Exam Sem 1 2014 Questions and Answers

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Exam Sem 1, 2014 Questions and Answers.pdf
Financial Institutions And Markets (Monash University)
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Monash University
Semester One Final Examination 2014
Faculty of Business and Economics
Department of Banking and Finance
EXAM CODES: BFC2000

TITLE OF PAPER: FINANCIAL INSTITUTIONS AND MARKETS
EXAM DURATION: 3 hours
READING TIME: 10 minutes
THIS PAPER IS FOR STUDENTS STUDYING AT: (office use only - tick where applicable)
 Berwick  Clayton  Peninsula  Distance Education  Open Learning

 Caulfield  Gippsland  Sunway  Hong Kong  Other (specify)
During an exam, you must not have in your possession, a book, notes, paper, calculator, pencil case, mobile
phone or any other material/item which has not been authorised for the exam or specifically permitted as noted
below. Any material or item on your desk, chair or person will be deemed to be in your possession. You are
reminded that possession of unauthorised materials in an exam is a disciplinable offence under Monash Statute
4.1.
AUTHORISED MATERIALS
CALCULATORS  YES  NO
(Permitted calculators: Citizen SRT-135, Casio FX82MS scientific calculator, the Casio FX82AU scientific
calculator, and Sharp EL-735 financial calculator, or calculators with an 'approved for use' Faculty label)
OPEN BOOK  YES  NO
SPECIFICALLY PERMITTED ITEMS  YES  NO
This paper consists of TWO SECTIONS A & B. Section A contains 20 multiple choice questions; Section
B contains 8 Short Answer Questions and three pages of formula printed on a total of 11 pages. ALL
QUESTIONS must be attempted.
PLEASE CHECK THE PAPER BEFORE COMMENCING. THIS IS A FINAL PAPER.
STUDENT ID: …………………………... DESK NUMBER: …………………….
THIS EXAMINATION PAPER MUST BE INSERTED INTO THE ANSWER BOOK AT THE
COMPLETION OF THE PAPER. NO EXAMINATION PAPERS SHOULD BE REMOVED FROM
THE EXAMINATION ROOM
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BFC2000 FINANCIAL INSTITUTIONS AND MARKETS
SECTION A (20 Marks)

Choose the correct answer and write down your answers on the FIRST page of your exam scrip.
In questions requiring a day count convention, assume 365 days unless otherwise stated. All
multiple choice questions MUST be answered.
1. The most important function of a financial market is to:

A. provide information about shares
B. provide a market for shares
C. facilitate the flow of funds between lenders and borrowers
D. provide employment for brokers and agents
2. Which of the following is NOT an example of primary market transactions?

A. A company issue of shares to raise funds for an investment project.
B. A government issue of bonds.
C. A mortgage bond.
D. A mortgage loan to buy a house.
3. Financial markets have developed to facilitate the exchange of money between savers and
borrowers. Which of the following is NOT a function of money?
A. A store of value
B. A medium of exchange for settling economic transactions
C. A claim to future cash flows
D. Short-term protection against inflation
4. When a government’s budget is in _____, it is required to issue new government securities,

and when the budget is in _______, it may retire maturing debt and redeem some debt prior to
maturity.
A. surplus; surplus
B. deficit; surplus
C. deficit; deficit
D. surplus; deficit
5. Which of the following statements in relation to the function and operation of the Reserve
Bank’s repurchase arrangements via the rediscount window is INCORRECT?
A. Banks may rediscount T-notes to meet their exchange settlement account requirements for
same-day funds.
B. T-notes with a residual maturity up to and including seven days will be purchased at market
yield, plus a penalty margin of 0.75 percentage points.
C. Eligible T-notes with a residual maturity of more than seven days will be purchased at market
yield, plus a penalty margin the same as that for seven-day T-notes.
D. In providing a repurchase arrangement, the Reserve Bank retains responsibility for the
management of liquidity by banks.
6. Monetary policy in Australia is implemented by the Reserve Bank, and is currently principally
directed towards:
A. affecting the level of short-term interest rates
B. effecting a reduction in the current account deficit

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C. affecting the level of growth in the money supply

D. affecting the value of the AUD, and the exchange rate
7. If the Australian Reserve Bank wants to decrease the money supply in the long term, it will:
A. buy repurchase agreements
B. buy Commonwealth government securities
C. lower the cash rate
D. sell Commonwealth government securities
8. Which of the following is NOT true of tightening of monetary policy?

A. Banks’ supplies of funds are depleted through open-market operations.
B. Interest rates fall.
C. The dollar may increase in value.
D. Bank lending is reduced.
9. The liabilities on the balance sheet of a bank are:

A. the sources of funds
B. the uses of funds
C. the different types of deposits the bank offers
D. equal to the assets of the banks
10. All of the following balance sheet portfolio items are liabilities of a bank EXCEPT:
A. term deposits
B. bill acceptance facilities
C. certificates of deposit
D. overdrafts
11. Foreign currency liabilities have increased in importance as a source of funds for Australian
banks. Major reasons for this include:
I. Deregulation of the foreign exchange market
II. Diversification of funding sources
III. Demand from multinational corporate clients
IV. Internationalisation of global financial markets
V. Avoidance of the non-callable deposit prudential requirement
VI. Expansion of banks’ asset-base denominated in foreign currencies
A.: I, II, III, IV, VI

B. II, III, IV, V, VI
C. I, III, IV, V, VI
D. All of the given answers.
12. What happens to the coupon rate of a $100 face value bond that pays $7 coupon annually, if
market interest rates change from 8 to 9%? The coupon rate:
A. increases to 8%
B. increases to 9%
C. remains at 7%
D. increases to just below 9%

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13. A bond’s price will be _______ when the coupon rate is higher than current market interest
rates; _______ when the coupon rate is equal to the current market interest rates; and _______
when the coupon rate is less than the current market interest rates.
A. at a premium; equal to the face value; at a discount
B. at a premium; at a discount; equal to the face value
C. at a discount; at a premium; equal to the face value
D. equal to the face value; at a discount; at a premium
14. Which of the following statements about bills is INCORRECT?

A. There is an active secondary market in bank-accepted bills.
B. Once a bill has been discounted into the marketplace, the cost of funds will vary for the issuer.
C. The drawer has a liability with a bank-accepted bill to pay face value to the acceptor bank.
D. At maturity for a bank-accepted bill, the acceptor will pay face value to the holder.
15. According to modern portfolio theory, the _______ the degree of systematic risk, the
_______ should be the expected return.
A. smaller; greater
B. greater; greater
C. smaller; smaller
D. greater; smaller
16. When a share goes ex-rights, assuming everything else remains the same, its price should:
A. increase, as the company no longer has the right to make the shareholder convert
B. decrease, as the shareholder is losing an option
C. remain the same, as the market knows about it in advance
D. increase, as a successful rights issue will raise a large amount of cash
17. For the writer of a put option, if the underlying share price:
A. moves above the strike price the potential profits are unlimited
B. drops below the strike price the potential profits are unlimited
C. moves above the strike price, the potential profits are limited to the premium
D. moves above the strike price, the premium is reduced by the difference
18. A US-based company that is exporting car components into Australia is about to complete an
export order and expects to receive payment of AUD 500 000 in three months’ time. The spot
exchange rate is USD/AUD 1.5380. In conducting an analysis of its foreign exchange risk
exposure, the company considers the impact of the following exchange rate changes:
I. USD/AUD 1.5180
II. USD/AUD 1.5280
III. USD/AUD 1.5480
Which of the above exchange rate scenarios represents foreign exchange risk to the company?
A: I
B: II
C: III
D: All of the given answers.

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19. Which of the following statements about life insurance companies is FALSE?
A. As inflows of funds are relatively predictable, they have a very stable level of liabilities.
B. They have greatly increased their assets over the past decade.
C. They sell contracts that offer financial cover against premature death.
D. They have large amounts of short-term liquid securities.
20. An investor who wishes to save for their retirement in 20 years’ time and who has a high
propensity for taking risk is likely to invest in a fund that invests in government securities and:
A. cash deposits
B. some property
C. debentures
D. foreign equities
(20 × 1 mark = 20 marks)

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SECTION B (80 Marks)
Question 1
Identify, discuss and provide example of the five main functions of the financial system.
(10 marks)
Question 2
a) Explain why banks are being regulated and monitored more closely than other industry.
b) Why is capital adequacy so important to banks?
(5 + 5 =10 marks)
Question 3
a) Suppose the spot rate on four-year bonds is 7 per cent and the spot rate on five-year bond
is 8 per cent. What forward rate is implied on a one-year bond delivered four years from
now?
b) Define ‘price risk’ and ‘reinvestment risk’. Explain how the two risks offset each other.
(5 + 5 = 10 marks)
Question 4
a) An investor pay $96 000 for a 180-day T-bill with $100000 face value. What is the yield
on the T-bill?
b) Define a money market and discuss its main role.
(5 + 5 = 10 marks)
Question 5
a) It is the end of 2013, and a $1 dividend is just about to be paid by XYZ Limited. In
future, the Board expects to pay a ‘once-a-year’ dividend of $3, $5, and $7 at the end of
2014, 2015, and 2016 respectively, after which they expect the dividends will grow by a
constant 5% p.a. If the rate of return required on XYZ Limited shares is k=14% p.a., what
do you estimate using the dividend growth model should be the current cum-div price of
their shares.
b) Describe five comparative differences between ordinary shares and preference shares

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(5 + 5 = 10 marks)
Question 6
a) Two companies, Company A and Company B, wish to borrow $20,000,000 for 3 years.
Company A wishes to borrow fixed rate, whilst Company B wishes to borrow floating
rate. Each company faces the following rates.
Fixed Floating
Company A 7% BBSW + 0.5%
Company B 9% BBSW + 3.5%
What effective rates will each company face if they decide to go into an interest rate swap
with each other and share the benefits equally? Assume no intermediary fees and that one
party pays BBSW to the other. Draw a diagram showing the payments between the
companies and the payments for the funds borrowed.
b) List five comparative differences between the futures and forward markets?
(5 + 5 = 10 marks)
Question 7
a) A wheat exporter sells 10,000 tonnes of wheat to an importer in China. The transaction is
to be made in Chinese Yuan. On the day of settlement, the Australian exporter converts
the Yuan he receives immediately into AUD, and receives AUD 1 million. If the spot
exchange rate was AUD/CNY 5.8042, what was the price of the wheat per tonne in
Chinese Yuan?
b) An Australian company receives the following indirect quotes for the AUD/USD
Bid Ask
Spot 0.8815 0.8828
One-month forward 0.8885 0.8893
Three-month forward 0.8931 0.8939
Six-month forward 0.8954 0.8959
(i) What would you receive in AUD if you sold USD 2 million at the spot rate?
(ii) What would you pay in AUD if you purchased USD 5 million at the 3-month
forward rate?
c) Why do domestic governments sometime try to prevent the flow of domestic currency
abroad for investment in foreign countries?
(2 + 3 + 3 + 2 = 10 marks)

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Question 8
Identify the five primary services of investment banks and give a brief description of each.
(10 marks)

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Formula Sheet
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OFFICE USE ONLY
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Imputation Credit   Franked Dividend
1 tc
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Gap = RSA -RSL
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SOLUTIONS AFC2000 FINANCIAL INSTITUTIONS AND MARKETS
Monash University
Semester One Final Examination 2014
Faculty of Business and Economics
Department of Accounting and Finance
EXAM CODES: BFC2000

TITLE OF PAPER: FINANCIAL INSTITUTIONS AND MARKETS
EXAM DURATION: 3 hours
READING TIME: 10 minutes
SOLUTIONS
ONLY
BFC2000 FINAL EXAM SOLUTIONS Minh Viet Do Page 1 of 12

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AFC2000 FINANCIAL INSTITUTIONS AND MARKETS
SECTION A (20 Marks)

In questions requiring a day count convention, assume 365 days unless otherwise stated.
1. The most important function of a financial market is to:

A. provide information about shares
B. provide a market for shares
C. facilitate the flow of funds between lenders and borrowers
D. provide employment for brokers and agents
Ans: C
Difficulty: Easy
2. Which of the following is NOT an example of primary market transactions?

A. A company issue of shares to raise funds for an investment project.
B. A government issue of bonds.
C. A mortgage bond.
D. A mortgage loan to buy a house.
Ans: C
Difficulty: Medium
3. Financial markets have developed to facilitate the exchange of money

between savers and borrowers. Which of the following is NOT a function of
money?
A. A store of value
B. A medium of exchange for settling economic transactions
C. A claim to future cash flows
D. Short-term protection against inflation
Ans: C
Difficulty: Medium
4. When a government’s budget is in _____, it is required to issue new

government securities, and when the budget is in _______, it may retire
maturing debt and redeem some debt prior to maturity.
A. surplus; surplus
B. deficit; surplus
C. deficit; deficit
D. surplus; deficit
Ans: B
Difficulty: Easy
5. Which of the following statements in relation to the function and operation

of the Reserve Bank’s repurchase arrangements via the rediscount window is
INCORRECT?
A. Banks may rediscount T-notes to meet their exchange settlement account
requirements for same-day funds.
B. T-notes with a residual maturity up to and including seven days will be
purchased at market yield, plus a penalty margin of 0.75 percentage points.
C. Eligible T-notes with a residual maturity of more than seven days will be
purchased at market yield, plus a penalty margin the same as that for seven-
day T-notes.
D. In providing a repurchase arrangement, the Reserve Bank retains
responsibility for the management of liquidity by banks.
Ans: D
Difficulty: Medium
6. Monetary policy in Australia is implemented by the Reserve Bank, and is

currently principally directed towards:
AFC2000 Minh Viet Do Page 2 of 12

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A. affecting the level of short-term interest rates

B. effecting a reduction in the current account deficit
C. affecting the level of growth in the money supply
D. affecting the value of the AUD, and the exchange rate
Ans: A
Difficulty: Easy
7. If the Australian Reserve Bank wants to decrease the money supply in the
long term, it will:
A. buy repurchase agreements
B. buy Commonwealth government securities
C. lower the cash rate
D. sell Commonwealth government securities
Ans: D
Difficulty: Medium
8. Which of the following is NOT true of tightening of monetary policy?

A. Banks’ supplies of funds are depleted through open-market operations.
B. Interest rates fall.
C. The dollar may increase in value.
D. Bank lending is reduced.
Ans: B
Difficulty: Medium
9. The liabilities on the balance sheet of a bank are:

A. the sources of funds
B. the uses of funds
C. the different types of deposits the bank offers
D. equal to the assets of the banks
Ans: A
Difficulty: Medium
[QUESTION]
10. All of the following balance sheet portfolio items are liabilities of a
bank EXCEPT:
A. term deposits
B. bill acceptance facilities
C. certificates of deposit
D. overdrafts
Ans: D
Difficulty: Medium
11. Foreign currency liabilities have increased in importance as a source of

funds for Australian banks. Major reasons for this include:
I. Deregulation of the foreign exchange market
II. Diversification of funding sources
III. Demand from multinational corporate clients
IV. Internationalisation of global financial markets
V. Avoidance of the non-callable deposit prudential requirement
VI. Expansion of banks’ asset-base denominated in foreign currencies
A.: I, II, III, IV, VI

B. II, III, IV, V, VI
C. I, III, IV, V, VI
D. All of the given answers.
Ans: A
Difficulty: Hard
12. What happens to the coupon rate of a $100 face value bond that pays $7
coupon annually, if market interest rates change from 8 to 9%? The coupon
rate:

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A. increases to 8%
B. increases to 9%
C. remains at 7%
D. increases to just below 9%
Ans: C
Difficulty: Easy
13. A bond’s price will be _______ when the coupon rate is higher than current
market interest rates; _______ when the coupon rate is equal to the current
market interest rates; and _______ when the coupon rate is less than the
current market interest rates.
A. at a premium; equal to the face value; at a discount
B. at a premium; at a discount; equal to the face value
C. at a discount; at a premium; equal to the face value
D. equal to the face value; at a discount; at a premium
Ans: A
Difficulty: Medium
14. Which of the following statements about bills is INCORRECT?

A. There is an active secondary market in bank-accepted bills.
B. Once a bill has been discounted into the marketplace, the cost of funds
will vary for the issuer.
C. The drawer has a liability with a bank-accepted bill to pay face value to
the acceptor bank.
D. At maturity for a bank-accepted bill, the acceptor will pay face value to
the holder.
Ans: B
Difficulty: Medium
15. According to modern portfolio theory, the _______ the degree of systematic
risk, the _______ should be the expected return.
A. smaller; greater
B. greater; greater
C. smaller; smaller
D. greater; smaller
Ans: B
Difficulty: Easy
16. When a share goes ex-rights, assuming everything else remains the same,
its price should:
A. increase, as the company no longer has the right to make the shareholder
convert
B. decrease, as the shareholder is losing an option
C. remain the same, as the market knows about it in advance
D. increase, as a successful rights issue will raise a large amount of cash
Ans: B
Difficulty: Medium
17. For the writer of a put option, if the underlying share price:
A. moves above the strike price the potential profits are unlimited
B. drops below the strike price the potential profits are unlimited
C. moves above the strike price, the potential profits are limited to the
premium
D. moves above the strike price, the premium is reduced by the difference
Ans: C
Difficulty: Medium
18. A US-based company that is exporting car components into Australia is

about to complete an export order and expects to receive payment of AUD 500
000 in three months’ time. The spot exchange rate is USD/AUD 1.5380. In

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conducting an analysis of its foreign exchange risk exposure, the company

considers the impact of the following exchange rate changes:
I. USD/AUD 1.5180
II. USD/AUD 1.5280
III. USD/AUD 1.5480
Which of the above exchange rate scenarios represents foreign exchange risk to
the company?
A: I
B: II
C: III
D: All of the given answers.
Ans: D
Difficulty: Medium
19. Which of the following statements about life insurance companies is FALSE?
A. As inflows of funds are relatively predictable, they have a very stable
level of liabilities.
B. They have greatly increased their assets over the past decade.
C. They sell contracts that offer financial cover against premature death.
D. They have large amounts of short-term liquid securities.
Ans: D
Difficulty: Medium
20. An investor who wishes to save for their retirement in 20 years’ time and
who has a high propensity for taking risk is likely to invest in a fund that
invests in government securities and:
A. cash deposits
B. some property
C. debentures
D. foreign equities
Ans: D
Difficulty: Medium
Question 1
Identify, discuss and provide example of the five main functions of the financial system.
• The roles of the financial system are:

– To facilitate the flow of funds
– To provide the mechanism to settle transactions
– To generate and disseminate information
– To provide the means to transfer and manage risk
– To provide ways of dealing with incentive problems
2 marks each. Identification (0.5), discuss (1) and example (0.5)
Question 2
a) Explain why banks are being regulated and monitored more closely than other industry.
Financial institutions are regulated because they provide goods and services that the
economy needs to function well.

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The environment in which financial institutions operate is characterised by asymmetric

information.
The social costs of bank failures and the resulting economic problems are high — banks
are heavily regulated.
• Because the costs of a bank failure are high, regulation has focussed on reducing the risk
of this occurrence.
• Banks can fail because of illiquidity or inadequate capital.
• Significantly, the failure of one bank undermines confidence in all other banks.
• This confidence may be maintained by the presence of a lender of last resort.
• Ensuring that banks have sufficient liquidity in a crisis is of the utmost importance.
• In Australia, the governments and the RBA have, in the past, provided support in a
liquidity crisis.
• Of course, banks are expected to have their own liquidity management strategies as well.
• The strong prudential supervision of Australian banks has contributed to the stability of
Australia’s financial system during the global financial crisis.
b) Why is capital adequacy so important to banks?
The central problem for bank management is reconciling the conflicting goals of
solvency and liquidity on the one hand and profitability on the other. Unfortunately,
it is a set of conflicts not easily resolved. For example, liquidity could be achieved by holding
only treasury securities. In this strategy, bank management would sleep well but
eat poorly because profits would be low.
At the other extreme, the bank could shift its asset portfolio into high-yielding, high risk
loans at the expense of better-quality loans or liquid investments. Bank management
would eat well temporarily because of increased profits but would sleep poorly because of the
possibility of a bank failure later on caused by large loan losses or inadequate
liquidity. Finally, bank liquidity is ultimately related to bank solvency. That is, most bank
runs are triggered by depositors and other creditors' expectations of extraordinary losses in the
bank's loan or investment portfolios.
(5 + 5 = 10 marks)
Question 3
a) Suppose the spot rate on four-year bonds is 7 per cent and the spot rate on five-year bond
is 8 per cent. What forward rate is implied on a one-year bond delivered four years from
now?
Solution:

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(1  t Rn ) n
1 f
t  n -1 1
(1  t Rn - 1 ) n - 1
(1.08) 5
 1
(1.07) 4
1.47
 1
1.31
 0.1209
 12.09 %
b) Define ‘price risk’ and ‘reinvestment risk’. Explain how the two risks offset each other.
Price risk is the variability of the market price of the bond caused by its inverse movement with
interest rates, while reinvestment risk is the variability in return caused by varying reinvestment
rates as payments are received. As interest rates fall, bond prices rise but reinvestment yields
decline. As interest rates rise, bond prices fall but reinvestment yields increase.
Question 4
a) An investor pay $96 000 for a 180-day T-bill with $100000 face value. What is the yield
on the T-bill?
Pf  P0 365
y be    100%
P0 n
$10 0000  $96000 365
   100%
$96000 180
 8.449%
b) Define a money market and discuss its main role.
The money markets are where depository institutions and other businesses adjust their
liquidity positions by borrowing or investing for short periods of time.
The money market consists of a collection of markets, each trading a distinctly different
financial instrument. There is no central exchange for money markets, such as the
Australian Stock Exchange for the equity markets, because they are over-the-counter
(OTC) markets.
The most important economic function of the money market is to provide an efficient
means for economic units to adjust their liquidity positions.
Q 5 (Equities)
a) It is the end of 2013, and a $1 dividend is just about to be paid by XYZ Limited. In
future, the Board expects to pay a ‘once-a-year’ dividend of $3, $5, and $7 at the end of
2014, 2015, and 2016 respectively, after which they expect the dividends will grow by a

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constant 5% p.a. If the rate of return required on XYZ Limited shares is k=14% p.a., what
do you estimate using the dividend growth model should be the current cum-div price of
their shares.
b) Describe five comparative differences between ordinary shares and preference shares
(5 + 5 = 10 marks)
Suggested Solutions:
a) (5 marks for correct logic and workings. Deductions for failures in logic and
workings)
$ $3 $5 $7 $7.35
End End End End End

2013 2014 2015 2016 2017
Price (cum-div) = $1 + $3/(1+0.14) + $5/(1+0.14)2 + $7/(1+0.14)3 …

+ $7.35/((0.14 – 0.05)*(1+0.14)3) = $67.33
b) (1 mark each for same or similar to a maximum of 5 marks)

Ordinary Shares Preference Shares Marks
Dividends(1) Variable Fixed 1
Dividends(2) No Cumulative May be 1
cumulative
Voting rights Yes Mostly no 1
Ranking for Last First 1
dividends
Claims to Last Second Last 1
assets in (traditionally)
liquidation
Total 5 marks
Q 6 (Derivatives)
a) Two companies, Company A and Company B, wish to borrow $20,000,000 for 3 years.
Company A wishes to borrow fixed rate, whilst Company B wishes to borrow floating
rate. Each company faces the following rates.
Fixed Floating
Company A 7% BBSW + 0.5%
Company B 9% BBSW + 3.5%
What effective rates will each company face if they decide to go into an interest rate swap
with each other and share the benefits equally? Assume no intermediary fees and that one
party pays BBSW to the other. Draw a diagram showing the payments between the
companies and the payments for the funds borrowed.

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b) List five comparative differences between the futures and forward markets?
(5 + 5 = 10 marks)
a) Suggested Solutions:
Overall benefit = (BBSW+3.5% - [BBSW+0.5%]) – (9% - 7%) = 3% - 2% = 1%

Shared equally, each would receive a benefit of 0.5% on their respective borrowings.
Company A borrows floating at BBSW+0.5% p.a. and Company B borrows fixed at 9%

p.a. They then enter an interest rate swap so that each company gets the form of loan they
want (i.e. Company A fixed, Company B floating). See diagram below.
(5 marks = 1 mark for correct A->B payment, 1 mark for A’s effective rate, 1 mark for
B’s effective rate, 1 mark for A’s payment to lender, 1 mark for B’s payment to lender.)
Pay 6% p.a. fixed

Company A Company B
Pays effectively Pays effectively
6.5% p.a. fixed floating BBSW +
3.0%
Pay BBSW
Pay BBSW + 0.5% Pay 9% p.a. fixed

p.a.
b) Suggested Solution ( 1 mark for each Forward/Futures contrast to a maximum of 5

marks)
FORWARD MARKET FUTURES MARKET

The forward market is unstructured and Futures transactions are conducted on an
trades over the counter. organised exchange.
Numerous dealers match individual Contracts are made between buyers or
buyers and sellers and/or trade for their sellers and the exchange.
own accounts.
No maintenance margin is required. Margin requirements are imposed to
ensure no one will default when prices
move adversely.
Most forward contracts are settled by Very few contracts are settled by
delivery. delivery.

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The forward market is useful when a set The futures market is useful when it is
amount of currency is needed on a necessary to hedge price risk over a
specific date. period of time.
No marking to market Marked to market daily.
All elements of the contract are All elements of the contract are
negotiated. standardised (Only price is variable).
Highly illiquid because of customized Trades on exchanges, and are very
features. liquid.
Default potential is quite high. Clearing house guarantees delivery and
payment, therefore low default risk.
Q7
a) A wheat exporter sells 10,000 tonnes of wheat to an importer in China. The transaction is
to be made in Chinese Yuan. On the day of settlement, the Australian exporter converts
the Yuan he receives immediately into AUD, and receives AUD 1 million. If the spot
exchange rate was AUD/CNY 5.8042, what was the price of the wheat per tonne in
Chinese Yuan?
b) An Australian company receives the following indirect quotes for the AUD/USD
Bid Ask
Spot 0.8815 0.8828
One-month forward 0.8885 0.8893
Three-month forward 0.8931 0.8939
Six-month forward 0.8954 0.8959
(i) What would you receive in AUD if you sold USD 2 million at the spot rate?
(ii) What would you pay in AUD if you purchased USD 5 million at the 3-month
forward rate?
c) Why do domestic governments sometime try to prevent the flow of domestic currency
abroad for investment in foreign countries?
(2 + [3 + 3] + 2 = 10 marks)
Suggested Solutions:
a) The wheat must have been AUD 1,000,000/10,000 = AUD 100 per tonne. Therefore for
the Chinese importer, the price of the wheat in CNY must have been 100 x 5.8042 = 580
Yuan per tonne. (2 marks)
b) (i) You are selling USD and buying AUD spot. Therefore, the dealer is buying USD and
selling AUD spot, therefore should use the dealers ‘ASK’ quote of AUD/USD 0.8828. You
are buying the AUD for USD2million, AUD received will be USD2,000,000/0.8828 =
AUD 2,265,518.80 (3 marks)
(ii) You are buying USD and selling AUD 3-months forward. Therefore, the dealer is
buying AUD 3-months forward, so should use the dealers ‘BID’ 3-month forward

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quote. Purchase USD5million, therefore quote is AUD/USD 0.8931 =>

5,000,000/(0.8931) = $5,598,477.21. (3 marks)
c) Governments try to limit the outflow of investment funds so there will be less domestic
currency being exchanged for foreign currency – thereby driving up the exchange price
of domestic currency. (2 marks for same or similar)
Q8
Identify the five primary services of investment banks and give a brief description of
each.
(5 x [1 + 1] = 10 marks)
Suggested Solution:
(1 mark for correct identification, + 1 mark for correct description. For a maximum of 10
marks)
 Initial Public Offerings: Investment banks can help companies and government to
issue new securities into the financial markets. If a company has never offered
securities before, particularly equities for companies that are listing on the stock
exchange for the first time, these are called initial public offerings and investment
banks play an important role in helping companies achieve there financing goals.
(+2 marks for same or similar)
 Underwriting: Investment bank bears price risk and guarantees to buy new
securities for a fixed price. This ensures that the issuing company will be able to
raise the funds that they require. Risk for the investment bank is that the securities
will have to be sold at a price less than the price at which the underwriter had to
buy them for. To reduce the underwriter’s risk, syndicates can be formed to spread
the risk. (+2 marks for same or similar)
 Trading and Brokerage: Investment banks also provide services as financial

market dealers and brokers. Dealers make money by trading on their own account.
Therefore they make a profit by buying securities at a low price and selling
securities at a high price. Brokers in financial markets make money by
commissions. A brokers role is to facilitate trades between buyers and sellers, and
receive a commission for a successful transaction. (+2 marks for same or similar)
 Project Finance: Investment banks provide advice and services related to the
financing of very large projects. Project finance differs from other types of
financing in a number of ways. The project is finance, not the company involved.
Finance is usually provided on a limited recourse basis. Syndication is involved to
share the risk amongst the financiers. (+ 2 marks for same or similar)

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Mergers and Acquisitions: This area of business has become a high profit service for investment
banks. Investment banks will identify candidate firms for mergers or acquisitions, price the deals,
provide advice and negotiation services, and source funds to finance the deal. (+ 2 marks for
same or similar

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Financial Institutions And Markets (Monash University)

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EXAM CODES: BFC2000

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BFC2000 FINANCIAL INSTITUTIONS AND MARKETS

SECTION A (20 Marks)

1. The most important function of a financial market is to:

2. Which of the following is NOT an example of primary market transactions?

4. When a government’s budget is in _____, it is required to issue new government securities,

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C. affecting the level of growth in the money supply

8. Which of the following is NOT true of tightening of monetary policy?

9. The liabilities on the balance sheet of a bank are:

A.: I, II, III, IV, VI

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14. Which of the following statements about bills is INCORRECT?

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SECTION B (80 Marks)

b) Why is capital adequacy so important to banks?

b) Define a money market and discuss its main role.

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