Question Paper Management of Financial Institutions – I (321): January 2005 Section A : Basic Concepts (30 Marks) • This section consists of questions with serial number 1 - 30. • Answer all questions. • Each question carries one mark. • Maximum time for answering Section A is 30 Minutes. 1.
If the RBI makes an open market purchase, which of the following will occur? (a) (b) (c) (d) (e)
2.
< Answer >
Money demand increases, and the interest rate increases Money demand decreases, and the interest rate falls The money supply decreases, and interest rates rise The money supply increases, and interest rates fall Both the money supply and money demand increase, and thus we cannot determine effect on the interest rate. < Answer >
The banking system’s excess reserves ratio is (a) Negatively related to both the market interest rate and expected deposit outflows (b) Positively related to both the market interest rate and expected deposit outflows (c) Negatively related to the market interest rate and positively related to expected deposit outflows (d) Positively related to the market interest rate and negatively related to expected deposit outflows (e) Positively related to the market interest rate but not related to expected deposit outflows.
3.
When the interest rates increase, the _______ in the interest income is _______than the ________ in the interest expenditure when the maturity gap is _________. (a) (b) (c) (d) (e)
4.
5.
Decrease, less, increase, negative Decrease, less, decrease, positive Increase, less, increase, positive Increase, more, decrease, negative Increase, more, increase, positive.
Which of the following is an example of crowding out? (a) (b) (c) (d) (e)
< Answer >
An increase in the money supply causes interest rates to fall and investment to rise An increase in government spending causes interest rates to rise and investment to fall An increase in government spending causes interest rates to fall and investment to rise A decrease in government spending causes interest rates to rise and investment to fall A decrease in the money supply causes interest rates to rise and investment to fall.
A bank can increase its leverage by increasing its ratio of (a) Earnings/total assets (c) Total assets/equity capital (e) Both (a) and (b) above.
6.
< Answer >
(b) Earnings/equity capital (d) Equity capital/total assets
The ‘rainy day segment’ as per Berry’s categorization of various social classes are (a) Middle class (c) Upper-middle and middle-class (e) Upper-class and rich class.
< Answer >
(b) Lower-middle and poor-class (d) Upper-class and upper-middle class
< Answer >
7.
(a) Underwriting commitments (c) Guarantee issued by the bank (e) Loans against pledge. 8.
(b) Loans against gold (d) Loans against hypothecation
Marketing management is accepted as the efficient management of four P’s in respect of manufacturing concerns and units dealing in tangibles. Which of the following is an additional P’ for service sector like banking? (a) Price
9.
< Answer >
Which of the following facilities give rise to credit risk?
(b) Process
(c) Place
(d) Product
(e) Promotion. < Answer >
The neutrality of money means that (a) (b) (c) (d) (e)
Changes in the money supply have no effect on the economy Changes in the money supply have no short-term effect on the economy Changes in the money supply have no long-run effect on the economy Changes in the money supply cause wages and prices to change in the long run, but have no effect on real variables, such as output Changes in the money supply cause real variables, such as output, to change in the long run, but have no effect on wages and prices.
10. If nominal GDP is $5000 billion and the money supply is $1250 billion, then the velocity of money is (a) 0.25 11.
(b) 2
(c) 4
(d) 8
< Answer >
The Internal Rate of Return is equal to or greater than the inflation rate The Internal Rate of Return is equal to inflation rate The Net Present Value of such a proposal is always positive irrespective of the discount rate Mortgage payments are of fixed amount Both (a) and (c) above.
12. Which of the following pricing strategies enables a bank to pay interest as a function of average balance? (a) Free banking by level (c) Relationship pricing (e) Symmetric account.
(a) Maturity intermediation (c) Liquidity intermediation (e) Denomination intermediation.
< Answer >
(b) Explicit pricing (d) Rebate strategy
13. The type of intermediation in which financial intermediaries lend to risky borrowers and issue relatively safe and liquid securities is known as
< Answer >
(b) Default-risk intermediation (d) Information intermediation
14. Which of the following liabilities is classified under demand liabilities for the computation of NDTL? (a) (b) (c) (d) (e)
< Answer >
(e) 12.
Which of the following statements is/are true regarding Price Level Adjusted Mortgage? (a) (b) (c) (d) (e)
< Answer >
< Answer >
Cash certificates Recurring deposits Unclaimed deposit Deposits held as securities for advances Staff security deposit.
15. If the RBI increases the money supply at a rate of 4% per year every year, the inflation rate will be _____, and the real interest rate will be ______. (a) Rising, rising (d) 4%, falling
(b) 4%, rising (e) Rising, falling.
(c) 4%, constant
< Answer >
16. ALM (Asset Liability Management) is a strategic balance sheet exercise that involves managing of risks caused by changes in
(a) (b) (c) (d) (e)
Exchange rates and Liquidity position of Banks Liquidity and NPAs position of Banks Interest rates and exchange rates of Banks Interest rates, Exchange rates and Liquidity position of Banks Profit and loss of the Banks. < Answer >
17. An upward sloping yield curve is suggested by (a) Market segmentation theory (c) Pure expectation’s theory (e) Both (a) and (c) above.
(b) Preferred habitat theory (d) Liquidity theory < Answer >
18. The risk exposure of a basis swap with remaining maturity of 4 years is (a) 1.50%
(b) 2.00%
(c) 3.00%
(d) 3.50%
(e) 4.00%. < Answer >
19. An increase in real output will cause which of the following? (a) (b) (c) (d) (e)
A decrease in interest rates and an increase in bond prices A decrease in interest rates and a decrease in bond prices An increase in interest rates and an increase in bond prices An increase in interest rates and no change in bond prices An increase in interest rates and a fall in bond prices.
20. OBC Bank has set its prime-lending rate (PLR) on advances for 2 year at 10%. What will be its PLR for 3 years if the implicit rate for 1 year, two year from now is 11%? (a) 10.33%
(b) 11.54%
(c) 11.89%
(d) 12.11%
(a) Decrease the spreads (c) Not affect the spreads (e) Insufficient information.
< Answer >
(b) Increase the spreads (d) Result in increase in the cost of funds
22. When the RBI wants to conduct a ______ open market _______ operation, it engages in a _______.
< Answer >
Permanent; purchase; reverse repo Permanent; purchase; repurchase agreement Temporary; sale; repurchase agreement Temporary; sale; reverse repo Temporary; purchase; reverse repo. < Answer >
23. Which of the following statement is/are false regarding liquidity risk management? (a) (b) (c) (d) (e)
< Answer >
(e) 13.23%.
21. If fixed rate of interest is charged for a loan that is being funded by a floating rate of deposit, then downward movement in the interest rates will
(a) (b) (c) (d) (e)
< Answer >
In liability management, a proposal for loan is approved when there is surplus funds Technical approach aims to eliminate liquidity risk in the short run Fundamental approach aims to eliminate liquidity risk in the long run Asset management aims to eliminate liquidity risk by holding near cash assets Both (c) and (d) above.
24. GTI Bank charges 13.50% p.a. for its personal loan to its customers. Capital Adequacy required to be maintained at 12%. The capital charge adjusted return on the loan, if the required return on capital is 9% is (a) 11.24%
(b) 12.00%
(c) 12.42%
(d) 13.04%
(e) 13.50%.
< Answer >
25. If the CRR requirement is 5.5% and RBI pays interest at 4% p.a. on CRR balance above the minimum base rate of 3%, the effective cost of a deposit on which interest is paid at 6% is (a) 6.04%
(b) 6.24%
(c) 6.32%
(d) 6.46%
(e) 6.50%. < Answer >
26. If actual inflation is less than expected inflation, then (a) (b) (c) (d) (e)
< Answer >
Borrowers are worse off and lenders are better off Borrowers are better off and lenders are worse off Both borrowers and lenders are better off Both borrowers and lenders are worse off Borrowers and lenders are neither better nor worse off. < Answer >
27. Which of the following statements is true? (a)
When duration gap is positive, if interest rates increase, the changes in the market value of assets decreases less than the changes in the market value of liabilities (b) When duration gap is positive, if interest rates decrease, the market value of the equity decreases (c) When duration gap is positive, if interest rates increase, the market value of equity increases (d) When duration gap is negative, if interest rates decline, the market value of the equity decreases (e) When duration gap is negative, if interest rates increase, the market value of equity decreases. 28. If a 91-day T-bill of face value Rs.100 is acquired in the auction at a yield of 4.25%, then the purchase price is (a)
Rs.95.75 Rs.98.95.
(b) Rs.96.25
(c) Rs.97.45
(d) Rs.98.35
(e)
29. Which of the following types of fire insurance policy is based on the principle that variation in the value of insured stock results in under-insurance or over-insurance? (a) Crop insurance policy (c) Reinstatement value policy (e) Both (b) and (c) above.
< Answer >
< Answer >
(b) Floating policy (d) Declaration policy
30. All landless agricultural laborers of India have been covered for a uniform sum assured of Rs.2000. This scheme is known as (a) Agriculture laborer scheme (c) Rural group life insurance scheme (e) Agricultural insurance scheme.
(b) Social security scheme (d) Lalgi scheme END OF SECTION A
< Answer >
Section B : Problems (50 Marks) • This section consists of questions with serial number 1 – 5.
• Answer all questions. • Marks are indicated against each question. • Detailed workings should form part of your answer. • Do not spend more than 110 - 120 minutes on Section B. 1.
Rubi Textiles Ltd. is a manufacturer and exporter of textile goods. Rubi is enjoying credit from two banks and your Bank has a share of Rs.5 crore, while the other bank also has a share of Rs.5 crore. The company approached you for enhancement of working capital limits to Rs.20 crore. Also the company is requesting for a reduction in the interest rate on both Cash Credit (CC) & Bills discounting (BD) by 100 basis points. While you are in the favor of the proposal, but the other bank is against it as in the current scenario interest rate is increasing. This has forced you to analyze more closely before proposing the credit enhancement to credit approval body. The following information is available. Average outstanding in Cash Credit a/c Rs.3.55 crore Average amount of Bills discounted Rs.0.92 crore Average balance in current a/c Rs.0.50 crore Average Float Funds available to Bank Rs.0.70 crore Bank’s cost of funds 6.45% Bank’s cost of operations 2.67% Interest rate on credit 15.00% Rate for discounting Bills 13.00% Provisioning cost 0.75% Average unutilized limits Rs.0.58 crore Commitment Fee 0.50% Credit Administration cost Rs.2.05 lakh Service Cost: Cash credit Rs.1.85 lakh Bills Rs.1.02 lakh Service charge recovered on CC and BD Rs.0.24 lakh Commission from L/Cs and Guarantees Rs.0.34 lakh Commission from DDs Rs.0.48 lakh Net income on forex business Rs.0.52 lakh Cost of handling L/Cs and Guarantees Rs.0.12 lakh Cost of handling DDs Rs.0.07 lakh Service charge received on current a/c Rs.0.08 lakh Cost of servicing current a/c Rs.0.14 lakh It is observed that 80% of float funds and current a/c balances have been shifted by the company recently to another bank. If the target spread is 4%, can you accede to the request of the company? What is the interest rate that you will be willing to offer on Cash Credit if you agreed to reduce interest on Bills discounting? (10 + 2 = 12 marks) < Answer >
2.
The balance sheet of Janata Bank, which includes the duration of assets and liabilities, is given below: (Rs. Crore)
Description Equity CDs Short term deposits Long term Deposits Other liabilities
Liabilities Market Interest value rate (%)
Duration (Years)
300
–
–
1,000
5
0.50
2,200
6
1.00
3,000
7
4.00
Description Cash and other assets Investments Short term loans Long term loans
Assets Market Interest value rate (%)
Duration (Years)
500
–
–
1,100
8
1.00
2,900
10
1.50
2,100
12
4.00
100 – 0.75 6,600 6,600 bank expects that the interest rates will fall by 100 basis points across all the maturities. From the above information you are required to a. Determine the impact of the change in interest rates on the assets, liabilities and equity of the bank. b.
The
Immunize the market value of the bank using the “Immunizing Asset Duration” method (6 + 4 = 10 marks) < Answer >
3.
A private bank has decided to increase its provision for standard assets from 1% to 2%. The gross NPA of the bank is 8% of gross advances and provision for NPA constitutes 20% of the gross NPA. You are required to find out the ratio of Net NPA/Net Advances consequent to the new policy. (6 marks) < Answer >
4.
The following balances are extracted from the books of a private sector bank on December 24, 2004, a Reporting Friday. Particulars Cash in hand with all branches in India Cash in hand with all its foreign branches Current a/c balances with RBI (includes Rs.580 cr. cash reserve) Cash held in currency chest Current a/c balances with banks in India Current a/c balances of its foreign branches with banks outside India Current a/c balances of other banks in India with the bank Current a/c balances of other banks outside India with its foreign branches Investments in approved securities Gold holding The reserve requirement as SLR 25% and CRR 5%.
Rs. Crore 424.62 80.35 592.50 285.29 46.64 10.44 52.50 12.70 3665 250.45
You are required to a. b. c.
Compute CRR, NDTL and SLR in that order. Compute SLR, NDTL and CRR in that order. Mention the maintenance periods for both CRR and SLR calculated above (3 + 4 + 1 = 8 marks) < Answer >
5.
The following abridged balance sheet of a private sector bank for the year ended March 2004. (Rs. Crore)
Capital Reserves Deposits Borrowings Other liabilities & Provisions
240 427 9450 1110 765
Cash in hand Cash with RBI Investments Advances Fixed Assets Other Assets
160 732 4564 5100 745 691 11,992 11,992 The bank expects a growth of 30% in deposits and 40% in advances. The CRR and SLR requirement are expected to be 5% and 25% respectively. The expected change in investment will be only in the form of investment in government securities. The return on asset that is currently at 2.10% is expected to increase to 2.50% of the existing assets. The capital adequacy ratio on the balance sheet date is 9.30%. Assume the following: i.
No dividend will be declared
ii.
Advances are with average risk weight of 100%
iii.
Other liabilities and provisions do not include any item for NDTL purposes
iv.
Borrowings are solely from other nationalized banks
v.
No change is expected in borrowings, other liabilities and provisions, in fixed assets and
in other assets.
You are required to find out the additional capital to be raised to maintain CAR at 10% to support the new level of business and project the balance sheet for the current year ending. (14 marks) < Answer >
END OF SECTION B
Section C : Applied Theory (20 Marks) • This section consists of questions with serial number 6 - 7.
• Answer all questions. • Marks are indicated against each question. • Do not spend more than 25 -30 minutes on section C.
6.
One of the shortcomings of maturity gap approach is that it ignores the time value of money for the cash flows while determining the gap. Discuss how this can be overcome and how the interest rate risk be immunized to protect the market value of the firm. (10 marks) < Answer >
7.
Burglary Insurance is useful to manufactures and traders in respect of their trading stocks, furniture, fixtures etc. Discuss the main types of Burglary Insurance Policies. (10 marks) < Answer >
END OF SECTION C END OF QUESTION PAPER
Suggested Answers Management of Financial Institutions – I (321): January 2005 Section A : Basic Concepts 1.
Answer : (d) Reason : By open market purchase RBI purchases Treasury securities from the market which causes an increase in the money supply, which in turn causes interest rates to fall.
< TOP >
2.
Answer : (c) Reason : The banking system’s excess reserves ratio is negatively related to the market interest rate and positively related to expected deposit outflows, since increase in interest will make lending more attractive than investing in government securities and expected increase in deposit outflows will induce banks to increase CRR.
< TOP >
3.
Answer : (e) Reason : If interest rate increases and maturity gap is positive, then increase in interest income will be more than the increase in interest expenditure.
< TOP >
4.
Answer : (b) Reason : If an increase in government spending results in a decrease in investment spending, the government spending is said to be crowding out investment.
< TOP >
5.
Answer : (c) Reason : By increasing Total Asses without increasing equity capital the bank can increase its total risk weighted assets thus increasing its leverage.
< TOP >
6.
Answer : (b) Reason : Berry’s categorization of the various social classes based on financial outlook defines lower-middle and poor class as rainy day segment.
< TOP >
7.
Answer : (d) Reason : Loans against hypothecation of goods carry credit risk. There is no credit risk in the case of loans against pledge and loans against gold since security is available to the lender with adequate margin. The off balance sheet items underwriting commitments, bank guarantees will give rise to the contingency risk..
< TOP >
8.
Answer : (b) Reason : Process is relevant to service sector like banking.
< TOP >
9.
Answer : (d) Reason : In the long run, when the economy is at full employment, changes in the money supply will only cause changes in nominal variables such as prices. For example, monetary expansion causes a short-run increase in output, but in the long run, wages and prices rise, and output returns to full employment.
< TOP >
10.
Answer : (c) Reason : Velocity of money = Nominal GDP / Money supply = 5000/1250 = 4.
< TOP >
11.
Answer : (a) Reason : In price level adjusted mortgage the internal rate of return is equal to or greater than inflation rate and mortgage payments vary as per the inflation rate.
< TOP >
12.
Answer : (e) Reason : In symmetric account banks pay interest as a function of minimal or average balance.
< TOP >
13.
Answer : (b) Reason : The type of intermediation in which financial intermediaries lend to risky borrowers and issue relatively safe and liquid securities in order to attract lendable funds from savers is known as default-risk intermediation.
< TOP >
14.
Answer : (c) Reason : Unclaimed deposit is classified under demand liabilities for the computation of NDTL.
< TOP >
15.
Answer : (c) Reason : In the long run, the rate of inflation must be equal to the rate of money supply growth. Thus expected inflation will be 4%, money demand will grow at a rate of 4% per year, and the real interest rate will be constant.
< TOP >
16.
Answer : (d) Reason : ALM (Asset - Liability Management) is a strategic balance sheet exercise, that involves, managing of risks caused by changes in (i) Interest rates (ii) Exchange rates and (iii) Liquidity position of Banks / F/s
< TOP >
17.
Answer : (d) Reason : Since the interest rates for the long term will be higher than the rates for short term under liquidity theory, the yield curve will be sloping upward. Pure expectation theory does not explicitly say that the yield curve will be an upward sloping, it may be downward sloping also. Preferred habitat theory states that higher interest rate with longer maturities can not be applicable for all the maturities. Hence, it is not assumed that the yield curve will be an upward sloping. Market segmentation theory states that interest rates depends on the demand for and supply of funds.
< TOP >
18.
Answer : (c) Reason : The risk exposure of a basis swap with remaining maturity up to 2 years is 1% and for every additional year is 1%, hence for 4 years (1% + 2 × 1%) = 3%.
< TOP >
19.
Answer : (e) Reason : As real output increases and thus incomes increase, individuals will wish to make more purchases, and money demand increases, which causes a rise in interest rates. This in turn causes a fall in bond prices, which are inversely related to the interest rate.
< TOP >
20.
Answer : (a) Reason : (1 + PLR3)3
< TOP >
PLR3 21.
=
(1 + PLR2) (1 + f21) =
(1 + 0.10)2 (1 + 0.11)
=
10.33%.
Answer : (b) Reason : If fixed rate of interest is charged for a loan, which is funded by a floating rate of deposit, then downward movement or decrease in the interest rate in the floating rate of deposit will increase the spreads.
< TOP >
22.
Answer : (d) Reason : A reverse repo agreement is a purchase of securities with a contract to resell them at a higher price at a specific future date. So when RBI wants to conduct a temporary open market sale operation it first purchases the securities and sells them later.
< TOP >
23.
Answer : (a) Reason : Statement under (a) is false as liquidity risk management tries to achieve liquidity by borrowing funds.
< TOP >
24.
Answer : (c) Reason : Suppose, loan amount
< TOP >
Interest earned
= Rs. 100 = Rs.13.50
Part of the loan financed through capital = Rs.12 Interest on capital = 12 x 0.09 = Rs.1.08 Return from loan = 13.50 – 1.08 = Rs.12.42 or, 12.42% 25.
< TOP >
Answer : (b) Reason : Suppose, Deposit
= Rs. 100
( – ) CRR
= Rs. 5.50
Amount available for investment
= Rs. 94.50
Interest
earned on CRR balance = 3 x 0 + 2.5 x 0.04 = Rs. 0.10 Effective cost =
6 − 0.10 94.50
= 6.24%
26.
Answer : (a) Reason : If actual inflation is less than expected inflation, then real interest rates are more than expected. This hurts borrowers but helps lenders.
< TOP >
27.
Answer : (d) Reason : It is true, that when D Gap is negative, if interest rates decline, the market value of the equity decreases.
< TOP >
28.
Answer : (e) Reason : Let, x = purchase price
< TOP >
100 − x 365 x x 91
= 0.0425
or, x = 98.95. 29.
Answer : (d) Reason : Declaration policy is based on the principle that variation in the value of insured stock results in under-insurance or over insurance.
< TOP >
30.
Answer : (d) Reason : Under Lalgi scheme all landless agricultural laborers of India have been covered for a uniform sum assured of Rs.2000, which is met from Social Security Fund maintained by LIC.
< TOP >
Section B : Problems 1.
Income from the account: (Rs. lakh) Existing
Revised
53.25
49.70
11.96
11.04
Commitment fee 0.5% on Rs.58 lakh
0.29
0.29
Service charge on CC & BD
0.24
0.24
Commission from L/c & BG,
0.34
0.34
Commission from DDs
0.48
0.48
Forex income
0.52
0.52
Service charge from current A/c
0.08
0.08
67.16
62.69
Average cash credit amount Rs.355 lakh Interest income Average Bills discounted Rs.92 lakh Interest income
Total Costs
(Rs. lakh)
Credit Admn. Cost
2.05
Service Cost (CC + BD)
2.87
Handing Cost (L/c + BG)
0.12
Handling cost for DDs
0.07
Service cost of Current A/c
0.14
Provisioning cost 0.75% of (355 + 92)
3.35
Total
8.60
Total outlay of funds
Rs.447 lakh
Funds available from customer (20% of CA & Float Funds)
Rs. 24 lakh
Net outlay
Rs.423 lakh
Income from the A/c (Revised)
62.69
Cost of funds @ 6.45%
27.28
Cost of operation @ 2.67 %
11.29
Other costs
8.60
Net Income
15.52
15.52 = 3.67% 423
Spread = Hence proposal is not accepted as it is falling short of target spread of 4%.
Required spread
=
4%
Required net income
=
423 × 0.04
Less: Net income as per offer
=
Rs.16.92 lakh
=
Rs.15.52 lakh Rs.1.40 lakh
Percentage
increase
in
net
1.40 = 0.39% 355
income = Hence, the minimum rate to be offered = 14 + 0.39 = 14.39%. < TOP >
2.
a.
Change in market value of assets: 1×1100
Duration of assets
6600
=
1.5×2900 4 ×2100 + + 6600 6600 0.08×1100
Average interest on assets
6600
=
−2.0985 1.0955
% Change in market value of assets =
+
= 2.0985
0.10 ×2900 6600
+
0.12 ×2100 6600
= 9.55%
×( −0.01)
= 1.92%
New market value of assets = 6,600 × 1.0192 = Rs.6726.72 crore Change in market value of liabilities: 0.5×1000
Duration of liabilities
6300
=
+
1×2200 6300
0.05×1000
Average interest on liabilities
6300
= −2.3452 1.0622
% change in market value =
b.
+
+
4 × 3000 6300
0.06 ×2200 6300
+
+
0.75 ×100 6300
0.07 ×3000 6300
×( −0.01)
= 2.21%
New market value of liabilities =
6,300 × 1.0221
= New market value of equity =
Rs.6439.23 crore 6726.72 – 6439.23 = Rs.287.49 crore.
Immunizing asset duration
=
DL ×
L A
6300
=
2.3452 ×
6600
= 2.2386 Change in the value of assets using the immunizing duration −2.2386
=
1.0955
= 2.3452
×( −0.01)
= 2.04 %.
New market value of assets = 6,600 × 1.0204 = Rs.6734.64 crore
= 6.22%.
New market value of liabilities = Rs.6,439.23 crores New market value of equity = 6734.64 – 6,439.23 = Rs.295.41 crores Thus by increasing the asset duration by the immunizing asset duration approach we can protect the market value of equity. < TOP >
Gross NPA = 0.08 Gross Advances
3.
Provisions = 0.20 Gross NPA Standard Assets = 0.92 Gross Advances
Let Gross Advances be ‘y’ Gross NPA = 0.08y Provisions = 0.08y × 0.20y Standard assets = 0.92y Additional provision due to new policy = 0.01 × 0.92y = 0.0092y Net NPA = =
0.08y – 0.08y × 0.20 – 0.0092y
=
0.0548y
Net Advance
∴
Gross NPA – Provisions
=
Gross Advances – Provisions
=
y – 0.08y × 0.20 – 0.0092y
=
0.9748y
Net NPA 0.0548 y = = 0.0562 or 5.62%. Net Advance 0.9748 y
< TOP >
4.
We should exclude assets and liabilities of the bank’s branches outside India as they come under the rules and regulations of the foreign countries. a.
CRR maintained as: Balance with RBI + Cash in currency chest = CRR
580 + 285.29 =
=
Rs.865.29 crore
5% of NDTL
Hence, NDTL =
865.29 = Rs .17305.80 crore 0.05
SLR = 25% of NDTL = 0.25 × 17305.80 = Rs.4326.45 crore. b.
SLR maintained as: Net current a/c balance with RBI and other banks in India + Cash in hand in India + Investment in approved
securities + Gold holding = [(46.64 + 12.50) – 52.50] + 424.62 + 3665 + 250.45 = Rs.4346.71 Hence, NDTL =
4346.71 = Rs .17386.84 crore 0.25
CRR = 5% of NDTL = 0.05 × 17386.84 = Rs.869.34 crore c.
Maintenance period for calculated CRR and SLR is the fortnight January 8, 2005 to January 21, 2005. < TOP >
5.
New deposit level = 9450(1 + 0.30) = Rs.12,285 crore New advances level = 5100 (1 + 0.40) = Rs.7,140 crore Net profit for the current year ending = 11,992(0.025) = Rs.299.80 crore New reserves = 427 + 299.80 = Rs.726.80 crore New CRR = = New SLR =
(Deposits + Borrowings) × 0.05 (12,285 + 1110) × 0.05 = Rs.669.75 crore (12,285 + 1110) × 0.25 = Rs.3348.75 crore
SLR from the given balance sheet
=
(9450 + 1110) × 0.25 = Rs.2640 crore
Non-SLR investment in the given balance sheet = 4564 – 2640 = Rs.1924 crore New investment level = 3348.75 + 1924 = Rs.5272.75 Existing RWAs = (1924 × 1.0 + 5100 × 1.0 + 745 × 1.0 + 691 × 1.0 + 2640 × 0.025) = Rs.8526 crore New RWAs
=
(1924 × 1.0 + 7140 × 1.0 + 745 × 1.0 + 691 × 1.0 + 3348.75 × 0.025) = Rs.10,583.72 crore
Capital requirement = 10,583.72 × 0.10 = Rs.1058.4 crore Additional capital required
=
1058.4 – 240 – 726.8 = Rs.91.6 crore. Statement of Cash (Rs. Crore)
Opening balance of cash
160.0
Add: Increase in liabilities –
Capital
91.6
–
Reserves
299.8
–
Deposits
2835.0
3226.4 3386.4
Less:Increase in assets –
Investments
–
Advances
–
Cash with RBI
708.8 2040.0 (62.2)
2686.6 699.8
Projected Balance Sheet (Rs. Crore) Capital (240 + 91.6)
331.6
Cash in hand
699.8
Reserves (427 + 299.8)
726.8
Cash with RBI
669.8
Deposits
12,285.0
Borrowing
1,110.0
Other liabilities & provisions
765.0
Investments
5272.8
Advances
7140.0
Fixed Assets
745.0
Other Assets
691.0
15218.4
15,218.4
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Section C: Applied Theory 6.
Duration is defined as weighted average term to maturity of assets or liabilities over which cash flows are expected and the present value of the cash flows are treated as weights. It immunizes interest rate risk by holding an investment till the end of Duration, instead of maturity. Duration can play a major role in an integrated Asset/Liability management strategy as an alternative for the time dimension of an asset or liability. It studies the effect of the rate fluctuation on the market value of the assets and liabilities and NIM – with the help of Duration. It studies the effect on NII for the given Duration gaps and also studies the impact on the MVE for the rate fluctuation. It overcomes the limitations of the maturity gap approach wherein the time value of money for the cash flows while determining the gap, is ignored. It concentrates on the price risk and reinvestment risk, while managing interest rate exposure. Measuring the duration gap is more complex than measuring the maturity gap due to the difficulty in identification of the timing of cashflows for both the assets and liabilities.
Sum of (the discounted cashflow of each year × period t) Sum of the present value of all the cashflows
Duration = Based on the above method, the duration of Rate Sensitive Assets and liabilities are found out. The Rate Sensitive Gap is measured. Rate Sensitive Gap (RSG) = Rate Sensitive Assets (RSA) – Rate Sensitive Liabilities (RSL) To find out the RSG, only the assets and liabilities having duration of less than one year alone is considered because of the NII being measured annually any change in the interest rate would affect only the corresponding assets and liabilities. Hence, it would be appropriate to have one year time horizon for measuring the impact of duration gap on NII for the given changes in interest rates. When the RSG is negative, a rise in interest rate will decrease the NII and vice versa. When the Duration gap is NIL, the NIM remains protected for any changes in the interest rate. A positive gap leads to rise in the NIM, while negative gap indicates a fall in NIM. Thus, the impact of rate fluctuations using the Duration is similar to maturity gap approach. Besides measuring the impact on NII, the duration can further be used to study the sensitivity of the market value of the assets and liabilities to changes in interest rates. Excess of assets over the liabilities gives the gap / surplus available to the shareholders. Duration analysis measures the Duration of the surplus in order to assess the exposure of the shareholders wealth to the interest rate risk. Since the surplus is given by the difference between the assets and liabilities, the Duration gap can be represented as follows: DS × S
= (DA × A) – (DL × L)
DS = DL + (A/S) (DA–DL)
Thus, the Duration gap is the composite duration of liabilities and the multiple of the difference between composite duration of assets and liabilities and the net surplus ratio. Once the Duration of the surplus is determined, the effect of the rate fluctuation on the market value of the asset/liability is calculated by the following method: Duration (change in int.rate) ×Current Market Value [1 + r]
Change in Market Value = r = Current rate of interest The new market value of the asset/liability will now be the sum of the original MV and the changes in the MV as compared above. New MV = Original Value + or (–) Change in M.V. (-) D(Ar) × Current MV (1 + r)
Change in MV = Once the impact of interest rate movement is found on the market value of equity is found, it is the question of protecting the market value of equity to the present level. How to immunize the interest rate risk? This can be possible only when the Duration of the surplus is zero, as it is in the case of zero coupon bond, the effect of interest rate changes will be eliminated. To make the duration of the surplus to zero, the duration of assets/liabilities is to be adjusted. While adjusting the Duration of assets and liabilities, the alternatives available are:
i.
•
Perfectly match the duration of assets and liabilities
•
A mismatch in Duration of assets and liabilities
Perfectly match the duration of assets and liabilities The following formula is used to find out the duration of the surplus. DS = DL + [A/S] × [DA – DL] If Duration of A & L are perfectly matched, the equation will be as follows: DS = DA – DL Duration of surplus will be equal to the Duration of assets/liabilities. Hence, the interest rate risk will not be eliminated. Substituting the duration in the above formula, the duration of surplus will not become zero and it will be again equal to the duration of the liability. Hence perfect matching the duration of assets and liabilities will not immunize the interest rate risk.
ii.
A mismatch in Duration of assets and liabilities To make the duration of the surplus to zero in the above formula i.e. Ds = 0: 0 = DL + (A/S) (DA – DL) (DA – DL) OR
=
DL (A/S)
-D L (A - L) A
(DA – DL) = Using any of the above equations, the Duration of surplus can be equated to “0” thereby immunizing the Market Value of Equity for the rate fluctuation. This can be done by adjusting the duration of (1) Assets, (2) Liabilities, (3) both Assets and Liabilities. It is comparatively easier to adjust the Duration of assets than the liabilities, as bank has flexibility in creating assets suiting its prerequisites. < TOP >
7.
The following are the main types of burglary insurance policies: 1. Burglary (Business Premises) Insurance Policies The perils covered are burglary and housebreaking. The policy may be extended to cover the perils of riot and strikes, robbery, dacoity and hold-up, on payment of additional premium. Any or all of the following property in any business premises can be covered: i. Stock-in-trade ii. Goods held in trust or on commission iii. Furniture, fixture and fittings iv. Cash and currency notes in locked safe. In addition to the loss of or damage to the insured property by any of the insured perils, the policy also covers the damage caused by the burglars to the premises containing the insured property. 2. Burglary (Private Dwellings) Insurance Policies The perils covered are burglary, housebreaking and theft (or larceny). All the contents of the insured in his private dwelling house are to be insured. The insurance has to be on full value basis. The total sum insured is to be divided under the following items: i. Furniture, fixtures and other household goods ii. Personal effects of every description iii. Jewelry and valuables. The sum insured on ‘jewelry and valuables’ cannot exceed one-third of the total sum insured, unless an extra premium is paid on the amount covering jewelry and valuables in excess of one-third of the total sum insured. Sometimes, the policies issued in respect of private dwellings also cover the peril of fire in addition to the perils of burglary, housebreaking and theft (larceny). These policies are then known as combined fire and burglary insurance policies. Currently, the issue of these policies is not common, and the modern trend is to issue composite insurance policies (also known as multi-peril policies). 3. All Risks Insurance Policies The perils covered are fire, burglary, housebreaking, theft (or larceny) and accidental external means. The policy is specially suitable for covering jewelry, valuables, curios, antiques and other works of art, paintings, watches, clocks, camera, opera glasses, furs, trinkets and other similar articles. Although these policies are known as all risks insurance policies, strictly speaking they are not all risks policies, because they do not cover all conceivable risks.
4.
5.
Baggage Insurance Policies These policies cover the wearing apparel and personal effects carried by the insured during journeys. Normally, jewelry and valuables are excluded, but wrist watches and fountain pens may be covered. The peril covered is theft, but accidental loss or damage is also covered by some insurers, pilferage is not covered. The cover is operative only when the insured is traveling by any accepted mode of travel. Temporary residence at any hotel or rest house during the course of travel, is also covered. The period of cover does not exceed one year. Money-in-transit Insurance Policies The property covered by these policies is money and/or securities in transit from one place to another. Sometimes, money and/or securities kept in the insured’s premises are also covered for short period of time. The perils covered for transit risks are theft, robbery and accident. If the money and/or securities kept in insured premises are also covered, the perils in respect of these risks are burglary and housebreaking only. The policy may be extended to cover riot and strikes risks, on payment of additional premium. The policy specifies the amounts viz. limit of the insurer’s liability for any one loss and the estimated amount in transit during the policy period. The former represents the maximum amount that the insurers may be required to pay in respect of such loss. The latter represents the amount to which the rate of premium is to be applied to arrive at the amount of premium. < TOP >
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