So I was completing an essay type question (Finquiz), where it basically says you have two clients: i) The Roths, 40 year old couple working for a retailer, and ii) a medium-sized savings bank.
The first question asks to identify two differences in IPS constraints, and I gave time horizon as a key difference, assuming the Roths have a long investment horizon whereas the bank should have quite a short-term investment horizon. The solution says “The bank has a very long-term time horizon, presumably indefinite, as it is a savings bank while the Roth’s time horizon is much shorter”
Is this really like that? I thought banks normally have short time horizons due to the need to repay short-term liabilities…
You’re confusing time-horizon with liquidity, the two tend to go hand in hand with individuals. But this is a little different.
A bank with no demand deposits tends to leave only around 10% of it’s liabilities as liquid money, while the rest goes in long-term investments, whereby the leveraged asset duration gap is always maximized within risk tolerance. The longer the duration of assets compared to the liabiities, the higher the bank’s profits, even though he has a regulatory (liqduidity) constraint.
Typical Finquiz questions that throws some stupid semantic driven curve ball into the question that goes against the spirit of what is beings taught in the curriculum just to catch you out and pose as “difficulty”
Nowhere is it stated in the curriculum that a “savings bank” only have long term deposit accounts, which can’t be accessed on a short term basis.
The Finquiz exams were the same for L1 and L2 with pulling that crap…that’s why I steer well clear of them. I’d be so, so surprised if the CFAI pulled shit like that in the exam…they clearly state banks have a short term time horizon, and while I follow and agree with MrSmarts logic…it’s semantic bullshit in the question that makes it so.
I agree it’s a little off-putting, but technically, the saving banks asset duration would be heavily dependant on it’s liability durations, after adjusting for reserve requirements. So their time horizon is indefinite in two ways, with the other acting as a “going concern”, again, after removing liquidity constraints from the equation.
I guess what the answer is really trying to say is saving banks’ do not have a time constraint with regards to their asset portfolios, seeing as it’s a legal entity and not a person. The word twisting and logic extrapolation is excessive, saving banks in real life have a more dynamic portfolio depending on their liabilities, which was not stated here. The author confused time-horizon (duration) of investments with the overall time-horizon of the portfolio since inception to liquidity. I’d focus on CFAI questions.
Agreed…if the questions had stated something like “a medium-sized savings bank, which holds only long term liabilities on its balance sheet…” then perhaps I could get behind it a little more.
I doubt most people, under exam conditions would make the logical step between the words “savings bank” and “no short or mid-term liabilities”.
Well, then it seems to me that the way I understand it is right:
Time horizon depends on the term of liabilities (given that banks are pure ALMs), so if liabilities are mostly long-term, it would make sense to say that time horizon is long term.
I guess my mistake has been to assume that all banks are mostly short-term funded.
Has any of you tried Finquiz for L3? I wonder how its exams and questions differ from official CFA ones.