Q16. What is an investment company? What are its different types?
Q17. What do you mean by mutual fund? Discuss the different aspects of mutual funds.
Q18. Define credit risk. What are the three steps in credit risk management process
Or. Discuss the risk management process for a Bank/ Financial Institution
Q19. Explain interest rate risk with example
Q18. Define credit risk. What are the three steps in credit risk management process
Or. Discuss the risk management process for a Bank/ Financial Institution
Q19. Explain interest rate risk with example
Q20. Define CAMELS rating and write down the composite ratings of this
Q16. What is an investment company? What are its different types?
Public corporation organized to invest in large blocks of securities of diverse firms, and to obtain its capital from issues of shares or units. Investment companies give a small investor the advantage of a full time professional investment management, and a very much wider spread of risk that it would have been otherwise possible.
They are divided into three major types:
1. Open-end funds/ mutual funds- that have a floating number of issued shares, and sells or redeem their shares at their current net asset value.
2. Closed-end funds/ investment trusts- that can sell only a fixed number of shares that are traded on stock exchanges, usually at a discount to their net asset value.
3. Unit investment trusts / unit trusts- that sells their redeemable securities which represent interests in the securities held by the trust in its investment portfolio.
Q17. What do you mean by mutual fund? Discuss the different aspects of mutual funds.
Public corporation organized to invest in large blocks of securities of diverse firms, and to obtain its capital from issues of shares or units. Investment companies give a small investor the advantage of a full time professional investment management, and a very much wider spread of risk that it would have been otherwise possible.
They are divided into three major types:
1. Open-end funds/ mutual funds- that have a floating number of issued shares, and sells or redeem their shares at their current net asset value.
2. Closed-end funds/ investment trusts- that can sell only a fixed number of shares that are traded on stock exchanges, usually at a discount to their net asset value.
3. Unit investment trusts / unit trusts- that sells their redeemable securities which represent interests in the securities held by the trust in its investment portfolio.
Q17. What do you mean by mutual fund? Discuss the different aspects of mutual funds.
A mutual fund is a type of Investment Company that pools money from many investors and invests the money in stocks, bonds, money-market instruments, other securities, or even cash.
The manager invests this money then continues to buy and sell stocks and securities according to the style dictated by the fund’s prospectus.
There are several important aspects of mutual funds:
1. Investors in mutual funds own a pro rata share of overall portfolio
2. The investment manager of the mutual fund actively manages the portfolio, that is buys some securities and sells others
3. The value or price of each share of portfolio, called Net Asset Value (NAV), equals the market value of the portfolio minus the liabilities of the mutual fund divided by the number of shares owned by the mutual fund investors.
4. The NAV or price of the fund is determined only once each day, at the close of the day
5. All new investments into the fund or withdrawals from the fund during a day are priced at the closing NAV
Q18. Define credit risk. What are the three steps in credit risk management process
Or, Discuss the risk management process for a Bank/ Financial Institution
Credit Risk: Credit risk arises from the potential that a borrower will fail to meet its obligations in accordance with agreed terms. It also refers the risk of negative effects on the financial result and capital of the bank caused by borrower's default. It comes from a bank's dealing with individuals, corporate, banks and financial institutions or a sovereign.
A financial institution employ a four-step procedure to measure and manage institution level exposure are mentioned below:
1. Risk identification: The institution must recognize and understand risks that may arise from both existing and new business initiatives. Risk identification should be a continuing process, and should be understood at both the transaction and portfolio levels.
2. Risk Measurement: Once risks have been identified, they should be measured in order to determine their impact on the banking institution’s profitability and capital.
3. Risk Monitoring: The institution should put in place an effective management information system (MIS) to monitor risk levels and facilitate timely review of risk positions and exceptions that should be frequent, timely, accurate, and informative.
4. Risk Control: The institution should establish and communicate risk limits through policies, standards, and procedures that define responsibility and authority that should serve as a means to control exposure to various risks
Q19. Explain interest rate risk with example
Interest rate risk is a risk that the value of investment will change due to a change in the absolute level of interest rates, in the spread between two rates, in any other interest rate relationship.
Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realize greater yields by switching to other investments that reflect the higher interest rate. As example, a 5% bond is worth more if interest rates decrease since the bondholder receives a fixed rate of return relative to the market, which is offering a lower rate of return as a result of the decrease in rates.
Q20. Define CAMELS rating and write down the composite ratings of this
A CAMELS rating is an international bank-rating system where bank supervisory authorities rate institutions according to six factors. These are
C - Capital adequacy
A - Asset quality
M - Management quality
E - Earnings
L - Liquidity
S - Sensitivity to Market Risk
Bank supervisory authorities assign each bank a score on a scale of one (best) to five (worst) for each factor. The system helps the supervisory authority identify banks that are in need of attention.
The composite rating:
Rating Composite Description
Range
1 1 - 1.4 Strong: Highest rating is indicative of performance is
higher
2 1.5 - 2.4 Satisfactory: Performance is average or above that
adequately provides for safe and sound operation
3 2.5 - 3.4 Fair: It is not satisfactory nor unsatisfactory but
characterized by performance of below average quality.
Marginal: performance is below average. It might
4 3.5 - 4.4 evolve into weakness that could threat the viability if
not changed.
5 & 6 4.5 - 5 & 6 Unsatisfactory: Performance is critically deficient that
need immediate remedial attention.
Or, Discuss the risk management process for a Bank/ Financial Institution
Credit Risk: Credit risk arises from the potential that a borrower will fail to meet its obligations in accordance with agreed terms. It also refers the risk of negative effects on the financial result and capital of the bank caused by borrower's default. It comes from a bank's dealing with individuals, corporate, banks and financial institutions or a sovereign.
A financial institution employ a four-step procedure to measure and manage institution level exposure are mentioned below:
1. Risk identification: The institution must recognize and understand risks that may arise from both existing and new business initiatives. Risk identification should be a continuing process, and should be understood at both the transaction and portfolio levels.
2. Risk Measurement: Once risks have been identified, they should be measured in order to determine their impact on the banking institution’s profitability and capital.
3. Risk Monitoring: The institution should put in place an effective management information system (MIS) to monitor risk levels and facilitate timely review of risk positions and exceptions that should be frequent, timely, accurate, and informative.
4. Risk Control: The institution should establish and communicate risk limits through policies, standards, and procedures that define responsibility and authority that should serve as a means to control exposure to various risks
Q19. Explain interest rate risk with example
Interest rate risk is a risk that the value of investment will change due to a change in the absolute level of interest rates, in the spread between two rates, in any other interest rate relationship.
Interest rate risk affects the value of bonds more directly than stocks, and it is a major risk to all bondholders. As interest rates rise, bond prices fall and vice versa. The rationale is that as interest rates increase, the opportunity cost of holding a bond decreases since investors are able to realize greater yields by switching to other investments that reflect the higher interest rate. As example, a 5% bond is worth more if interest rates decrease since the bondholder receives a fixed rate of return relative to the market, which is offering a lower rate of return as a result of the decrease in rates.
Q20. Define CAMELS rating and write down the composite ratings of this
A CAMELS rating is an international bank-rating system where bank supervisory authorities rate institutions according to six factors. These are
C - Capital adequacy
A - Asset quality
M - Management quality
E - Earnings
L - Liquidity
S - Sensitivity to Market Risk
Bank supervisory authorities assign each bank a score on a scale of one (best) to five (worst) for each factor. The system helps the supervisory authority identify banks that are in need of attention.
The composite rating:
Rating Composite Description
Range
1 1 - 1.4 Strong: Highest rating is indicative of performance is
higher
2 1.5 - 2.4 Satisfactory: Performance is average or above that
adequately provides for safe and sound operation
3 2.5 - 3.4 Fair: It is not satisfactory nor unsatisfactory but
characterized by performance of below average quality.
Marginal: performance is below average. It might
4 3.5 - 4.4 evolve into weakness that could threat the viability if
not changed.
5 & 6 4.5 - 5 & 6 Unsatisfactory: Performance is critically deficient that
need immediate remedial attention.
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