Define money and its forms 1. Borrowings from the central bank (the commercial 1.
the central bank (the commercial 1. Earn a high enough interest rate to cover the cost of
Anything that is generally accepted in payment for goods
and services. Not the same as wealth or income.
Forms of Moneya) Money of Account (refers to the unit
in which the transactions of an economy are settled) b)
Legal Tender Money (those which are sanctioned legally,
since it ensure the acceptability of money. That is any
amount of debt can be paid by the money. Generally
legal tender money includes both motes (with high face
value) and coins (with less face value) c) Standard
Money (if the entire value of an economy’s transactions
are measured in a particular label, then we can say it as
standard money. For example; Dollar, Euro, Rupee, Yen
etc are standard money forms) d) Full Bodied Money
(form of money which is based on the intrinsic value.
That is the face value of the money will equal to the
metallic value contained in the money. Actually this form
of money was widely used in olden times) e) Token
Money (this is the advanced form of full bodied money.
Token money is a form of money in which the face value
is greater than the metallic value) f) Bank Money /
Deposit Money (refers to the deposits in the bank.
Generally there are two types of deposits like time
deposits and demand deposits)g) Inside Money and
Outside Money (today, people are borrowing loans and
advances from financial institutions. That is the private
debt of inside the economy. This is actually meant by
inside money. In other words inside money is the
quantity of money which created from endogenous
private sector, and it is the debt of private units. On the
other side, outside money is the amount of money in the
economy which created by exogenous unit, that is
government. So, government issued money is called
outside money)
Describe financial institutions
Any institutions, which collect money and put it into
assets such as stocks, bonds, bank deposits, or loans.
There are two types of financial institutions: depository
institutions and non - depository institutions. Depository
institutions, such as banks and credit unions, pay you
interest on your deposits and use the deposits to make
loans. Non - depository institutions, such as insurance
companies, brokerage firms, and mutual fund
companies, sell financial products. Many financial
institutions provide both depository and non -
depository services.Example: common example is retail
banks, which take deposits into safekeeping and use
them to make loans to other customers, and insurance
companies, which do not take deposits, but provide
guarantees of payment if a certain situation occurs in
exchange for premium.
Explain how banks create money and how they are
regulated
In the modern monetary system, most money in
circulation exists not as cash or coins but as bank
deposits. The main way in which those bank deposits are
created, is through loans made by commercial banks.
When a bank makes a loan, a deposit is created at the
same time in the borrower's bank account. In that way,
new money is created as a bookkeeping entry, with the
loan representing an asset and the deposit a liability on
the bank's balance sheet.
Discuss the functions and tools of the Central Bank
The primary function of a central bank is to control the
nation's money supply (monetary policy), through active
duties such as managing interest rates, setting the reserve
requirement, and acting as a lender of last resort to the
banking sector during times of bank insolvency or
financial crisis. Central banks usually also have
supervisory powers, intended to prevent bank runs and to
reduce the risk that commercial banks and other financial
institutions engage in reckless or fraudulent behavior.
Central banks in most developed nations are
institutionally designed to be independent from political
interference. Still, limited control by the executive and
legislative bodies usually exists.
The main monetary policy instruments available to
central banks are open market operation, bank reserve
requirement, interest rate policy, re-lending and re-
discount.
To enable open market operations, a central bank must
hold foreign exchange reserves (usually in the form of
government bonds) and official gold reserves. It will
often have some influence over any official or mandated
exchange rates: Some exchange rates are managed,
some are market based (free float) and many are
somewhere in between.
Describe the most common sources of funds for
commercial banks
This study source was downloaded by 100000815478877 from CourseHero.com on 06-29-2022 14:11:23 GMT -05:00
https://www.coursehero.com/file/20032291/For-exam/
banks in times of emergency borrow loans from the
central bank of the country. The central bank extends
help as and when financial help is required by the
commercial banks)
2. Borrowings from money market (are short – term
loans between banks; allow banks to meet reserve
requirements of funding needs; interest rate charged is
the central bank funds rate)
3. Current deposits (is a deposit to a bank account or
financial institution without a specified maturity date)
4. Saving deposits (is a deposit that provides principal
security and a modest interest rate)
5. Time deposit (money deposit at a banking institution
that cannot be withdrawn for a certain ‘term’ or period
of time (unless a penalty is paid). Generally speaking, the
longer the term the better the yield on the money)
6. Transaction deposit (a banking deposit that has
immediate and full liquidity, with no delays or waiting
periods. Transaction deposits can be transferred into
other cash instruments, have electronic payments
authorized against them, or otherwise be transacted by
the financial institution solely at the request of the
account holder)
7. Repurchase agreements (sale of securities by one
party to another with an agreement to repurchase the
securities at a specified date and price)
8. Eurodollar borrowings (for banks which are outside
the United States make dollar-denominated loans;
9. Bonds issued by the bank (for finance long-term fixed
assets; usually subordinated to deposits; part of
secondary regulatory capital)
10. Bank capital (obtained from issuing
stock or retaining earnings; no obligation to pay out
funds in the future; must be sufficient to absorb
operating loses; risk-based capital requirement)
Describe the most common uses of funds for
commercial banks
1. Cash and “due from” balances at institutions
2. Investment securities – bank income and liquidity
(government securities and corporate and municipal
securities)
3. Repurchase agreements
4. Eurodollar loans (branches of the US banks located
outside the US; foreign – owned banks)
5. Fixed assets (land and office buildings)
6. Bank loans (working capital loans; term loans;
informal line of credit; revolving credit loan; installment
loans; credit cards; real estate loans (mortgage))
Describe typical off-balance sheet activities for
commercial banks
1. Loan commitments (obligation of bank to provide a
specified loan amount to a particular business upon
request; note issuance facility (NIF); banks earn fee
income for risk assumed)
2. Standby letters of credit (SLC) (backs a customer’s
obligation to a third party; banks earn fee income)
3. Forward contracts (agreement between a customer
and bank to exchange one currency for another on a
particular future date at a specified exchange rate; allows
customers to hedge their exchange-rate risk)
4. Swap contracts (two parties agree to periodically
exchange interest payments on a specified notional
amount of principal; banks serve as intermediaries or
dealer and/or guarantor for a fee)
Interest rate is the rate at which interest is paid by
borrowers (debtors) for the use of money that they
borrow from lenders (creditors). Specifically, the interest
rate is a percentage of principal paid a certain number of
times per period for all periods during the total term of
the loan or credit. Interest rates are normally expressed
as a percentage of the principal for a period of one year,
sometimes they are expressed for different periods such
as a month or a day.
Describe the major categories of bank loans
Secured/Unsecured
A secured loan is a promise to pay a debt, where the
promise is "secured" by granting the creditor an interest
in specific property (collateral) of the debtor. If the
debtor defaults on the loan, the creditor can recoup the
money by seizing and liquidating the specific property
used for collateral on the debt.
Unsecured is also a promise to pay a debt. Unlike a
secured loan, the promise is not supported by granting
the creditor an interest in any specific property. The
lender is relying upon the creditworthiness and
reputation of the borrower to repay the obligation.
Fixed/Floating rate loans
The interest on floating loans is periodically adjusted to
changes in a selected short term rate usually an
EURIBOR. In case of unstable interest rates banks prefer
to make floating rate loans. Short-time bank loans mostly
carry fixed rates.
Also, categories may be divided into Long- time need
(long term debt instruments), seasonal need (short-term
credit (i.e overdraft)), extraordinary need – short term
credit (i.e. overdraft, leasing, factoring)
Describe the key considerations on loan pricing
loanable funds
2. Recover administrative costs of originating and
monitoring the loan
3. Provide adequate compensation for risk - Credit (or
default) risk, Liquidity risk, Interest rate risk
4. The “Prime Rate” (The fewer loans are priced using
“prime” The rate banks charged their most creditworthy
customers. Lenders choose among several benchmarks
(LIBOR, EURIBOR, Treasury rates, Fed Funds rates)
5. Base rate pricing (most banks use a base rate of
interest as a markup base for loan rates. The base rate
may be the prime rate, EURIBOR, LIBOR, etc. and is
expected to cover the following: the cost of funds of the
bank; the bank's administrative costs; a fair return to the
bank shareholders)
6. Non-price adjustments
7. Matched-funding loan pricing (a way to control
interest rate risk of fixed rate loans by financing them
with deposits of the same maturity. e.g. Bank gives1 year
fixed rate loan, can be financed with 1 year CD)
Describe how the credit risk is analyzed
The Five "Cs" of Credit Analysis:
1. Capacity to repay from the cash flow of the business,
the timing of the repayment to match cash flow, and the
probability of successful repayment, payment history on
existing credit relationships is an indicator of future
performance, contingent sources of repayment.
2. Capital is what the owner has invested and what that
person(s) have at risk should the business fail.
3. Collateral or guarantees are additional forms of
security provided to a lender as a repayment in case the
loan cannot be repaid under anticipated means, or some
other entity agrees to repay the loan in the event of the
primary borrower's default.
4. Conditions focus on the intended purpose of the loan,
the local economic climate and the conditions within the
industry that may effect the borrower.
5. Character is the subjective opinion/impression
(education, experience references and trust) of the
borrower by the lender.
Explain the term “securitization”
Securitization is the process of taking an illiquid asset, or
group of assets, and through financial engineering,
transforming them into a security. Securities are sold to
individual and institutional investors. The cash flow
collections from the loans are forwarded to the trust and
investors. The bank earns loan origination fees, perhaps
underwriting fees, and loan servicing fees, and the funds
raised by the securitization are used to originate more
loans. Securitizing loans enables the bank to generate
fees without added bank equity capital, required
reserves (no funding needed), and deposit insurance
premiums.
General principles of bank management
The first is to make sure that the bank has enough ready
cash to pay its depositors when there are deposit
outflows, that is, when deposits are lost because
depositors make withdrawals and demand payment. To
keep enough cash on hand, the bank must engage in
liquidity management, the acquisition of sufficiently
liquid assets to meet the bank’s obligations to
depositors. Second, the bank manager must pursue an
acceptably low level of risk by acquiring assets that have
a low rate of default and by diversifying asset holdings
(asset management), which is separated credit risk (the
risk arising because borrowers may default), interest-rate
risk (the riskiness of earnings and returns on bank assets
that results from interest-rate changes). The third
concern is to acquire funds at low cost (liability
management). Finally, the manager must decide the
amount of capital the bank should maintain and then
acquire the needed capital (capital adequacy
management)
Off-balance sheet activities
All off-balance sheet activities involves risks and
potential conflicts. There are 3 basic off-balance sheet
activities:
1. Loan sales (secondary loan participation)
2. Fee income received from (foreign exchange trades
for customers; servicing mortgage – backed securities;
guarantees of dept; backup lines of credit)
3. Trading activities and risk management techniques
(financial futures and options; foreign exchange trading;
interest rate swaps)
Measuring bank performance
For clear measuring bank performance, companies
should look at the income statement, which is divided
into 3 parts for banks:
1. Operating income (the amount of profit realized from
operations after taking out operating expenses also, it
typically a synonym for earnings before interest and
taxes). 2)Op. expenses (a category of expenditure that
incurs as a result of performing its normal operations.
One of the typical responsibilities is determining how
low operating expenses can be reduced without
significantly affecting the ability to compete with
competitors). 3)Net operating income (a calculation used
to analyze real estate investments that generate income)
 This study source was downloaded by 100000815478877 from CourseHero.com on 06-29-2022 14:11:23 GMT -05:00

https://www.coursehero.com/file/20032291/For-exam/
Powered by TCPDF (www.tcpdf.org)