brief definitions

Question 1

Sovereign risk

Answer 1

This is the risk of a country defaulting on its financial obligations.

It also encompasses risks associated with changes in a country’s political landscape, such as significant policy changes or regime changes.

which might affect the country’s ability or willingness to meet its financial obligations

Question 2

Market Risk

Answer 2

This is the risk of financial loss due to changes in market prices or rates, such as interest rates, equity prices, commodity prices, or exchange rates.

These changes can be influenced by a variety of factors, including economic indicators, natural disasters, political instability, etc.

Question 3

Operational Risk

Answer 3

This refers to the risk of loss resulting from inadequate or failed internal processes, people, and systems or from external events.

It includes risks arising from fraud, system failures, business interruptions, inadequate procedures, legal risks, etc.

Question 4

Liquidity Risk.

Answer 4

This is the risk that a company or individual will be unable to meet short-term financial obligations due to an inability to convert an asset into cash without a loss of capital and/or income in the process.

Liquidity risk can also refer to the market’s ability to buy or sell assets without causing a significant movement in the asset’s price.

Question 5

Moral Hazard

Answer 5

a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost.

For example, if you buy AppleCare+ you will tend to not care about the phone breaking because you know it’s insured. Therefore, might leave it with no case.

Question 6

Transaction Costs

Answer 6

expenses incurred when executing a financial or economic transaction.
These costs are not limited to monetary expenses but also include time, effort, and resources involved in completing the transaction

Question 7

agency costs

Answer 7

internal expenses that come from an agent acting on behalf of a principal.
Examples include booking the most expensive hotel when travelling.

Question 8

liquidity transformation

Answer 8

a financial process in which financial intermediaries, take in funds from savers (e.g., deposits or investments) which have a high level of liquidity (e.g., savers can quickly and easily withdraw funds) and use them to finance loans or investments that have much lower levels of liquidity.
it creates risk if too many savers want their money back at the same time (like a bank run).

Question 9

Size transformation

Answer 9

Exploiting economies of scale, banks transform many small deposits into larger-size loans.

Question 10

maturity transformation

Answer 10

Creating a maturity mismatch on their balance sheet, banks convert demand deposits into long-term financing for borrowers

Question 11

required reserve ratio

Answer 11

The fractional reserve amount a bank takes out to face withdrawals.
This is important for liquidity management and promoting financial stability

Question 12

commitment mechanisms

Answer 12

tools or strategies used to lock oneself into following a financial plan, essentially making it harder to deviate from set financial goals.
For example, you might automatically have part of your paycheck moved to a retirement account every month, so you’re committed to saving for the future.
these mechanisms help individuals and companies stay disciplined about their finances,

Question 13

The brokerage function

Answer 13

when financial intermediaries match transactors and provide transactions and other services. As a result, they reduce transaction costs and remove information costs.

Question 14

The asset transformation function

Answer 14

when financial institutions issue claims that are far more attractive to savers (in terms of lower monitoring costs, lower liquidity costs and lower price risk) than the claims issued directly by corporations

Question 15

What is securitization?

Answer 15

-it is a form of bank financing that allows lenders to sell off their loans repackaged as securities (ABS) to other banks or investors and to use the raised funds to increase lending

Question 16

Ratio analysis

Answer 16

quantitative method of gaining insight into a company’s liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement.
Financial Ratios are used both internally and externally to assess bank performance and can be used to identify early warning signals

Question 17

Credit risk

Answer 17

the possibility of loss due to a borrower’s defaulting on a loan or not meeting contractual obligations
The source of this risk is the deterioration of the creditworthiness of the borrower.
Expected losses due to credit risk are covered with PLL. Unexpected losses are expected to be covered with bank capital.

Question 18

Balance sheet

Answer 18

Financial statement of the wealth of a firm on a given date.
This is usually at the end of the financial year.
The balance sheets report the assets and liabilities of the bank

Question 19

Income statement (or Profit and Loss - P/L)

Answer 19

A financial statement that reports a firm’s profitability over a time period by subtracting all costs from all income.
The income statement reports the revenues and costs and measures bank performance between the two-year-end balance sheet.

Question 20

Country risk

Answer 20

the risk that economic, social and political conditions of a foreign country will adversely affect a bank’s commercial and financial interests.

Question 21

Foreign exchange risk .

Answer 21

It is the risk that liabilities and off-balance sheet activities are denominated in foreign currency (both in the banking and trading book).
A bank that lends in a currency that depreciates more quickly than its home currency will be subject to foreign exchange risk

Question 22

A whole life

Answer 22

A whole-life policy protects the individual over an entire lifetime.

In return for periodic or level premiums, the individual’s beneficiaries receive the face value of the life insurance contract on death.

Thus, there is a certainty that if the policyholder continues to make premium payments, the insurance company will make a payment—unlike term insurance.

Question 23

An Endowment life

Answer 23

An endowment life policy combines a pure (term) insurance element with a savings element.

it guarantees a pay-out to the beneficiaries of the policy if death occurs during some endowment period (e.g., before reaching retirement age).

An insured person who lives to the endowment date receives the face amount of the policy

Question 24

A variable life

Answer 24

variable life insurance invests fixed premium payments in mutual funds of stocks, bonds, and money market instruments.

Unlike traditional policies that promise to pay the insured the fixed or face amount of a policy if a contingency arises.

Usually, policyholders can choose mutual fund investments to reflect their risk preferences.

Thus, the value of the policy increases or decreases with the asset returns of the mutual fund in which the premiums are invested.

Question 25

Reinsurance

Answer 25

essentially insurance for insurance companies is an alternative way to manage risk by purchasing reinsurance from a reinsurance company.

Depending on the contract, reinsurance can enable insurers to improve their capital position, expand their business, limit losses, and stabilize cash flows, among other things.

Some investment banks are now setting up reinsurers as part of a move to develop alternative risk-financing deals.

Question 26

defined benefit pension funds

Answer 26

retirement plans in which an employer promises to pay employees a specific monthly amount during retirement. (راتب تقاعدي)

This benefit may also include a cost-of-living increase each year during retirement.

The monthly benefit amount is based on the participant’s wages and length of service.

Question 27

Defined contribution pension funds

Answer 27

A pension plan under which an employee pays certain contributions during employment, but with no guaranteed retirement benefit.

This is because the eventual retirement benefits are based on the accumulated contributions and the investment performance of those contributions over time.

In the case of underfunding, the benefit can be reduced, and the overall risk of the portfolio is on the employee.

Question 28

Sales finance institutions

Answer 28

They are financial companies specialised in making loans to the customers of a retailer or manufacturer.

They buy (at a discount) the instalment sales contracts of retail merchants. In addition to their retail financing.

However, most companies engage also in wholesale financing, thus supplying the dealer with the funds he needs for the purchase of goods from the manufacturer.

They are direct competitors of depository institutions for consumer lending and can offer loans faster and more conveniently.

Question 29

Personal credit institutions

Answer 29

FCs specialised in making loans to customers that depositary institutions find too risky to lend to.

They usually charge higher interest rates than depositary institutions for the additional risk they are taking.

They can accept as collateral goods or assets that depositary institutions would not find acceptable.

Question 30

Business credit institutions

Answer 30

FCs specialised in providing financing to corporations by purchasing accounts receivable from corporate customers.

The accounts are purchased at a discount from their face value by the finance companies which assume the responsibility for collecting the accounts receivable.

The corporation receives cash in advance and no longer worries about customers’ payments.

Examples: Leasing and factoring