I am struggling to understand the questions and the answers of this problem. First, we are asked to “evaluate the effect of (four) scenarios on the bank’s investment objectives, constraints, or risk-taking ability”. A. Question: “The target average maturity of loans is increased, with overall risk tolerance unchanged”. Answer: “Because the loan portfolio is now subject to greater interest rate risk, although overall risk tolerance has not changed, the target maturity of the securities portfolio must be reduced to offset the loan portfolio’s greater risk”. I understand the part about the greater interest rate risk, but not why the target maturity of the securities portfolio must be reduced. B. Question: “The ALCO decides to increase Withrop Bank’s credit standards for loans although Withrop Bank’s overall risk tolerance is unchanged”. Answer: “Withrop Bank should have more leeway to invest in below-investment quality debt in its bond portfolio as a result”. I would answer the opposite. C. That’s the only one I understand! D. Question: “More opportunities exist for expanding net interest margins with low risk in Winthorp’s loan portfolio than in its securities portfolio”. Answer: “The development suggests taking less risk in its securities portfolio”. Is the answer related to risk budgeting? Though I feel fine with the other problems, this one completely throws me off! Thanks.
- If the risk increases, the duration should be decreased. 2. If banks’ standards for loans have increased, It can take more risk, so invest in risky securities 3. I do not understand.