INSTITUTE OF BANKERS OF SRI LANKA
Diploma in Applied Banking and Finance (DABF)
Financial Management - Guidance Questions
a) The questions below are provided to guide students and teachers in their
studies on the subject as per the syllabus.
b) Each question will carry 20 marks distributed as 2 marks for each subquestion under question No. 1 and 5 marks for each sub-question under
question No. 2-18.
c) It is expected that about 30-35 minutes will take to answer a question.
d) Precise answers are expected in points. Detailed essay typed long answers
are not expected.
e) Contents of some of these questions may be useful for the subjects of
“Financial Market Operations” and “Investment Banking” due to
interconnectedness of these subjects. But, the focus of each subject will be
different.
1)
Provide answers for the following multiple choice and direct short questions
appropriately.
i.
As a Treasury manager, you forecast an increase in interest rates over the next
several months. Which of the following combination of maturity and coupon
rate would most likely result in the largest decrease in portfolio value?
Maturity
Coupon rate
a)
2015
10%
b)
2015
12%
c)
2030
10%
d)
2030
12%
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ii.
Which of the following is least likely to affect the required rate of return on an
investment?
a) Real risk free rate
b) Asset risk premium
c) Expected rate of inflation
d) Investor’s composite propensity to consume.
iii.
Which one of the following falls in to investment grade bonds?
a) Sovereign bonds.
b) Securities with rating of CCC and above.
c) Securities with rating of BBB and above.
d) Securities with rating of BBB-and above.
iv.
Which one of the following shows a Negative Gap?
a) Make a loan for one year at 15% funded with a six months deposit at
10% betting that the future interest rates will be the same
b) Make a loan for six months at 25% funded with a one year deposit at
20% betting that he future interest rates will rise
c) Make a loan for one year at 15% funded with a six month deposit at 10%
betting that he future interest rates will rise
d) Make a loan for six months at 25% funded with a one year deposit at
20% betting that the future interest rates will ease.
v.
Which one of the following objectives for which issuers and investors engage
in derivative products?
a) Derive value from other markets.
b) Limit the effect of market volatility.
c) Guarantee the amount of settlement.
d) Eliminate the risk inherent in market transactions.
vi.
As a money market dealer, how much do you pay for an investor who invests
in a commercial paper of Rs 1,000,000 face value maturing in 31 days at a rate
of return of 8% p.a.
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vii.
Spot USD/CHF is quoted to you at 1.1250-55. If you sold CHF30,000,000 at
this quote, how many USD would you receive in exchange?
viii.
Spot EUR/USD 1.3690, 6 month EUR deposit rate is 0.40% 6 months USD
deposit rate is 0.30%. Calculate the 6 month EUR/USD outright forward rate.
ix.
Calculate the value of the following put options: Long position: Strike price is
$ 80, premium $ 4 and stock price is $ 76.
x.
2)
Derive the spot/zero coupon yield curve using the following bonds:
Bond
Maturity
Par yield
A
1 Year
10%
B
2 Year
8%
C
3 Year
6%
A Treasury Manager in a commercial bank is assigned to manage day-to-day
surplus or deficit of funds generally amounting to 15% of capital funds of the
bank.
Explain how you as a Treasury Manager would manage such funds
position using the each of the following instruments paying attention to
prudence, profit and compliance with any regulations applicable.
3)
i.
Call Money
ii.
Repurchase Agreements
iii.
Reverse Repurchase Agreements
iv.
Equities
Assume that you have professional qualifications in Financial Management and
receive a job as a fund manager in a large corporation. You are assigned to
manage the “Approved Provident Fund” of the employees of the corporation.
Explain your specific strategies to manage the Fund for each of the following.
i.
Maintenance of liquidity
ii.
Diversification to enhance annual return to members
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4)
iii.
Diversification to grow the fund long-term with solvency
iv.
Payments to members and protecting their benefits after retirement
The nature of the governance framework in the office of portfolio management is
fundamental to risk management of the portfolio. Explain each of the following
and their importance to risk management giving appropriate examples.
i.
Organization of treasury operations under three offices
ii.
Designing of the limit structure with various categories
iii.
Compliance with the "Model Code” – the International Code of Conduct
and Practice for the Market issued by the ACI Financial Market
iv.
5)
Management Reporting
In terms of best practices, financial reporting of a portfolio should comply with
International Financial Reporting Standards (IFRS). Explain how investments
will be classified (Accounting Categories) and profit/loss and investment will be
accounted for under each of the instances.
6)
i.
Securities held for day-to-day trading purpose
ii.
Securities held with the intension to sell if the market is good
iii.
Securities purchased with long-term investment
iv.
Improvement of the long-term investments
In managing an investment portfolio of securities, risk management involves
common sense techniques based on experience of portfolio managers as well as
sophisticated IT based techniques. Identification of risk is a pivotal component
of the risk management. Briefly explain how the following techniques are used
to measure the risks and the types of risks so measured.
i.
Gap Analysis
ii.
Modified Duration
iii.
Value at Risk (VAR)
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iv.
7)
Stress Testing
Investment portfolios are managed with different strategies based on riskappetite and flows of funds. Answer the following questions.
i.
Name the strategy/concept introduced by Mr. Harry Markowitz and
outline its salient features.
ii.
Explain how the concept of correlation is used to decide the diversification
among investment securities.
iii.
Explain the difference between passive strategies and active strategies in
the portfolio management and underlying risk-return outlook.
Give
examples.
iv.
In case of a “Hedge Fund”, outline the risk-return strategy you will follow
in managing the Fund.
8)
In managing an investment portfolio actively, portfolio managers follow
benchmarking to assess their performance on overall outcome of the portfolio
management and underlying risk appetite. Answer the following questions.
i.
What is meant by benchmarking of a portfolio?
ii.
Explain the methodology generally adopted for benchmarking of a
portfolio of securities under management.
9)
iii.
How does a benchmarking of a portfolio differ from a performance target?
iv.
Explain the risk-return trade-off.
Despite the well-established governance structures to manage risks, portfolio
managers/dealers tend to engage in unauthorized dealing/trading through
various strategies and such trading scandals are known as rogue trading.
Explain the reasons for each of the following scandals and their outcome to the
respective dealers responsible for and to the respective bank.
i.
Nick Leeson in Barings Bank.
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ii.
Jerome Kerviel in Societe Generale
iii.
Kweku Adaboli in UBS
iv.
London Whale in JP Morgan Chase Manhattan
Describe the following fund raising instruments and specific cost and benefits to
corporate raising long-term funds.
11)
i.
Convertible Debentures
ii.
Global Depository Receipts
iii.
Preference Shares
iv.
Fixed Rate Debentures
Assume that a fund manager practicing in the New York is appointed to manage
a pension fund. He does not wish to have a high exposure to equity market, but
he is willing to earn a short-term profit from the current upward market trend of
equities without investing in equities. Accordingly, he decides to deal in a stock
index futures traded at the NYSE. Answer the following question.
i.
What could be the reasons for his decision?
ii.
What is a stock index futures? Explain it by giving an example.
iii.
How will he deal in the index to make profit?
iv.
In what situation will he be losing? What should be his strategy to cut
losses?
12)
Portfolio managers undertake dealings on some securities in the portfolio to
make interim profit through various dealings in the market. Describe how a fund
manager may attempt to make profit through each of the following instruments.
i.
Arbitraging
ii.
Securities/bond lending
iii.
Short-selling
iv.
Repos and Reverse Repos
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13)
Market risk relating to financial transactions and instruments can be mitigated to
some extents by resorting to certain financial derivatives. Describe how you as a
financial manger of a large exporting company chose a derivative product for
each of the following instances.
i.
Your company is to receive export proceeds in next two month as the
Central Bank excessively defends the local currency.
ii.
The world market price of yours company’s import of raw material is
rising.
iii.
Your company is paying interest on its debenture issue at a fixed interest
rate where as the Central Bank has started easing the monetary policy.
iv.
Your company has raised a short-term US$ loan to meet working capital in
the country and the company wishes to keep the dollars while raising
Rupees as the local currency is expected to depreciate in the near future.
14)
Consider the following over-the-counter hedging/derivative contract entered
into by a bank and a petroleum importing company to hedge the oil price risk.
This contract was agreed at the time the world oil price was rising.
(a)
Underlying price: Singapore Gas Oil 0.5
(b)
Strike price: US$ 134,
(c)
Cap: US$ 139, Floor: US$ 124
(d)
If the price is between the cap and strike), the bank will pay the Company:
100,000 X (price-strike)
(e)
If the price is between the strike and floor, no payment is involved.
(f)
If the price is equal to or greater than the ca), the bank will pay CPC:
100,000 X (cap-strike or US$5) and the contract terminates in 3 months of such
consecutive payments.
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If the price is less than the floor), the Company will pay the bank: 200,000
(g)
X (floor-price) and the contract terminates in 12 months of such consecutive
payments.
i.
Why is this contract considered as a derivative?
ii.
If the market price is US$ 140, how much the bank will pay?
iii.
If the market price is US$ 140 for 4 months, how much the bank would
have paid?
iv.
15)
Is this a fair deal or sale of a derivative by the bank to the company? Why?
Treasury Managers can use “options” to hedge risks of underlying investments
as well as to take risks seeking profit. There are various types of “options” and
strategies in dealing of “options” for the intended objective.
Answer the
following questions:
i.
There are two types of options, i.e., “call options” and “put options”.
What is the difference between these two?
ii.
What is the difference between “American options” and “European
options”?
iii.
Dealings in options involve in two basic prices, i.e., premium (or option
price) and strike price. What is the difference between these two prices?
iv.
Assume that a Treasury Manager of a large tea exporting firm has entered
into an option contract of “Long-put” for US $ 10 million for underlying
export proceeds in 3 month time at a strike price of 132 Rupees per US
Dollar by paying a premium one Rupee per US Dollar.
If the spot
exchange rate of the bank at the maturity date of the option increases to
Rs. 134 per US Dollar, what should be the strategy of the Treasury
Manager? What will be the gain/loss on this strategy?
16)
Financial Planning is an important element to monitor future business operations
of a company. However, financial planning is only a financial professionals’
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exercise and there is no universally accepted one technique.
Answer the
following questions:
i.
What is meant by capital budgeting?
ii.
Compare the Net Present Value (NPS) estimate and Internal Rate of
Return (IRR) estimate used in capital budgeting decisions.
iii.
Describe the difference between “Top-Down” approach and “Bottom-up”
approach used in financial budgeting/planning of a company and the
benefits of financial planning.
iv.
Describe the difference between the use of Ratios and use of
Regression/Statistical methods for financial forecasting and their benefits.
17)
Outline each of the following fund-raising instruments and their benefits to the
company and investor.
18)
i.
Contingent convertibles
ii.
Convertibles
iii.
Warrants
iv.
Redeemable preference shares
One area of financial management of a corporate is the working capital
management in order to avoid liquidity problems.
Answer the following
questions.
i.
What are meant by working capital and working capital management?
ii.
What is the importance of current ratio as a relative liquidity measure for
working capital management?
iii.
How does the yield curve help working capital financing decisions?
iv.
How can interest rate swaps be used to reduce the dependence on the
matching principle in working capital finance?
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