FIM Questions and Answering Techniques

FIM Questions and Answering Techniques

Chapter 1: Economics of Financial System

1.            Write about the different institutions participating in financial markets in the context of Nepal.

Ans: Regulatory Institutions

Intermediaries

   Depository (Banking)

   Non-depository (Non-banking)

Non-intermediaries

2.            What Define financial system. Write about different types of securities instruments used in the financial markets.

Ans: Definition of financial system,

         Components of financial system

            Markets

            Institutions

            Instruments

                        Money market instruments: T-bills, CDs, CP, BA etc..

                        Capital market instruments: Corporate securities, Government bonds, and ….

3.            What are the basic needs served by financial system? Explain in brief about the various technologies adopted in financial system to serve those needs.

Ans: Financial system, opening line

         Deal very briefly the basic needs served by FS; payment…all in one paragraph

         Explain briefly the technologies; credit substitution, delegation, netting, pooling

4.            What are the basic forms of risk in trade? Explain how risk is shared in one of those forms of trade.

Ans: Insurance and Forward Transaction: Write why they are form of risk trading

         Explain with example in one, how risk is shared; eg, forward transaction: steel mining company and plane manufacture company, risk of price fall for one and price rise for another, entered into forward transaction to share risk

5.            What do you understand by efficiency in the financial markets? What are the government measures to promote efficiency?

Ans: Major conditions for market efficiency: Competitive pricing, minimum transaction cost, and service integration

         Reason for inefficiency: Economies of scale, natural monopoly

         Government intervention: to lower cost and to promote competition

Chapter 2: Money, Prices, Interest Rates and Exchange Rates

6.            What do you mean by nominal interest rate and real interest rate? Explain the relationship between interest rate and the inflation.

Ans: Define nominal interest rate

         Define real interest rate and inflation

         Explain the fisher equation

         Take a numerical example, show real interest rate subtracting inflation from nominal rate

7.            Explain pure expectation theory of term structure. How this theory differs to that of preferred habitat theory?

Ans: First explain the pure expectation theory with examples

         Then point out the key differences with preferred habitat theory

                                                                                       

8.            Explain with example the impact of inflation on exchange rate and draw your conclusion.

9.            Suppose the yield on 11-year bond is 10.6 percent. If the yield on 9 and 10-year bonds are 10.25 and 10.50 percent. Determine the forward rate on two year bond starting on year 10.

Ans: You can do it

10.        Consider the following rates for bonds of differing maturities

  

  Maturity                                       Yield

1                                                                                              10%

2                                                                                              11%

3                                                                                              12%

4                                                                                              13%

5                                                                                              14%

         Compute all possible forward rates.

Ans: You can do it

11.        Five year ago, you invested Rs.100,000 in a portfolio of Treasury Bill and kept all proceeds fully invested in the portfolio. Today your portfolio worth Rs.146,932. What nominal rate of interest have you earned over this period? At the time of purchase, the consumer price index (CPI) stood at 133, and today it is at 189. What was the average inflation over the period?

Ans: You can do it

Chapter 3: Financial Intermediation by Depository Institutions

12.        Explain with examples about the factors affecting deposit and loan pricing.

Ans: Competitive environment

         Asymmetric information and adverse selection: explain with example how asymmetric information leads to adverse selection      

         Default risk

         Transaction cost

13.        What are the major risks faced by financial institutions? Explain about interest rate risk?

Ans: Credit, liquidity, interest rate, foreign exchange and operational risk

         While dealing with interest rate risk, don’t forget to explain the i) impact of increase in interest rate when the maturity of assets exceeds maturity of liability and ii) impact of interest rate decrease when the maturity of liabilities exceeds maturity of assets.

14.        What is credit risk? How does an FI evaluate its credit risk with respect to mid-market commercial and industrial lending?

Ans: Define credit risk, arises from credit quality problem

         To manage;        i) Credit analysis             

                                                Five Cs of Credit,

                                                cash flow analysis,

                                                ratio analysis,

                                                common size analysis

                                    ii) Calculation on return on loan

                                                ROA approach

                                                RAROC approach

           

                        Explain above two points very briefly

15.        What do you mean by liquidity risk in the financial institutions? Discuss about the sources of liquidity to manage such risk.

Ans: Define liquidity risk, types asset side and liability side liquidity risk

         Explain how it arises:   Deposit withdrawal: lack of confidence, need of money

                                                            Exercise of loan commitment

         Sources: i)          stored liquidity (reserve, asset sell etc.) and

ii)                  purchased liquidity (inter bank borrowing, discount window)

16.        Explain in brief, the methods of measuring liquidity exposure in financial institution.

Ans: sources and uses of liquidity, maturity ladder, peer group ratio comparison, liquidity index, financing gap and financing requirement analysis, and liquidity planning

17.        Why calculation of Return on Loan is important in the credit risk management process? Explain the Return on Asset (ROA) approach and Risk Adjusted Return on Capital (RAROC) approach of calculating return on loan.

Ans: Above in Q 14

18.        The Acme Corporation is acquired by the Conglomerate Corporation. To help finance the takeover, Conglomerate is going to liquidate the overfunded portion of Acme’s pension fund. The assets listed below are going to be liquidated. Listed are their face values, liquidation values today and their anticipated liquidation values one year from now (their fair market values).

Assets	Face Value	Current Liquidation Value	One-year liquidation value
IBM stock	$10,000	$9,900	$10,500
GE Bonds	5,000	4,000	4,500
Treasury Securities	15,000	13,000	14,000

         Calculate the one year liquidity index for these securities.

Ans: You can do it

Chapter 4: Insurance

19.        Explain insurance in terms of risk trading. Discuss the incentive problems in insurance business.

Ans: Define insurance explaining how risk is shared.

         Define incentive problems; Write the parties involved in insurance business and explain their interest; Explain mechanism that creates incentives to different parties i.e., insurance contract and organizational form of insurer

20.        What do you understand by Life Insurance? Discuss different types of life insurance policies offered by insurance companies.

Ans: You can do it from handout: be careful with the marks and the time given

21.        Explain the different types of non-life insurance policies.

Ans: Explain both health insurance and property and liability insurance

22.        Explain the regulation of insurance industry in Nepal.

Ans: Open a paragraph with insurance and need for regulation in insurance business; Write regulatory framework; Write about regulator and its roles

         Generalize the provisions made in regulatory framework: don’t forget major provisions for regulation and supervision of insurer, agents, surveyor and insured

Chapter 5: Securities Markets

23.        Define securities markets. Explain the three major functions of securities markets? 

Ans: Securities markets

         Functions:

            Price discovery: Definition, basis for evaluation and expectation, bid and offer prices, price formation in auction and dealer market

                       

            Liquidity provision: definition, need for converting securities into cash, pooling of diverse need for investing in securities and requiring cash, conditions for liquidity i.e. marketability and fair price, liquidity imbalance

            Minimization of trading cost: standardization: importance of cost reduction in financial markets, ways to reduce trading cost: restricted access and rules of conduct, standardization, conflict resolution, and guaranteed execution

24.        What are the three basic mismatches between the savers and the borrowers in the economy? Explain how securities markets reconcile these mismatches.

Ans: Saving and borrowing aspects of economy in brief

         Amount, duration and cost/return mismatch and its reconciliation by securities markets

          

25.        Explain the general organization of securities markets.

Ans: About securities markets, brief

         Primary market: private placement and public issue (IPO, FPO, and Rights Offering) and secondary market (stock exchange, OTC market and third and fourth markets)

26.        What do you understand by ‘Clearing and Settlement’? Explain the process of clearing and settlement in securities market.

Ans: Clearing, settlement, figure, explanation of figure

27.        Write about the regulation of securities markets in Nepal. 

Ans: Open a paragraph with securities markets and purpose of its regulation

         Write regulatory framework;

         Write about different regulators and their roles

         Write the general regulatory provisions

Chapter 6: Market for Government Securities Markets

28.        Write about different types of Government Securities.

Ans: discount securities and coupon securities, bearer and book entry securities, TIPS and TIIS

29.        Write about Treasury Bills. What do you understand by competitive and non-competitive bids on Treasury Bills? Explain with example. 

Ans: Purpose of issuing government securities, T-bills: nature, process of issue (Auction), competitive and non-competitive auction with hypothetical numerical example

30.        Explain about the government securities markets in Nepal.

Ans: regulatory framework, issuer, types, issue process, secondary market management

Chapter 7: Stability of the Financial System

31.        What are the Government solutions for bank runs and banking panics? Explain.

Ans: Define bank run and panics

         Government solution: regulation and supervision, lender of the last resort, discount window, government guarantee

32.        What are the private solutions for bank runs and banking panics?

Ans: Define bank run and panics

         Private solution: clearing house association, private guarantee

33.        What are the factors affecting stability in the financial system?

Ans: Fragmentation and interdependence, connection between banks and securities markets, institutional investors, globalization, methods of managing liquidity

34.        Short notes

a)            Payments

b)            Delegation

c)            Credit substitution

d)           Life Insurance

e)            Health Insurance

f)             Property and Liability Insurance

g)            Price discovery

h)           Risk of trade execution

i)              Minimization of trading cost

j)              OTC markets

k)            Clearing and settlement

l)              Dealer market and auction market

m)         Government securities

Ans: Note the time and mark, don’t miss the major points