University of Phoenix Material
Week 3 Learning Team Assignment: Financial Transaction Risks
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 Type | Describe and justify risk type | Interest Rate or Interest Income? |
| A bank finances a $10 million, six-year fixed-rate commercial loan by selling one-year certificate of deposit. | Interest rate risk and credit risk | If the borrower defaults on the 6 year loan, the bank will only have a 1 year CD to cover it. When the CD matures the bank is out of funds and must pay back money they lended out. Also, if rates go up after the C matures then the bank could have gotten more interest for the term than it is currently tied to. | Both |
| An insurance company invests its policy premiums in a long-term municipal bond portfolio. | Credit risk and interest rate risk | Although the chances are low the municipal bonds may default if the municipality goes bankrupt. A much higher risk is interest rate risk in long term bond portfolios. If interest rates go up and similar bonds are paying more then these bonds will be less attractive. | Interest income |
| A French bank sells two-year fixed-rate notes to finance a two-year fixed-rate loan to a British entrepreneur. | Sovereign and credit risk | Any type of debt security can always run the risk of default and since it is a French bank issueing the note to a British entrepreneur they run the risk of the French government going through instability and default | both |
| A Japanese bank acquires an Austrian bank to facilitate clearing operations. | Technology Risk | The transition of Austrian bank services to Japanese may not be suitable for the existing banking systems | Interest rate |
| A bond dealer uses his own equity to buy Mexican debt on the less developed country (LDC) bond market. | Foreign exchange and country risk | Anytime you are purchasing securities tied to a foreign currency you run the risk of the currency rates changing not in your favor. Also, foreign countries can always run the risk of defaulting on their bonds and this is even more so in less developed countries. | Interest income |
| A securities firm sells a package of mortgage loans as mortgage-backed securities. | Pre-payment risk | Since most mortgages aren’t held until the full term, but rather paid off earlier through refinances. | Interest rate |
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