adl 55 management of financial institutions

37
Management of Financial Institutions Section A Q1. Define money market. What are its broad objectives and functions? How is money market different from capital markets? Ans.1 The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers’ acceptances, certificates of deposit, federal funds, and short-lived mortgage- backed and asset-backed securities. It provides liquidity funding for the global financial system. MONEY MARKET: As per RBI definitions “A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market”. The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year). It is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded. It does not actually deal in cash or money but deals with substitute of cash like trade bills, promissory notes R govt. papers which can convert into cash without any loss at low transaction cost. It includes all individual, institution and intermediaries. Objective of Money Market: To provide a parking place to employ short term surplus funds. To provide room for overcoming short term deficits. To enable the central bank to influence and regulate liquidity in the economy through its intervention in this market. To provide a reasonable access to users of short-term funds to meet their requirement quickly, adequately at reasonable cost.

Upload: sunil-parashar

Post on 02-Dec-2015

12 views

Category:

Documents


4 download

DESCRIPTION

Amity university solved assignment

TRANSCRIPT

Page 1: ADL 55 Management of Financial Institutions

Management of Financial Institutions

Section A

Q1. Define money market. What are its broad objectives and functions? How is money market different from capital markets?

Ans.1

The money market is a component of the financial markets for assets involved in short-term borrowing and lending with original maturities of one year or shorter time frames. Trading in the money markets involves Treasury bills, commercial paper, bankers’ acceptances, certificates of deposit, federal funds, and short-lived mortgage-backed and asset-backed securities. It provides liquidity funding for the global financial system.

MONEY MARKET:

As per RBI definitions “A market for short terms financial assets that are close substitute for money, facilitates the exchange of money in primary and secondary market”.

The money market is a mechanism that deals with the lending and borrowing of short term funds (less than one year). It is a segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.

It does not actually deal in cash or money but deals with substitute of cash like trade bills, promissory notes R govt. papers which can convert into cash without any loss at low transaction cost. It includes all individual, institution and intermediaries.

Objective of Money Market:

• To provide a parking place to employ short term surplus funds.• To provide room for overcoming short term deficits.• To enable the central bank to influence and regulate liquidity in the economy through its

intervention in this market.• To provide a reasonable access to users of short-term funds to meet their requirement quickly,

adequately at reasonable cost.

The key distinguishing feature between the money and capital markets is the maturity period of the securities traded in them. The money market refers to all institutions and procedures that provide for transactions in short-term debt instruments generally issued by borrowers with very high credit ratings. By financial convention, short-term means maturity periods of one year or less. Notice that equity instruments, either common or preferred, are not traded in the money market. The major instruments issued and traded are U.S. Treasury bills, various federal agency securities, bankers’ acceptances, negotiable certificates of deposit, and commercial paper. Deep in mind that the money market is an intangible market. You do not walk into a building on Wall Street that has the words “Money Market”

Page 2: ADL 55 Management of Financial Institutions

etched in stone over its arches. Rather, the money market is primarily a telephone and computer market.

The capital market refers to all institutions and procedures that provide for transactions in long-term financial instruments. Here, long-term means having maturity periods that extended beyond one year. In the broad sense, this encompasses term loans and financial leases, corporate equities, and bonds. The funds that comprise the firm’s capital structure are raised in the capital market. Important elements of the capital market are the organized security exchanges and the over-the-counter markets.

2

“.What is a derivative contract? bxplain forward” future and options contracts.

Future :ontracts

Options

Forwards Ans ;. <erivative financial trades are gaining prominence in trading. A derivative trade is one whosevalue depends on another instrument’s value.Future :ontract= Infinance, a futures contract is a standardi9edcontract between two parties to buy orsell a specified asset of standardi9ed quantity and quality at a specified future date at a price agreedtoday (the

futures price

,. The contracts are traded on a futures exchange . Futures contracts are not5direct5 securities like stocks, bonds, rights or warrants. They are still securities, however, though they area type ofderivative contract. The party agreeing to buy the underlying asset in the future assumes along position , and the party agreeing to sell the asset in the future assumes ashort position.The price is determined by the instantaneous equilibrium between the forces of supply and demandamong competing buy and sell orders on the exchange at the time of the purchase or sale of thecontract.In many cases, the underlying asset to a futures contract may not be traditional 5commodities5 at all >that is, for

financial futures

, the underlying asset or item can becurrencies,securities orfinancial instruments and intangible assets or referenced items such asstock indexes andinterest rates.The future date is called the

delivery date

Page 3: ADL 55 Management of Financial Institutions

or

final settlement date

. The official price of the futures contractat the end of a day’s trading session on the exchange is called the

settlement price

for that day ofbusiness on the exchangeForward :ontract= In a normal contract, usually referred to as a spot contract, the delivery date is asclose as possible to the trade date. Forward contracts are agreements to do the delivery sometime in thefuture. For example, consider a French company that wants to buy a commodity from an Americancompany in two months. The company, usually, would do financing in francs. If there is a high degree ofuncertainty in the franc?dollar exchange rate, the company cannot afford to take risk. 4o, it enters into aforward contract exchange rate deal, paying an agreed amount of francs for the required dollars. Theprice would be offered by the bank who is carrying out the deal based on the market’s perception ofwhere the exchange rate is likely to go in the next two months. 4uch a deal is said to have a tenor of twomonths. 2ow, we can model the forward contract as follows=One important thing to be noted is the tenor. It is the period between the trade date and the delivery date.@rices are generally quoted on the market with a a particular tenor in mind.

owever, the tenor is simply

One important thing to be noted is the tenor. It is the period between the trade date and the delivery date.@rices are generally quoted on the market with a a particular tenor in mind. owever, the tenor is simply

Page 4: ADL 55 Management of Financial Institutions

3

not the duration between trade and delivery dates. For example, let us assume that the above mentionedcontract was traded on Bune 10. If, August 10 happened to be a 4aturday, then August 1; is the actualdelivery date. olidays have a big impact on how these dates are calculated. 2ote that we have toconsider the holidays for both the parties. In this kind of structure, the calculation of the delivery date isnot something that can be done by the trade date and tenor alone. This means that the market shouldhave a date calculation routine that ad usts for holidays.Option= In the French company example given above, the forward contract is a valuable tool in reducingthe risk of an exchange rate change that would cause them to pay more. 'ut the company does run therisk of losing out should the exchange rate change in their favor. 4o, according to the financial manager,he has to buy the commodity on the spot market or forward contract based on his estimate of exchangerate change. Options are more helpful in this respect. An option gives the buyer the right to buy dollars ata prearranged exchange rate if the holder wishes. If the franc goes down, the company can exercise itsoption and buy the dollars at the prearranged priceC otherwise they can ignore the option and buy on thespot market. The bank charges a premium to the company to sell them the option, so the bank nowmanages the risk. Many features of the option are similar to a normal contract. Dike a contract, optionshave counterparties and trade dates. Other features of the option include expiration date, the amount ofpremium, and date the premium is delivered. Thus, the following model is obtained, which considers anoption to be a subtype of contract=2ote= The Ederived indicator is a reminder to the implementer that it is not something that is actuallystored or calculated. In the above model, the terms

call

and

put

are from the trader’s vocabulary. A call is an option to buy,while a put is an option to sell. 8e can buy or sell a call, or buy or sell a put, which gives rise to fourcombinations. Representing this in the model is slightly tricky. 8hat we have done is use the terms

long

and

short

for options only to indicate the state of the option rather than the contract. 4o, if we sell anoption to buy German marks, then this option would be classified as a short callC if we buy an option to

Page 5: ADL 55 Management of Financial Institutions
Page 6: ADL 55 Management of Financial Institutions
Page 7: ADL 55 Management of Financial Institutions
Page 8: ADL 55 Management of Financial Institutions
Page 9: ADL 55 Management of Financial Institutions

4

sell marks, this would be a long put.

(.,

Write short notes on the followin-'1. ommercial Oanks'

:ommercial 'anks in India are broadly categori9ed into 4cheduled :ommercial'anks and 3nscheduled :ommercial 'anks. The 4cheduled :ommercial 'anks have been listed underthe 4econd 4chedule of the Reserve 'ank of India Act, 1H J. The selection measure for listing a bankunder the 4econd 4chedule was provided in section J; (K0 of the Reserve 'ank of India Act, 1H J. Activities of :ommercial 'anksThe modern :ommercial 'anks in India cater to the financial needs of different sectors. The mainfunctions of the commercial banks comprise=

Page 10: ADL 55 Management of Financial Institutions

Transfer of funds

Acceptance of deposits

Offering those deposits as loans for the establishment of industries

@urchase of houses, equipments, capital investment purposes etc.

The banks are allowed to act as trustees. On account of the knowledge of the financial market ofIndia the financial companies are attracted towards them to act as trustees to take theresponsibility of the security for the financial instrument like a debenture.

The Indian Government presently hires the commercial banks for various purposes like taxcollection and refunds, payment of pensions etc.

“. O0 '

non banking financial company (2'F:, is a company registered under the :ompanies Act,1HLK and is engaged in the business of loans and advances, acquisition ofshares?stock?bonds?debentures?securities issued by government or local authority or other securities oflike marketable nature, leasing, hire purchase, insurance business, chit business, but does not includeany institution whose principal business is that of agriculture activity, industrial activity,sale?purchase?construction of immovable property. A non banking institution which is a company and which has its principal business of receiving depositsunder any scheme or arrangement or any other manner, or lending in any manner is also a non bankingfinancial company (residuary non banking company,.

,. niversal Oankin-'

As per the 8orld 'ank, 5In 3niversal 'anking, large banks operate extensivenetwork of branches, provide many different services, hold several claims on firms(including equity anddebt, and participate directly in the :orporate Governance of firms that rely on the banks for funding oras insurance underwriters5.In a nutshell,

a Universal Banking is a superstore for financial products under one roof

Page 11: ADL 55 Management of Financial Institutions

. :orporate can getloans and avail of other handy services, while can deposit and borrow. It includes not only servicesrelated to savings and loans but also investments. owever in practice the term ‘universal banking’ refers to those banks that offer a wide range of financialservices, beyond the commercial banking functions like Mutual Funds, Merchant 'anking, Factoring,:redit :ards, Retail loans, ousing Finance, Auto loans, Investment banking, Insurance etc. This is mostcommon in uropean countries

5

(.2 3n every lendin- decision” credit officers refer to a principle of lendin- known as the 4 s ofcredit.5a6 What is the relevance of this principle in a loan evaluation process?

A.J (a, As providers of the capital small businesses need to grow or expand, banks are cautious abouthow they lend their money, particularly in today-s economy. ow do they determine who gets a loan andwho doesn-t ssentially, bankers follow the guidelines of the five :-s affecting credit=If you and your business pass muster and the bank grants you a loan, keep it your friend=

7 Make the bank your one8stop8shop.

In fact, the bank will probably expect more from you than ust therepayment of the loan. It will most likely require a depository relationship as well as the opportunity toprovide treasury and other value added services. 8hile this is normally a

quid pro quo

in the bankingrelationship anyway, it is becoming mandatory in the present banking environment.

7 Meet re-ularly.

To keep and maintain the positive relationship you have now developed with yourbanker, make sure to meet with your banker regularly and keep him or her apprised of the good, the bad,and the ugly concerning your present business position and outlook. If you-re looking to make dramaticchanges, make sure your banker is “in the loop.” 'y keeping constant communication ongoing with yourbanker, you are assuring him or her that you care about your business, your finances, and their money.

5b6 bxplain with details” the 4 s of credit.

A.Jb

redit haracter

In analy9ing a borrower’s credit history, you first need to have a goal in mind. Thegoal should be to confirm that the borrower’s history meets

or exceeds

Page 12: ADL 55 Management of Financial Institutions

the credit guidelines for theproduct?program you wish to have the loan underwritten to. In making the confirmation, you shouldconsider these factors separately as not meeting any one of them could drop the borrower into a lowercredit grade. :ompare the credit report to the lender’s underwriting matrix or underwriting guidelines toevaluate the following=The FI:O score Is it within an acceptable range for the loan program ow does the lender determinethe score the lower of two or the middle of three The mortgage payment history Is the number of late payments at or below the lender’s standard The number and characteristic of each open trade lines=

The quantity Are there enough traditional credit trade lines If not, is alternative credit allowed. Ifso, what are the documentation requirements for alternative credit sources

The installment?revolving account payment history Is the number of late payments at or belowthat stated standard

The installment?revolving account age or seasoning <oes the account meet the agingrequirement 1; months, ;J months, etc.The installment?revolving account credit limit <oes the account meet the required standard for credit linelimit ere is an example of a lender’s trade line requirements= Minimum of trade lines, 1 year established,with 1 credit line of N1,000 or more

6

@ublic records Are there any 8ere they disclosed 8hat is the status ow will they affect theunderwriting decision 4ocial security number(s, Are they consistent with the information disclosed on the 100 <erogatory credit Other derogatory credit. :an we document the status

as it been satisfied or will itbe satisfied on or before closing Inquiries ow many have there been in the past K months <uplicate entries :an you confirm that it is in fact a duplicate :an you get it removed prior tounderwriting submission

apacity 8

Regardless of how good a borrower’s credit is, they must demonstrate the financial capacityto handle the debt. Reviewing the borrower’s past income and employment history is the best indicator ofthe ability to handle future debt. The following items should be considered when analy9ing yourborrower’s capacity=4tability as the borrower’s employment remained stable for two or more years as it been in thesame or a related field <oes the income fluctuate or is it consistent Income Type 8hat is the nature of the borrower’s income Is it wages, commission, or other 8hat isthe frequency Is it on a regular recurring schedule or is it seasonal Is it bonus income tied toperformance and

Page 13: ADL 55 Management of Financial Institutions

therefore not guaranteed If it is from a source other than traditional employment, howlong will it continue Income amount Is it adequate to cover the proposed new debt <oes the income show a pattern ofdecreasing or declining

apital 8

The capital that the borrower has on hand for down payment, closing costs, and?or reserves willimpact your product choice. It will also impact underwriting. In the last module, we made note of the typeof funds that are considered to be 5liquid assets5. In reviewing capital, consider them as the underwriterwould=Ownership <oes the borrower have full or limited access to the disclosed capital?assets If not, whatportion is available for the loan transaction Access?Diquidity Are the funds liquid now or will they be soon Is the borrower fully or partially vested Are there penalties for withdrawal 8ill the disbursement process be complete prior to the approval?ratelock expiration Amount Is it enough to meet the requirements for down payment, closing costs, or cash reserves 'eing able to answer the questions 58hose is it 5 5 ow much is it 5 and 58hen can they get it 5 will helpyou evaluate your borrower’s capital.

onditions 8

An underwriter looks at the many documents in the loan file to determine if there are anydisclosed or undisclosed factors that might adversely affect the borrower or sub ect property. A fewconsiderations include=

mployment at a place that has had a public announcement of shutting down.

A recently awarded divorce settlement where the borrower has to payout significant proceeds orwill have a high alimony?support payment.

A lawsuit

7

An adverse change in the industry that the borrower is employed in

An adverse change in the area where the sub ect property is located

Page 14: ADL 55 Management of Financial Institutions

ollateral 8

A loan is secured using the sub ect property as collateral. 4ince the property is the lender’sprotection against default, it must be structurally sound and functional. 8hen evaluating the collateral, anunderwriter considers=Features Are the features and style of the home consistent with what is available in the area Functionality Is the home functional or has it been rendered obsolete by outdated features andcapability.:ondition Is the home structurally sound and visually appealing Is the home inhabitable or is it adangerous contraption. Is the home complete as is or will renovations be required @roperty type?3se Is it residential or commercial Is it owner occupied or is it a rental unit. Is it vacant or occupied After carefully and cautiously looking at all of these items and how they stack up to establishedguidelines. The underwriter should he able to confidently make a credit decision.

(.4 Outline the main elements of the prudential norms relatin- to the credit and investmentportfolios of banks. Discuss briefly the capital ade9uacy norms applicable to banks.

A.L Master :ircular on O@rudential 2orms on :apital Adequacy- @urpose The Reserve 'ank of Indiadecided in April 1HH; to introduce a risk asset ratio system for banks (including foreign banks, in India asa capital adequacy measure in line with the :apital Adequacy 2orms prescribed by 'asel :ommittee.This circular prescribes the risk weights for the balance sheet assets, non funded items and other off balance sheet exposures and the minimum capital funds to be maintained as ratio to the aggregate of therisk weighted assets and other exposures, as also, capital requirements in the trading book, on anongoing basis.This master circular covers instructions regarding the components of capital and capital charge requiredto be provided for by the banks for credit and market risks. It deals with providing explicit capital chargefor credit and market risk and addresses the issues involved in computing capital charges for interest raterelated instruments in the trading book, equities in the trading book and foreign exchange risk (includinggold and other precious metals, in both trading and banking books. .:apital adequacy norms=The basic approach of capital adequacy framework is that a bank should have sufficient capital to providea stable resource to absorb any losses arising from the risks in its business. :apital is divided into tiersaccording to the characteristics?qualities of each qualifying instrument. For supervisory purposes capitalis split into two categories=Tier I and Tier II. These categories represent different instruments- quality as capital.Tier I capital consists mainly of share capital and disclosed reserves and it is a bank-s highest qualitycapital because it is fully available to cover losses.Tier II capital on the other hand consists of certain reserves and certain types of subordinated debt. Theloss absorption capacity of Tier II capital is lower than that of Tier I capital

8

Management of Financial Institutions Assignment 'Marks 10 Answer all questions.

(.1 bxplain briefly the main elements of the ‘sset :iability Mana-ement 0ramework prescribed bythe $O3 for the banks in 3ndia.’.1

Page 15: ADL 55 Management of Financial Institutions

Over the last few years the Indian financial markets have witnessed wide ranging changes at fastpace. Intense competition for business involving both the assets and liabilities, together with increasingvolatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on themanagement of banks to maintain a good balance among spreads, profitability and long term viability.These pressures call for structured and comprehensive measures and not ust ad hoc action. TheManagement of banks has to base their business decisions on a dynamic and integrated riskmanagement system and process, driven by corporate strategy. 'anks are exposed to several major risks in the course of their business credit risk, interest rate risk, foreign exchange risk, equity ?commodity price risk, liquidity risk and operational risks.This note lays down broad guidelines in respect of interest rate and liquidity risks management systemsin banks which form part of the Asset Diability Management (ADM, function. The initial focus of the ADMfunction would be to enforce the risk management discipline vi9. managing business after assessing therisks involved. The ob ective of good risk management programmes should be that these programmeswill evolve into a strategic tool for bank management.The ADM process rests on three pillars= P

ADM information systemsQR Management Information 4ystemQR Information availability, accuracy, adequacy and expediency P

ADM organi9ationQR 4tructure and responsibilitiesQR Devel of top management involvement P

ADM processQR Risk parametersQR Risk identificationQR Risk measurementQR Risk managementQR Risk policies and tolerance levels.

2. ‘:M information systems

Information is the key to the ADM process. :onsidering the large network of branches and the lack of anadequate system to collect information required for ADM which analyses information on the basis ofresidual maturity and behavioral pattern it will take time for banks in the present state to get the requisiteinformation. The problem of ADM needs to be addressed by following an A': approach i.e. analysing thebehavior of asset and liability products in the top branches accounting for significant business and thenmaking rational assumptions about the way in which assets and liabilities would behave in otherbranches. In respect of foreign exchange, investment portfolio and money market operations, in view ofthe centrali9ed nature of the functions, it would be much easier to collect reliable information. The data

9

Page 16: ADL 55 Management of Financial Institutions

and assumptions can then be refined over time as the bank management gain experience of conductingbusiness within an ADM framework.The spread of computeri9ation will also help banks in accessing data.

4. ‘:M or-ani;ation4.1 a6

The 'oard should have overall responsibility for management of risks and should decide the riskmanagement policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity pricerisks.

b6

The Asset Diability :ommittee (AD:O, consisting of the bank’s senior management including : Oshould be responsible for ensuring adherence to the limits set by the 'oard as well as for deciding thebusiness strategy of the bank (on the assets and liabilities sides, in line with the bank’s budget anddecided risk management ob ectives.

c6

The ADM desk consisting of operating staff should be responsible for analysing, monitoring andreporting the risk profiles to the AD:O. The staff should also prepare forecasts (simulations, showing theeffects of various possible changes in market conditions related to the balance sheet and recommend theaction needed to adhere to bank’s internal limits.

4.”

The AD:O is a decision making unit responsible for balance sheet planning from risk returnperspective including the strategic management of interest rate and liquidity risks. ach bank will have todecide on the role of its AD:O

,

its responsibility as also the decisions to be taken by it. The business andrisk management strategy of the bank should ensure that the bank operates within the limits ? parametersset by the 'oard. The business issues that an AD:O would consider, inter alia, will include product pricingfor both deposits and advances, desired maturity profile of the incremental assets and liabilities, etc. Inaddition to monitoring the risk levels of the bank, the AD:O should review the results of and progress inimplementation of the decisions made in the previous meetings. The AD:O would also articulate thecurrent interest rate view of the bank and base its decisions for future business strategy on this view. Inrespect of the funding policy, for instance, its responsibility would be to decide on source and mix ofliabilities or sale of assets. Towards this end, it will have to develop a view on future direction of interestrate movements and decide on a funding mix between fixed vs floating rate funds, wholesale vs retaildeposits, money market vs capital market funding, domestic vs foreign currency funding, etc. Individualbanks will have to decide the frequency for holding their AD:O meetings.

Page 17: ADL 55 Management of Financial Institutions

4., omposition of ‘: O

The si9e (number of members, of AD:O would depend on the si9e of each institution, businessmix and organi9ational complexity. To ensure commitment of the Top Management, the : O?:M< or

<should head the :ommittee. The :hiefs of Investment, :redit, Funds Management ? Treasury (forex anddomestic,, International 'anking and conomic Research can be members of the :ommittee. In additionthe ead of the Information Technology <ivision should also be an invitee for building up of MI4 andrelated computeri9ation. 4ome banks may even have sub committees.

4.2 ommittee of Directors

'anks should also constitute a professional Managerial and 4upervisory :ommittee consisting of three tofour directors which will oversee the implementation of the system and review its functioning periodically.

4.4 ‘:M process'

The scope of ADM function can be described as follows= P

Diquidity risk management P

Management of market risks(including Interest Rate Risk, P

Funding and capital planning P

@rofit planning and growth pro ection P

Trading risk managementThe guidelines given in this note mainly address Diquidity and Interest Rate risks.

10

(.” bxplain briefly the major types of risks to which banks are exposed.

A.; In the course of their operations, banks is invariably faced with different types of risks that may havea potentially negative effect on their business. Risk management in bank operations includes

Page 18: ADL 55 Management of Financial Institutions

riskidentification, measurement and assessment, and its ob ective is to minimi9e negative effects risks canhave on the financial result and capital of a bank. 'anks are therefore required to form a specialorgani9ational unit in charge of risk management. Also, they are required to prescribe procedures for riskidentification, measurement and assessment, as well as procedures for risk management.The risks to which a bank is particularly exposed in its operations are= liquidity risk, creditrisk, market risks (interest rate risk, foreign exchange risk and risk from change in marketprice of securities, financial derivatives and commodities,, exposure risks, investment risks,risks relating to the country of origin of the entity to which a bank is exposed, operationalrisk, legal risk, reputation risk and strategic risk.Diquidity risk is the risk of negative effects on the financial result and capital of the bankcaused by the bank-s inability to meet all its due obligations.:redit risk is the risk of negative effects on the financial result and capital of the bankcaused by borrower-s default on its obligations to the bank.Market risk includes interest rate and foreign exchange risk.

Interest rate risk

is the risk of negative effects on the financial result and capital of the bankcaused by changes in interest rates.

Foreign exchange risk

is the risk of negative effects on the financial result and capital of thebank caused by changes in exchange rates. A special type of market risk is the

risk of change in the market price

of securities, financialderivatives or commodities traded or tradable in the market. xposure risks include risks of bank-s exposure to a single entity or a group of relatedentities, and risks of banks- exposure to a single entity related with the bank.Investment risks include risks of bank-s investments in entities that are not entities in thefinancial sector and in fixed assets.Risks relating to the country of origin of the entity to which a bank is exposed (country risk,is the risk of negative effects on the financial result and capital of the bank due to bank-sinability to collect claims from such entity for reasons arising from political, economic or social conditions in such entity-s country of origin. :ountry risk includes political andeconomic risk, and transfer risk.Operational risk is the risk of negative effects on the financial result and capital of the bankcaused by omissions in the work of employees, inadequate internal procedures andprocesses, inadequate management of information and other systems, and unforeseeableexternal events.Degal risk is the risk of loss caused by penalties or sanctions originating from court disputesdue to breach of contractual and legal obligations, and penalties and sanctions pronouncedby a regulatory body

11

Page 19: ADL 55 Management of Financial Institutions

Reputation risk is the risk of loss caused by a negative impact on the market positioning of the bank.4trategic risk is the risk of loss caused by a lack of a long term development component inthe bank-s managing team.

(.,. Describe the role of developmental financial institutions in industrial financin-. <iveexamples of some of the developmental financial institutions in 3ndia.

A. To provide long and medium term credit to industrial concerns engaged in manufacturing, mining,shipping and electricity generation and distribution.(b, The period of credit can be as long as ;L years and should not exceed that periodC(c, To grant credit to a single concern up to a maximum amount of rupees one crore. This limit can beexceeded with the permission of the government under certain circumstancesC(d, Guarantee loans and deferred paymentsC(e, 3nderwrite and directly subscribe to shares and debentures issued by companiesC(f, Assist in setting up new pro ects as well as in moderni9ation of existing industrial concerns in mediumand large scale sectorC(g, Assist pro ects under co operatives and in backward areas.4peciali9ed financial institutions may be divided into the following types=(a, All India <evelopment 'anks1. Industrial <evelopment 'ank of India (I<'I,;. 4mall Industries <evelopment 'ank of India (4I<'I, . Industrial Finance :orporation of India (IF:I,J. Industrial credit and Investment corporation of India (I:I:I,L. 2ational 'ank for Agriculture and Rural <evelopment(2A'AR<,K. Industrial Investment 'ank of India Dtd. (previously, IndustrialReconstruction 'ank of India,(b, 4tate level Institutions1. 4tate Financial :orporations (4F:s,;. 4tate Industrial <evelopment :orporations (4I<:, . 4tate Industrial Investment :orporations (4II:,(c, Investment institutions1. 3nit Trust of India (3TI,;. Dife Insurance :orporation of India (DI:, . General Insurance :orporation (GI:,

12

1.:ase study= @lease read the case study given below and answer questions given at the end. :ase 4tudy <ilemma of Asian 'ags Asia @aper 'ag has since 1HH0 operated as a manufacturer of plastic carrier bags supplying them ona contract manufacturing basis to well known supermarket chains, fast food outlets, pharmacies anddepartment stores. Dately, Asia @aper 'ag exports customi9ed plastic carrier bags to Marks n4pencer and 'oots @harmacy in the 3nited 6ingdom.<uring the Asian financial crisis, Asia @aper 'ag had difficulties in meeting its term loan repayment,and had to restructure the term loan last year. The term loan was restructured by way of a debtmoratorium of ;J months on the principal and an extension of the maturity period from five years toeight years.:urrently, Asia @aper 'agOs turnover is about Rs

million per month with an average net profit marginof S . Dately, with the increase in world oil prices, raw materials for plastic bag production haveincreased by over L to 34<1, ;00 per tone. Asia @aper 'ag-s capacity utili9ation is still low at onlyJ0 , after it expanded rapidly pre crisis. Asia @aper 'ag 4dn 'hd-s production capacity increasedfrom ;00,000 tonnes per annum to L0,000 tonnes per annum during the pre crisis period. This waswhen the

Page 20: ADL 55 Management of Financial Institutions

company borrowed a term loan of Rs. 10 million to finance the machinery. The rawmaterials, @ resins, are purchased mainly from 4ingapore and Thailand, whilst only 1L is sourceddomestically.Uuestions=a.Dist the qualitative risks of Asia @aper 'ag relation to bank lending. Ans a. Asia paper bag request the bank to restructured the term loan by way of a debtmoratorium of ;J months on the principal and an extension of the maturity period from fiveyears to eight years. 8hich is not a good sign for a company, and it is matter which will effecton the long run. 2ext time when company will apply for loan or long term loan then bank willthink about the past and will consider the case. 'anks always go with the previous history inthe loan banking. It will affect the company in the long term relationship. It will also leave badimpact on the share holders of the company. Their faith in the company will reduce.b.Dist and explain the appropriate financial ratios to analy9e the financial performance(profitability, of Asia @aper 'ag 4dn 'hd. Ans ' Financial ratios quantify many aspects of a business and are an integral part offinancial statement analysis. Financial ratios are categori9ed according to the financial aspectof the business which the ratio measures.Financial ratios allow for comparisons

between companies

between industries

between different time periods for one company

between a single company and its industry average

13

Ratios generally hold no meaning unless they arebenchmarked against something else, like pastperformance or another company. Thus, the ratios of firms in different industries, which face differentrisks, capital requirements, and competition, are usually hard to compare I will suggest two ratios for the company

@rofitability ratios measure the firm’s use of its assets and control of its expenses to generate anacceptable rate of return.

Page 21: ADL 55 Management of Financial Institutions

Market ratios measure investor response to owning a company’s stock and alsothe cost of issuing stock.c.4tate the motives for using ratio analysis as a credit evaluation tool. Ans :. Ratio Analysis is the study and interpretation of relationships between variousfinancialvariables, byinvestors or lenders. It is a quantitativeinvestment technique used for comparinga company’s financial performance to the market in general. A change in these ratios helps tobring about a change in the way a company works. It helps to identify areas where themanagement needs to change. 3sing ratio analysis can be a big motivation for the company.If anyone will see the ratio analysis then they can see the increased in production and profit.Ratio analysis will give the clear picture to the investor and banks to evaluate the financialcondition of the company, because company is doing well in the past year. 4o using ratioanalysis can be a source of motivation for credit evaluation

14

Assignment :

Assignment – C1. The role of Financial arbets an, instit’tions$a%

Involves the movement of huge quantities of money.

$R% Affects the 'rofits of R’sinesses.$c% Affects the t”'es of goo,s an, serxices 'ro,’ce, in an econom”.$,% “oes all of the aRoxe.2. (hich of the follo,ing is a mone” marbet instr’ment$a

x T-bill

$R% - O$c% hare$,% O'tion3. (hich of the follo,ing is a ,erixatixes instr’ment $a% Commercial a'er $R% Certificate of “e'osit$c%

Forward Contract

$,% eliance hares4. (hich of the follo,ing is a ca'ital marbet instr’ment $a% “eRent’re$R% T Rill$c%

Commercial Paper

$,% Certificate of “e'osit5. (hich -nterest rates are im'ortant to financial instit’tions since aninterest rate increase $a% “ecreases the cost of ac ’iring f’n,s.$R% -ncreases the cost of ac ’iring f’n,s.$c%

aises the income from assets.$,%

bx and Cx of the above.

$e% $A% an, $C% of the aRoxe.6. anb Ass’rance refers to ,hich of the follo,ing $a% A tie ‘' Ret,een ins’rance an, Ranb ,hereR” the ins’rance com'an” can ‘sethe sales channel of the Ranb $R%

,n assurance of safety by ban’s

Page 22: ADL 55 Management of Financial Institutions

15$c% An inxestment Ranbing serxice 'roxi,e, R” Ranbs$,% F’n,ing of ins’rance com'anies R” Ranbs7. (hat is an FC $a% ationalise, Ranbing an, financing com'an”$R%

on on, Finance Co’'on$c%

$on ban’ing Financial Corporation

$,% e, marbet on, an, Finance Cor'oration8. (hich of the follo,ing is an e am'le of a commercial Ranb $a%

%RI' ban’

$R% CitiRanb $c% -$,% eserxe anb of -n,ia9. (hich of the follo,ing is an e am'le of a ,exelo'ment Ranb $a% :- anb $R%

Citiban’

$c% -$,% eserxe anb of -n,ia10. Ca'ital A,e ’ac” refers to ,hich of the follo,ing $a% -t is the minim’m amo’nt of loan ,hich has to Re gixen R” a Ranb $R% -t is the ratio of the asset to liaRilities of a Ranb.$c%

It is the minimum capital which ban’s have to ‘eep with the “bI to ensuresufficient funds in case of default.

$,% -t is the total ca'ital of the Ranb.11. (hich of the follo,ing is an Oxer the co’nter $OTC % “erixatixe instr’ment $a% F’t’re$R% O'tion$c% ,a'$,%

bonds

12. (hich of the follo,ing is an e change tra,e, ,erixatixe instr’ment $a% F’t’re$R% For,ar,$c%

wap

$,% on,s

1613. rimar” arbet refers to $a% A s’Rset of mone” marbet; ,here the goxernment iss’es ne, T Rills$R%

, subset of the money mar’et” where the government issues new bonds

$c% A s’Rset of the ca'ital marbet; ,here the e ’ities are tra,e,$,% A s’Rset of the ca'ital marbet; ,here the com'an” iss’es ne, e ’it”14. econ,ar” arbet refers to $a% A s’Rset of mone” marbet; ,here the goxernment iss’es ne, T Rills$R% A s’Rset of the mone” marbet; ,here the goxernment iss’es ne,

on,s$c%

Page 23: ADL 55 Management of Financial Institutions

, subset of the capital mar’et” where the equities are traded

$,% A s’Rset of the ca'ital marbet; ,here the com'an” iss’es ne, e ’it”15. For a 'ro<ect to Re xiaRle ; the et 'resent xal’e of the 'ro<ect sho’l, Re $a%

Positive

$R% egatixe$c% =ero$,% > ,oesn?t haxe an” im'act on 'ro<ect xiaRilit”.16. Asset @iaRilit” anagement for the Ranbs inxolxes $a% anaging the assets an, liaRilities of com'anies ,ho haxe taben cre,itfrom the Ranb $R% Cons’lting the com'anies ,ho haxe taben cre,it on asset liaRilit”mismatch$c%

It is a ‘ind of ris’ management technique adopted by ban’s

$,% -t is a bin, of 'rofit enhancement techni ’e a,o'te, R” Ranbs.17. Cre,it isb refers to the risb of $a % isb of non 'a”ment of ,’es R” the Ranb to its len,ers.$R%

“is’ if non payment of dues to the ban’ by its borrowers.

$c% isb of non 'a”ment from cre,it car, hol,ers$,% isb of non 'a”ment from the ta cre,its to -.18. (hich of the follo,ing is not a factor consi,ere, as a 'art of assetliaRilit” management R” the

Ranbs $a% C’rrenc” rates$R% -nterest rates$c% @i ’i,it”$,%

%mployee Turnover

1719. The 'rice of one co’ntr”?s c’rrenc” in terms of another?s is calle,$a%

The e(change rate.

$R% The interest rate.$c% The “o, ones in,’strial axerage.$,% one of the aRoxe.20. r’,ential norms relate to ,hich of the follo,ing $a%

$orms related to 'anagement of ban’ funds in a systematic manner.

$R% orms relate, to ne, e ’it” inxestment as gixen R” -.$c% orms R” ,hich ’Rlic ector Com'anies haxe to com'l”.$,% orms to Re

follo,e, R” - ,hile mabing 'olic” ,ecisions.21. -ns’rance com'anies are reg’late, R” ,hich instit’tion $a% -$R%

I”,,

$c% -$,% tate Boxernments22. $-% “eRt marbets are often referre, to genericall” as the Ron, marbet. $--%A Ron, is a sec’rit” that is a claim on the earnings an, assets of acor'oration.$a%

Ix is true” IIx false.

Page 24: ADL 55 Management of Financial Institutions

$R% $-% is false; $--% tr’e.$c% oth are tr’e.$,% oth are false.23. $-% A Ron, is a ,eRt sec’rit” that 'romises to mabe 'a”ments 'erio,icall”for a s'ecifie, 'erio, of time. $--% A stocb is a sec’rit” that is a claim onthe earnings an, assets of a cor'oration.$a% $-% is tr’e; $--% false.

bx Ix is false” IIx true.

$c% oth are tr’e.$,% oth are false.24. eins’rance refers to ,hich of the follo,ing $a%

, client who is ta’ing insurance for the second time.

$R% A com'an” ,hich is getting its assets ins’re, R” more than t,o com'anies.$c% -ns’rance taben R” an ins’rance com'an” itself $,% -ns’rance taben on something ,hich is alrea,” ins’re,.25.

arsimhan Committee recommen,ations ,ere in relation to ,hich of thefollo,ing instit’tions $a%

ban’

18$R% -$c% -$,% Ca'ital arbets26. T”'icall”; increasing interest rates$a% “isco’rage cor'orate inxestments.$R% “isco’rage in,ixi,’als from saxing.$c% nco’rage cor'orate e 'ansion.$,% nco’rage cor'orate Rorro,ing.$e%

$one of the above.

27. Com'are, to interest rates on long term . . goxernment Ron,s; interestrates on three month Treas’r” Rills fl’ct’ate DDDDD an, are DDDDD on axerage.$a% moreE lo,er $R%

less lower

$c% moreE higher $,% lessE higher 28. anbs; saxings an, loan associations; m’t’al saxings Ranbs; an, cre,it’nions $a% Are no longer im'ortant 'la”ers in financial interme,iation $R% Gaxe Reen 'roxi,ing serxices onl” to small ,e'ositors since ,ereg’lation.$c% Gaxe Reen a,e't at innoxating in res'onse to changes in the reg’lator”enxironment.$,% All of the aRoxe.$e%

nly ,x and Cx of the above.

29. anbs are im'ortant to the st’,” of mone” an, the econom” Reca’se the”– $a% roxi,e a channel for linbing those ,ho ,ant to saxe ,ith those ,ho ,antto inxest.$R% Gaxe Reen a so’rce of ra'i, financial innoxation that is e 'an,ing thealternatixes axailaRle to those ,anting to inxest their mone”.$c% Are the onl” financial instit’tions to 'la” a role in ,etermining the ’antit” of mone” in the econom” $,% “o all of the aRoxe.$e%

,o only ,x and bx of the above.

30. conomists gro’' commercial Ranbs; saxings an, loan associations; cre,it’nions; m’t’al f’n,s; m’t’al saxings Ranbs; ins’rance com'anies; 'ension f’n,s;an, finance com'anies together ‘n,er the hea,ing

Page 25: ADL 55 Management of Financial Institutions

financial interme,iaries.Financial interme,iaries $a% Act as mi,,lemen; Rorro,ing f’n,s from those ,ho haxe saxe, an, len,in

19these f’n,s to others.$R% la” an im'ortant role in ,etermining the ’antit” of mone” in theeconom”.$c% Gel' 'romote a more efficient an, ,”namic econom”.$,%

,o all of the above.

$e% “o onl” $A% an, $C% of the aRoxe.31. $-% anbs are financial interme,iaries that acce't ,e'osits an, mabe loans.$--% -ncl’,e, ‘n,er the term HRanbs? are firms s’ch as commercial Ranbs; saxingsan, loan associations; m’t’al saxings Ranbs; cre,it ‘nions; an, ins’rancecom'anies.$a%

Ix is true” IIx false

.$R% $-% is false; $--% tr’e.$c% oth are tr’e.$,% oth are false.32. The organiIation res'onsiRle for the con,’ct of monetar” 'olic” in -n,ia isthe– $a% Com'troller of the C’rrenc”.$R% -$c%

“eserve ban’ of India

$,% ’rea’ of onetar” Affairs.33. The 'rice 'ai, for the rental of Rorro,e, f’n,s $’s’all” e 'resse, as a 'ercentage of the rental of s 100 'er “ear% is commonl” referre, to as the$a% -nflation rate.$R%

change rate.$c%

Interest rate.

$,% Aggregate 'rice lexel.34. The Ron, marbets are im'ortant Reca’se$a% The” are easil” the most ,i,el” follo,e, financial marbets in -n,ia an,the nite, tates.$R% The” are the marbets ,here foreign e change rates are ,etermine,.$c%

They are the mar’ets where interest rates are determined.

$,% Of all of the aRoxe.$e% Of onl” $A% an, $ % of the aRoxe.35. The stocb marbet is im'ortant Reca’se$a% -t is ,here interest rates are ,etermine,.$R% -t is the most ,i,el” follo,e, financial marbet in the nite, tates.$c%

It is where foreign e(change rates are determined.

$,% All of the aRoxe

2036. T”'icall” ; stocb 'rices in -n,ia an, other ,orl, marbets haxe Reen$a% elatixel” staRle; tren,ing ‘',ar, at a stea,” 'ace.$R% elatixel” staRle; tren,ing ,o,n,ar, at a mo,erate rate.$c% tremel” xolatile.$,%

Onstable” trending downward at a moderate rate.

Page 26: ADL 55 Management of Financial Institutions

37. A rising stocb marbet in,e ,’e to higher share 'rices$a% -ncreases 'eo'le?s ,ealth an, as a res’lt ma” increase their ,illingnessto s'en,.$R%

Increases the amount of funds that business firms can raise by sellingnewly issued stoc’.

$c% “ecreases the amo’nt of f’n,s that R’siness firms can raise R” sellingne,l” iss’e, stocb.$,% oth $A% an, $ % of the aRoxe.38. A ,eclining stocb marbet in,e ,’e to lo,er share 'rices$a% e,’ces 'eo'le?s ,ealth an, as a res’lt ma” re,’ce their ,illingness tos'en,.$R% -ncreases 'eo'le?s ,ealth an, as a res’lt ma” increase their ,illingnessto s'en,.$c%

,ecreases the amount of funds that business firms can raise by sellingnewly issued stoc’.

$,% oth $A% an, $C% of the aRoxe.$e% oth $ % an, $C% of the aRoxe.39. Changes in stocb 'rices$a% Affect 'eo'le?s ,ealth an, their ,illingness to s'en,.$R% Affect firm?s ,ecisions to sell stocb to finance inxestment s'en,ing.$c% Are characteriIe, R” consi,eraRle fl’ct’ations.$,%

,ll of the above.

$e% Onl” $A% an, $ % of the aRoxe.40. one” is ,efine, as$a% An”thing that is generall” acce'te, in 'a”ment for goo,s an, serxices or in the re'a”ment of ,eRt.$R% ills of e change.$c% A risb less re'ositor” of s'en,ing 'o,er.$,% All of the aRoxe.

ex nly ,x and bx of the above

21

0.

'

1.

A

2.

<

3.

<

4.

<

5.

Page 27: ADL 55 Management of Financial Institutions

:

6.

<

7.

'

8.

A

09.

A

00.

:

01.

'

02.

:

03.

A

04.

:

05.

:

06.

'

07.

<

Page 28: ADL 55 Management of Financial Institutions

08.

'

19.

A

10.

'

11.

A

12.

A

13.

A

14.

:

15.

:

16.

<

17.

:

18.

<

29.

:

20.

Page 29: ADL 55 Management of Financial Institutions

'

21.

A

22.

A

23.

A

24.

:

25.

:

26.

:

27.

'

28.

:

39.

<