Exercise No.

Mod 3-1 (Essay)

What is your understanding on how risks are managed in the financial market?
In a Financial Market, there are various risks where assets can be exposed to danger of losses. It is
managed by having a criteria wherein there will be a credit rating on how to foresee the possibilities of the
credit risks to be invested.
Exercise No. Mod 3-2 (True or False)
T 1). Credit risk is one type of business risk that the borrower was not able to repay its obligation.
T 2). Credit risk also affects the valuation of accounts receivable.
T 3). BSP defined interest rates to be a type of price. Interest are set to compensate the risk of
allowing the finances to flow into the financial system.
T 4). The interest as a price is different on the perspective of the lender or borrower. For lenders,
interest rate is called as lending rate or return.
T 5). The interest as a price is different on the perspective of the lender or borrower. For the
borrowers, these will serve as cost of debt.
T 6). The tenor of the investment also defines the riskiness of the repayment of debt.
T 7). There are two economic theories that affect the term structure of interest rate. These are
expectations theory and market segmentation theory.
T 8). Expectation theories is that the interest rates are driven by the expectation of the lender or
borrowers in the risks of the market in the future. These maybe a pure expectation theory and
biased expectation theory.
T 9). Pure expectations theory is based on the current data and statistical analysis to project the
behavior of the market in the future.
T 10). Biased Expectation Theory includes that there are other factors that affect the term structure
of the loans as well as the interest to be perceived moving forward.
T 11). The adjustment or increase on the interest rate is called the liquidity premium
T 2). Liquidity premium increases as the maturity lengthens. This theory is called the liquidity
theory.
T 13). The risk-free rate should be the rate that assumes zero default in the market where this is
more or less equivalent to the rates offered by the sovereign.
T 14). Market Segmentation Theory assumes that the driver of the interest rates are the savings
and investment flows.
T 15). In commerce, risk is a very important factor to consider that may drives the business up or
down. Risk relates to the volatility of return patterns in the business.
T 16). There are risks that are inherent in every financing transaction. These are default risk, liquidity
risk, legal risks, and market risks, among others.
T 17). Default risk arise on the inability to make payment consistently.
T 18). Liquidity Risk is identified by ensuring the business to be capable of meeting all its currently
maturing obligation.
T 19). Legal risk is dependent on the covenants set and agreed in between the lenders and the
borrowers.
T 20). Market risk is the impact of the market drivers to the ability of the borrowers to settle the
obligation.
T 21). Since the interest rate is dependent on the inflation, tenor and other market risks. Companies
should consider and make reasonable estimates to mitigate these risks.
T 22). When the agreement is a spot rate the applicable interest rate is based on the prevailing
market rate at the particular time.
T 23). Forward rates are normally contracted rates that fixed the rates and allow a party to assume
such risk on the difference between the contracted rate and the spot rate.
T 24). Swap rate is another contract rate where a fixed rate exchange for a certain market rate at a
certain maturity.
T 25). The credit ratings are determined by companies that are recognized globally that objectively
assigns or evaluates countries and companies based on the riskiness of doing business with
them.
Exercise No. Mod 3-3 (Multiple Choice)
B 1. Which of the following is incorrect about credit risk?
a. Credit risk is one type of business risk.
b. This is the risk that the lender was not able to repay its obligation. (borrower not lender)
c. Credit risk also affects the valuation of accounts receivable.
d. Such risk is valuated as a factor to determine the cost of lending or financing using debt.
A 2. This economic theory accordingly drives the interest rate assumes that it is ideal to supply
funds when the interests are high and vice versa.
a. Loanable funds b. Liquidity preference c. Expectation d. Market Segmentation
B 3. This economic theory accordingly drives the interest rate assumes that the interest rates are
dependent on the preference of the household whether they hold or use it for investment.
a. Loanable funds b. Liquidity preference c. Expectation d. Market Segmentation
A 4. Which of the following is correct about interest rates?
a. BSP defined interest rates to be a type of price.
b. The interest as a price is similar on the perspective of the lender or borrower. (different)
c. For borrowers, interest rate is called as lending rate or return. (For lenders)
d. For lenders, these will serve as cost of debt. (For borrowers)
C 5. This economic theory accordingly affects the term structure of interest rate. Interest rates are
driven by the expectation of the lender or borrowers in the risks of the market in the future.
a. Loanable funds b. Liquidity preference c. Expectation d. Market Segmentation
D 6. This economic theory accordingly affects the terms structure of interest rate. This theory
assumes that the driver of the interest rates are the savings and investment flows.
a. Loanable funds b. Liquidity preference c. Expectation d. Market Segmentation
A 7. This theory is based on the current data and statistical analysis to project the behavior of the
market in the future
a. Pure Expectation b. Biased Expectation c. Liquidity d. Preferred Habitat
B 8. This theory includes that there are other factors that affect the term structure of the loans as
well as the interest to be perceived moving forward. The forward rates will be affected or will be
adjusted if the liquidity of the borrower will be weaker or stronger in the future.
a. Pure Expectation b. Biased Expectation c. Liquidity preference d. Market Expectation
D 9. To determine the appropriate interest rate or rates the following factors should be considered
assuming the cash flows are already been established:
a. Interest rates in the industry
b. Risk exposure
c. Compensation on the market expectation.
d. All of the above
D 10. Related to the determination of interest rates, the following are true except:
a. In finance, interest can be determined by the function of the risk and the compensation of
the investor on the difference between the risk-free rate and the market fluctuations
b. Another way on how to calculate the interest rate is by the function of the market value, par
value and the interest expense paid by debt securities or bonds.
c. The risk-free rate should the rate that assumes zero default in the market where this is more
or less equivalent to the rates offered by the sovereign.
d.The low risk rate can be real or excludes the effect of inflation or the exclusion of the effect
of the purchasing power of Philippine Peso. (Risk free rate)
B 11. Identify the risks described in each statement:
1st: Arise on the inability to make payment consistently. Most of the businesses was able to
raise financing on their demands, however their cash flows projected were not that guaranteed.
2nd: Identified by ensuring the business to be capable of meeting all its currently maturing
obligation.
a. Liquidity; Default b. Default; Liquidity c. Solvency; Default d. Default; Solvency
A 12. Identify the risks described in each statement:
1st: Dependent on the covenants set and agreed in between the lenders and the borrowers.
2nd: Classified as a systematic risk because it arises from external forces or based on the
movement of the industry.
a. Legal; Market b. Market; Legal c. Contractual; Industry d. Industry; Contractual
B 13. __________ is the interest rate or yield available / applicable for a particular time.
a. Prevailing rate b. Spot rate c. Forward rate d. Day rate
C 14. Normally contracted rates that fixed the rates and allow a party to assume such risk on the
difference between the contracted rate and the spot rate.
a. Prevailing rate b. Spot rate c. Forward rate d. Future rate
A15. Contract rate where a fixed rate exchange for a certain market rate at a certain maturity.
Usually the one used as reference is the LIBOR.
a. Swap rate b. Exchange rate c. Forward rate d. Future rate
A 16. The ______________ are determined by companies that are recognized globally that
objectively assigns or evaluates countries and companies based on the riskiness of doing
business with them. The riskiness is primarily driven by their ability to manage their liquidity and
solvency in the long run. The higher the grade the lower the default risk associated to the country
or company.
a. Credit Ratings b. Credit Score c. Investment Rating d. Investment Score
B 17. The following statements are correct, except:
a. Standard and Poor’s Corporation or S&P is an American financial services corporation was
founded in 1941 by Henry Varnum Poor in New York, USA.
b. Moody’s Investors Services or Moody’s is credit rating company particularly on equity
securities established in 1909 in New York, USA. (debt securities not equity)
c. Fitch Ratings was founded in 1914 in New York, USA. The company was owned by Hearst.
d. DBRS was established in 1976 in Toronto, Canada. The company was considered as the
fourth largest ratings agency.
D18. The following are major credit ratings company, except:
a. S&P b. Moody's c. Fitch d. MTRCB
B 19. Which of the following is not correct?
a. One of the challenges in financing is to ensure the ability of the borrowers to settle the
obligation. The risk involve in financing are: default risk, liquidity risk, and market risk among
others.
b. It is theoretically assumed that the cost of financing is affected by the availability of loanable
funds which is the Loanable Funds Theory and the maturity of the loans, where the longer the life
of the loans the higher the rate is Liquidity Premium Theory. (Liquidity Preference Theory)
c. The three factors that affect the interest rates: (1) industry; (2) risk exposure; and (3)
compensation for the market expectation. Hence, the interest formula will require the function of
default or risk-free rate, inflation and debt premium for the compensation.
d. In order to mitigate the risk, most businesses hedge forward rates or enter into a swap rate
agreement. It is important for the borrowers and lenders to know what the spot rate in the
prevailing market is and employ certain expectations in the future.
A 20. The common unit of measure for interest rates and other percentage in finance is called BPS.
What does BPS stand for?
a. Basis points b. Basic percentages c. Basic point system d. Basic percentage system