Chapter Eight 
Interest Rate Risk I 

True/False Questions

T  F  1.  The economic insolvency of many thrift institutions during the 1980s was due, at least in part, to major increases in interest rates. 
Answer: True   

T  F  2.  The interest rate risk exposure to an FI from mismatching the maturities of assets and liabilities tends to be smaller when the Federal Reserve targets the supply of bank reserves. 
Answer: False   

T  F  3.  The relative volatility of 91-day T-bill rates seems to increase during periods when the Federal Reserve adopts a strategy of targeting the level of interest rates. 
Answer: False   

T  F  4.  Although the Federal Reserve usually targets the short-term interest rates, the effects of any policy implementation on short-term rates normally carries through to long-term rates as well. 
Answer: True   

T  F  5.  Because the increased level of financial market integration has increased the speed that interest rate changes are transmitted among countries, the control of U.S. interest rates by .  the Federal Reserve is more difficult. 
Answer: True   

T  F  6.  The repricing gap model is an accounting based model. 
Answer: True   

T  F  7.  The maturity gap model estimates the difference between the interest earned and paid out during a given period of time. 
Answer: False   

T  F  8.  The repricing gap approach calculates the gaps in each maturity bucket by subtracting the rate sensitive liabilities (RSL) from the rate sensitive assets (RSA) on the balance sheet. 
Answer: True   

T  F  9.  In the repricing gap model, assets or liabilities are rate sensitive within a given time period if the dollar values of each are subject to receiving a different interest rate should market rates change. 
Answer: True   

T  F  10.  When repricing all interest rate sensitive assets and liabilities in a balance sheet, the cumulative gap will always be zero. 
Answer: True   

T  F  11.  The repricing model is a simplistic approach to focusing on the exposure of net interest income to changes in market levels of interest rates for given maturity periods. 
Answer: True   

T  F  12.  A positive gap implies that an increase in interest rates will cause a increase in net interest income. 
Answer: True   

T  F  13.  A positive gap implies that a decrease in interest rates will cause interest expense to decrease more than the decrease in interest income. 
Answer: False   

T  F  14.  If interest rates decrease 50 basis points (0.5 percent) for an FI that has a gap of $5 million, the expected change in net interest income is +$25,000. 
Answer: False   

T  F  15.  If interest rates increase 75 basis points (0.75 percent) for an FI that has a gap of -$15 million, the expected change in net interest income is -$112,500. 
Answer: True   

T  F  16.  The cumulative gap position of an FI for a given extended time period is the sum of the gap values for the individual time periods that make up the extended time period. 
Answer: True   

T  F  17.  If interest rates decrease 40 basis points (0.40 percent) for an FI that has a cumulative gap of -$25 million, the expected change in net interest income is +$100,000. 
Answer: True   

T  F  18.  A bank with a negative repricing (or funding) gap faces reinvestment risk. 
Answer: False   

T  F  19.  One reason to include demand deposits when estimating interest rate gap is because rising 
interest rates could lead to high withdrawals. 
Answer: True   

T  F  20.  One reason to not include transaction demand deposit accounts when estimating rate sensitive liabilities is that explicit interest rates cannot be paid by regulation. 
Answer: False   

T  F  21.  Retail passbook savings accounts should not be considered as part of rate sensitive liabilities because the rates on these accounts are very sticky. 
Answer: False   

T  F  22.  Runoffs in deposits in a repricing model typically are lower during falling interest rates. 
Answer: True   

T  F  23.  The gap ratio expresses the gap for a given time period as a percentage of total assets. 
Answer: True   

T  F  24.  The gap ratio is useful because it indicates the directional change in interest rate exposure. 
Answer: False   

T  F  25.  Because the repricing model ignores the market value effect of changing interest rates, the repricing gap is an incomplete measure of the true interest rate risk exposure of an FI. 
Answer: True   

T  F  26.  Defining buckets of time over a range of maturities assures the capture of all relevant information necessary to accurately assess the interest rate risk exposure of an FI. 
Answer: False   

T  F  27.  Defining buckets of time over wider intervals creates greater accuracy in the use of the repricing model because fewer calculations are required. 
Answer: False   

T  F  28.  The runoff component of long-term mortgages should be considered in the time buckets in which the maturities actually occur. 
Answer: True   

T  F  29.  In most countries FIs report their balance sheet using market value accounting. 
Answer: False   

T  F  30.  When an FI mismatches the maturities of its assets and liabilities, it is exposed to credit risk. 
Answer: False   

T  F  31.  Mark-to-market accounting is a market value accounting method that reflects the prices of assets and liabilities when purchased. 
Answer: False   

T  F  32.  The market value of a fixed-rate liability will decrease as interest rates rise, just as the market value of a fixed-rate asset will decrease as interest rates rise. 
Answer: True   

T  F  33.  The market value of a fixed-rate liability will increase as interest rates rise, although the market value of a fixed-rate asset will decrease as interest rates rise. 
Answer: False   

T  F  34.  The change in economic value of a fixed-rate liability for a decrease in interest rates is considered to be good news. 
Answer: False   

T  F  35.  For a given change in interest rates, fixed-rate assets with longer-term maturities will have greater changes in price than assets with shorter maturities. 
Answer: True   

T  F  36.  For a given change in interest rates, fixed-rate liabilities with longer-term maturities will have smaller changes in price than liabilities with shorter maturities. 
Answer: False   

T  F  37.  For a given change in interest rates, the change in price for each additional year of maturity of a fixed-rate asset is smaller as the maturity increases. 
Answer: True   

T  F  38.  The maturity of a portfolio of assets or liabilities is a weighted average of the maturities of the assets or liabilities that comprise that portfolio. 
Answer: True   

T  F  39.  If the average maturity of assets is 4 years and the average maturity of liabilities is 4 years, then the FI has no interest rate risk exposure. 
Answer: False   

T  F  40.  If the average maturity of assets is 5 years and the average maturity of liabilities is 7 years, then the FI has no interest rate risk exposure. 
Answer: False   

T  F  41.  The maturity model is an inaccurate model of interest rate risk exposure because it ignores the timing of cash flows. 
Answer: True   

T  F  42.  An FI can immunize its portfolio by matching the maturity of its asset with its liabilities. 
Answer: False   

T  F  43.  The difference between the changes in the market value of the assets and liabilities for a given change in interest rates definitionally is the change in the FI's net worth. 
Answer: True   

T  F  44.  If an FI has assets with an average maturity that is longer than the average maturity of its liabilities, an increase in interest rates likely will cause net worth to decrease. 
Answer: False   

T  F  45.  The maturity gap for a bank is the average maturity of the assets minus the average maturity of the liabilities. 
Answer: True   

T  F  46.  Deep discount bonds are fixed-rate coupon bonds that sell at a market price that is less than par value. 
Answer: False   

T  F  47.  The immunization of a portfolio against interest rate risk means that the portfolio will neither gain nor lose value if interest rates change. 
Answer: True   

T  F  48.  Perfect matching of the maturities of the assets and liabilities will always achieve perfect immunization for the equity holders against interest rate risk. 
Answer: False   

T  F  49.  Matching the maturities of assets and liabilities is not a perfect method of immunizing the balance sheet because the timing of the cash flows is likely to differ between the assets and liabilities. 
Answer: True   

Multiple Choice Questions

50.  In the 1980s, interest rate risk exposure became 
A)  less of a problem for FIs because of the decreased volatility of interest rates. 
B)  more of a problem for FIs because of the change in the Federal Reserve's conduct of monetary policy. 
C)  less of a problem for FIs because of the change in the Federal Reserve's conduct of monetary policy. 
D)  more of a problem for FIs because of the decreased volatility of interest rates. 
E)  more of a problem for FIs because of the thrift crisis. 
Answer: B   

51.  The repricing gap does not accurately measure FI interest rate risk exposure because 
A)  FIs cannot accurately predict the magnitude change in future interest rates. 
B)  FIs cannot accurately predict the direction of change in future interest rates. 
C)  accounting systems are not accurate enough to allow the calculation of precise gap measures. 
D)  it does not recognize timing differences in cash flows within the same maturity grouping. 
E)  equity is omitted. 
Answer: D   

52.  An FI's net interest income reflects 
A)  its assetliability structure. 
B)  market rates of interest. 
C)  the riskiness of its loans and investments. 
D)  the cost of its deposit and nondeposit sources of funds. 
E)  all of the above. 
Answer: E   

53.  An FI finances a $250,000 2-year fixed-rate loan with a $200,000 1-year fixed-rate CD. 
Use the repricing model to determine (a) the FI's repricing (or funding) gap using a 1-year maturity bucket, and (b) the impact of a 100 basis point (0.01) decrease in interest rates on the FI's annual net interest income? 
A)  $0; $0 
B)  -$200,000; +$2,000 
C)  -$200,000; -$2,000 
D)  +$50,000; $500 
E)  $200,000; $1,000 
Answer: B   

Use the following to answer questions 54-57:

Use the following information about a government security dealer for the following questions.

54.  Use the repricing model to determine the funding gap for a maturity bucket of 30 days. 
A)  $425 million 
B)  $95 million 
C)  $10 million 
D)  $475 million 
E)  +$150 million 
Answer: A   

55.  Use the repricing model to determine the funding gap for a maturity bucket of 91 days. 
A)  –$60 million 
B)  –$150 million 
C)  $0 
D)  –$250 million 
E)  –$300 million 
Answer: B   

56.  Use the repricing model to determine the funding gap for a maturity bucket of 365 days. 
A)  +$15 million. 
B)  $20 million. 
C)  $350 million. 
D)  $450 million. 
E)  $290 million. 
Answer: C   

57.  What is the impact over the next 30 days on the dealer's net interest income if all interest rates rise by 50 basis points? 
A)  Net interest income will decrease by $50,000. 
B)  Net interest income will decrease by $2.125 million. 
C)  Net interest income will decrease by $475,000. 
D)  Net interest income will decrease by $2.375 million. 
E)  Net interest income will increase by $750,000. 
Answer: B   

Use the following to answer questions 58-60:

Refer to the following rate sensitivity report for Gotbucks Bank, Inc. ($million).

58.  Calculate the funding gap for Gotbucks Bank using (a) a 30 day maturity period and (b) a 91 day maturity period? (Note: Each maturity period is cumulative.) 
A)  $25;   +$80 
B)  $35;  $75 
C)  $75;   +$5 
D)  +$55;  $40 
E)  0; 0 
Answer: B   

59.  How will a decrease of 25 basis points in all interest rates affect Gotbuck's net interest
income over a planning period of 91 days? 
A)  +$0.1875 million 
B)  +$0.1250 million 
C)  -$0.1375 million 
D)  +$0.0625 million 
E)  0 
Answer: A   

60.  What does Gotbucks Bank's 91-day gap positions reveal about the bank management's interest rate forecasts and the bank's interest rate risk exposure? 
A)  The bank is exposed to interest rate decreases and positioned to gain when interest rates decline. 
B)  The bank is exposed to interest rate increases and positioned to gain when interest rates decline. 
C)  The bank is exposed to interest rate increases and positioned to gain when interest rates increase. 
D)  The bank is exposed to interest rate decreases and positioned to gain when interest rates increase. 
E)  Insufficient information. 
Answer: B   

Use the following to answer questions 61-63:

61.  What is the repricing gap for the FI? 
A)  $0 
B)  $5,000,000 
C)  $9,800,000 
D)  -$5,000,000 
E)  $8,000,000 
Answer: D   

62.  What will be the FI's net interest income at year-end if interest rates do not change? 
A)  $3.20 million 
B)  $5.39 million 
C)  $4.04 million 
D)  $1.89 million 
E)  $1.35 million 
Answer: E   

63.  Suppose short-term interest rates increase by 1 percent. Calculate the change in net 
interest income after the interest rate increase. 
A)  $13,500 
B)  $18,900 
C)  $40,400 
D)  $53,900 
E)  $32,000 
Answer: A   

64.  If an FI's repricing gap is less than zero, then 
A)  it is deficient in its required reserves. 
B)  it is deficient in its capital ratio requirement. 
C)  its liability costs are more sensitive to changing market interest rates than are its asset yields. 
D)  its liability costs are less sensitive to changing market interest rates than are its asset yields. 
E)  the duration of the FI's liabilities exceeds the duration of FI's assets. 
Answer: C   

Use the following to answer questions 65-66:

65.  What is the repricing gap over the 1-year maturity bucket? 
A)  +$100 million 
B)  -$500 million 
C)  $100 million 
D)  +$500 million 
E)  $900 million 
Answer: B   

66.  If all interest rates decrease by 15 basis points, what is the expected impact on the FI's net interest income?  (Hint: Use the repricing model to answer this question.) 
A)  +$150,000 
B)  $150,000 
C)  -$750,000 
D)  +$750,000 
E)  No change. 
Answer: D   

67.  A bank that finances long-term fixed-rate mortgages with short-term deposits is exposed to 
A)  increases in net interest income and decreases in the market value of equity when interest rates fall. 
B)  decreases in net interest income and decreases in the market value of equity when interest rates fall. 
C)  decreases in net interest income and increases in the market value of equity when interest rates increase. 
D)  increases in net interest income and increases in the market value of equity when interest rates increase. 
E)  decreases in net interest income and decreases in the market value of equity when interest rates increase. 
Answer: E   

68.  The repricing model measures the impact of unanticipated changes in interest rates on 
A)  the market value of equity. 
B)  net interest income. 
C)  both market value of equity and net interest income. 
D)  the FI's capital position. 
E)  the prices of assets and liabilities. 
Answer: B   

69.  If the chosen maturity buckets are too long, the repricing model may produce inaccurate results because 
A)  as the time to maturity increases, the price volatility increases. 
B)  price changes will be overestimated. 
C)  there may be large differentials in the time to repricing for different securities within each maturity bucket. 
D)  the FI will be unable to accurately measure the quantity of rate sensitive assets. 
E)  the FI will be unable to accurately measure the quantity of rate sensitive liabilities. 
Answer: C   

70.  An increase in interest rates 
A)  increases the market value of the FI's financial assets and liabilities. 
B)  decreases the market value of the FI's financial assets and liabilities. 
C)  decreases the book value of the FI's financial assets and liabilities. 
D)  increases the book value of the FI's financial assets and liabilities. 
E)  has no impact on the market value of the FI's financial assets and liabilities. 
Answer: B   

Use the following to answer questions 71-74:

The following balance sheet for Boston Bank. The average maturity of demand deposits is estimated at 2 years.

71.  What is the repricing gap if a 0 to 3 month maturity gap is used? Ignore runoffs. 
A)  $60 million 
B)  $40 million 
C)  -$80 million 
D)  -$120 million 
E)  -$180 million 
Answer: A   

72.  What is the repricing gap if a 3-year maturity gap is used? Ignore runoffs. 
A)  $21 million 
B)  $44 million 
C)  -$80 million 
D)  -$60 million 
E)  -$120 million 
Answer: D   

73.  What is the repricing gap if a 1-year maturity gap is used if runoffs are also considered? 
A)  $10.5 million 
B)  $22 million 
C)  -$42 million 
D)  -$40 million 
E)  -$70 million 
Answer: C   

74.  What is the impact on net interest income in year two if interest rates increase by 50 basis points at the end of year one? Ignore runoffs. 
A)  +$0.210 million 
B)  +$0.300 million 
C)  -$0.300 million 
D)  -$0.210 million 
E)  +$0.600 million 
Answer: B   

Use the following to answer questions 75-77:

Consider a one-year maturity, $100,000 face value bond that pays a 6 percent fixed coupon annually. 

75.  What is the price of the bond if market interest rates are 7 percent? 
A)  $99,050.15 
B)  $99,457.94 
C)  $99,249.62 
D)  $100,000.00 
E)  $99,065.42 
Answer: E   

76.  What is the price of the bond if market interest rates are 5 percent? 
A)  $100,952.38 
B)  $101,238.10 
C)  $100,963.71 
D)  $100,000.00 
E)  $101,108.27 
Answer: A   

77.  What is the percentage price change for the bond if interest rates increase 50 basis points from the original 6 percent? 
A)  -0.1033 percent 
B)  -0.4766 percent 
C)  0.4695 percent 
D)  0.0000 percent 
E)  -0.2907 percent 
Answer: C   

Use the following to answer questions 78-80:

Consider a six-year maturity, $100,000 face value bond that pays a 5 percent fixed coupon annually. 

78.  What is the price of the bond if market interest rates are 6 percent? 
A)  $105,816.44 
B)  $105,287.67 
C)  $105,242.14 
D)  $100,000.00 
E)  $106,290.56 
Answer: C   

79.  What is the price of the bond if market interest rates are 6 percent? 
A)  $95,082.68 
B)  $95,769.55 
C)  $95,023.00 
D)  $100,000.00 
E)  $96,557.87 
Answer: A   

80.  What is the percentage price change for the bond if interest rates decline 50 basis points from the original 6 percent? 
A)  -2.106 percent 
B)  +2.579 percent 
C)  +0.000 percent 
D)  +3.739 percent 
E)  +2.444 percent 
Answer: B   

81.  An interest rate increase 
A)  benefits the FI by increasing the market value of the FI's liabilities. 
B)  harms the FI by increasing the market value of the FI's liabilities. 
C)  harms the FI by decreasing the market value of the FI's liabilities. 
D)  benefits the FI by decreasing the market value of the FI's liabilities. 
E)  benefits the FI by decreasing the market value of the FI's assets. 
Answer: D   

82.  Which of the following statements is true? 
A)  An increase in interest rates leads to an increase in the market value of financial securities. 
B)  Value of longer term securities decreases at a diminishing rate for increases in interest rates. 
C)  Value of longer term securities increases at an increasing rate for any decline in interest rates. 
D)  The shorter the maturity of a fixed income asset or liability, the greater the fall in market value for any given interest rate increase. 
E)  The longer the maturity of a fixed income asset or liability, the greater the fall in market value for any given interest rate decrease. 
Answer: B   

Use the following to answer questions 83-88:

All assets and liabilities are currently priced at par and pay interest annually.

83.  What is the weighted average maturity of assets? 
A)  5.50 years 
B)  6.40 years 
C)  5.00 years 
D)  4.60 years 
E)  10.0 years 
Answer: D   

84.  What is the weighted average maturity of liabilities? 
A)  5.50 years 
B)  6.40 years 
C)  1.44 years 
D)  1.30 years 
E)  1.10 years 
Answer: C   

85.  What is this FI's maturity gap? 
A)  4.00 years 
B)  4.28 years 
C)  3.16 years 
D)  4.06 years 
E)  5.10 years 
Answer: C   

86.  What is market value of the one-year bond if all market interest rates increase by 2 
percent? 
A)  $60.000 million 
B)  $60.566 million 
C)  $59.444 million 
D)  $58.899 million 
E)  $61.142 million 
Answer: D   

87.  What is market value of the ten-year loan if all market interest rates increase by 2 percent? 
A)  $40.000 million 
B)  $44.916 million 
C)  $37.830 million 
D)  $42.356 million 
E)  $35.827 million 
Answer: E   

88.  What is market value of the one-year CD if all market interest rates increase by 2 percent? 
A)  $49.065 million 
B)  $50.481 million 
C)  $49.528 million 
D)  $50.971 million 
E)  $50.000 million 
Answer: A   

89.  What is market value of the two-year CD if all market interest rates increase by 2 percent? 
A)  $40.381 million 
B)  $39.626 million 
C)  $40.000 million 
D)  $39.259 million 
E)  $40.769 million 
Answer: D   

90.  What is the impact on the FI's equity of a 2 percent overall increase in market interest rates on all fixed-rate instruments? 
A)  Equity rises by $4.318 million. 
B)  Equity declines by $3.598 million. 
C)  Equity rises by $2.060 million. 
D)  Equity declines by $1.880 million. 
E)  Equity does not change. 
Answer: B   

91.  Which of the following statements is true? 
A)  An increase in interest rates will benefit the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities. 
B)  An increase in interest rates will harm the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities. 
C)  An increase in interest rates will harm the FI since the decrease in the market value of assets will be greater than the decrease in the market value of liabilities. 
D)  A decrease in interest rates will harm the FI since the increase in the market value of assets will be greater than the increase in the market value of liabilities. 
E)  A decrease in interest rates will benefit the FI since the increase in the market value of assets will be smaller than the increase in the market value of liabilities. 
Answer: C   

92.  Can the FI immunize itself from interest rate risk exposure by setting the maturity gap equal to zero? 
A)  Yes, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities. 
B)  No, because with a maturity gap of zero, the change in the market value of assets exactly offsets the change in the market value of liabilities. 
C)  No, because the maturity model does not consider the timing of cash flows. 
D)  Yes, because the timing of cash flows is not relevant to immunization against interest rate risk exposure. 
E)  No, because a representative bank will always have a positive maturity gap. 
Answer: C   

Use the following to answer questions 93-100:

All assets and liabilities are currently priced at par and pay interest annually.

93.  What is the weighted average maturity of the assets of the FI? 
A)  2.0 years 
B)  2.3 years 
C)  2.5 years 
D)  2.6 years 
E)  3.0 years 
Answer: D   

94.  What is the weighted average maturity of the liabilities of the FI? 
A)  3.67 years 
B)  3.30 years 
C)  3.00 years 
D)  5.00 years 
E)  4.33 years 
Answer: A   

95.  What is the FI's maturity gap? 
A)  -2.03 years 
B)  -2.50 years 
C)  -1.07 years 
D)  -0.70 years 
E)  -0.40 years 
Answer: C   

96.  Is the bank exposed to interest rate increases or decreases and why? 
A)  Interest rate increases because the value of its assets will rise more than its liabilities. 
B)  Interest rate increases because the value of its assets will fall more than its liabilities. 
C)  Interest rate decreases because the value of its assets will rise less than its liabilities. 
D)  Interest rate decreases because the value of its assets will fall more than its liabilities. 
E)  Interest rate increases because the value of its assets will fall less than its liabilities. 
Answer: C   

97.  What is the change in the value of its assets if all interest rates decrease by 1 percent? 
A)  Approximately $1.6 million 
B)  Approximately $2.6 million 
C)  Approximately $1.9 million 
D)  Approximately $2.2 million 
E)  Approximately $2.5 million 
Answer: B   

98.  What is the change in the value of its liabilities if all interest rates decrease by 1 percent? 
A)  Approximately $2.0 million 
B)  Approximately $2.3 million 
C)  Approximately $2.6 million 
D)  Approximately $2.9 million 
E)  Approximately $3.2 million 
Answer: D   

99.  What is the effect on the value of the FI's equity if interest rates decrease by 1 percent? 
A)  Gain of $0.6 million 
B)  Gain of $0.3 million 
C)  Loss of $1.6 million 
D)  No change in equity 
E)  Loss of $0.3 million 
Answer: E   

100.  Can an FI immunize itself against interest rate risk exposure even though its maturity gap is not zero? 
A)  Yes, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities. 
B)  No, because with a maturity gap of zero the change in the market value of assets exactly offsets the change in the market value of liabilities. 
C)  Yes, because the maturity model does not consider the timing of cash flows. 
D)  No, because the timing of cash flows is relevant to immunization against interest rate risk exposure. 
E)  No, because a representative bank will always have a positive maturity gap. 
Answer: C   

101.  What should be the decrease in interest rates of the 2-year loan in order for the value of the equity to remain at $10 million? Assume the interest rates for all other instruments decreased by 1 percent. 
A)  5.50 percent 
B)  6.19 percent 
C)  4.15 percent 
D)  6.54 percent 
E)  7.25 percent 
Answer: B   

102.  A method of measuring the interest rate or gap exposure of an FI is 
A)  the duration model. 
B)  the maturity model. 
C)  the repricing model. 
D)  all of the above. 
E)  only b and c of the above. 
Answer: D   

103.  The repricing model is based on an accounting world that reports asset and liability values at 
A)  their market value. 
B)  their book value. 
C)  their historic values or costs. 
D)  all of the above. 
E)  only b and c of the above. 
Answer: E   

104.  The repricing model suffers from 
A)  the over aggregation of assets and liabilities in the rate buckets. 
B)  the consideration only of market value effects of interest rate changes. 
C)  the consideration of the reinvestment of maturing loan portfolios. 
D)  all of the above. 
E)  none of the above. 
Answer: E   

105.  Which of the following relationships does not hold in the pricing of fixed-rate assets given
changes in market rate? 
A)  A decrease in interest rates generally leads to an increase in the value of assets. 
B)  Longer maturity assets have greater changes in price than shorter maturity assets for given changes in interest rates. 
C)  The absolute change in price per unit of maturity time for given changes in interest rates decreases over time, although the relative changes actually increase. 
D)  For a given percentage decrease in interest rates, assets will increase in price more than they will decrease in price for the same, but opposite increase in rates. 
E)  None of the above is untrue. 
Answer: C   

106.  Immunizing the balance sheet to protect equity holders from the effects of interest rate risk occurs when 
A)  the maturity gap is zero. 
B)  the repricing gap is zero. 
C)  the duration gap is zero. 
D)  the effect of a change in the level of interest rates on the value of the assets of the FI is exactly offset by the effect of the same change in interest rates on the liabilities of the FI. 
E)  after the fact analysis demonstrates that immunization coincidentally occurred. 
Answer: D   

107.  The average maturity of the liabilities of an FI's balance sheet is equal to 
A)  the weighted-average of the liabilities where the weights are determined relative to the total liabilities and equity of the FI. 
B)  the weighted-average of the liabilities where the weights are determined relative to the total liabilities of the FI. 
C)  the weighted-average of the liabilities where the weights are determined relative to the total assets of the FI. 
D)  the weighted-average of the liabilities where the weights are determined using market values of liabilities. 
E)  None of the above is correct. 
Answer: B   

108.  The term structure of interest rates assumes that 
A)  the risk of all assets is the same. 
B)  the time to maturity for all assets is the same. 
C)  the coupon rate of all assets is the same. 
D)  all of the above are correct. 
E)  only two of the above are correct. 
Answer: E   

109.  The yield curve 
A)  relates rates for different maturities of assets. 
B)  is normally calculated using U.S. Treasury securities. 
C)  may change shape over time. 
D)  should be calculated for securities in the same risk class. 
E)  All of the above are correct. 
Answer: E   

110.  The unbiased expectations theory of the term structure of interest rates 
A)  assumes that long-term interest rates are an arithmetic average of short-term rates. 
B)  assumes that the yield curve reflects the market's current expectations of future short-term interest rates. 
C)  recognizes that forward rates are perfect predictors of future interest rates. 
D)  assumes that risk premiums increase uniformly with maturity. 
E)  None of the above is correct. 
Answer: B   

111.  The liquidity premium theory of the term structure of interest rates 
A)  assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term. 
B)  assumes that long-term interest rates are an arithmetic average of short-term rates plus a liquidity premium. 
C)  recognizes that forward rates are perfect predictors of future interest rates. 
D)  assumes that risk premiums increase uniformly with maturity. 
E)  None of the above is correct. 
Answer: A   

112.  The market segmentation theory of the term structure of interest rates 
A)  assumes that investors will hold long-term maturity assets if there is a sufficient premium to compensate for the uncertainty of the long-term. 
B)  assumes that the yield curve reflects the market's current expectations of future short-term interest rates. 
C)  assumes that market rates are determined by supply and demand conditions within fairly distinct time or maturity buckets. 
D)  fails to recognize that forward rates are not perfect predictors of future interest rates. 
E)  More than one of the above is correct. 
Answer: C