Financial Institutions and Markets

Question 1

(a) Explain how financial intermediation exposes banks to risk and explain what those risks are.                                                                                                    [10 marks]

(b) Examine the main solutions a bank can adopt to manage credit risk and identify how the solutions impact on the adverse selection and moral hazard problems associated with lending.                                                                                                    [15 marks]

(c) Explain operational risk as it affects banks. Give examples of this risk. [8 marks]

[Total: 33 marks]

Question 2

(a)    Compare and contrast the characteristics of ordinary shares and corporate bonds from the perspective of both an investor and a firm issuing the securities.                                                                                                                          [10 marks]

(b)    Consider the following two financial assets:

(1)  an ordinary share that is expected to pay a dividend of £5 next year with dividend growth expected to be 3% per annum thereafter;

(2)  a  corporate bond with an annual coupon rate of 5%, par (face) value of £100, and maturity in 4 years time.

If the required return on similar US equities is 10% and on similar US bonds Is 5%, calculate the value of the US stock and the US bond.                [8 marks]

(c)   Using the data given above and assuming an annual discount rate, calculate the duration of the corporate bond.                                                 [5 marks]

(d)    Explain why the duration of a bond paying coupons is always less than its maturity.

[5 marks]

(e)   Distinguish between primary and secondary capital markets.             [5 marks]

[Total: 33 marks]                                                                                            

Question 3

Discuss the causes and consequences of the 2008 global financial crisis.

                                                                                            [33 marks]

Question 4

(a) Discuss the advantages and disadvantages of inflation targeting.

 [10 marks]

(b) Explain the transmission mechanism of monetary policy (i.e. the channels by which a change in interest rates can affect inflation).                                                  [10 marks]

(c) Discuss the reasons for the adoption of policy of quantitative easing by the Bank of England in 2009 and explain how this policy works.                                     [13 marks]

• [Total: 33 marks]            

Question 5                                                                                                   

(a)      Explain what capital and liquid assets are in the context of banking and explain their role in ensuring the stability of a bank.

•                                                            [10 marks]
• (b) Explain the Basel 3 capital adequacy regime and discuss how it can help prevent a future financial crisis. [23 marks]

[Total: 33 marks