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 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 firms 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 instruments 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 alongposition, 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 orfinancialinstruments and intangible assets or referenced
items such asstock indexes andinterest rates.The future date is called the
delivery date
or
final settlement date
. The official price of the futures contractat the end of a days 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 markets 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

3
not the duration between trade and delivery dates. For example, let us assume that
the abovementionedcontract 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 adusts 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 traders 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

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, 1HJ. The
selection measure for listing a bankunder the 4econd 4chedule was provided in
section J; (K0 of the Reserve 'ank of India Act, 1HJ. Activities of :ommercial
'anksThe modern :ommercial 'anks in India cater to the financial needs of different
sectors. The mainfunctions of the commercial banks comprise=


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'
nonbanking 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 nonbanking 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
nonbankingfinancial company (residuary nonbanking 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

. :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 lendinknown 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 borrowers credit history, you first need to have a goal in mind.
Thegoal should be to confirm that the borrowers history meets
or exceeds
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 lenders 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 threeThe mortgage payment history Is the
number of late payments at or below the lenders standardThe 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
linelimitere is an example of a lenders 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 borrowers credit is, they must demonstrate the financial
capacityto handle the debt. Reviewing the borrowers past income and employment
history is the best indicator ofthe ability to handle future debt. The following items
should be considered when analy9ing yourborrowers capacity=4tability as the
borrowers employment remained stable for two or more years as it been in
thesame or a related field <oes the income fluctuate or is it consistentIncome
Type 8hat is the nature of the borrowers 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 therefore not guaranteed If
it is from a source other than traditional employment, howlong will it
continueIncome 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 it5 5ow much is it5 and 58hen can they get it5 will helpyou
evaluate your borrowers 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
subect 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

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
ollateral 8
A loan is secured using the subect property as collateral. 4ince the property is
the lendersprotection 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 areaFunctionality
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, nonfunded items and other
offbalance 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
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 longterm 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
AssetDiability 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 obective 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
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 banks 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 banks budget anddecided risk management
obectives.
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 banks 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.
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 subcommittees.
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 proection 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 riskidentification, measurement and
assessment, and its obective 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 a
ndeconomic 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
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
longterm 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 mediumterm credit to industrial concerns engaged in manufactur
ing, 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 proects 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
contractmanufacturing basis to wellknown supermarket chains, fast food
outlets, pharmacies
anddepartment stores. Dately, Asia @aper 'ag exports customi9ed plastic carrier ba
gs 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 precrisis. 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 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 firms use of its assets and control of its expenses
to generate anacceptable rate of return.

Market ratios measure investor response to owning a companys 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 companys 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, instittions$a%
Involves the movement of huge quantities of money.
$R% Affects the 'rofits of Rsinesses.$c% Affects the t'es of goo,s an, serxices
'ro,ce, in an econom.$,% oes all of the aRoxe.2. (hich of the follo,ing is a mone
marbet instrment$a
x T-bill
$R% -O$c% hare$,% O'tion3. (hich of the follo,ing is a ,erixatixes instrment
$a% Commercial a'er $R% Certificate of e'osit$c%
Forward Contract
$,% eliance hares4. (hich of the follo,ing is a ca'ital marbet instrment $a%
eRentre$R% TRill$c%
Commercial Paper
$,% Certificate of e'osit5. (hich -nterest rates are im'ortant to financial instittions
since aninterest rate increase $a% ecreases the cost of ac iring fn,s.$R%
-ncreases the cost of aciring fn,s.$c% aises the income from assets.$,%
bx and Cx of the above.
$e% $A% an, $C% of the aRoxe.6. anb Assrance refers to ,hich of the follo,ing
$a% A tie ' Ret,een insrance an, Ranb ,hereR the insrance com'an can sethe
sales channel of the Ranb $R%
,n assurance of safety by bans

15$c% An inxestment Ranbing serxice 'roxi,e, R Ranbs$,% Fn,ing of insrance

com'anies R Ranbs7. (hat is an FC$a% ationalise,
Ranbing an, financing com'an$R% on on, Finance Co'on$c%
$on baning Financial Corporation
$,% e,marbet on, an, Finance Cor'oration8. (hich of the follo,ing is
an eam'le of a commercial Ranb$a%
%RI' ban

$R% CitiRanb $c% -$,% eserxe anb of -n,ia9. (hich of the follo,ing is an
eam'le of a ,exelo'ment Ranb $a% :- anb $R%
Citiban
$c% -$,% eserxe anb of -n,ia10. Ca'ital A,eac refers to ,hich of the
follo,ing $a% -t is the minimm amont 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 bans 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 conter
$OTC % erixatixe instrment $a% Ftre$R% O'tion$c% ,a'$,%
bonds
12. (hich of the follo,ing is an echange tra,e, ,erixatixe instrment $a% Ftre$R%
For,ar,$c%
wap
$,% on,s

1613. rimar arbet refers to $a% A sRset of mone marbet; ,here

the goxernment isses ne, TRills$R%
, subset of the money maret where the government issues new bonds
$c% A sRset of the ca'ital marbet; ,here the eities are tra,e,$,% A sRset of the
ca'ital marbet; ,here the com'an isses ne, eit14. econ,ar arbet refers to
$a% A sRset of mone marbet; ,here the goxernment isses ne, TRills$R%
A sRset of the mone marbet; ,here the goxernment isses ne, on,s$c%
, subset of the capital maret where the equities are traded
$,% A sRset of the ca'ital marbet; ,here the com'an isses ne, eit15. For a
'ro<ect to Re xiaRle ; the et 'resent xale of the 'ro<ect shol, 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 $R% Conslting the com'anies ,ho haxe taben cre,it on asset
liaRilitmismatch$c%

It is a ind of ris management technique adopted by bans

$,% -t is a bin, of 'rofit enhancement techni e a,o'te, R Ranbs.17. Cre,it isb
refers to the risb of $a% isb of non 'ament of ,es R the Ranb to its len,ers.$R
%
is if non payment of dues to the ban by its borrowers.
$c% isb of non 'ament from cre,it car, hol,ers$,% isb of non 'ament 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 $a% Crrenc rates$R% -nterest rates$c%
@ii,it$,%
%mployee Turnover

1719. The 'rice of one contr?s crrenc 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.
$R% orms relate, to ne, eit inxestment as gixen R -.$c%
orms R ,hich Rlic ector Com'anies haxe to com'l.$,%
orms to Re follo,e, R - ,hile mabing 'olic ,ecisions.21. -nsrance
com'anies are reglate, R ,hich instittion$a% -$R%
I,,
$c% -$,% tate Boxernments22. $-% eRt marbets are often referre, to
genericall as the Ron, marbet. $--%A Ron, is a secrit that is a claim on the
earnings an, assets of acor'oration.$a%
Ix is true IIx false.
$R% $-% is false; $--% tre.$c% oth are tre.$,% oth are false.23. $-% A
Ron, is a ,eRt secrit that 'romises to mabe 'aments 'erio,icallfor a s'ecifie,
'erio, of time. $--% A stocb is a secrit that is a claim onthe earnings an, assets of a
cor'oration.$a% $-% is tre; $--% false.
bx Ix is false IIx true.
$c% oth are tre.$,% oth are false.24. einsrance refers to ,hich of
the follo,ing $a%

, client who is taing insurance for the second time.

$R% A com'an ,hich is getting its assets insre, R more than t,o com'anies.$c%
-nsrance taben R an insrance com'an itself $,% -nsrance taben on something
,hich is alrea, insre,.25. arsimhan Committee recommen,ations ,ere in
relation to ,hich of thefollo,ing instittions $a%
ban

18$R% -$c% -$,% Ca'ital arbets26. T'icall; increasing interest

rates$a% iscorage cor'orate inxestments.$R% iscorage in,ixi,als from saxing.$c
% ncorage cor'orate e'ansion.$,% ncorage cor'orate Rorro,ing.$e%
$one of the above.
27. Com'are, to interest rates on longterm .. goxernment Ron,s; interestrates
on threemonth Treasr Rills flctate DDDDD an, are DDDDD on axerage.$a%
moreE lo,er $R%
less lower
$c% moreE higher $,% lessE higher 28. anbs; saxings an, loan associations;
mtal saxings Ranbs; an, cre,itnions $a% Are no longer im'ortant 'laers
in financial interme,iation$R% Gaxe Reen 'roxi,ing serxices onl to small ,e'ositors
since ,ereglation.$c% Gaxe Reen a,e't at innoxating in res'onse to changes in the
reglatorenxironment.$,% 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 Recase the $a%
roxi,e a channel for linbing those ,ho ,ant to saxe ,ith those ,ho ,antto inxest.$R%
Gaxe Reen a sorce of ra'i, financial innoxation that is e 'an,ing thealternatixes
axailaRle to those ,anting to inxest their mone.$c% Are the onl financial
instittions 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,itnions;
mtal fn,s; mtal saxings Ranbs; insrance com'anies; 'ension fn,s;an, finance
com'anies together n,er the hea,ing financial interme,iaries.Financial interme,iaries
$a% Act as mi,,lemen; Rorro,ing fn,s from those ,ho haxe saxe, an, len,in

19these fn,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
sch as commercial Ranbs; saxingsan, loan associations; mtal saxings Ranbs; cre,it
nions; an, insrancecom'anies.$a%
Ix is true IIx false
.$R% $-% is false; $--% tre.$c% oth are tre.$,% oth are false.32. The
organiIation res'onsiRle for the con,ct of monetar 'olic in -n,ia isthe $a%
Com'troller of the Crrenc.$R% -$c%
eserve ban of India
$,% rea of onetar Affairs.33. The 'rice 'ai, for the rental of Rorro,e, fn,s
$sall e'resse, as a 'ercentage of the rental of s 100 'er ear% is commonl
referre, to as the$a% -nflation rate.$R% change rate.$c%
Interest rate.
$,% Aggregate 'rice lexel.34. The Ron, marbets are im'ortant Recase$a% The are
easil the most ,i,el follo,e, financial marbets in -n,ia an,the nite, tates.$R%
The are the marbets ,here foreign echange rates are ,etermine,.$c%
They are the marets where interest rates are determined.
$,% Of all of the aRoxe.$e% Of onl $A% an, $% of the aRoxe.35. The stocb
marbet is im'ortant Recase$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.
37. A rising stocb marbet in,e ,e to higher share 'rices$a% -ncreases 'eo'le?s
,ealth an, as a reslt ma increase their ,illingnessto s'en,.$R%

Increases the amount of funds that business firms can raise by

sellingnewly issued stoc.
$c% ecreases the amont of fn,s that Rsiness firms can raise R sellingne,l isse,
stocb.$,% 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 reslt ma re,ce
their ,illingness tos'en,.$R% -ncreases 'eo'le?s ,ealth an, as a reslt ma increase
their ,illingnessto s'en,.$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 flctations.$,%
,ll of the above.
$e% Onl $A% an, $% of the aRoxe.40. one is ,efine, as$a% Anthing that is
generall acce'te, in 'ament for goo,s an, serxices or in the re'ament of ,eRt.$R%
ills of echange.$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.

:
6.
<
7.
'
8.
A
09.
A
00.
:
01.
'
02.
:
03.
A
04.
:
05.
:
06.
'
07.
<
08.

'
19.
A
10.
'
11.
A
12.
A
13.
A
14.
:
15.
:
16.
<
17.
:
18.
<
29.
:
20.
'
21.

A
22.
A
23.
A
24.
:
25.
:
26.
:
27.
'
28.
:
39.
<