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.
< Answer
1. If the RBI makes an open market purchase, which of the following will occur? >

(a) Money demand increases, and the interest rate increases

(b) Money demand decreases, and the interest rate falls
(c) The money supply decreases, and interest rates rise
(d) The money supply increases, and interest rates fall
(e) Both the money supply and money demand increase, and thus we cannot determine effect on the
interest rate.
< Answer
2. 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.
< Answer
3. When the interest rates increase, the _______ in the interest income is _______than the ________ in the >
interest expenditure when the maturity gap is _________.
(a) Decrease, less, increase, negative
(b) Decrease, less, decrease, positive
(c) Increase, less, increase, positive
(d) Increase, more, decrease, negative
(e) Increase, more, increase, positive.
< Answer
4. Which of the following is an example of crowding out? >

(a) An increase in the money supply causes interest rates to fall and investment to rise
(b) An increase in government spending causes interest rates to rise and investment to fall
(c) An increase in government spending causes interest rates to fall and investment to rise
(d) A decrease in government spending causes interest rates to rise and investment to fall
(e) A decrease in the money supply causes interest rates to rise and investment to fall.
< Answer
5. A bank can increase its leverage by increasing its ratio of >

(a) Earnings/total assets (b) Earnings/equity capital

(c) Total assets/equity capital (d) Equity capital/total assets
(e) Both (a) and (b) above.
< Answer
6. The ‘rainy day segment’ as per Berry’s categorization of various social classes are >

(a) Middle class (b) Lower-middle and poor-class

(c) Upper-middle and middle-class (d) Upper-class and upper-middle class
(e) Upper-class and rich class.
 < Answer
7. Which of the following facilities give rise to credit risk? >

(a) Underwriting commitments (b) Loans against gold

(c) Guarantee issued by the bank (d) Loans against hypothecation
(e) Loans against pledge.
< Answer
8. 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 (b) Process (c) Place (d) Product (e) Promotion.
< Answer
9. The neutrality of money means that >

(a) Changes in the money supply have no effect on the economy

(b) Changes in the money supply have no short-term effect on the economy
(c) Changes in the money supply have no long-run effect on the economy
(d) 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
(e) 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.
< Answer
10. If nominal GDP is $5000 billion and the money supply is $1250 billion, then the velocity of money is >

(a) 0.25 (b) 2 (c) 4 (d) 8 (e) 12.

< Answer
11. Which of the following statements is/are true regarding Price Level Adjusted Mortgage? >

(a) The Internal Rate of Return is equal to or greater than the inflation rate
(b) The Internal Rate of Return is equal to inflation rate
(c) The Net Present Value of such a proposal is always positive irrespective of the discount rate
(d) Mortgage payments are of fixed amount
(e) Both (a) and (c) above.
< Answer
12. Which of the following pricing strategies enables a bank to pay interest as a function of average >
balance?
(a) Free banking by level (b) Explicit pricing
(c) Relationship pricing (d) Rebate strategy
(e) Symmetric account.
< Answer
13. The type of intermediation in which financial intermediaries lend to risky borrowers and issue relatively >
safe and liquid securities is known as
(a) Maturity intermediation (b) Default-risk intermediation
(c) Liquidity intermediation (d) Information intermediation
(e) Denomination intermediation.
< Answer
14. Which of the following liabilities is classified under demand liabilities for the computation of NDTL? >

(a) Cash certificates

(b) Recurring deposits
(c) Unclaimed deposit
(d) Deposits held as securities for advances
(e) Staff security deposit.
< Answer
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 (b) 4%, rising (c) 4%, constant
(d) 4%, falling (e) Rising, falling.
 < Answer
16. ALM (Asset Liability Management) is a strategic balance sheet exercise that involves managing of risks >
caused by changes in
(a) Exchange rates and Liquidity position of Banks
(b) Liquidity and NPAs position of Banks
(c) Interest rates and exchange rates of Banks
(d) Interest rates, Exchange rates and Liquidity position of Banks
(e) Profit and loss of the Banks.
< Answer
17. An upward sloping yield curve is suggested by >

(a) Market segmentation theory (b) Preferred habitat theory

(c) Pure expectation’s theory (d) Liquidity theory
(e) Both (a) and (c) above.
< 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) A decrease in interest rates and an increase in bond prices

(b) A decrease in interest rates and a decrease in bond prices
(c) An increase in interest rates and an increase in bond prices
(d) An increase in interest rates and no change in bond prices
(e) An increase in interest rates and a fall in bond prices.
< Answer
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% (e) 13.23%.
< Answer
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) Decrease the spreads (b) Increase the spreads
(c) Not affect the spreads (d) Result in increase in the cost of funds
(e) Insufficient information.
< Answer
22. When the RBI wants to conduct a ______ open market _______ operation, it engages in a _______. >

(a) Permanent; purchase; reverse repo

(b) Permanent; purchase; repurchase agreement
(c) Temporary; sale; repurchase agreement
(d) Temporary; sale; reverse repo
(e) Temporary; purchase; reverse repo.
< Answer
23. Which of the following statement is/are false regarding liquidity risk management? >

(a) In liability management, a proposal for loan is approved when there is surplus funds
(b) Technical approach aims to eliminate liquidity risk in the short run
(c) Fundamental approach aims to eliminate liquidity risk in the long run
(d) Asset management aims to eliminate liquidity risk by holding near cash assets
(e) Both (c) and (d) above.
< Answer
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) Borrowers are worse off and lenders are better off
(b) Borrowers are better off and lenders are worse off
(c) Both borrowers and lenders are better off
(d) Both borrowers and lenders are worse off
(e) 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.
< Answer
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 (b) Rs.96.25 (c) Rs.97.45 (d) Rs.98.35 (e)
Rs.98.95.
< Answer
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 (b) Floating policy
(c) Reinstatement value policy (d) Declaration policy
(e) Both (b) and (c) above.
< Answer
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 (b) Social security scheme
(c) Rural group life insurance scheme (d) Lalgi scheme
(e) Agricultural insurance scheme.

END OF SECTION A
 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)
 Liabilities Assets
Market Interest Duration Market Interest Duration
Description Description
value rate (%) (Years) value rate (%) (Years)
Cash and other
Equity 300 – – 500 – –
assets
CDs 1,000 5 0.50 Investments 1,100 8 1.00
Short term Short term
2,200 6 1.00 2,900 10 1.50
deposits loans
Long term Long term
3,000 7 4.00 2,100 12 4.00
Deposits loans
Other liabilities 100 – 0.75
6,600 6,600 The
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. 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 Rs. Crore
Cash in hand with all branches in India 424.62
Cash in hand with all its foreign branches 80.35
Current a/c balances with RBI (includes Rs.580 cr. cash reserve) 592.50
Cash held in currency chest 285.29
Current a/c balances with banks in India 46.64
Current a/c balances of its foreign branches with banks outside India 10.44
Current a/c balances of other banks in India with the bank 52.50
Current a/c balances of other banks outside India with its foreign branches 12.70
Investments in approved securities 3665
Gold holding 250.45
The reserve requirement as SLR 25% and CRR 5%.
You are required to
a. Compute CRR, NDTL and SLR in that order.
b. Compute SLR, NDTL and CRR in that order.
c. 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 240 Cash in hand 160
Reserves 427 Cash with RBI 732
Deposits 9450 Investments 4564
Borrowings 1110 Advances 5100
Other liabilities & Provisions 765 Fixed Assets 745
Other Assets 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) < TOP
>
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.
2. Answer : (c) < TOP
>
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.
3. Answer : (e) < TOP
>
Reason : If interest rate increases and maturity gap is positive, then increase in interest
income will be more than the increase in interest expenditure.
4. Answer : (b) < TOP
>
Reason : If an increase in government spending results in a decrease in investment
spending, the government spending is said to be crowding out investment.
5. Answer : (c) < TOP
>
Reason : By increasing Total Asses without increasing equity capital the bank can
increase its total risk weighted assets thus increasing its leverage.
6. Answer : (b) < TOP
>
Reason : Berry’s categorization of the various social classes based on financial outlook
defines lower-middle and poor class as rainy day segment.
7. Answer : (d) < TOP
>
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..
8. Answer : (b) < TOP
>
Reason : Process is relevant to service sector like banking.
9. Answer : (d) < TOP
>
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.
10. Answer : (c) < TOP
>
Reason : Velocity of money = Nominal GDP / Money supply = 5000/1250 = 4.
11. Answer : (a) < TOP
>
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.
12. Answer : (e) < TOP
>
Reason : In symmetric account banks pay interest as a function of minimal or average
balance.
13. Answer : (b) < TOP
>
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.
14. Answer : (c) < TOP
>
Reason : Unclaimed deposit is classified under demand liabilities for the computation of
NDTL.
15. Answer : (c) < TOP
>
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.
16. Answer : (d) < TOP
>
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
17. Answer : (d) < TOP
>
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.
18. Answer : (c) < TOP
>
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%.
19. Answer : (e) < TOP
>
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.
20. Answer : (a) < TOP
>
Reason : (1 + PLR3)3 = (1 + PLR2) (1 + f21)
= (1 + 0.10)2 (1 + 0.11)
PLR3 = 10.33%.
21. Answer : (b) < TOP
>
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.
24. Answer : (c) < TOP
>
Reason : Suppose, loan amount = Rs. 100
Interest earned = 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. Answer : (b) < TOP
>
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
6 − 0.10
94.50
Effective cost = = 6.24%
26. Answer : (a) < TOP
>
Reason : If actual inflation is less than expected inflation, then real interest rates are more
than expected. This hurts borrowers but helps lenders.
27. Answer : (d) < TOP
>
Reason : It is true, that when D Gap is negative, if interest rates decline, the market value
of the equity decreases.
28. Answer : (e) < TOP
>
Reason : Let, x = purchase price
100 − x 365
x
x 91
= 0.0425
or, x = 98.95.
29. Answer : (d) < TOP
>
Reason : Declaration policy is based on the principle that variation in the value of insured
stock results in under-insurance or over insurance.
30. Answer : (d) < TOP
>
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.
 Section B : Problems
1. Income from the account:
(Rs. lakh)
Existing Revised
Average cash credit amount Rs.355 lakh
Interest income 53.25 49.70
Average Bills discounted Rs.92 lakh
Interest income 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
Total 67.16 62.69
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 = Rs.16.92 lakh
Less: Net income as per offer = 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 1.5×2900 4 ×2100
+ +
6600 6600 6600
Duration of assets = = 2.0985
0.08×1100 0.10 ×2900 0.12 ×2100
+ +
6600 6600 6600
Average interest on assets = = 9.55%
−2.0985
×( −0.01)
1.0955
% Change in market value of assets = = 1.92%
New market value of assets = 6,600 × 1.0192 = Rs.6726.72 crore
Change in market value of liabilities:
0.5×1000 1×2200 4 × 3000 0.75 ×100
+ + +
6300 6300 6300 6300
Duration of liabilities = = 2.3452
0.05×1000 0.06 ×2200 0.07 ×3000
+ +
6300 6300 6300
Average interest on liabilities = = 6.22%.
−2.3452
×( −0.01)
1.0622
% change in market value = = 2.21%
New market value of liabilities = 6,300 × 1.0221
= Rs.6439.23 crore
New market value of equity = 6726.72 – 6439.23 = Rs.287.49 crore.
L
A
b. Immunizing asset duration = DL ×
6300
6600
= 2.3452 ×
= 2.2386
Change in the value of assets using the immunizing duration
−2.2386
×( −0.01)
1.0955
= = 2.04 %.
New market value of assets = 6,600 × 1.0204 = Rs.6734.64 crore
 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 = Gross NPA – Provisions
= 0.08y – 0.08y × 0.20 – 0.0092y
= 0.0548y

Net Advance = 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
= 580 + 285.29 = Rs.865.29 crore
CRR = 5% of NDTL
865.29
= Rs .17305.80 crore
0.05
Hence, NDTL =
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
4346.71
= Rs .17386.84 crore
0.25
Hence, NDTL =
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 = (Deposits + Borrowings) × 0.05
= (12,285 + 1110) × 0.05 = Rs.669.75 crore
New SLR = (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 708.8

– Advances 2040.0

– Cash with RBI (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 Investments 5272.8

Borrowing 1,110.0 Advances 7140.0

Other liabilities & provisions 765.0 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:
• Perfectly match the duration of assets and liabilities
• A mismatch in Duration of assets and liabilities
i. 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)
DL
(A/S)
(DA – DL) =
OR
-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.

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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. 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.
5. 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.

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