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risk exposure

Describe the risk exposure(s) in the following financial transactions. Identify which transactions are influenced by interest rates or interest income. (CAUTION: Some can be influenced by both!)

Risk Types: Interest rate risk, Credit risk, Technology risk, Foreign exchange rate risk, Country or sovereign risk

Financial Transactions Risk TypeDescribe and justify risk type Interest Rate or Interest Income?

1.A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.

2. An insurance company invests its policy premiums in a long-term municipal bond portfolio.

3.A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur.

4.A Japanese bank acquires an Austrian bank to facilitate clearing operations.

5.A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market.

6.A securities firm sells a package of mortgage loans as mortgage-backed securities.

Describe the features of the method you would choose to measure the interest risks identified.

Solution Preview

1.A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit.

It is an interest rate risk as well as credit risk. It is an interest rate risk because change in interest rate can change the value of the fixed rate assets such as commercial loan. It is also a credit risk because cash flows from the loan may not be paid in full. It is exposed to interest rate as well as interest income.

2. An insurance company invests its policy premiums in a long-term municipal bond portfolio.

It is an interest rate risk because returns on the portfolio may increase or decrese due to interest rate movements. It is exposed to interest rate as well as interest income.

3.A French bank sells two-year fixed-rate ...

Solution Summary

Describe the risk exposure(s) in the following financial transactions. Identify which transactions are influenced by interest rates or interest income.

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