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BIBF Financial Advice Programme study materials
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BIBF Financial Advice Programme practice questions

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Question 1Banking & Finance

A bank advertises a savings account with a nominal annual rate of 6% compounded monthly. What is the effective annual rate, rounded to two decimal places?

  1. 6.00%
  2. 6.17% Correct answer.
  3. 6.34%
  4. 6.09%

Explanation

The effective annual rate converts nominal compounding into a single annual figure using (1 + i/m)^m − 1, where i is the nominal rate and m the number of compounding periods. With 6% and monthly compounding, (1 + 0.06/12)^12 − 1 equals approximately 0.0617, or 6.17%. Because interest is added to principal each month, the effective rate always exceeds the nominal rate when m is greater than one.

Question 2Banking & Finance

An investor deposits a lump sum today at a fixed annual rate with annual compounding. Which factor determines the future value of that deposit?

  1. The interest rate and the number of years only
  2. The present value and the interest rate only
  3. The present value and the number of years only
  4. The present value, the interest rate and the number of years Correct answer.

Explanation

Future value is calculated as PV × (1 + r)^n, so it depends jointly on the starting amount, the rate of return and the time horizon. Omitting any one of these inputs makes the calculation impossible. All three variables interact multiplicatively rather than independently.

Question 3Banking & Finance

A client wants to receive a fixed payment every year for twenty years from a fund earning a constant rate. Which calculation determines the lump sum needed today?

  1. The present value of an ordinary annuity Correct answer.
  2. The future value of an annuity due
  3. The future value of a single sum
  4. The present value of a perpetuity

Explanation

A level payment received at regular intervals for a fixed number of periods is an annuity, and the amount required today is its present value. The present value of an ordinary annuity discounts each payment back to today and sums them. A perpetuity would apply only if the payments continued forever.

Question 4Banking & Finance

Which statement best describes the relationship between risk and expected return in a well-functioning capital market?

  1. Risk and expected return are unrelated in efficient markets
  2. Lower risk always produces higher realised returns
  3. Higher expected returns are guaranteed whenever risk is higher
  4. Investors generally require higher expected returns to accept greater risk Correct answer.

Explanation

Rational investors are risk averse and demand compensation for bearing additional uncertainty, so expected return rises with risk. This is an expectation about average outcomes, not a guarantee for any single investment. Realised returns can differ substantially from expectations in either direction.

Question 5Banking & Finance

A portfolio holds two assets with equal weights. Asset A has an expected return of 4% and Asset B has an expected return of 10%. What is the portfolio's expected return?

  1. 8%
  2. 6%
  3. 7% Correct answer.
  4. 14%

Explanation

Portfolio expected return is the weighted average of the component expected returns. With equal weights of 0.5 each, the result is 0.5 × 4% + 0.5 × 10% = 7%. Diversification affects risk through correlation but does not change the weighted-average expected return.

Question 6Banking & Finance

What does diversification primarily reduce in a portfolio?

  1. Unsystematic risk specific to individual securities Correct answer.
  2. The expected return of the portfolio
  3. Systematic risk driven by the whole market
  4. Inflation risk affecting all assets

Explanation

Combining assets whose returns are not perfectly correlated cancels out firm-specific and industry-specific variability, known as unsystematic or diversifiable risk. Market-wide systematic risk affects all securities and cannot be removed by holding more of them. Diversification therefore lowers total risk without necessarily lowering expected return.

Question 7Banking & Finance

A central bank raises its policy interest rate. Which effect is most likely in the short term?

  1. Market interest rates rise and bond prices fall Correct answer.
  2. Market interest rates fall and bond prices rise
  3. Market interest rates rise and bond prices rise
  4. Market interest rates fall and bond prices fall

Explanation

Bond prices and yields move inversely because a bond's fixed future cash flows are discounted at prevailing rates. When the policy rate rises, required yields on bonds generally increase, so the present value of those cash flows declines. Hence prices fall as rates rise.

Question 8Banking & Finance

Which institution typically acts as lender of last resort to commercial banks during a liquidity crisis?

  1. A retail insurance company
  2. A credit rating agency
  3. The central bank Correct answer.
  4. A stock exchange

Explanation

Central banks can create reserves and lend them to solvent but illiquid banks, which is the essence of the lender-of-last-resort function. This role supports financial stability by preventing temporary liquidity shortages from becoming insolvencies. Other market participants lack the ability to create base money.

Question 9Banking & Finance

A client with a moderate risk profile holds a portfolio of 60% equities and 40% bonds. Equity markets fall sharply. Assuming no rebalancing, what happens to the portfolio's asset allocation?

  1. Both weights remain exactly at 60% and 40%
  2. The equity weight rises above 60% and the bond weight falls below 40%
  3. The equity weight falls below 60% and the bond weight rises above 40% Correct answer.
  4. The bond weight falls because bond prices always rise when equities fall

Explanation

When equity values decline while bond values hold steady, equities become a smaller share of total portfolio value. The bond share therefore rises proportionally. Rebalancing would restore the target weights by buying equities and selling bonds.

Question 10Banking & Finance

An investor buys a bond with a face value of 1,000 at a price of 950, held to maturity in one year with a single coupon of 40. What is the holding-period return?

  1. 9.47% Correct answer.
  2. 13.68%
  3. 4.21%
  4. 4.00%

Explanation

Total return combines the coupon received and any capital gain relative to the purchase price. Here the coupon is 40 and the gain is 50, giving 90 on a cost of 950, which equals approximately 9.47%. The denominator must be the price paid, not the face value.

Question 11Banking & Finance

A company's dividend is expected to be 2.00 next year, and dividends are expected to grow at 4% indefinitely. If the required return is 10%, what is the estimated share value using the Gordon growth model?

  1. 34.67
  2. 33.33 Correct answer.
  3. 20.00
  4. 50.00

Explanation

The Gordon growth model values a share as the next dividend divided by the difference between the required return and the growth rate. Here 2.00 divided by (0.10 − 0.04) equals 33.33. The numerator must be the expected dividend one period ahead, not the most recent dividend.

Question 12Banking & Finance

Which measure of risk is most appropriate for comparing a well-diversified portfolio with the overall market?

  1. Standard deviation of standalone returns
  2. Range of historical returns
  3. Beta Correct answer.
  4. The coefficient of variation of a single security

Explanation

In a diversified portfolio, unsystematic risk has been largely eliminated, so the relevant risk is the sensitivity to market movements. Beta measures exactly that sensitivity. Standalone volatility measures total risk, which overstates the risk that matters once diversification is achieved.

Question 13Banking & Finance

A client earns 5% nominal return in a year when inflation is 3%. What is the approximate real return?

  1. 5%
  2. 2% Correct answer.
  3. 1.94%
  4. 8%

Explanation

The approximate real return is the nominal return minus inflation, giving 2% here. The precise Fisher relationship divides (1 + nominal) by (1 + inflation) and subtracts one, which yields about 1.94%. The approximation is close enough for small rates and is commonly used in client discussions.

Question 14Banking & Finance

Which of the following best describes the purpose of a client risk-profiling questionnaire?

  1. To predict future market returns with accuracy
  2. To determine the client's tax residency status
  3. To establish the client's capacity and willingness to bear investment risk Correct answer.
  4. To guarantee that a portfolio will not lose value

Explanation

Risk profiling combines objective capacity to bear loss, such as time horizon and financial resources, with subjective willingness or attitude toward risk. The output guides suitable asset allocation. It is a planning tool and cannot forecast markets or eliminate losses.

Question 15Banking & Finance

An adviser recommends a product that pays the adviser a higher commission than a comparable lower-cost alternative. Which principle is most directly engaged?

  1. Ensuring the client's tax efficiency
  2. Managing conflicts of interest in the client's best interest Correct answer.
  3. Maximising the adviser's firm revenue
  4. Diversifying the client's portfolio

Explanation

Commission-based remuneration creates a conflict between the adviser's financial interest and the client's interest in suitable, cost-effective advice. Conduct standards require firms to identify and manage such conflicts, for example by disclosing them or by using independent or fee-based structures. Suitability must be judged on the client's needs, not on adviser remuneration.

Question 16Banking & Finance

Under a typical 'know your client' process, which item is least relevant to assessing investment suitability?

  1. The adviser's own personal investment preferences Correct answer.
  2. The client's existing financial commitments
  3. The client's investment time horizon
  4. The client's tolerance for risk

Explanation

Suitability assessment focuses on the client's circumstances, objectives, horizon, risk tolerance and financial position. The adviser's personal preferences have no bearing on what is suitable for the client and could introduce bias. Objective and subjective client factors are both relevant.

Question 17Banking & Finance

A client's portfolio has an expected return of 8% and a standard deviation of 12%. Assuming returns are normally distributed, approximately what is the probability of a return below −4% in a given year?

  1. About 16% Correct answer.
  2. About 50%
  3. About 5%
  4. About 32%

Explanation

A return of −4% lies exactly one standard deviation below the 8% mean. Under a normal distribution, roughly 68% of outcomes fall within one standard deviation, leaving about 16% in each tail. The probability of a result more than one standard deviation below the mean is therefore approximately 16%.

Question 18Banking & Finance

A bank holds long-term fixed-rate mortgages funded by short-term deposits. Which risk is most prominent?

  1. Credit risk from the mortgages defaulting
  2. Operational risk from staff error
  3. Currency risk from foreign exchange exposure
  4. Interest rate risk from maturity mismatch Correct answer.

Explanation

Funding long-duration fixed-rate assets with short-term liabilities creates a repricing mismatch. If short-term rates rise while mortgage income is fixed, the net interest margin is squeezed. This is a classic form of interest rate risk in banking.

Question 19Banking & Finance

An investor wishes to reduce the volatility of a portfolio without lowering its expected return, if possible. Which action is most consistent with modern portfolio theory?

  1. Buy additional units of the largest existing holding
  2. Concentrate holdings in the single highest-return asset
  3. Increase the allocation to cash
  4. Combine assets with low or negative return correlation Correct answer.

Explanation

Modern portfolio theory shows that combining assets whose returns are imperfectly correlated lowers portfolio variance for a given level of expected return. The benefit is greatest when correlations are low or negative. Concentration increases idiosyncratic risk rather than reducing it.

Question 20Banking & Finance

A bond has a duration of 6 years. If yields rise by 0.5 percentage points, what is the approximate percentage change in the bond's price?

  1. +3.0%
  2. −0.5%
  3. −6.0%
  4. −3.0% Correct answer.

Explanation

Duration approximates the percentage price change for a small change in yield as −duration × change in yield. With a duration of 6 and a yield increase of 0.5%, the estimated price change is −6 × 0.005 = −3.0%. The negative sign reflects the inverse relationship between yields and prices.

Question 21Banking & Finance

An investor buys a stock at 50 and sells it one year later at 56 after receiving a dividend of 2. What is the total return?

  1. 14%
  2. 16% Correct answer.
  3. 4%
  4. 12%

Explanation

Total return includes both the capital gain and the income received, divided by the initial price. The gain is 6 and the dividend is 2, giving 8 on an outlay of 50, which equals 16%. Ignoring either component understates the true return.

Question 22Banking & Finance

A client nearing retirement holds a portfolio heavily weighted in growth equities. Which adjustment is most consistent with a life-cycle approach to asset allocation?

  1. Shift progressively toward lower-volatility income assets Correct answer.
  2. Concentrate further in a single high-growth sector
  3. Extend the investment horizon by deferring all withdrawals
  4. Increase leverage to enhance returns before retirement

Explanation

The life-cycle approach reduces exposure to volatile growth assets as the investment horizon shortens and the need for capital preservation and income rises. Sequencing risk matters more near retirement because withdrawals during a downturn can permanently impair the portfolio. A gradual shift toward lower-volatility assets addresses this.

Question 23Banking & Finance

A portfolio has an expected return of 11%, a risk-free rate of 3% and a standard deviation of 16%. What is its Sharpe ratio?

  1. 8.00
  2. 0.50 Correct answer.
  3. 0.19
  4. 0.69

Explanation

The Sharpe ratio measures excess return per unit of total risk, calculated as (portfolio return − risk-free rate) divided by standard deviation. Here (11% − 3%) / 16% equals 0.50. The numerator must use excess return rather than the raw return.

Question 24Banking & Finance

Two portfolios have identical expected returns, but Portfolio X has a beta of 1.4 and Portfolio Y has a beta of 0.8. According to the capital asset pricing model, how should they be assessed?

  1. Portfolio X is preferable because higher beta reduces diversification
  2. The portfolios are equivalent because expected returns are equal
  3. Portfolio Y is preferable because it achieves the same return with less systematic risk Correct answer.
  4. Portfolio X is preferable because higher beta signals superior management

Explanation

CAPM implies that expected return should compensate only for systematic risk, so a portfolio delivering the same return with lower beta is generating more return per unit of market risk. Portfolio X would be expected to earn a higher return to justify its higher beta, so matching Y's return suggests underperformance on a risk-adjusted basis. Beta measures non-diversifiable risk, not management skill.

Question 25Banking & Finance

A bond trading at a premium to par has a yield to maturity of 4% and a current yield of 4.5%. What does this imply about the bond's price path if held to maturity with unchanged yields?

  1. The price will gradually decline toward par, producing a capital loss that lowers total return to the yield to maturity Correct answer.
  2. The price will rise further because the coupon exceeds the yield
  3. The current yield will fall below the yield to maturity over time
  4. The price will remain constant at the premium until maturity

Explanation

When a bond trades above par, its yield to maturity is below its current yield because the investor will suffer a pull-to-par capital loss by maturity. That loss offsets the above-market coupon, so total return converges on the lower yield to maturity. The price therefore drifts down toward face value as maturity approaches.

Question 26Banking & Finance

Which statement best describes the role of a commercial bank's capital adequacy ratio?

  1. It sets the maximum interest rate a bank may charge on consumer loans.
  2. It determines the dividend policy approved by shareholders.
  3. It records the bank's daily cash holdings at the central bank.
  4. It measures the proportion of a bank's assets funded by equity relative to risk-weighted exposures. Correct answer.

Explanation

Capital adequacy compares a bank's regulatory capital with its risk-weighted assets, giving a cushion against losses. It is a solvency measure, not a pricing or liquidity rule. Regulators use it to limit leverage and protect depositors.

Question 27Banking & Finance

A saver deposits 10,000 at an annual interest rate of 4% compounded annually. What is the balance after two years?

  1. 10,816 Correct answer.
  2. 10,800
  3. 10,400
  4. 10,816.50

Explanation

Compound interest multiplies the balance by 1.04 each year, so 10,000 x 1.04 x 1.04 = 10,816. Simple interest would give only 10,800. Compounding adds interest on the first year's interest.

Question 28Banking & Finance

Which body typically sets monetary policy for a currency union such as the euro area?

  1. A single central bank for the union Correct answer.
  2. The union's stock exchange regulator
  3. Each national finance ministry separately
  4. The largest commercial bank in the union

Explanation

In a currency union, one central bank sets a single policy rate for the whole area, because a shared currency needs a unified monetary stance. National ministries handle fiscal policy instead. Commercial banks and securities regulators do not set policy rates.

Question 29Banking & Finance

Which feature most clearly distinguishes a defined-contribution pension from a defined-benefit pension?

  1. The scheme must invest only in government bonds.
  2. The investment risk is borne by the member rather than the sponsor. Correct answer.
  3. The scheme pays benefits only as a lump sum.
  4. The employer guarantees a specified retirement income based on salary and service.

Explanation

In a defined-contribution scheme the contribution is fixed and the final pot depends on investment returns, so the member bears the risk. A defined-benefit scheme promises an income formula and places investment risk on the sponsor. Investment restrictions and payout form do not define the distinction.

Question 30Banking & Finance

An investor holds a share that pays a fixed annual dividend of 3.00 indefinitely, and the required return is 6%. Using a no-growth model, what is the share worth?

  1. 50.00 Correct answer.
  2. 30.00
  3. 60.00
  4. 18.00

Explanation

With no growth, value equals dividend divided by required return, so 3.00 / 0.06 = 50.00. The model treats the dividend as a perpetual level annuity. Growth assumptions would raise the value.

Question 31Banking & Finance

Which of the following is a primary function of a stock exchange?

  1. Setting the dividends that listed companies must pay
  2. Lending funds directly to retail borrowers
  3. Guaranteeing investors a positive return
  4. Providing a regulated secondary market where securities can be traded Correct answer.

Explanation

An exchange provides an organised, regulated marketplace where existing securities change hands, which supports price discovery and liquidity. It does not guarantee returns, dictate dividend policy or lend to consumers. Those functions belong to markets, company boards and banks respectively.

Question 32Banking & Finance

A bank's customer deposits are protected by a deposit insurance scheme up to a stated limit. What is the main purpose of such a scheme?

  1. To increase the interest rate paid to depositors
  2. To reduce the risk of bank runs by protecting small depositors Correct answer.
  3. To fund the bank's mortgage lending
  4. To eliminate all credit risk from the banking system

Explanation

Deposit insurance reassures small savers that their money is safe up to a limit, which reduces the incentive to withdraw funds at the first sign of trouble. This supports financial stability. It does not remove credit risk or set interest rates.

Question 33Banking & Finance

Which document must a product provider typically supply to a retail client before a packaged investment is purchased, summarising key features, risks and costs?

  1. A key investor information or product disclosure document Correct answer.
  2. The central bank's policy statement
  3. The auditor's management letter
  4. The company's annual report

Explanation

Regulators require a short, standardised disclosure document so retail clients can compare products on features, risk and cost before buying. Annual reports, audit letters and policy statements serve other purposes and are not pre-sale product summaries.

Question 34Banking & Finance

A client wants to invest 12,000 in a fund with a 2% front-end sales charge. How much is actually invested in the fund?

  1. 11,520
  2. 11,760 Correct answer.
  3. 12,240
  4. 12,000

Explanation

The sales charge is 2% of 12,000, which is 240, leaving 11,760 to be invested. The charge is deducted before purchase, so the invested amount is below the amount paid. The other figures apply the wrong percentage or add rather than deduct the charge.

Question 35Banking & Finance

An investor buys a bond with a face value of 1,000, a coupon of 5% paid annually, and five years to maturity. If the yield to maturity is 5%, what is the price?

  1. Exactly 1,000 Correct answer.
  2. Cannot be determined without the credit rating
  3. Below 1,000
  4. Above 1,000

Explanation

When the coupon rate equals the yield to maturity, the bond prices at par, because the discounted coupons and principal exactly repay the face value. Credit rating affects the yield required, not the arithmetic relationship once the yield is given. Prices diverge from par only when coupon and yield differ.

Question 36Banking & Finance

A portfolio returned 9% while its benchmark returned 7%. The portfolio's beta is 1.2 and the risk-free rate is 2%. What is the portfolio's alpha using the capital asset pricing model?

  1. 1.0%
  2. 2.0%
  3. -0.4%
  4. 0.6% Correct answer.

Explanation

CAPM predicts a return of 2% + 1.2 x (7% - 2%) = 8%. Alpha is the actual 9% minus the predicted 8%, which is 1.0 percentage point. Wait: the predicted value is 8%, so alpha equals 1.0%.

Question 37Banking & Finance

Which risk is reduced by matching the currency of a bond's coupon payments to the investor's home currency?

  1. Interest-rate risk
  2. Credit risk
  3. Liquidity risk
  4. Currency risk Correct answer.

Explanation

Currency risk arises when cash flows are denominated in a foreign currency whose value can move against the investor's home currency. Matching the currency removes that exposure. Credit, interest-rate and liquidity risks are unrelated to the currency of denomination.

Question 38Banking & Finance

An adviser uses a risk-profiling tool that classifies a client as 'balanced'. Which action is most consistent with that classification?

  1. Borrowing to double the equity allocation
  2. Placing all funds in a savings account
  3. Holding a diversified mix of equities and bonds with moderate volatility Correct answer.
  4. Investing 100% in a single small-cap stock

Explanation

A balanced profile implies willingness to accept moderate volatility for moderate growth, which a diversified equity-bond mix provides. Concentrated single stocks and leveraged positions carry far higher risk, while an all-cash holding is far more conservative.

Question 39Banking & Finance

A bank's assets have an average duration of 3 years and its liabilities an average duration of 5 years. Which statement about its interest-rate exposure is most accurate?

  1. It is immunised against rate changes because both durations are positive.
  2. Its equity value tends to fall when interest rates rise. Correct answer.
  3. Duration mismatch has no effect on a bank's equity.
  4. Its equity value tends to rise when interest rates rise.

Explanation

When liabilities have a longer duration than assets, rising rates reduce the value of liabilities less than the value of assets, so net worth falls. This is a negative duration gap. Immunisation requires matched durations, not merely positive ones.

Question 40Banking & Finance

An investor wants to hedge a long equity position against a broad market fall using index futures. Which action is appropriate?

  1. Buy more of the same equities
  2. Sell index futures Correct answer.
  3. Buy index futures
  4. Buy a call option on the index

Explanation

Selling index futures creates a short exposure that offsets losses on a long equity portfolio if the market falls. Buying futures or calls adds to market exposure rather than reducing it. Buying more equities increases the risk being hedged.

Question 41Banking & Finance

A client is 30 years from retirement and can tolerate volatility. Which asset allocation is generally most suitable for long-term growth?

  1. A majority allocation to long-dated government bonds
  2. A single corporate bond issue
  3. Predominantly short-term money market instruments
  4. A majority allocation to diversified equities Correct answer.

Explanation

A long horizon allows time to recover from equity volatility, and equities historically offer higher expected growth. Money market and bond-heavy portfolios suit shorter horizons or lower risk tolerance. A single bond concentrates credit risk.

Question 42Banking & Finance

Which statement best explains why a central bank might use quantitative easing when policy rates are near zero?

  1. To increase the value of the domestic currency
  2. To raise short-term interest rates above market levels
  3. To force commercial banks to lend to specific borrowers
  4. To inject liquidity and support demand by purchasing assets Correct answer.

Explanation

When the policy rate cannot be cut much further, a central bank can buy assets to push money into the system and lower longer-term yields. This supports spending and investment. It is not a tool for raising rates, directing lending or strengthening the currency.

Question 43Banking & Finance

A company has earnings per share of 2.00 and trades at a price-earnings ratio of 15. What is its share price?

  1. 17.00
  2. 30.00 Correct answer.
  3. 45.00
  4. 7.50

Explanation

Price equals earnings per share multiplied by the price-earnings ratio, so 2.00 x 15 = 30.00. The ratio expresses how many times earnings investors pay for a share. The other figures apply the wrong arithmetic.

Question 44Banking & Finance

Which of the following best describes systemic risk in banking?

  1. The risk that a fund underperforms its benchmark
  2. The risk that one borrower defaults on a loan
  3. The risk that a bank's computer system fails for a day
  4. The risk that a shock to one institution or market spreads through the financial system Correct answer.

Explanation

Systemic risk is the danger that distress at one institution or in one market propagates widely, potentially disrupting the whole financial system. Individual borrower defaults and short IT outages are idiosyncratic or operational risks. Benchmark underperformance is an investment risk, not a system-wide one.

Question 45Banking & Finance

An investor has 20,000 to invest and wishes to hold a 70/30 equity-bond split. How much should be allocated to bonds?

  1. 6,000 Correct answer.
  2. 14,000
  3. 7,000
  4. 3,000

Explanation

A 30% bond allocation of 20,000 is 6,000, with the remaining 14,000 in equities. The split must sum to the total. The other figures reflect the equity share or an incorrect percentage.

Question 46Banking & Finance

A bond's credit spread widens from 150 basis points to 250 basis points while the risk-free rate is unchanged. What is the most likely effect on the bond's price?

  1. The price is unchanged because the risk-free rate is unchanged.
  2. The price falls because the required yield has risen. Correct answer.
  3. The price rises because credit risk has fallen.
  4. The price rises because the yield is higher.

Explanation

A wider credit spread raises the bond's yield to maturity, and higher yields reduce the present value of fixed cash flows. Bond prices therefore fall. The risk-free rate being unchanged does not offset the effect of the wider spread.

Question 47Banking & Finance

A portfolio's returns have a standard deviation of 10% and its benchmark has a standard deviation of 8%. The correlation between them is 0.8. What is the portfolio's beta relative to the benchmark?

  1. 1.25
  2. 0.80
  3. 0.64
  4. 1.00 Correct answer.

Explanation

Beta equals correlation multiplied by the portfolio standard deviation divided by the benchmark standard deviation: 0.8 x (10/8) = 1.0. The ratio of volatilities is 1.25, which is then scaled by the correlation. A beta of 1.0 indicates average sensitivity to the benchmark.

Question 48Banking & Finance

A client holds a large single-company stock position with a low cost base. Which strategy best reduces concentration while deferring capital gains tax?

  1. Use a charitable remainder trust or exchange fund to diversify over time Correct answer.
  2. Sell the entire position immediately
  3. Hold the position unchanged and ignore the concentration
  4. Borrow against the position and buy more of the same stock

Explanation

Vehicles such as exchange funds or charitable remainder trusts can diversify a concentrated holding while deferring or reducing capital gains tax. Immediate full sale triggers the entire gain. Borrowing to buy more increases concentration rather than reducing it.

Question 49Banking & Finance

A bank's loan portfolio has an average probability of default of 2% and a loss given default of 45%. What is the expected loss rate on the portfolio?

  1. 4.5%
  2. 2.0%
  3. 9.0%
  4. 0.9% Correct answer.

Explanation

Expected loss equals probability of default multiplied by loss given default: 0.02 x 0.45 = 0.009, or 0.9%. This is the average credit cost per unit of exposure. The other figures omit one factor or misplace the decimal.

Question 50Banking & Finance

An investor holds a two-asset portfolio with 60% in an asset returning 10% and 40% in an asset returning 4%. What is the portfolio's expected return?

  1. 6.4%
  2. 8.0%
  3. 7.6% Correct answer.
  4. 7.0%

Explanation

Expected return is the weighted average: 0.6 x 10% + 0.4 x 4% = 6% + 1.6% = 7.6%. The weights must sum to one. The other figures use incorrect weights or an unweighted average.