Alternative sources of finance-7

Question 1

Traditional banks raise finance within the regular banking system through

Answer 1

maturity transformation.

Question 2

Shadow banks are

Answer 2

non-bank financial institutions that carry out banking activity outside the regulated system.

Question 3

Regular banks accept deposits, while shadow banks

Answer 3

borrow short-term funds and lend them long-term.

Question 4

Regular banks are subject to

Answer 4

regulatory scrutiny, which involves reserve and capital requirements and disclosure of prescribed information.

Question 5

Regular banks are subject to

Answer 5

regulatory scrutiny, which involves reserve and capital requirements and disclosure of prescribed information.

Question 6

Benefits of regulation include

Answer 6

central banks providing liquid funds to regulated banks in an emergency and protection of customers’ deposits.

Question 7

Shadow banks offer _______returns to lenders but are ____

Answer 7

Shadow banks offer higher returns to lenders but are more exposed in emergencies since they are not able to borrow from central banks.

Question 8

Shadow banks may offer what benefits

Answer 8

cheaper loans, increase competition, and be available in countries where traditional banks are not.

Question 9

The majority of a bank’s assets are

Answer 9

long-term loans, which can be sold on.

Question 10

Putting a value on loan assets is difficult since

Answer 10

their value falls in a recession.

Question 11

A company wishes to take out a loan. Explain the possible advantages the shadow banking sector
might have over the traditional banking sector for a company looking to borrow money.
Solution

Answer 11

he loan may be cheaper as shadow banks avoid the costs of complying with banking regulation.
The existence of the shadow banking sector also potentially increases the level of competition in
the sector by increasing the number of players in the market to more than just traditional banks.
The availability may also be better, for example a shadow bank may be prepared to lend in
circumstances where traditional banks wouldn’t or finance might be available in countries where
there isn’t a developed banking sector, or in developed markets where the traditional banking
sector is being constrained by other regulatory or political issues.

Question 12

Question
Complying with regulatory requirements involves costs for banks. State the benefits associated
with regulation of banks

Answer 12

Solution
The main benefit is access to the protections of the regulatory system. For example, central
banks provide liquid funds to regulated banks in an emergency and provide protection of
customers’ deposits (possibly up to a maximum amount).
These protections provide an economy with confidence in the banking system and have
reputational benefits for the banks, eg increasing their ability to attract customers

Question 13

Project financing involves

Answer 13

raising finance for a specific project and not for the business carrying out the project.

Question 14

Project financing is used for large infrastructure projects, particularly public-private partnerships (PPP) that require

Answer 14

a substantial amount of capital.

Question 15

______________of lenders from the host country and foreign lenders provide capital for the project

Answer 15

Consortium

Question 16

PPP involves a partnership approach where both public and private sectors provide finance and share

Answer 16

the project’s risks and rewards.

Question 17

Project financing is used for projects related to

Answer 17

the development or exploitation of natural resources.

Question 18

A new legal entity called_______ is formed for the project to achieve the characteristic ring-fencing needed for project financing.

Answer 18

Special Purpose Vehicle (SPV)

Question 19

_______________ is generally used in project financing where lenders rely on the revenues from the project for repayment of the loan with the project’s assets held as collateral.

Answer 19

Non-recourse financing

Question 20

Non-recourse financing is different from recourse financing where lenders

Answer 20

can be paid from the assets or cash flows of the shareholders in case of default.

Question 21

is Non-recourse financing factoring cheaper than -recourse financing

Answer 21

Non-recourse financing involves higher risk to the lender, making recourse financing cheaper.

Question 22

Off-balance-sheet financing is used in project financing to keep the liabilities of the project

Answer 22

off the balance sheet of the borrowing company.

Question 23

SPVs have their own accounts separate from

Answer 23

the accounts of the borrowing company or companies involved.

Question 24

Crowdfunding

Answer 24

Crowdfunding allows many individuals or businesses to support a project or campaign.

Question 25

Crowdfunding typically takes place through

Answer 25

a dedicated website and social media channels.

Question 26

attractive to small businesses and entrepreneurs.

Answer 26

The process of crowdfunding is less formal than other sources of finance, making it

Question 27

why Crowdfunding attractive to small businesses and entrepreneurs.

Answer 27

The process of crowdfunding is less formal than other sources of finance, making it

Question 28

Crowdfunding websites charge a fee for their services and may or may not vet the projects that

Answer 28

are promoted on their platform.

Question 29

Crowdfunding has gained popularity as a means of financing

Answer 29

start-up projects or new products.

Question 30

Four types of crowdfunding exist:

Answer 30

donation-based, pre-payment or reward-based, loan-based, and investment-based.

Question 31

Donation-based crowdfunding yields a

Answer 31

loss of the amount invested.

Question 32

Pre-payment or reward-based crowdfunding yields the value of the reward given to

Answer 32

investors.

Question 33

Loan-based crowdfunding yields

Answer 33

interest on the money invested and repayment of the capital over time.

Question 34

Investment-based crowdfunding allows investors to

Answer 34

buy shares in the business and benefit if the venture succeeds.

Question 35

Rewards-based crowdfunding might have lower costs but may appeal to

Answer 35

a smaller number of potential investors.

Question 36

Investment-based crowdfunding offers potential long

Answer 36

delays before any return is paid to investors, and the cost of dilution of ownership and future profit sharing.

Question 37

Loan-based crowdfunding avoids giving away equity but may struggle to find

Answer 37

investors with an appetite for risk.

Question 38

Crowdfunding carries additional risks, such as lack of a

Answer 38

secondary market, the project may not go ahead if insufficient investors are found, and uncertainty about how long the call for funds will be open.

Question 39

Microfinance provides small loans

Answer 39

that are faster and easier to secure than traditional loans.

Question 40

Microfinance provides small loans that are faster and

Answer 40

that are faster and easier to secure than traditional loans.

Question 41

Microloans are typically small amounts available to borrowers who may not

Answer 41

have access to traditional loans.

Question 42

Microloans broaden

Answer 42

financial inclusion.

Question 43

Microloans have generous repayment periods and

Answer 43

are used for start-ups and small businesses.

Question 44

Charities involved in reducing poverty and promoting small-scale start-ups in developing countries use microfinance to

Answer 44

encourage funding.

Question 45

Which of the following is NOT a type of crowdfunding?
A donation-based
B pre-payment
C loan-based
D non-recourse.

Answer 45

Answer = D
The fourth type of crowdfunding mentioned is investment-based

Question 46

Which of the following statements about project finance is true?
A It entails the formation of a new legal entity.
B It is a recourse method of financing.
C It provides on-balance-sheet financing.
D It always involves the public sector. [2

Answer 46

Answer = A
Project finance is a non-recourse, off-balance sheet method of obtaining finance. It often involves
public-private partnerships, but does not have to involve the public sector.

Question 47

Outline the similarities and differences between shadow banking and regular banking

Answer 47

Similarities
Both perform ‘maturity transformation’ ie the conversion of short-term liabilities to long-term
assets. [1]
Both face the risk of investors losing confidence which can create a liquidity risk. [1]
Differences
In regular banking, the liabilities are cash deposits from banking customers. Shadow banks do not
take deposits. Instead they borrow money in the money markets. [1]
Customers in regular banks may demand the return of their deposits. The bank will not hold
enough in cash to meet this demand if a large number of customers want their money at the
same time. [1]
Shadow banks may struggle to roll over their short-term borrowings, for example if investors are
concerned about the value of the shadow banks assets. [1]
Shadow banks are outside the banking regulatory system and so are not subject to the reserve
and capital requirements imposed on regular banks. [1]
Shadow banks are not able to borrow from the central bank and so are more exposed in an
emergency. [1