Exam Extras

Question 1

What can changing the short term interest rate effect?

Answer 1

SEDaTE
Spending, exchange rate, demand for money, currency/trade balance
Spending increases if lower interest rates (corporate and consumer)
Exchange rate falls - overseas investors earn less in deposits
Demand for money increases, so money supply increases so inflation
Currency/trade balance remains unchanged if globally all are reducing rates

Question 2

If companies spend more, what can it lead to?

Answer 2

Increased employment

Growth, but time lag before between increased investments and this

Question 3

What effect in consumer banks will lowering the short term interest rate have

Answer 3

Reduction in credit card (debt servicing) interest rates
Lower borrowing costs
Lower savings rate

Question 4

Why might a lowering of interest rates not help increase consumer spending?

Answer 4

If confidence very low

Question 5

What effects does a lower exchange rate have on companies?

Answer 5

Exports more competitive
Raw materials more expensive
Supply side inflation in imported goods
Increased competitiveness of domestically made goods

Question 6

What other reasons would you reduce interest rates?

Answer 6

Pressure from government
Decrease exchange rate
Global tendencies
Restore confidence in property market
Increase inflation to the desired band

Question 7

When thinking about effects of a change in interest rates on assets prices (demand/supply), what are the most important things

Answer 7

Growth (hence profits)
Short term yield 
Long term yield
Long term inflation
Inflation uncertainty
Exchange rate
Borrowing costs

Question 8

How is the short term yield on government bonds related to money market intstruments?

Answer 8

Money market instruments effected by short term interest rates. So yield goes the same way as short term interest rates

Question 9

If interest rates decrease, what happens to yield hence price on government/corporate bonds

Answer 9

Increase in yield, decrease in price of short term bonds

Question 10

If long term inflation expectations increase what happens to the yield on long term government bonds?

Answer 10

Yield decreases, but not as much as short term. So price increases, but not as much as short term, due to inflation risk

Question 11

If exchange rate weakends, what happens to the price of government.corp bonds?

Answer 11

Increases, as o/s investors demand a lock in of interest????

Question 12

What happens to the price of index linked government bonds with a decrease in interest rates?

Answer 12

More demands as long term inflation uncertainty, price increases

Question 13

What extra effect on corporate bonds would a lowering of interest rates have over government bonds?

Answer 13

Growth increases, profitability increases, so default risk decreases, yield over government bonds decreases

Question 14

How are equities affected by a change in interest rates?

Answer 14

Growth so profitablity increases, so equity level increases
dividend level increases, norminal and real
Uncertain inflation leads to demand for hedging that risk, so equity demand increases and level does, compared to bonds
Exchange rate decreases so exporters profits increase and importers decrease

Question 15

How is property affected by a decrease in short term interest rates (think about mortgages)

Answer 15

Growth increase, employment increases, demand for commercial and industrial property increases
Cost of borrowing decrease, prices increase
Supply stays the same, demand increases, so price increases
Expected ifnlation increase, this is a hedge of inflation, so demand increases and prices
O/S demand increases so price increases

Question 16

First approaches to managing enterprise risk (multi business unit company)

Answer 16

1) Determine overall risk appetite, divide amongst business units
2) Let the management teams of the business units manage their risks dependant on the allocated RA
3) No allowance for diversification
4) Allow for diversification by allowing allocated RA’s to be 130% of overall RA

Question 17

Second approach to managing Enterprise risk

Answer 17

1) Set up group risk management function at enterprise level
2) Do similar risk assessments on all business units to combine into entity level risk assessment model
3) This shows where we have too much or too little risk
4) It is important to business planning and capital allocation cycles

Question 18

Explain discounted covers (ART)

Answer 18

Provide full cover with no immediate need to finance the full undiscounted liability

Question 19

Intergrated risk covers

Answer 19

Between insurers and reinsurers usually

Used to smooth results, avoid excess cover, lock into attractive terms

Question 20

Securitisation

Answer 20

Transfer of insurance risk into the banking sector and capital markets
Insurance risk is uncorrelated with market risk so attractive to investors

Question 21

Post loss funding

Answer 21

In exchange for a commitment fee, funding will be provided on the occurrence of a specified loss.
Funding will be on a loan on a pre-arranged terms or equity

Question 22

Insurance derviatives

Answer 22

e.g. catastrophe or weather options

Question 23

Swaps

Answer 23

Organisations of similar but negatively correlated risks can swap packages of risk so they have greater risk diversification

Question 24

What internal ways can you manage risk?

Answer 24

Underwriting, fair price paid for the risk
Claims control, reduces fraud
Management control to reduce exposure to risk

Question 25

Explain unregulated markets (why would we have them)?

Answer 25

Costs of regulated outweight the benfits

For example a market where only professionals operate

Question 26

Explain voluntary codes of conduct and their weakness

Answer 26

They operate effictively in many circumstances

vulnerable to rogue traders and hence lack of public confidence

Question 27

Explain self regulation

Answer 27

A system organised and operated by the market particiapnts without government intervention

Question 28

Explain statutory regulation

Answer 28

The government sets out the rules and polices them for the market participants

Question 29

Explain mixed regimes

Answer 29

These are a mixture of all the other regimes

regulations are developed by market-driven private institutions like the stock exchange, as well as governments