Answer to Question #166146 in Finance for BISHEM

Question

QUESTION ONE

One of the functions of the Bank of Zambia (BoZ) is to act as the bank of re-discount and lender of last resort.

Required:

a). In detail, demonstrate how the Central bank achieves these particular functions.

b). Identify and explain other central bank functions and illustrate how the Bank of Zambia performs these functions in the management of the financial system in Zambia.

c). Distinguish commercial banks and micro-finance institutions (MFIs) by function and objective

QUESTION TWO

a).What do you understand by the terms ‘financial intermediation’ and ‘financial dis-intermediation’? Explain in detail                                                              

b).Outline and explain the problems that would arise in the absence of financial intermediation. c).Explain how financial intermediation overcomes the problems identified in (b) above.                                                                                      

QUESTION THREE

a).Outline and discuss the main risks faced by financial institutions and how they manifest giving practical examples.                                                                                                        

b).Discuss how these risks can be mitigated and managed.       

 

 QUESTION FOUR

The financial market is composed of products and services provided by financial institutions. Identify and describe the following financial institutions.

a).Identify and explain at least five financial instruments (for each) traded in money and capital markets.                                                                                                             

b).distinguish the two types of markets in (a) above.

Answer 1

1.a)The Central Bank of Zambia acts as the provider of liquidity to a financial institution which finds itself unable to obtain sufficient liquidity in the interbank lending market and other facilities or sources have been exhausted. The lender of last resort functions to protect individuals who have deposited funds—and to prevent customers from withdrawing out of panic from banks with temporary limited liquidity.

b) The Central Bank of Zambia ensures appropriate monetary policy formulation and implementation.

The Central Bank of Zambia provides banking services to Government , commercial banks and to act as Settlement Agent.

The Central Bank of Zambia licenses, regulate and supervise banks and financial service institutions.

c) Microfinance renders financial assistance and or gives loans to low-income earners of local families. On the other hand, commercial banks give loans to people and prominent organizations that open accounts.

2.a) Financial institutions are intermediaries that facilitate the flow of funds between two parties. The main advantage that they have is the ability to provide safety, liquidity and the economies of scale. On the other hand, financial disintermediation refers to moving funds between parties directly without a financial intermediary.

b) Aligning business models to the fair treatment of consumers.

Complexity in retail investment products and services.

Firms' responses to regulatory and/or legislative change.

c) They can reduce adverse selection by collecting information on borrowers and screening them to check their creditworthiness.

They can reduce moral hazard by monitoring what borrowers are doing with borrowed funds.

In the end, the vast majority of firms’ finance comes from internal sources, suggesting that information problems are too big for even financial intermediaries to solve.

3.Market risk mostly occurs from a bank’s activities in capital markets. It is due to the unpredictability of equity markets, commodity prices, interest rates, and credit spreads. Banks are more exposed if they are heavily involved in investing in capital markets or sales and trading.

Operational risk is the risk of loss due to errors, interruptions, or damages caused by people, systems, or processes. The operational type of risk is low for simple business operations such as retail banking and asset management, and higher for operations such as sales and trading.

Credit risk is the biggest risk for banks. It occurs when borrowers or counterparties fail to meet contractual obligations. An example is when borrowers default on a principal or interest payment of a loan. Defaults can occur on mortgages, credit cards, and fixed income securities.

b) To manage credit risk, the institution has to maintain credit exposure within the acceptable parameters. One effective way is via a risk rating model that gauges how much a bank stands to lose on credit portfolio. Further, lending decisions are routinely based on the credit score and report of the prospective borrower.

4.a)Treasury Bills

Treasury bills are considered the safest instruments since they are issued with a full guarantee by the Zambia government.

Certificate of Deposit (CD)

A certificate of deposit (CD) is issued directly by a commercial bank, but it can be purchased through brokerage firms.

Commercial Paper

Commercial paper is an unsecured loan issued by large institutions or corporations to finance short-term cash flow needs, such as inventory and accounts payables.

Banker’s Acceptance

A banker’s acceptance is a form of short-term debt that is issued by a firm but guaranteed by a bank. It is created by a drawer, providing the bearer the rights to the money indicated on its face at a specified date.

Repurchase Agreements

A repurchase agreement (repo) is a short-term form of borrowing that involves selling a security with an agreement to repurchase it at a higher price at a later date.

b) The money market is the trade in short-term debt.The capital market encompasses the trade in both stocks and bonds. These are long-term assets bought by financial institutions, professional brokers, and individual investors.