MONEY, BANKING AND FINANCIAL INSTITUTIONS EXAM Time: 2 Hrs

Instructions to Candidates: Answer question 1 (Compulsory) and any other two questions. 1. a) Discuss the loanable funds theory of interest rates (b) State the services offered by investment banks (c) Distinguish between commercial banks and thrifts (12mks) (6mks) (4mks)

(d) Assume an insurance firm has a loss ratio of 70%, an expense ratio of 35 % and the company pays 4% of its premiums earned as dividends. If the premiums are invested in a portfolio with a yield of 12.3%, evaluate the overall profitability of the firm (4mks) (e) Explain how the cash reserve requirement affects the ability of banks to create money (4mks)

2. (a) Explain the rationale behind the regulation of financial institutions and markets (6mks) (b) Differentiate between the money and bond market and give an example of an instruments traded in each of the market (c) (i) State the functions of money (ii) Define M1, M2, M3 and L measures of monetary aggregates (4mks) (6mks) (4mks)

3. (a) Describe the pure expectation theory and the liquidity premium theory of interest rates (12mks) (b) Consider the following term and yield to maturity of 4 hypothetical treasury securities with a par value of Ksh. 100 Term in years 0.5 1 1.5 2 Coupon rate 0.0 0.0 0.085 0.09 YTM 0.080 0.083 0.089 0.92 Price (Ksh) 96.15 92.19 99.45 99.64 (6mks)

(i) Calculate the spot rates for the 1.5 and 2 year treasury securities

(ii)Using the spot rates compute the price of a 2 year 9% coupon bond with a par value of Ksh. 1000 (2mks)

4. (a) Discuss the quantity theory of money (b) State the major categories of commercial bank asset and liabilities

(12mks) (6mks)

(c) Suppose an investor purchases 90 day commercial paper with a par value of Ksh.1,000,000 for a price of Ksh $960,000. Calculate the discount yield and bond equivalent yield (2mks)