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Management of Financial Institutions

Assignment AMarks 10

Answer all questions.

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

A.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.[1] 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). A segment of the financial market in which financial instruments with high liquidity and very short maturities are traded.

It doesn’t actually deal in cash or money but deals with substitute of cash like trade bills, promissory notes & 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. Keep 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" 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. Long-term here means having maturity periods that extend 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? Explain forward, future and options contracts.

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Future Contracts Options Forwards

Ans 2. Derivative financial trades are gaining prominence in trading. A derivative trade is one whose value depends on another instrument's value.

Future Contract: In finance, a futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed today (the futures price). The contracts are traded on a futures exchange. Futures contracts are not "direct" securities like stocks, bonds, rights or warrants. They are still securities, however, though they are a type of derivative contract. The party agreeing to buy the underlying asset in the future assumes a long position, and the party agreeing to sell the asset in the future assumes a short position.

The price is determined by the instantaneous equilibrium between the forces of supply and demand among competing buy and sell orders on the exchange at the time of the purchase or sale of the contract.

In many cases, the underlying asset to a futures contract may not be traditional "commodities" at all – that is, for financial futures, the underlying asset or item can be currencies, securities or financial instruments and intangible assets or referenced items such as stock indexes and interest rates.

The future date is called the delivery date or final settlement date. The official price of the futures contract at the end of a day's trading session on the exchange is called the settlement price for that day of business on the exchange

Forward Contract: In a normal contract, usually referred to as a spot contract, the delivery date is as close as possible to the trade date. Forward contracts are agreements to do the delivery sometime in the future. For example, consider a French company that wants to buy a commodity from an American company in two months. The company, usually, would do financing in francs. If there is a high degree of uncertainty in the franc/dollar exchange rate, the company cannot afford to take risk. So, it enters into a forward contract exchange rate deal, paying an agreed amount of francs for the required dollars. The price would be offered by the bank who is carrying out the deal based on the market's perception of where the exchange rate is likely to go in the next two months. Such a deal is said to have a tenor of two months. Now, 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. Prices are generally quoted on the market with a a particular tenor in mind. However, the tenor is simply not the duration between trade and delivery dates. For example, let us assume that the above-mentioned

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contract was traded on June 10. If, August 10 happened to be a Saturday, then August 12 is the actual delivery date. Holidays have a big impact on how these dates are calculated. Note that we have to consider the holidays for both the parties. In this kind of structure, the calculation of the delivery date is not something that can be done by the trade date and tenor alone. This means that the market should have a date calculation routine that adjusts for holidays.  

Option: In the French company example given above, the forward contract is a valuable tool in reducing the risk of an exchange rate change that would cause them to pay more. But the company does run the risk of losing out should the exchange rate change in their favor. So, according to the financial manager, he has to buy the commodity on the spot market or forward contract based on his estimate of exchange rate change. Options are more helpful in this respect. An option gives the buyer the right to buy dollars at a prearranged exchange rate if the holder wishes. If the franc goes down, the company can exercise its option and buy the dollars at the prearranged price; otherwise they can ignore the option and buy on the spot market. The bank charges a premium to the company to sell them the option, so the bank now manages the risk.   Many features of the option are similar to a normal contract. Like a contract, options have counterparties and trade dates. Other features of the option include expiration date, the amount of premium, and date the premium is delivered. Thus, the following model is obtained, which considers an option to be a subtype of contract:

 Note: The {derived} indicator is a reminder to the implementer that it is not something that is actually stored 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. We can buy or sell a call, or buy or sell a put, which gives rise to four combinations. Representing this in the model is slightly tricky. What we have done is use the terms long and short for options only to indicate the state of the option rather than the contract. So, if we sell an option to buy German marks, then this option would be classified as a short call; if we buy an option to sell marks, this would be a long put.

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    Q.3 Write short notes on the following:

1. Commercial Banks: Commercial Banks in India are broadly categorized into Scheduled Commercial Banks and Unscheduled Commercial Banks. The Scheduled Commercial Banks have been listed under the Second Schedule of the Reserve Bank of India Act, 1934. The selection measure for listing a bank under the Second Schedule was provided in section 42 (60 of the Reserve Bank of India Act, 1934.

Activities of Commercial Banks

The modern Commercial Banks in India cater to the financial needs of different sectors. The main functions of the commercial banks comprise:

Transfer of funds Acceptance of deposits Offering those deposits as loans for the establishment of industries Purchase of houses, equipments, capital investment purposes etc. The banks are allowed to act as trustees. On account of the knowledge of the financial market of

India the financial companies are attracted towards them to act as trustees to take the responsibility of the security for the financial instrument like a debenture.

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

2. NBFC: non-banking financial company (NBFC) is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares/stock/bonds/debentures/securities issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business, but does not include any 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 deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company (residuary non-banking company).

3. Universal Banking: As per the World Bank, "In Universal Banking, large banks operate extensive network of branches, provide many different services, hold several claims on firms(including equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks for funding or as insurance underwriters".

In a nutshell, a Universal Banking is a superstore for financial products under one roof. Corporate can get loans and avail of other handy services, while can deposit and borrow. It includes not only services related to savings and loans but also investments.

However in practice the term 'universal banking' refers to those banks that offer a wide range of financial services, beyond the commercial banking functions like Mutual Funds, Merchant Banking, Factoring, Credit Cards, Retail loans, Housing Finance, Auto loans, Investment banking, Insurance etc. This is most common in European countries.

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Q.4 In every lending decision, credit officers refer to a principle of lending known as the 5 Cs of credit.

(a) What is the relevance of this principle in a loan evaluation process?A.4 (a) As providers of the capital small businesses need to grow or expand, banks are cautious about how they lend their money, particularly in today’s economy. How do they determine who gets a loan and who doesn’t? Essentially, bankers follow the guidelines of the five C’s affecting credit:

If you and your business pass muster and the bank grants you a loan, keep it your friend:

• Make the bank your one-stop-shop. In fact, the bank will probably expect more from you than just the repayment of the loan. It will most likely require a depository relationship as well as the opportunity to provide treasury and other value added services. While this is normally a quid pro quo in the banking relationship anyway, it is becoming mandatory in the present banking environment.

• Meet regularly. To keep and maintain the positive relationship you have now developed with your banker, 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 dramatic changes, make sure your banker is “in the loop.” By keeping constant communication ongoing with your banker, you are assuring him or her that you care about your business, your finances, and their money.

(b) Explain with details, the 5 Cs of credit.

A.4bCredit Character - In analyzing a borrower's credit history, you first need to have a goal in mind. The goal should be to confirm that the borrower's history meets or exceeds the credit guidelines for the product/program you wish to have the loan underwritten to. In making the confirmation, you should consider these factors separately as not meeting any one of them could drop the borrower into a lower credit grade. Compare the credit report to the lender's underwriting matrix or underwriting guidelines to evaluate the following:

The FICO score - Is it within an acceptable range for the loan program? How does the lender determine the 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. If so, what are the documentation requirements for alternative credit sources?

The installment/revolving account payment history - Is the number of late payments at or below that stated standard?

The installment/revolving account age or seasoning - Does the account meet the aging requirement -12 months, 24 months, etc.

The installment/revolving account credit limit - Does the account meet the required standard for credit line limit?

Here is an example of a lender's trade line requirements: Minimum of 3 trade lines, 1 year established, with 1 credit line of $1,000 or more

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Public records - Are there any? Were they disclosed? What is the status? How will they affect the underwriting decision?

Social security number(s) - Are they consistent with the information disclosed on the 1003?

Derogatory credit - Other derogatory credit. Can we document the status? Has it been satisfied or will it be satisfied on or before closing? Inquiries -How many have there been in the past 6 months?

Duplicate entries - Can you confirm that it is in fact a duplicate? Can you get it removed prior to underwriting submission?

Capacity - Regardless of how good a borrower's credit is, they must demonstrate the financial capacity to handle the debt. Reviewing the borrower's past income and employment history is the best indicator of the ability to handle future debt. The following items should be considered when analyzing your borrower's capacity:

Stability -Has the borrower's employment remained stable for two or more years? Has it been in the same or a related field? Does the income fluctuate or is it consistent?

Income Type -What is the nature of the borrower's income? Is it wages, commission, or other? What is the frequency? Is it on a regular recurring schedule or is it seasonal? Is it bonus income tied to performance and therefore not guaranteed? If it is from a source other than traditional employment, how long will it continue?

Income amount - Is it adequate to cover the proposed new debt? Does the income show a pattern of decreasing or declining?

Capital -The capital that the borrower has on hand for down payment, closing costs, and/or reserves will impact your product choice. It will also impact underwriting. In the last module, we made note of the type of funds that are considered to be "liquid assets". In reviewing capital, consider them as the underwriter would:

Ownership - Does the borrower have full or limited access to the disclosed capital/assets? If not, what portion is available for the loan transaction?

Access/Liquidity - Are the funds liquid now or will they be soon? Is the borrower fully or partially vested? Are there penalties for withdrawal? Will the disbursement process be complete prior to the approval/rate lock expiration?

Amount - Is it enough to meet the requirements for down payment, closing costs, or cash reserves? Being able to answer the questions "Whose is it?" "How much is it?" and "When can they get it?" will help you evaluate your borrower's capital.

Conditions - An underwriter looks at the many documents in the loan file to determine if there are any disclosed or undisclosed factors that might adversely affect the borrower or subject property. A few considerations include:

Employment 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 or

will have a high alimony/support payment. A lawsuit

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An adverse change in the industry that the borrower is employed in An adverse change in the area where the subject property is located

Collateral - A loan is secured using the subject property as collateral. Since the property is the lender's protection against default, it must be structurally sound and functional. When evaluating the collateral, an underwriter 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 and capability.

Condition - Is the home structurally sound and visually appealing? Is the home inhabitable or is it a dangerous contraption. Is the home complete as is or will renovations be required?

Property type/Use - 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 established guidelines. The underwriter should he able to confidently make a credit decision.

Q.5 Outline the main elements of the prudential norms relating to the credit and investment portfolios of banks. Discuss briefly the capital adequacy norms applicable to banks.A.5 Master Circular on ‘Prudential Norms on Capital Adequacy’ Purpose The Reserve Bank of India decided in April 1992 to introduce a risk asset ratio system for banks (including foreign banks) in India as a capital adequacy measure in line with the Capital Adequacy Norms prescribed by Basel Committee. 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 the risk weighted assets and other exposures, as also, capital requirements in the trading book, on an ongoing basis.This master circular covers instructions regarding the components of capital and capital charge required to be provided for by the banks for credit and market risks. It deals with providing explicit capital charge for credit and market risk and addresses the issues involved in computing capital charges for interest rate related instruments in the trading book, equities in the trading book and foreign exchange risk (including gold and other precious metals) in both trading and banking books. .

Capital adequacy norms:

The basic approach of capital adequacy framework is that a bank should have sufficient capital to provide a stable resource to absorb any losses arising from the risks in its business. Capital is divided into tiers according to the characteristics/qualities of each qualifying instrument. For supervisory purposes capital is 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 quality capital 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. The loss absorption capacity of Tier II capital is lower than that of Tier I capital

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Management of Financial Institutions

Assignment BMarks 10

Answer all questions.

Q.1 Explain briefly the main elements of the Asset Liability Management Framework prescribed by the RBI for the banks in India.A.1 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 increasing volatility in the domestic interest rates as well as foreign exchange rates, has brought pressure on the management of banks to maintain a good balance among spreads, profitability and long-term viability. These pressures call for structured and comprehensive measures and not just ad hoc action. The Management of banks has to base their business decisions on a dynamic and integrated risk management system and process, driven by corporate strategy. Banks 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 systems in banks which form part of the Asset-Liability Management (ALM) function. The initial focus of the ALM function would be to enforce the risk management discipline viz. managing business after assessing the risks involved. The objective of good risk management programmes should be that these programmes will evolve into a strategic tool for bank management.

The ALM process rests on three pillars:

ALM information systems=> Management Information System=> Information availability, accuracy, adequacy and expediency

ALM organization=> Structure and responsibilities=> Level of top management involvement

ALM process=> Risk parameters=> Risk identification=> Risk measurement=> Risk management=> Risk policies and tolerance levels.

4. ALM information systemsInformation is the key to the ALM process. Considering the large network of branches and the lack of an adequate system to collect information required for ALM which analyses information on the basis of residual maturity and behavioral pattern it will take time for banks in the present state to get the requisite information. The problem of ALM needs to be addressed by following an ABC approach i.e. analysing the behavior of asset and liability products in the top branches accounting for significant business and then making rational assumptions about the way in which assets and liabilities would behave in other branches. In respect of foreign exchange, investment portfolio and money market operations, in view of the centralized nature of the functions, it would be much easier to collect reliable information. The data

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

5. ALM organization5.1 a) The Board should have overall responsibility for management of risks and should decide the risk management policy of the bank and set limits for liquidity, interest rate, foreign exchange and equity price risks.b) The Asset - Liability Committee (ALCO) consisting of the bank's senior management including CEO should be responsible for ensuring adherence to the limits set by the Board as well as for deciding the business strategy of the bank (on the assets and liabilities sides) in line with the bank's budget and decided risk management objectives.c) The ALM desk consisting of operating staff should be responsible for analysing, monitoring and reporting the risk profiles to the ALCO. The staff should also prepare forecasts (simulations) showing the effects of various possible changes in market conditions related to the balance sheet and recommend the action needed to adhere to bank's internal limits.5.2 The ALCO is a decision making unit responsible for balance sheet planning from risk -return perspective including the strategic management of interest rate and liquidity risks. Each bank will have to decide on the role of its ALCO, its responsibility as also the decisions to be taken by it. The business and risk management strategy of the bank should ensure that the bank operates within the limits / parameters set by the Board. The business issues that an ALCO would consider, inter alia, will include product pricing for both deposits and advances, desired maturity profile of the incremental assets and liabilities, etc. In addition to monitoring the risk levels of the bank, the ALCO should review the results of and progress in implementation of the decisions made in the previous meetings. The ALCO would also articulate the current interest rate view of the bank and base its decisions for future business strategy on this view. In respect of the funding policy, for instance, its responsibility would be to decide on source and mix of liabilities or sale of assets. Towards this end, it will have to develop a view on future direction of interest rate movements and decide on a funding mix between fixed vs floating rate funds, wholesale vs retail deposits, money market vs capital market funding, domestic vs foreign currency funding, etc. Individual banks will have to decide the frequency for holding their ALCO meetings.

5.3 Composition of ALCOThe size (number of members) of ALCO would depend on the size of each institution, businessmix and organizational complexity. To ensure commitment of the Top Management, the CEO/CMD or ED should head the Committee. The Chiefs of Investment, Credit, Funds Management / Treasury (forex and domestic), International Banking and Economic Research can be members of the Committee. In addition the Head of the Information Technology Division should also be an invitee for building up of MIS and related computerization. Some banks may even have sub-committees.

5.4 Committee of DirectorsBanks should also constitute a professional Managerial and Supervisory Committee consisting of three to four directors which will oversee the implementation of the system and review its functioning periodically.5.5 ALM process:The scope of ALM function can be described as follows:Liquidity risk managementManagement of market risks(including Interest Rate Risk)Funding and capital planningProfit planning and growth projectionTrading risk management

The guidelines given in this note mainly address Liquidity and Interest Rate risks.

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Q.2 Explain briefly the major types of risks to which banks are exposed.A.2 In the course of their operations, banks is invariably faced with different types of risks that may have a potentially negative effect on their business. Risk management in bank operations includes risk identification, measurement and assessment, and its objective is to minimize negative effects risks can have on the financial result and capital of a bank. Banks are therefore required to form a special organizational unit in charge of risk management. Also, they are required to prescribe procedures for risk identification, 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, credit risk, market risks (interest rate risk, foreign exchange risk and risk from change in market price 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, operational risk, legal risk, reputation risk and strategic risk.

Liquidity risk is the risk of negative effects on the financial result and capital of the bank caused by the bank’s inability to meet all its due obligations.

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

Foreign exchange risk is the risk of negative effects on the financial result and capital of the bank caused by changes in exchange rates.

A special type of market risk is the risk of change in the market price of securities, financial derivatives or commodities traded or tradable in the market.

Exposure risks include risks of bank’s exposure to a single entity or a group of related entities, 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 the financial 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’s inability to collect claims from such entity for reasons arising from political, economic or social conditions in such entity’s country of origin. Country risk includes political and economic risk, and transfer risk.

Operational risk is the risk of negative effects on the financial result and capital of the bank caused by omissions in the work of employees, inadequate internal procedures and processes, inadequate management of information and other systems, and unforeseeable external events.

Legal risk is the risk of loss caused by penalties or sanctions originating from court disputes due to breach of contractual and legal obligations, and penalties and sanctions pronounced by a regulatory body.

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Reputation risk is the risk of loss caused by a negative impact on the market positioning of the bank.

Strategic risk is the risk of loss caused by a lack of a long-term development component in the bank’s managing team.

 Q.3. Describe the role of developmental financial institutions in industrial financing. Give examples of some of the developmental financial institutions in India.

A.3 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 25 years and should not exceed that period;(c) To grant credit to a single concern up to a maximum amount of rupees one crore. This limit can be exceeded with the permission of the government under certain circumstances;(d) Guarantee loans and deferred payments;(e) Underwrite and directly subscribe to shares and debentures issued by companies;(f) Assist in setting up new projects as well as in modernization of existing industrial concerns in medium and large scale sector;(g) Assist projects under co-operatives and in backward areas.

Specialized financial institutions may be divided into the following types:(a) All India Development Banks1. Industrial Development Bank of India (IDBI) 2. Small Industries Development Bank of India (SIDBI)3. Industrial Finance Corporation of India (IFCI)4. Industrial credit and Investment corporation of India (ICICI)5. National Bank for Agriculture and Rural Development(NABARD)6. Industrial Investment Bank of India Ltd. (previously, IndustrialReconstruction Bank of India)(b) State-level Institutions1. State Financial Corporations (SFCs)2. State Industrial Development Corporations (SIDC)3. State Industrial Investment Corporations (SIIC)(c) Investment institutions1. Unit Trust of India (UTI)2. Life Insurance Corporation of India (LIC)3. General Insurance Corporation (GIC)

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1. Case study: Please read the case study given below and answer questions given at the end.

Case Study Dilemma of Asian Bags

Asia Paper Bag has since 1990 operated as a manufacturer of plastic carrier bags supplying them on a contract-manufacturing basis to well-known supermarket chains, fast-food outlets, pharmacies and department stores. Lately, Asia Paper Bag exports customized plastic carrier bags to Marks n Spencer and Boots Pharmacy in the United Kingdom.

During the Asian financial crisis, Asia Paper Bag 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 debt moratorium of 24 months on the principal and an extension of the maturity period from five years to eight years.

Currently, Asia Paper Bag‘s turnover is about Rs 3million per month with an average net profit margin of 7%. Lately, with the increase in world oil prices, raw materials for plastic bag production have increased by over 5% to USD1, 200 per tone. Asia Paper Bag’s capacity utilization is still low at only 40%, after it expanded rapidly pre-crisis. Asia Paper Bag Sdn Bhd’s production capacity increased from 200,000 tonnes per annum to 350,000 tonnes per annum during the pre-crisis period. This was when the company borrowed a term loan of Rs. 10 million to finance the machinery. The raw materials, PE resins, are purchased mainly from Singapore and Thailand, whilst only 15% is sourced domestically.

Questions:a. List the qualitative risks of Asia Paper Bag relation to bank lending. Ans a. Asia paper bag request the bank to restructured the term loan by way of a debt moratorium of 24 months on the principal and an extension of the maturity period from five years to eight years. Which is not a good sign for a company, and it is matter which will effect on the long run. Next time when company will apply for loan or long term loan then bank will think about the past and will consider the case. Banks always go with the previous history in the loan banking. It will affect the company in the long term relationship. It will also leave bad impact on the share holders of the company. Their faith in the company will reduce.

b. List and explain the appropriate financial ratios to analyze the financial performance (profitability) of Asia Paper Bag Sdn Bhd.

Ans B Financial ratios quantify many aspects of a business and are an integral part of financial statement analysis. Financial ratios are categorized according to the financial aspect of 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

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Ratios generally hold no meaning unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition, are usually hard to compare

I will suggest two ratios for the company

Profitability ratios measure the firm's use of its assets and control of its expenses to generate an acceptable rate of return.

Market ratios measure investor response to owning a company's stock and also the cost of issuing stock.

c. State the motives for using ratio analysis as a credit evaluation tool. Ans C. Ratio Analysis is the study and interpretation of relationships between various financial variables, by investors or lenders. It is a quantitative investment technique used for comparing a company's financial performance to the market in general. A change in these ratios helps to bring about a change in the way a company works. It helps to identify areas where the management needs to change. Using 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 financial condition of the company, because company is doing well in the past year. So using ratio analysis can be a source of motivation for credit evaluation.

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Assignment C

Assignment – C1. The role of Financial Markets and institutions(a) Involves the movement of huge quantities of money.(b) Affects the profits of businesses.(c) Affects the types of goods and services produced in an economy.(d) Does all of the above.

2. Which of the following is a money market instrument(a) T-bill(b) IPO(c) Share(d) Option

3. Which of the following is a derivatives instrument :(a) Commercial Paper(b) Certificate of Deposit(c) Forward Contract(d) Reliance Shares

4. Which of the following is a capital market instrument :(a) Debenture(b) T-bill(c) Commercial Paper(d) Certificate of Deposit

5. Which Interest rates are important to financial institutions since aninterest rate increase :(a) Decreases the cost of acquiring funds.(b) Increases the cost of acquiring funds.(c) Raises the income from assets.(d) (B) and (C) of the above.(e) (A) and (C) of the above.

6. Bank Assurance refers to which of the following :(a) A tie up between insurance and bank whereby the insurance company can usethe sales channel of the bank(b) An assurance of safety by banks(c) An investment banking service provided by banks(d) Funding of insurance companies by banks

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7. What is an NBFC?(a) Nationalised banking and financing company(b) Non Bond Finance Coupon(c) Non Banking Financial Corporation(d) New-market Bond and Finance Corporation

8. Which of the following is an example of a commercial bank?(a) EXIM Bank(b) Citibank(c) SEBI(d) Reserve Bank of India

9. Which of the following is an example of a development bank ?(a) EXIM Bank(b) Citibank(c) SEBI(d) Reserve Bank of India

10. Capital Adequacy refers to which of the following :(a) It is the minimum amount of loan which has to be given by a bank(b) It is the ratio of the asset to liabilities of a bank.(c) It is the minimum capital which banks have to keep with the RBI to ensuresufficient funds in case of default.(d) It is the total capital of the bank.

11. Which of the following is an Over the counter (OTC ) Derivative instrument ?(a) Future(b) Option(c) Swap(d) Bonds

12. Which of the following is an exchange traded derivative instrument ?(a) Future(b) Forward(c) Swap(d) Bonds

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13. Primary Market refers to :(a) A subset of money market, where the government issues new T-bills(b) A subset of the money market, where the government issues new Bonds(c) A subset of the capital market, where the equities are traded(d) A subset of the capital market, where the company issues new equity

14. Secondary Market refers to :(a) A subset of money market, where the government issues new T-bills(b) A subset of the money market, where the government issues new Bonds(c) A subset of the capital market, where the equities are traded(d) A subset of the capital market, where the company issues new equity

15. For a project to be viable , the Net present value of the project should be:(a) Positive(b) Negative(c) Zero(d) NPV doesn’t have any impact on project viability.

16. Asset Liability Management for the banks involves :(a) Managing the assets and liabilities of companies who have taken creditfrom the bank(b) Consulting the companies who have taken credit on asset liabilitymismatch(c) It is a kind of risk management technique adopted by banks(d) It is a kind of profit enhancement technique adopted by banks.

17. Credit Risk refers to the risk of :(a) Risk of non payment of dues by the bank to its lenders.(b) Risk if non payment of dues to the bank by its borrowers.(c) Risk of non payment from credit card holders(d) Risk of non payment from the tax credits to RBI.

18. Which of the following is not a factor considered as a part of assetliability management by the banks ?(a) Currency rates(b) Interest rates(c) Liquidity(d) Employee Turnover

19. The price of one country’s currency in terms of another’s is called(a) The exchange rate.(b) The interest rate.

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(c) The Dow Jones industrial average.(d) None of the above.

20. Prudential norms relate to which of the following?(a) Norms related to Management of bank funds in a systematic manner.(b) Norms related to new equity investment as given by SEBI.(c) Norms by which Public Sector Companies have to comply.(d) Norms to be followed by RBI while making policy decisions.

21. Insurance companies are regulated by which institution?(a) SEBI(b) IRDA(c) RBI(d) State Governments

22. (I) Debt markets are often referred to generically as the bond market. (II)A bond is a security that is a claim on the earnings and assets of acorporation.(a) (I) is true, (II) false.(b) (I) is false, (II) true.(c) Both are true.(d) Both are false.

23. (I) A bond is a debt security that promises to make payments periodicallyfor a specified period of time. (II) A stock is a security that is a claim onthe earnings and assets of a corporation.(a) (I) is true, (II) false.(b) (I) is false, (II) true.(c) Both are true.(d) Both are false.

24. Reinsurance refers to which of the following :(a) A client who is taking insurance for the second time.(b) A company which is getting its assets insured by more than two companies.(c) Insurance taken by an insurance company itself(d) Insurance taken on something which is already insured.

25. Narsimhan Committee recommendations were in relation to which of thefollowing institutions :(a) Banks(b) RBI(c) SEBI(d) Capital Markets

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26. Typically, increasing interest rates(a) Discourage corporate investments.(b) Discourage individuals from saving.(c) Encourage corporate expansion.(d) Encourage corporate borrowing.(e) None of the above.

27. Compared to interest rates on long-term U.S. government bonds, interestrates on three-month Treasury bills fluctuate _____ and are _____ on average.(a) more; lower(b) less; lower(c) more; higher(d) less; higher

28. Banks, savings and loan associations, mutual savings banks, and creditunions—(a) Are no longer important players in financial intermediation?(b) Have been providing services only to small depositors since deregulation.(c) Have been adept at innovating in response to changes in the regulatoryenvironment.(d) All of the above.(e) Only (A) and (C) of the above.

29. Banks are important to the study of money and the economy because they–(a) Provide a channel for linking those who want to save with those who wantto invest.(b) Have been a source of rapid financial innovation that is expanding thealternatives available to those wanting to invest their money.(c) Are the only financial institutions to play a role in determining thequantity of money in the economy?(d) Do all of the above.(e) Do only (A) and (B) of the above.

30. Economists group commercial banks, savings and loan associations, creditunions, mutual funds, mutual savings banks, insurance companies, pension funds,and finance companies together under the heading financial intermediaries.Financial intermediaries :(a) Act as middlemen, borrowing funds from those who have saved and lendingthese funds to others.(b) Play an important role in determining the quantity of money in theeconomy.(c) Help promote a more efficient and dynamic economy.

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(d) Do all of the above.(e) Do only (A) and (C) of the above.

31. (I) Banks are financial intermediaries that accept deposits and make loans.(II) Included under the term ‘banks’ are firms such as commercial banks, savingsand loan associations, mutual savings banks, credit unions, and insurancecompanies.(a) (I) is true, (II) false.(b) (I) is false, (II) true.(c) Both are true.(d) Both are false.

32. The organization responsible for the conduct of monetary policy in India isthe–(a) Comptroller of the Currency.(b) SEBI(c) Reserve Bank of India(d) Bureau of Monetary Affairs.

33. The price paid for the rental of borrowed funds (usually expressed as apercentage of the rental of Rs 100 per year) is commonly referred to as the(a) Inflation rate.(b) Exchange rate.(c) Interest rate.(d) Aggregate price level.

34. The bond markets are important because(a) They are easily the most widely followed financial markets in India andthe United States.(b) They are the markets where foreign exchange rates are determined.(c) They are the markets where interest rates are determined.(d) Of all of the above.(e) Of only (A) and (B) of the above.

35. The stock market is important because(a) It is where interest rates are determined.(b) It is the most widely followed financial market in the United States.(c) It is where foreign exchange rates are determined.(d) All of the above.

36. Typically , stock prices in India and other world markets have been(a) Relatively stable, trending upward at a steady pace.(b) Relatively stable, trending downward at a moderate rate.

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(c) Extremely volatile.(d) Unstable, trending downward at a moderate rate.

37. A rising stock market index due to higher share prices(a) Increases people’s wealth and as a result may increase their willingnessto spend.(b) Increases the amount of funds that business firms can raise by sellingnewly issued stock.(c) Decreases the amount of funds that business firms can raise by sellingnewly issued stock.(d) Both (A) and (B) of the above.

38. A declining stock market index due to lower share prices(a) Reduces people’s wealth and as a result may reduce their willingness tospend.(b) Increases people’s wealth and as a result may increase their willingnessto spend.(c) Decreases the amount of funds that business firms can raise by sellingnewly issued stock.(d) Both (A) and (C) of the above.(e) Both (B) and (C) of the above.

39. Changes in stock prices(a) Affect people’s wealth and their willingness to spend.(b) Affect firm’s decisions to sell stock to finance investment spending.(c) Are characterized by considerable fluctuations.(d) All of the above.(e) Only (A) and (B) of the above.

40. Money is defined as(a) Anything that is generally accepted in payment for goods and services orin the repayment of debt.(b) Bills of exchange.(c) A risk less repository of spending power.(d) All of the above.(e) Only (A) and (B) of the above

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1. B2. A3. D4. D5. D6. C7. D8. B9. A10. A11. C12. B13. C14. A15. C16. C17. B18. D19. B20. A21. B22. A23. A24. A25. C26. C27. D28. C29. D30. C31. B32. A33. A34. A35. C36. C37. C38. B39. C40. D