q )

The statement c is True. The economic value of equity (EVE) is calculated by taking the present value of all asset cash flows and subtracting the present value of all liability cash flows. It is expressing risk based on theoretcal value.
The statement a is False. The EVE is not expressed as risk in terms of cumulative gap.

The statement b is False. They reflect risk as long-term economic measure to assess the degree of interest rate risk exposure but not over a short horizon.
The statement

Q)

The statement b is True.
The higher capital levels reduce risk of bank failures and taxpayer-funded bailouts, but they also reduce shareholder profitability ratios, such as ROE as higher levels of capital provide cushion during economic downturns.
The statement a is False.
Lower capital levels increase the risk of bank failures and hgher capiyal levels increases the financial soundness of banks.
The statement c is False.
Higher capital requirements benefit larger banks and not smaller banks, because small banks find it difficult  to raise capital compared to larger banks.

Q)

The statement a is True.
The substantial drop in mortgage interest rate on Mortgage backed securities (MBS) will increase the yield on the investment portfolio.
The satement b is False.
As the duration of investment portfolio will decrease with decrease in interest rates on MBS as prepayment risk increases and chances of refinancing the loans increases.
The statement c is False.
The yield on investment portfoilo will not decline but will increase.