SPRING-2022
Q#. 1: Define financial intermediation and transaction cost.
Ans.
Financial Intermediation:
The financial intermediation process channels funds between third parties with a surplus and
those with a lack of funds.
A financial intermediary does not only act as an agent for other institutional units, but places
itself at risk by acquiring financial assets and incurring liabilities on its own account (for
example banks, insurance corporations, investments funds).
Transaction Cost:
A transaction cost is any expense incurred when conducting an economic transaction. For
example, while purchasing a product or foreign currency, there will be some transaction
charges (in addition to the currency’s price). The transaction cost could be monetary, extra
time, or inconvenience.
Examples of common transaction costs are labor, transportation, broker fees, bank charges,
commissions, etc.
Q#. 2: Differentiate between primary and secondary market.
Ans. The primary market refers to the market where securities are created and first issued,
while the secondary market is one in which they are traded afterward among investors. An
initial public offering, or IPO, is an example of a primary market.
The secondary market is where investors buy and sell securities they already own. It is what
most people typically think of as the “stock market,” though stocks are also sold on the
primary market when they are first issued. National Stock Exchange (NSE), New York Stock
Exchange (NYSE) and Bombay Stock Exchange (BSE) are examples of such platforms.
Q#. 3: Differentiate between the bid/ask and direct/indirect quotation with the help of an
example. Also elaborate bid/ask spread.
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Ans. In foreign exchange (Forex) trading, there are two types of quotations: bid/ask and
direct/indirect. The main difference between the two is the currency that is used as a
reference point.
Bid/Ask Quotation:
A bid/ask quotation is also known as a two-way quotation or a price quotation. It represents
the prices at which a trader can buy or sell a particular currency. The bid price is the price at
which the market maker is willing to buy the base currency, and the ask price is the price at
which the market maker is willing to sell the base currency. The difference between the bid
and ask prices is known as the bid/ask spread.
For example, suppose the EUR/USD pair is quoted as 1.2345/1.2347. In this case, the bid
price is 1.2345, and the ask price is 1.2347. If a trader wants to buy the EUR/USD pair, they
would need to pay the ask price of 1.2347. If a trader wants to sell the EUR/USD pair, they
would receive the bid price of 1.2345. The bid/ask spread in this case is 0.0002, or 2 pips.
Direct/Indirect Quotation:
A direct quotation is a currency pair where the domestic currency is the base currency, and
the foreign currency is the quote currency. An indirect quotation is a currency pair where the
domestic currency is the quote currency, and the foreign currency is the base currency.
For example, let’s say you are in the United States, and you want to know the value of the
British pound. The direct quotation would be the number of US dollars required to purchase
one British pound. On the other hand, the indirect quotation would be the number of British
pounds required to purchase one US dollar.
Suppose the GBP/USD pair is quoted as 1.3920. In this case, the direct quotation would be
that one British pound can be bought for 1.3920 US dollars. The indirect quotation would be
that one US dollar can be bought for 0.7181 British pounds.
Bid/ask spread:
The bid-ask spread is the difference between the bid price and the ask price for a given
security. The bid price represents the highest price a buyer is willing to pay for the security,
while the ask price represents the lowest price a seller is willing to accept.
For example, if the bid price of the EUR/USD pair is 1.2345, and the ask price is 1.2347, then
the bid/ask spread is 2 pips. The spread can vary depending on market conditions and
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liquidity. A smaller spread typically indicates a more liquid market, while a larger spread
may indicate lower liquidity or higher volatility.
Q#. 4: Write the main idea of agency theory.
Ans. The theory assumes that both the principal and the agent are utility maximizers with
different interests, and that because of information asymmetry the agent will not always act in
the best interests of the principal.
Agency theory says that people will obey an authority when they believe that the authority
will take responsibility for the consequences of their actions.
Agency theory posits that corporations act as agents of its shareholders. That is, shareholders
invest in corporate ownership and thereby entrust their resources to the management of the
directors and officers of the corporation.
Q#. 5: Define fixed and variable rate mortgage.
Ans. A fixed rate loan has the same interest rate for the entirety of the borrowing period,
while variable rate loans have an interest rate that changes over time depending on the
market.
A fixed-rate mortgage is a home loan option with a specific interest rate for the entire term
of the loan. Essentially, the interest rate on the mortgage will not change over the lifetime of
the loan and the borrower’s interest and principal payments will remain the same each month.
A variable mortgage rate is an interest rate which can move up and down at any time,
meaning your monthly mortgage payments may occasionally go up or down to match this.
LONG QUESTIONS
Q#. 6: Define Broker and Dealer. What are the primary services offered by the brokerage
firm?
Ans. A broker is a person or a company that acts as an intermediary between buyers and
sellers in financial markets. Brokers execute buy and sell orders on behalf of their clients,
charging a commission or a fee for their services.
A dealer, on the other hand, is a person or a company that buys and sells securities for their
own account, rather than acting as an intermediary for clients. Dealers may operate in a
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variety of financial markets, such as stocks, bonds, and derivatives, and may hold an
inventory of securities to facilitate trading.
Brokerage firms are companies that provide financial services to clients, such as individuals
and institutions, who want to buy and sell securities in financial markets. The primary
services offered by brokerage firms include:
1. Execution of trades: Brokerage firms execute buy and sell orders on behalf of their
clients in financial markets.
2. Investment advice: Brokerage firms provide investment advice and guidance to their
clients to help them make informed investment decisions.
3. Portfolio management: Brokerage firms offer portfolio management services to
clients who want a professional to manage their investment portfolio.
4. Research and analysis: Brokerage firms conduct research and analysis of financial
markets and securities to provide clients with up-to-date information and insights.
5. Retirement planning: Brokerage firms help clients plan for their retirement by
offering investment and savings options such as Individual Retirement Accounts
(IRAs) and 401(k)s.
6. Education and training: Brokerage firms provide educational resources and training
to clients to help them improve their knowledge of financial markets and investments.
7. Margin lending: Brokerage firms provide margin accounts that allow clients to
borrow money to invest in securities, using their existing investments as collateral.
8. Access to IPOs and other investment opportunities: Brokerage firms may provide
their clients with access to initial public offerings (IPOs) and other investment
opportunities that are not available to the general public.
9. Trading platforms and tools: Brokerage firms offer trading platforms and tools that
enable clients to monitor financial markets, analyze securities, and execute trades.
10. Tax planning and reporting: Brokerage firms provide tax planning and reporting
services to help clients manage their tax liabilities and comply with tax regulations.
11. Estate planning: Brokerage firms offer estate planning services to help clients plan
for the transfer of their assets to their heirs or beneficiaries.
12. Insurance products: Some brokerage firms offer insurance products, such as life
insurance and annuities, to help clients manage risk and protect their financial assets.
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Q#. 7: Write a note on stock quotations and stock indexes.
Ans. A stock quote is the price of a stock as quoted in decimals on an exchange. A stock
quote is generally displayed with supplemental information, such as high and low prices for a
given security in a day or its change in value.
Stock quotations are typically displayed in a standardized format that includes several key
components:
1. Ticker Symbol: A unique combination of letters assigned to a specific stock, which
serves as its unique identifier. For example, “AAPL” represents Apple Inc.
2. Stock Price: The current trading price of the stock, typically displayed in the
currency of the stock market where it is traded. For example, “$150.25” represents a
stock priced at $150.25 per share.
3. Change in Price: The difference between the current stock price and the previous
day’s closing price, usually expressed as a dollar amount or percentage. A positive
number indicates an increase in stock price, while a negative number indicates a
decrease.
4. Volume: The total number of shares of the stock that have been traded during a
specified period of time, such as the current trading day or the past 30 days. Volume
is often used as an indicator of a stock’s liquidity and investor interest.
5. High and Low Prices: The highest and lowest prices at which the stock has traded
during a specific period of time, such as the current trading day or the past 52 weeks.
These prices provide information about the stock’s price range and volatility.
6. Market Capitalization: The total value of a company’s outstanding shares of stock,
calculated by multiplying the stock price by the total number of shares outstanding.
Market capitalization is often used to determine the size and relative value of a
company.
7. Dividend Information: If the stock pays dividends, the dividend amount, yield, and
frequency may be included in the stock quotation. Dividends are typically periodic
payments made to shareholders as a portion of the company’s profits.
8. Additional Information: Depending on the source and format of the stock quotation,
additional information such as the company name, sector, exchange, and time of the
last trade may also be included.
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Stock indexes, also known as stock market indexes or simply indexes, are numerical
indicators that track the performance of a group of stocks or securities in a particular financial
market. They are used to provide a snapshot of the overall health and direction of a stock
market or a specific segment of the market.
An index is a group or basket of securities, derivatives, or other financial instruments that
represents and measures the performance of a specific market, asset class, market sector, or
investment strategy.
Stock indexes are calculated using a formula that takes into account the prices or market
capitalization of the component stocks. They are typically weighted based on the size, market
capitalization, or other factors of the constituent companies. The value of an index is usually
expressed in points or as a percentage change from a base value.
There are various types of stock indexes, and they can cover different regions, countries,
sectors, or investment styles. Some well-known stock indexes include:
1. S&P 500: A widely followed index that includes 500 of the largest publicly traded
companies in the United States, covering about 80% of the U.S. equities market.
2. Dow Jones Industrial Average (DJIA): A price-weighted index that tracks the
performance of 30 large, publicly traded companies in the United States, representing
various industries.
3. NASDAQ Composite: An index that includes all the stocks listed on the NASDAQ
stock exchange, which is known for its heavy representation of technology
companies.
4. FTSE 100: An index that measures the performance of the 100 largest companies
listed on the London Stock Exchange in the United Kingdom.
5. Nikkei 225: A stock index that tracks the performance of 225 major companies listed
on the Tokyo Stock Exchange in Japan.
Q#. 8: Explain the instruments of bond market and their properties.
Ans. Bond market is a market place where purchasing and selling of debt securities like
bonds, take place. It is platform for raising funds from the general public at a large.
Instruments of Bond Market
There are several types of instruments commonly traded in the bond market, including:
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1. Treasury Bonds: These are debt securities issued by governments, such as the U.S.
Treasury bonds, and are considered to be the safest type of bonds. They are backed by
the government’s credit and are typically used to finance government spending.
2. Corporate Bonds: These are debt securities issued by corporations to raise capital for
various purposes, such as expanding operations or funding acquisitions. Corporate
bonds typically offer higher yields than Treasury bonds, but also carry higher risks, as
they are subject to the creditworthiness of the issuing corporation.
3. Municipal Bonds: These are debt securities issued by state and local governments,
usually to finance public infrastructure projects such as roads, schools, and hospitals.
Municipal bonds can be either general obligation bonds, backed by the government’s
credit, or revenue bonds, backed by the revenue generated by the specific project
being financed.
4. Government Agency Bonds: These are debt securities issued by governmentsponsored entities such as Fannie Mae, Freddie Mac, and the Federal Home Loan
Banks. These entities are created by the government to support specific sectors of the
economy, such as housing finance or agriculture. Government agency bonds are
considered to be relatively safe as they are backed by the creditworthiness of the
government, but they may offer slightly higher yields compared to treasury bonds due
to slightly higher credit risk.
5. Mortgage-backed Securities (MBS): These are bonds backed by a pool of mortgage
loans, such as residential mortgages. MBS are created by financial institutions and
then sold to investors, and they can offer different levels of risk and return depending
on the underlying mortgage loans.
6. Collateralized Debt Obligations (CDOs): These are complex instruments that are
backed by a pool of debt securities, including bonds, loans, and other debt
instruments. CDOs are typically structured into different tranches with varying levels
of risk and return, and they gained notoriety during the 2008 financial crisis due to
their role in the subprime mortgage meltdown.
7. Zero-coupon Bonds: These are bonds that do not pay periodic interest payments, but
are sold at a discount to their face value and mature at face value. The return on zerocoupon bonds comes from the difference between the purchase price and the face
value, and they are often used for long-term investment or retirement planning.
Properties of Bond Market
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Here are some key properties of the bond market:
1. Debt securities: Bonds are debt securities that represent a loan made by an investor to
the issuer of the bond. The issuer typically pays periodic interest payments to the
bondholder and returns the principal amount when the bond matures.
2. Diversification: The bond market offers a wide range of bond types with varying risk
profiles, including government bonds, corporate bonds, municipal bonds, mortgagebacked securities, and more. This allows investors to diversify their investment
portfolios and manage risk by choosing bonds with different levels of credit risk,
duration, and yield.
3. Yield and interest rates: Bonds pay periodic interest payments, also known as
yields, to bondholders. The yield on a bond is influenced by various factors, including
prevailing interest rates, credit risk of the issuer, and bond’s maturity. Bonds with
higher credit ratings or longer maturities generally offer higher yields to compensate
investors for the increased risk or longer holding period.
4. Secondary market: Bonds are traded in the secondary market, which provides
liquidity to investors by allowing them to buy or sell bonds before they mature. The
secondary market for bonds is typically less liquid compared to stock markets, and
bond prices can be affected by factors such as changes in interest rates, market
sentiment, and credit risk perceptions.
5. Credit risk: Bonds are subject to credit risk, which refers to the risk that the issuer
may default on interest payments or fail to repay the principal amount at maturity.
Credit risk varies depending on the creditworthiness of the issuer, which is assessed
by credit rating agencies. Bonds with higher credit ratings are generally considered
less risky but may offer lower yields, while bonds with lower credit ratings may offer
higher yields but come with higher risk.
6. Duration: Duration is a measure of a bond’s sensitivity to changes in interest rates.
Bonds with longer durations are typically more sensitive to changes in interest rates,
which can affect their market value. Investors may use duration as a tool to manage
interest rate risk in their bond portfolios.
7. Capital gains and losses: Bond prices can fluctuate in the secondary market, leading
to capital gains or losses for investors who buy or sell bonds before maturity. Factors
such as changes in interest rates, credit risk, and market sentiment can impact bond
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prices. Investors should be aware of the potential for capital gains or losses when
trading bonds.
8. Diverse investor base: The bond market attracts a wide range of investors, including
individual investors, institutional investors such as pension funds and insurance
companies, and central banks. This diverse investor base contributes to the liquidity
and stability of the bond market.
9. Economic indicators: The bond market is closely monitored by investors and
policymakers as it can provide insights into the overall health of the economy. Bond
yields are often used as a benchmark for interest rates in the broader economy, and
changes in bond prices can reflect changes in market sentiment and economic
conditions.
Q#. 9: Write a note on the sources of funds for banks.
Ans. A bank is a financial institution and a financial intermediary that accepts deposits and
channels those deposits into lending activities, either directly or through capital markets. A
bank connects customers with capital deficits to customers with capital surpluses.
Here are the key sources of funds for banks:
1. Deposits: Deposits are the primary source of funds for banks. Banks accept deposits
from individuals, businesses, and other entities, and use these deposits to make loans
and investments. Deposits can be in the form of savings accounts, current accounts,
fixed deposits, and other types of deposit accounts. Banks pay interest on deposits,
which serves as an incentive for depositors to park their funds with the bank.
2. Borrowings: Banks can also raise funds by borrowing from other financial
institutions, such as other banks or the central bank. Borrowings can be in the form of
short-term loans, medium-term notes, or long-term debt. Banks may borrow to meet
temporary liquidity needs or to finance their lending activities.
3. Capital Infusion: Banks can raise funds by issuing equity shares or other forms of
capital instruments. This is known as capital infusion and is typically done through
initial public offerings (IPOs), private placements, or rights issues. Capital infusion
increases the bank’s capital base, which enhances its ability to absorb losses and
support growth.
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4. Retained Earnings: Banks can also use their retained earnings, which are
accumulated profits from previous years, as a source of funds. Retained earnings can
be used to finance growth, expand operations, or strengthen the bank’s capital base.
5. Interbank Market: Banks can borrow or lend funds in the interbank market, which is
a market where banks trade funds with each other. This market allows banks to
manage their short-term liquidity needs and balance their cash flows.
6. Sale of Assets: Banks can sell their assets, such as loans, securities, or properties, to
raise funds. This can include selling non-performing loans, excess securities, or
surplus real estate holdings. The proceeds from the sale of assets can be used to fund
new loans or investments.
7. Central Bank Facilities: Banks can also access funds from the central bank through
various facilities, such as discount windows or repurchase agreements. These facilities
provide banks with short-term liquidity support during times of financial stress or
liquidity shortages.
8. Customer Fees and Commissions: Banks generate revenue by charging fees and
commissions for various services provided to their customers, such as account
maintenance fees, transaction fees, loan processing fees, and other service charges.
These fees and commissions can contribute to the bank’s overall funds and can be
used to support their operations and lending activities.
9. Foreign Borrowings: Banks may also raise funds by borrowing from international
financial markets. This can be done through issuing foreign currency-denominated
debt or obtaining lines of credit from foreign banks or financial institutions. Foreign
borrowings can provide banks with access to additional funds and diversify their
sources of funding.
10. Government and Central Bank Support: During times of financial crisis or
economic instability, banks may receive support from the government or central bank
in the form of bailout packages, capital injections, or other financial assistance
programs. This can provide banks with additional funds to stabilize their operations
and maintain their financial stability.
Q#. 10: Explain the closed end, Exchange traded and venture capital mutual funds.
Ans.
➢ Closed-end mutual funds:
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A closed-end mutual fund is a type of investment fund that pools money from multiple
investors to invest in a diversified portfolio of securities, such as stocks, bonds, or other
assets. However, unlike open-end mutual funds, closed-end funds issue a fixed number of
shares through an initial public offering (IPO), and these shares are then traded on an
exchange, such as a stock exchange. Once the shares are issued, they are bought and sold like
regular stocks, and their prices are determined by supply and demand in the market. Closedend mutual funds typically have a professional manager who makes investment decisions on
behalf of the fund and charges fees for managing the portfolio. Investors can buy or sell
shares of a closed-end fund at any time during market hours, but the price may trade at a
premium or discount to the net asset value (NAV) of the fund’s underlying assets, depending
on market conditions and investor sentiment.
➢ Exchange-traded mutual funds (ETFs):
An ETF is a type of investment fund that is similar to a closed-end mutual fund in that it
trades on an exchange like a stock. However, unlike closed-end funds, ETFs are typically
designed to track the performance of a specific market index, such as the S&P 500 or the
Nasdaq Composite, and their shares can be bought and sold throughout the trading day at
their market price. ETFs are also known for their lower fees compared to traditional mutual
funds, as they often passively track an index rather than having an actively managed
portfolio. ETFs can provide diversification and flexibility for investors, as they allow for
trading in real-time and can be bought or sold at any time during market hours.
➢ Venture capital mutual funds:
A venture capital mutual fund is a type of mutual fund that invests in early-stage or startup
companies with high growth potential. These funds pool money from multiple investors and
use it to provide equity financing to companies in exchange for ownership stakes. Venture
capital mutual funds are typically managed by professional venture capital firms that have
expertise in identifying and investing in promising startups. These funds typically have a
long-term investment horizon and are considered high-risk investments, as the companies
they invest in are often in the early stages of development and may not have a proven track
record or revenue. However, they also offer the potential for high returns if the invested
companies are successful. Venture capital mutual funds are usually not publicly traded and
have specific investment criteria and holding periods, as they aim to support companies in
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their early stages and help them grow before exiting the investment through methods such as
initial public offerings (IPOs) or mergers and acquisitions (M&A) in the future.
...THE END...
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