Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
INSTITUTE OF BANKERS IN MALAWI ADVANCED DIPLOMA IN BANKING EXAMINATION SUBJECT: FINANCIAL MARKETS II Date: Time Allocated: 3 hours (13:30 – 16:30 pm) SUGGESTED SOLUTIONS SECTION A 1. FROM: To: Subject: (60 MARKS) MEMO Martyre Consulting Group (MCG) Government of Martyred Economic policy choices for 2014/15 fiscal year a) Monetary Policy relates to the control of some measure (or measures) of the money supply and /or the level and structure of interest rates. The importance attached to monetary policy within a government’s policy package will depend not only upon its view of the operations of the economy but also upon its decision it has reached regarding the priority given to different objectives (2 Marks) b) Fiscal Policy is concerned with decision regarding the level and structure of government expenditure and taxation. Given the importance of the level of government expenditure and taxation in determining the size of the public sector borrowing requirement of the debt repayment, fiscal policy also involves decisions regarding the size of the public sector borrowing requirement. (2 Marks) c) Exchange rate policy involves the targeting of a particular value of the exchange rate relative to any one currency may carry particular weight the value of the currency relative to the country’s major trading partners in general is more likely to be objective. (2 Marks) d) Price and Income Policy is intended to influence the rate of inflation by means of either statutory or voluntary restriction upon increase in wages, dividends and/ or prices and incomes over which such a policy may prevail, and the degree of statutory control involved, is subject to considerable variation. (2 Marks) e) National Debt Management Policy is concerned with the manipulation of the outstanding stock of government debt instruments held by the domestic private sector with the objective of influencing the level and structure of interest rate and/ or the availability of reserves asset to the banking system (2 Marks) A qualification examined by the Institute of Bankers in Malawi 2 (Total Marks 10 Marks) Actual as at 30th June 2013 Target for 30th June 2014 Policy Key economic indicator Martyre Kwacha/USD Minimum wage Inflation Income tax Treasury bills issued 350 MK 18,000 30% 30% MK 500 Bn 400 MK 30,000 20% 40% MK 700 Bn Exchange rate policy Price & Income policy Monetary policy Fiscal Policy National Debt Policy (3 marks) 3. It is important that government takes a mixture because one policy has an influence on the outcome for another policy i.e. a pursuant of fiscal policy has impact on the monetary policy (2 marks) Question 2 FROM: To: Subject: a) b) Officer Supervisor Response to petition by movement for justice Reserve requirements; Banks and building societies need to hold a base of reserve asset for prudential purposes. If and when a bank or building society false to its minimum desired reserve asset ratio it will have to turn away any incoming demands for loans or else seek to acquire additional reserve assets from which to expand its lending Special deposits are deposits that reserve bank of Malawi may require certain banking institutions to deposits, equal to a specified proportion of certain element of their deposits liabilities, are the frozen at the reserve bank of Malawi and may not be used as part of the reserve asset within the system. c) Supplementary special deposits are additional deposit are deposit that banking institutions had to make at the reserve bank of Malawi if and when a category of their deposit liability exceeded an upper limit set by the reserve bank of Malawi. d) ‘Moral suasion refers to the range of informal request and pressure that reserve bank of Malawi may exert over banking institutions. The extent to which this is a real power of the bank relative to direct controls is open to question, since A qualification examined by the Institute of Bankers in Malawi 3 much of the pressure that the bank would exert would involve the institutions taking actions that were not in their commercial interest. e) Direct controls involve the Reserve Bank of Malawi in issuing directives in order to attain particular targets. Thus for example, the RBM might impose control on interest rates payable upon deposits, impose limits on the volume of credit creation or direct banks priorities lending banks priorities lending according to type of customers. Total Marks (10 Marks) i) The prices for banking services – Direct control ii) The banks to open agencies in districts – Moral suasion iii) High lending rate – Direct control iv) Banks corporate social responsibilities – Moral suasion v) Increased capital requirement – Reserve requirement (5 Marks) (Total 15 Marks) Question 3 i) Covered interest parity is condition relating the interest rate differential on similar financial assets in two nations to the spot and forward exchange rates, in equilibrium; the interest differential on the two assets is equal to the forward premium or discount. If covered interest parity does not hold, financial arbitrage is possible, and individuals will move savings from one nation to another. Uncovered interest parity is a condition relating the nominal interest rate differential on two similar financial instruments to the expected change in the spot exchange rate. If there is a sizable amount of foreign exchange risk or country risk, the interest rate differential may also reflect a risk premium, which compensates individuals for the additional risk they assume. (5 Marks) ii) Open ended Investment Scheme is any collective investment scheme which offers for sale on a continuous basis or has outstanding any security which is redeemable at the holder’s option. Another distinguishing feature is that the scheme agrees to buy back shares from investors at any time. Similarities: A qualification examined by the Institute of Bankers in Malawi 4 Both terms refer to types of investment schemes. (5 Marks) Leading is the bringing forward from the original due dates the payment of a debt while lagging is the postponement of a payment beyond the due date. Similarities: Both terms refer different ways of hedging against foreign currency risks. (5 Marks) Crawling peg is an exchange rate arrangement in which a country peg its currency to the currency of another nation but allows the parity value to change at regular time intervals. The most common argument foe pegged exchange rates is that reducing exchange rate volatility and uncertainty may yield gains in economic efficiency. Currency basket peg is an exchange rate system in which a country pegs its currency to the weighted average value of a basket or selected number of currencies. The most common argument pegging one’s currency is that it reduces exchange rate volatility and uncertainty may yield gains in economic efficiency. Similarities: Both terms refer to different exchange rate systems (4 Marks) (Total 15 Marks) Question 4 i) Fund Manager is a corporate body or an institution or an individual that manages the collective investment scheme. The fund managers will handle operation, human resources and finance of the collective investment scheme. Mostly fund managers are financial institutions like banks, discount houses, and brokers. A qualification examined by the Institute of Bankers in Malawi 5 ii) Fund Administrators mages the trading, reconciliations, valuation and unit pricing. iii) Board of Directors or trustees are persons who are entrusted with safeguarding the assets and ensuring compliance with laws, regulations and rules of the collective investment scheme. iv) Unit holders these are persons who own (or rights to) the assets and associated income of collective investment scheme. (8 Marks) a) Load open-ended investment scheme is a scheme that charges a sale fee for shares sold. The offering price for a share of a load scheme equals the net asset value plus sale charge, which can be as large as 7.5 -8% of the net asset value. A Load open-ended investment scheme imposes no initial sales charge so it sells shares at their asset value. Some of these funds charge a small redemption fee of about one-half of % (5 Marks) a) Cost of shares = MK 5,000,000. Number of shares = 1,000,000 shares 5% of MK 5,000,000.00 = MK 250,000.00 Therefore 1,000,000 shares costing MK 4,750,000.00 The cost per share is MK 4.75 (3 Marks) (Total 15 Marks) SECTION B (40 MARKS) Question 5 A qualification examined by the Institute of Bankers in Malawi 6 1. Transaction exposure is the risk that the cost of a transaction, or the proceeds from a transaction, in terms of the domestic currency, may change due to changes in exchange rates Transaction exposure is created when a firm agrees to complete a foreign currency denominated transaction some future time in the future. Translation exposure is the foreign exchange risk that results from the conversion of the future value of a firm’s foreign currency denominated assets and liabilities into a common currency value. Translation risk arises because financial data denominated in one currency are then expressed in terms of another currency. Between two accounting dates the figures can be affected by exchange rate movements, greatly distorted comparability. The translation exposure has two elements the balance sheet effect (Financial Position Effect) assets and liabilities denominated in a foreign currency can fluctuate in value in home currency terms with forex market changes. The profit and loss account effect (Comprehensive Income Effect) currency changes can have an adverse impact on the profit because of the translation of foreign subsidiary units. Economic exposure is the risk that changes in exchange values might alter a firm’s present value of future income stream. Economic exposure affects the ability of a firm to compete in a particular market over an extended period of time. (9 Marks) i) ii) iii) iv) v) vi) Invoice customer in the home currency Do Nothing Netting Matching Leading and lagging Money market hedge (One of them) (1 Mark) i) ii) iii) Expansion of agricultural export base – More agricultural products will be commercial and exported there by creating foreign currency for the country Explorations of mining- the exploration of minerals and exportation of minerals will bring more create a forex base for the country as a majority of the minerals will be sold to other countries. Regional Transport integration – where the transport system is integrated regionally the cost of transportation will be low, and therefore A qualification examined by the Institute of Bankers in Malawi 7 the prices of the goods will also be low, making the goods compete at the international markets iv) Foreign direct investment – the foreign companies will provide startup capital in foreign currency and this will boost the local forex reserve. Increased domestic manufacturing – will slow the import base thereby creating a low pressure to provide import cover. (10 Marks) v) (Total 20 Marks) Question 6 Segmented markets theory Segmented market theory is a theory of the term structure of interest rates that views Bonds with differing maturities as non-substitutable, so that their yields differ because They are determined in separate markets. The key idea behind the segmented markets theory of the term structure of interest rates in that financial instruments with differing terms to maturity are not perfect substitutes .consequently , they essentially are traded in separate financial markets ,even though they may be nearly identical instruments in all respect other than in their terms to maturity. Then the interactions between supply and demand conditions within each individual market determine each instrument’s yield. The expectation theory The expectation theory of the term structure of interest rates that views bonds with differing maturities as perfect substitutes, causing their yields to differ solely because traders anticipate that short – term interest rates will rise or fall. A theory that can shed light on both of these issues is called the expectation theory of the term structure of interest rates, we can illustrate that basic features of the expectation theory be examining a setting in which an individual plans to save funds over a two – year period. The individual confronts two possibilities. One option is to hold a two year bond for two years to maturity or to hold a year bond but roll it for two years. Naturally the individual would be willing to hold either one –year bond or either a two year bond only if he expects that his return over the two would be the same. A qualification examined by the Institute of Bankers in Malawi 8 The preferred habitat theory Preferred habitat theory of the term structure of interest rates that views bonds as imperfectly substitutes, so that yields on long term bonds must be greater than those on short term bonds even if short-term interest rates are not expected to rise or fall The key assumption on preferred habitat theory is that holding all other factors constant investors usually prefer to hold financial instruments with shorter maturities. The reason is that short term instruments are more liquid hence desired as compared to long term instruments. (Total 20 Marks) Question 7 Current Price – is the underlying price The current price will change as the price of the underlying asset changes. For a call option as the underlying price increases. (4 Marks) Strike Price – is the strike price which is fixed for the life of the option. All other factors equal, the lower the strike price, the higher for a call option. (4 Marks) Time to expiration – An option is wasting asset. That is, after the expiration date the option, ha no value. All other factors equal, the longer the time to expiration of the option, the higher the option price. This is because, as the time expiration decreases, less time remains for the underlying asset’s price to rise (for a call buyer) or fall (for a put buyer), and therefore the probability of a favorable price movement decreases. (4 Marks) Expected price volatility of the underlying asset over the life of the option. The greater the expected volatility (as a measure by the standard deviation or variance) of the price of the underlying asset, the more an investor would be willing to pay for the option, and the more an option writer would demand for it. (4 Marks) Short – term, risk free interest rate over the life of the option A qualification examined by the Institute of Bankers in Malawi 9 Buying an option on the same quantity of the underlying asset makes the difference between the asset price and the option available for investment at an interest rate at least as high as the risk-free rate. (4 Marks) Total Marks (20 Marks) Question Eight The four panels below relate to a Malawi Kwacha currency and a Botswana pula currency, in relation to interest rates Vis a Vis supply and demand for these two countries. S (K/BWP) F (K/BWP) SBWP S’BWP A SBWP F2 S1 S2 B F1 B A DBWP D’BWP Q BW P DBWP Q BW P Q 1 BWP Q 2 BWP Q 1 BWP Panel (a) Q 2 BWP Panel (b) RBW S’L S’L SL SL B R1MW R2BW R1BW A R2MW B A DL Q 2 L Q1 L Panel (c) DL Q 2 L Q1 L Panel (d) A qualification examined by the Institute of Bankers in Malawi 10 Each of these market frameworks at an initial equilibrium indicated by point ‘A’ Panel a show the spot market for the Botswana pula, panel b) displays the forward market for the pula, panel c illustrates the loanable funds (L) market in Botswana, and panel d displays the market for loanable funds in Malawi. To move savings into Malawi, individuals must exchange the Botswana pula for the kwacha, so there is an increase in the demand for the kwacha. The increase in demand for the kwacha corresponds to an increase in the supply of the pula, shown by a shift of the supply curve in panel ‘a’ from S BWP to S’BWP as shown in panel a, the increase in the supply of the pula in the spot market causes a decline in the spot rate, or depreciation of the pula relative to the kwacha, shown by the movement from S 1 to S 2. Botswana individuals who purchase Malawi treasury instrument will likely desire to receive their principal and interest in pula upon maturity If these individuals cover their exposure to foreign exchange risk, they will purchase the pula forward. This is illustrated by an increase in the demand for pula in the forward market, shown by a shift from DBWP to D’BWP in panel b, the increase in the demand for the pula on the for the pula on the forward market will cause the Pula to appreciate relative to the kwacha, as shown by an increase in the forward rate from F1 to F2. The flow of savings out of Botswana causes a decrease in the supply and loanable funds, shown by the shift of the supply curve from SL to S’L in panel C. a decrease in supply of loanable funds in Botswana causes an increase the Botswana interest rate from RBW1 to RBW2. The flow of savings into Malawi causes an increase the supply of loanable funds from SL to S’L in panel d which causes Malawi interest rate to decline from RMW1 to RMW2. (Total 20 Marks) END OF EXAMINATION PAPER A qualification examined by the Institute of Bankers in Malawi 11