Assignment And Quiz

Eco. 521 Assignment—16th April, 2019

Assignment
Assignment

Discuss and analyse the following concepts in Monetary Economics

1.
Risk analysis
2.
Bank capital
adequacy
3.
Bank earnings
4.
Balance sheet
management
5.
Liquidity
concepts and policies
6.
Lending policies
7.
Investment
instruments and policies
8.
Comparative
Financial Systems

 

 

 

(Not more than 12 -15pages)

 

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Tony Orji

Dr. Tony Orji is the founder and owner of Success Tonics Blog. He is a Senior Lecturer at the Department of Economics, University of Nigeria, Nsukka.

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  1. TOPIC: DISCUSS AND ANALYSE THE FOLLOWING CONCEPTS IN MONETARY ECONOMICS (RISK ANALYSIS, BANK CAPITAL ADEQUACY, BANK EARNINGS, BALANCE SHEET MANAGEMENT, LIQIDITY CONCEPTS AND POLICIES, INVESTMENT INSTRUMENTS AND POLICIES, COMPARATIVE FINANCIAL SYSTEMS.

    AN ASSIGNMENT
    SUBMITTED IN PARTIAL FUFILLMENT FOR THE REQUIREMENT OF THE COURSE: ECO 521 (MONETARY ECONOMICS)

    BY

    OBOZUA OBEHI DESTINY
    PG/MSC/17/O2972

    LECTURER: DR. A. ORJI

    APRIL, 2019

    INTRODUCTION
    A concept is an idea or a principle that is connected with something abstract. Concepts in monetary economics are ideas that guide the activities in the financial markets (bond and stock market) and financial intermediaries (banks, insurance companies, pension funds). Financial markets perform the essential economic function of channeling funds from households, firms, and government that have saved surplus funds by spending less than their income to those that have a shortage of funds because they wish to spend more than their income. The risk involved in the activities is worth analyzing.

  2. UNIVERSITY OF NIGERIA NSUKKA
    DEPARTMENT OF ECONOMICS

    ASSIGNMENT SUBMITTED IN PARTIAL FULFILMENT OF THE COURSE ECO 521

    COURSE: MONETARY ECONOMICS

    AMEH MONDAY
    REG NO: PG/MSC/17/01563

    LECTURER: DR. TONY ORJI

    30TH APRIL, 2019

    Discuss and analyses the following concepts in monetary economics?
    Introduction
    Risk Analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks.
    Performing a risk analysis includes considering the probability of adverse events caused by either natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or inadvertent human activities; an important part of risk analysis is identifying the potential for harm from these events, as well as the likelihood that they will occur.

  3. RISK ANALYSIS
    A risk is the probability that an actual return on an investment will be lower than the excepted return. Risk implies future uncertainly about deviation from expected earnings or expected outcome. Risk measures the uncertainly that an investor is willing to take to realize a gain from an investment.
    Risks are of different types, and originate from different situations. We have liquidity risk, sovereign risk, insurance risk, business risk, default risk, economic risk etc. various risks originated due to the uncertainly arising out of various sectors that influence an investment or a situation.
    Risk analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks. Performing a risk analysis includes considering the probability of advance events caused by either natural processes, like severe storms, or floods or adverse events caused malicious or inadvertent human activities, an important part of risk analysis is identifying the potential for harm from these events, well as the likelihood that they will occur.

  4. LIQUIDITY CONCEPTS AND POLICIES
    Liquidity refers to degree to which an asset or security can be quickly bought or sold in the market without effecting the asset price. Cash is considered the standard for liquidity because it can most quickly and easily to converted into other assets. Liquidity can be classified as:
    Market liquidity
    Market liquidity refers to the extent to which a market such as a country’s stock market or a city’s real estate market, allows assets to be bought and sold at stable price. Cash is considered the most liquid asset while real estates are relatively liquid.
    Accounting liquidity
    Accounting liquidity measures the ease with which an individual or company can meet their financial obligations with the liquid assets available to them. Accounting liquidity is a measure of ability of a company to pay off debt as and at when due.
    There are a numbers of ratios that measures accounting liquidity, which differ in how strict they define liquid asset. They are:
    Current Ratio: The current ratio is the simplest and least strict ratio. Current assets are those that can reasonably be converted to cash in one year.
    Acid-Test Ratio: The acid –test ratio is slightly more strict. It excludes inventories and other current assets, which are not as liquid as cash and cash equivalent account receivable and short-term investments.
    Cash Ratio: the cash ratio is most exact of the liquidity ratios excluding accounts receivable, as well as inventories and other current assets. More than the current ratio or acid-test ratio, it assesses an entity’s ability to stay solvent in the case of an emergency. Even highly profitable companies can run into trouble if they do not have the liquidity to react to unforeseen events.

  5. UUNIVERSITY OF NIGERIA NSUKKA
    DEPARTMENT OF ECONOMICS

    AN ASSIGNMENT SUBMITTED IN PARTIAL FULFILMENT OF THE COURSE ECO 521(MONETARY ECONOMICS)
    BY
    ALI DAVID
    PG/MSC/17/02861

    LECTURER:DR ANTHONY ORJI

    30TH APRIL, 2019

    RISK ANALYSIS:
    Risk analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks.
    Performing a risk analysis includes considering the probability of adverse events caused by either natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or inadvertent human activities; an important part of risk analysis is identifying the potential for harm from these events, as well as the likelihood that they will occur.
    Enterprises and other organizations use risk analysis to:
    anticipate and reduce the effect of harmful results from adverse events;
    evaluate whether the potential risks of a project are balanced by its benefits to aid in the decision process when evaluating whether to move forward with the project;
    plan responses for technology or equipment failure or loss from adverse events, both natural and human-caused; and
    identify the impact of and prepare for changes in the enterprise environment, including the likelihood of new competitors entering the market or changes to government regulatory policy.
    Benefits of risk analysis
    Organizations must understand the risks associated with the use of their information systems to effectively and efficiently protect their information assets.
    Risk analysis can help an organization improve its security in a number of ways. Depending on the type and extent of the risk analysis, organizations can use the results to help:
    identify, rate and compare the overall impact of risks to the organization, in terms of both financial and organizational impacts;
    identify gaps in security and determine the next steps to eliminate the weaknesses and strengthen security;
    enhance communication and decision-making processes as they relate to information security;
    improve security policies and procedures and develop cost-effective methods for implementing these information security policies and procedures;
    put security controls in place to mitigate the most important risks;
    increase employee awareness about security measures and risks by highlighting best practices during the risk analysis process; and
    understand the financial impacts of potential security risks.
    Done well, risk analysis is an important tool for managing costs associated with risks, as well as for aiding an organization's decision-making process.
    Steps in risk analysis process
    The risk analysis process usually follows these basic steps:
    Conduct a risk assessment survey: This first step, getting input from management and department heads, is critical to the risk assessment process. The risk assessment survey is a way to begin documenting specific risks or threats within each department.
    Identify the risks: The reason for performing risk assessment is to evaluate an IT system or other aspect of the organization and then ask: What are the risks to the software, hardware, data and IT employees? What are the possible adverse events that could occur, such as human error, fire, flooding or earthquakes? What is the potential that the integrity of the system will be compromised or that it won't be available?
    Analyze the risks: Once the risks are identified, the risk analysis process should determine the likelihood that each risk will occur, as well as the consequences linked to each risk and how they might affect the objectives of a project.
    Develop a risk management plan: Based on an analysis of which assets are valuable and which threats will probably affect those assets negatively, the risk analysis should produce control recommendations that can be used to mitigate, transfer, accept or avoid the risk.

  6. DISCUSS AND ANALYZE THE FOLLOWING CONCEPTS IN MONETARY ECONOMICS (RISK ANALYSIS, BANK CAPITAL ADEQUACY, BANK EARNINGS, BALANCE SHEET MANAGEMENT, LIQUIDITY CONCEPTS AND POLICIES, INVESTMENT INSTRUMENTS AND POLICIES, COMPARATIVE FINANCIAL SYSTEMS.

    AN ASSIGNMENT
    ON
    ECO 521 (MONETARY ECONOMICS)

    BY

    MUORAH EBUKA MICHAEL
    PG/MSC/17/O2955

    LECTURER: DR. A. ORJI

    APRIL, 2019
    Introduction
    Monetary economics is concerned with the effects of monetary institutions and policy on economic variables including commodity prices, wages, interest rates, quantities of employment, consumption, and production.
    The study of monetary economics enables us to understand not just how an economy functions efficiently but also how monetary policy can help the economy adjust from one state to another and how it can find balance and grow.
    Risk analysis is defined as the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. It is the study of the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, the variance of portfolio/stock returns, the probability of a project's success or failure, and possible future economic states. Risk analysts often work in synergy with forecasting professionals to minimize future negative unforeseen effects
    Bank capital adequacy is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. These requirements are put into place to ensure that these institutions do not take on excess leverage and become insolvent. Capital requirements govern the ratio of equity to debt, recorded on the liabilities and equity side of a firm's balance sheet.
    Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole.
    Liquidity refers to the availability of cash or cash equivalents to meet short-term operating needs. In other words, liquidity is the amount of liquid assets that are available to pay expenses and debts as they become due. Obviously, the most liquid asset of all is cash.
    A policy is a deliberate plan of action to guide decisions and achieve rational outcome(s) Stafford (2001). A bank’s lending policy is a statement of philosophy, standards, and guidelines that its employees must observe in granting or refusing a lending request. Minimum information requirements are outlined as well as the verification process and have to be followed before releasing any facility
    An investment is an asset or item acquired with the goal of generating income or appreciation. In an economic sense, an investment is the purchase of goods that are not consumed today but are used in the future to create wealth. In finance, an investment is a monetary asset purchased with the idea that the asset will provide income in the future or will later be sold at a higher price for a profit.
    A financial system can be defined at the global, regional or firm-specific level and is a set of implemented procedures that track financial activities. On a regional scale, the financial system is the system that enables lenders and borrowers to exchange funds. A financial system is the system that covers financial transactions and the exchange of money between investors, lender and borrowers. A financial system can be defined at the global, regional or firm specific level. Financial systems are made of intricate and complex models that portray financial services, institutions and markets that link depositors with investors.

  7. NAME: KELECHUKWU GLADYS ONYINYECHI
    REG. NUMBER: PG/MSC/17/01234
    DEPARTMENT: ECONOMICS
    COURSE/CODE: MONETARY ECONOMIC ECO 521
    DATE: 1ST MAY 2019.

    AN ASSIGNMENT ON RISK ANALYSIS, BANK CAPITAL ADEQUACY, BANK EARNINGS, BALANCE SHEET MANAGEMENT, LIQUIDITY CONCEPT AND POLICIES, LENDING POLICIES, INVESTMENT INSTRUMENT AND POLICIES, AND COMPARATIVE SYSTEM.
    SUMMARY:
    RISK ANALYSIS:The process of risk analysis includes identifying and quantifying uncertainties, estimating their impact on outcomes that we care about, building a risk analysis model that expresses these elements in quantitative form, exploring the model through simulation and sensitivity analysis, and making risk management. The risk analysis will determine which risk factors would potentially have a greater impact on out project and, therefore, must be managed by the entrepreneur with particular care. There are three kinds of methods used for determining the level of risk.
    BANK CAPITAL ADEQUACY: is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usual expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. These requirements are put into place to ensure that these institutions do not take on excess leverage and become insolvent. Capital requirements govern the ratio of equity to debt, recorded on the liabilities and equity side of a firm’s balance sheet.
    BANK EARNINGS: Is a daily calculation of interest that a bank pays on customer deposits. The earnings credit rate is often correlated with the Treasury bill. Earning are rates that banks impute to offset service charge. Calculating earnings credit: Average collected Balance. The total collected daily balances divided by the number of days in a statement cycle. Federal Reserve requirement. Federal regulation require bank to hold a percentage of funds on deposit deducted from the average collected balance.
    BALANCE SHEET MANAGEMENT: Balance sheet management covers regulatory policy for investment securities, Bank-owned life insurance (BOLI), Liquidity risk and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole. Balance sheet management is the process of planning, coordinating, and directing business activities that determine the assets, liabilities and equity of a company.
    LIQUIDITY CONCEPT AND POLICIES: Liquidity means how quickly you can get your hands on your cash. In simpler terms, liquidity is to get your money whenever you need it. Liquidity might be your emergency savings account or the cash lying with you that you can access in case of any unforeseen happening or any financial setback.
    LENDING POLICIES: Lending policy is a set of guidelines and criteria developed and used by a lending institution or bank and its employees to reach a decision on a loan application. The bank and credit union and their employee all complied with their institution’s lending policy.
    Comparative financial system: A financial system is a system that allows the exchange of funds between lenders, investors and borrowers. Financial systems operate at national and global levels. They consist of complex, closely related services, market and institutions intended to provide an efficient and regular linkage between investors and deposits.

  8. AN ASSIGNMENT
    SUBMITTED IN PARTIAL FUFILLMENT FOR THE REQUIREMENT OF THE COURSE: ECO 521 (MONETARY ECONOMICS)
    BY
    OJIEM PATRICK KELECHI
    PG/MSC/17/O0457
    LECTURER: DR. A. ORJI
    MAY, 2019.

    Monetary economics terminologies use in our daily transactions in banks or other various organizations such as risk analysis, bank capital adequacy, bank earnings and its balance sheet management, liquidity concepts here will look at the various types of liquidity and the role of the various types of liquidity, it's applicable policies, lending policies, investments instruments and policies and lastly a comparative financial system which illustrate the financial flows to banks and other financial intermediaries.
    However, the study of Nigeria financial is of paramount interest to this course.

  9. TOPIC
    DISCUSS AND ANALYSE THE FOLLOWING CONCEPTS IN MONETARY ECONOMICS:
    1. RISK ANALYSIS
    2. BANK CAPITAL ADEQUACY
    3. BANK EARNING
    4. BALANCE SHEET MANAGEMENT
    5. LIQUIDITY CONCEPTS AND POLICIES
    6. LENDING POLICIES
    7. INVESTMENT INSTRUMENTS AND POLICIES
    8. COMPARATIVE FINANCIAL SYSTEM

    AN ASSIGNMENT
    ON ECO 521 (MONETARY ECONOMICS)

    BY
    ANI CHARITY CHIKAODIRI
    PG/M.Sc/ 17/00262

    LECTURER: DR. TONY ORJI
    1ST MAY, 2019

    RISK ANALYSIS
    Risk analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks. Performing risk analysis includes considering the probability of adverse events cause by either natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or inadvertent human activities; an important part of risk analysis is identifying the potential for h harm from these events, as well as the likelihood that they may occur. Risk analysis is also the study of the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, the variance portfolio/stock returns, the probability of a project’s success or failure, and possible future economic states.
    STEPS IN RISK ANALYSIS PROCESS
    1. Conduct risk assessment survey: The risk assessment survey is a way to begin documenting specific risks or threats within each department. The information gather from each unit or department in an organization will be integrated in a confidential summary document. This document will be submitted to senior administration and the joint audit and compliance committee of the board of trustees. The results of this process will be used as basis for future audit and compliance work plans.
    2. Identify the risks: Risk identification is the process of determining or taking notes of the risks that could potentially prevent the enterprise from achieving its objective. The objective of risk identification is the early and continuous identification of events that will have negative impacts on the project’s ability to achieve performance or capability outcome goals, if they occur. The process includes stages such as group discussions and brainstorming sessions to generate a variety of ideas. The ideas
    3. Analyze the risks: Once the risks are identified, the risk analysis process should determine the likelihood that each risk will occur, as well as the consequences linked to each risk and how they might affect the objectives of a project. At this stage the threats and risks identified and documented are being addressed.
    4. Develop risk management plan: Based on an analysis of which assets are valuable and which threats will probably affect those assets negatively, the risk analysis should produce control recommendations that can be used to mitigate, transfer, accept or avoid the risk.
    5. Implement the risk management plan: The ultimate goal of risk assessment is to implement measures to remove or reduce the risks. Starting with the highest priority risk, resolve or at least mitigate each risk so it's no longer a threat.
    6. Monitor the risks: The ongoing process of identifying, treating and managing risks should be an important part of any risk analysis process.

  10. BANK CAPITAL ADEQUACY
    A capital requirement (also known as regulatory capital or capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted assets. The capital adequacy of banks is tightly regulated worldwide in order to better ensure the stability of the financial system and the global economy. It also provides additional protection for depositors. In Nigeria, banks are regulated by the central bank of Nigeria (CBN).
    Monitoring the financial condition of banks is also important because banks have to deal with a mismatch in liquidity between their assets and liabilities. On the liabilities side of a bank's balance sheet are very liquid accounts, such as demand deposits. However, a bank's assets primarily consist of rather illiquid loans. While loans can be (and frequently are) sold by banks, they can only quickly be converted to cash by selling them at a substantial discount. The most commonly used assessment of a bank's capital adequacy is the capital adequacy ratio. However, many analysts and banking industry professionals prefer the economic capital measure. Additionally, analysts or investors may look at the Tier 1 leverage ratio or basic liquidity ratios when examining a bank's financial health. Banks are required to maintain a minimum capital adequacy ratio. The capital adequacy ratio represents the risk-weighted credit exposure of a bank.

  11. An assignment
    by
    Osuagwu Vivian
    PG/MSC/17/00062
    On monetary economics(Eco 521)

    BANK EARNINGS:
    The continued viability of a bank depends on its ability to earn an appropriate return on its assets and capital. Good earnings performance enables a bank to fund its expansion, remain competitive in the marketable, and replenish and/or increase its capital funds.
    From the standpoint of the bank supervisor, the essential purpose of bank earnings, both current and accumulated, is to provide for absorption of losses. The earnings power of a bank is the initial safeguard against the risks of engaging in the business of banking. Earnings, therefore, represent a bank's first line of defense against capital depletion resulting from shrinkage in asset value.
    In the analysis of bank earnings, the primary focus is placed on income before securities transactions rather than on net income. The difficulty with net income in bank analysis is that it includes realized gains (or losses) on investment securities. These transactions usually occur at the discretion of management in order, for example, to maintain a proper maturity balance, maximize portfolio yield, or effect some degree of control over income tax liability. Therefore, such gains and losses may not be truly reflective of the bank's operating performance during a give accounting period.

  12. NAME: ONWE JOSHUA CHUKWUMA
    REG NUMBER: PG/MSC/17/02670
    COURSE CODE: ECO 521
    COURSE TITLE: MONETARY ECONOMICS AND POLICY
    DATE: 1ST MAY 2019
    ASSIGNMENT: Discuss and Analyze the Following Concept in Monetary Economics
    Risk Analysis
    Risk Analysis is a process that helps you identify and manage potential problems that could undermine key business initiatives or projects. To carry out a Risk Analysis, you must first identify the possible threats that you face, and then estimate the likelihood that these threats will materialize. Risk Analysis can be complex, as you'll need to draw on detailed information such as project plans, financial data, security protocols, marketing forecasts, and other relevant information. However, it's an essential planning tool, and one that could save time, money, and reputations.
    Corporate: As a component of risk management, it consists of
    (1) Identification of possible negative external and internal conditions, events, or situations,
    (II) Determination of cause-and-effect (causal) relationships between probable happenings, their magnitude, and likely outcomes,
    (III) Evaluation of various outcomes under different assumptions, and under different probabilities that each outcome will take place

  13. NAME: OKORIE WILLIAMS
    REG NUMBER: PG/MSC/17/02934
    COURSE CODE: ECO 521
    COURSE TITLE: MONETARY ECONOMICS
    DATE: 1ST MAY 2019
    What Is Risk Analysis?
    Risk analysis is the process of assessing the likelihood of an adverse event occurring within the corporate, government, or environmental sector. Risk analysis is the study of the underlying uncertainty of a given course of action and refers to the uncertainty of forecasted cash flow streams, the variance of portfolio/stock returns, the probability of a project's success or failure, and possible future economic states. Risk analysts often work in tandem with forecasting professionals to minimize future negative unforeseen effects.
    2) Bank Capital Adequacy
    Percentage ratio of a financial institution's primary capital to its assets (loans and investments), used as a measure of its financial strength and stability. According to the Capital Adequacy Standard set by Bank for International Settlements (BIS), banks must have a primary capital base equal at least to eight percent of their assets: a bank that lends 12 dollars for every dollar of its capital is within the prescribed limits. Fundamental objective for holding adequate capital by banks

  14. ACHUAGU HENRY CHUKWUEMEKA
    PG/MSC/17/02862
    ACHUAGUHENRY@GMAIL.COM
    RISK ANALYSIS
    Risk analysis is the systematic study of uncertainties and risks we encounter in business, engineering, public policy, and many other areas. Risk analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks. Performing a risk analysis includes considering the probability of adverse events caused by either natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or inadvertent human activities; an important part of risk analysis is identifying the potential for harm from these events, as well as the likelihood that they will occur.
    Some institutions, such as banks and investment management firms, are in the business of taking risks every day. Risk analysis and management is clearly crucial for these institutions. One of the roles of risk management in these firms is to quantify the financial risks involved in each investment, trading, or other business activity, and allocate a risk budget across these activities. Banks in particular are required by their regulators to identify and quantify their risks, often computing measures such as Value at Risk (VaR), and ensure that they have adequate capital to maintain solvency should the worst (or near-worst) outcomes occur.
    Enterprises and other organizations use risk analysis to:
    • anticipate and reduce the effect of harmful results from adverse events;
    • evaluate whether the potential risks of a project are balanced by its benefits to aid in the decision process when evaluating whether to move forward with the project;
    • plan responses for technology or equipment failure or loss from adverse events, both natural and human-caused; and
    • Identify the impact of and prepare for changes in the enterprise environment, including the likelihood of new competitors entering the market or changes to government regulatory policy.
    Steps in risk analysis process
    The risk analysis process usually follows these basic steps:
    1. Conduct a risk assessment survey: This first step, getting input from management and department heads, is critical to the risk assessment process. The risk assessment survey is a way to begin documenting specific risks or threats within each department.
    2. Identify the risks: The reason for performing risk assessment is to evaluate an IT system or other aspect of the organization and then ask: What are the risks to the software, hardware, data and IT employees? What are the possible adverse events that could occur, such as human error, fire, flooding or earthquakes? What is the potential that the integrity of the system will be compromised or that it won't be available?
    3. Analyze the risks: Once the risks are identified, the risk analysis process should determine the likelihood that each risk will occur, as well as the consequences linked to each risk and how they might affect the objectives of a project.
    4. Develop a risk management plan: Based on an analysis of which assets are valuable and which threats will probably affect those assets negatively, the risk analysis should produce control recommendations that can be used to mitigate, transfer, accept or avoid the risk.
    5. Implement the risk management plan: The ultimate goal of risk assessment is to implement measures to remove or reduce the risks. Starting with the highest-priority risk, resolve or at least mitigate each risk so it's no longer a threat.
    6. Monitor the risks: The ongoing process of identifying, treating and managing risks should be an important part of any risk analysis process.
    The focus of the analysis, as well as the format of the results, will vary depending on the type of risk analysis being carried out

  15. Name: Onyeonagu chioma kenechukwu
    Reg Number: PG/MSC/17/02506
    Department: Economics
    Course / code: Monetary economics ECO 521
    Date : Ist MAY 2019
    RISK ANALYSIS
    This is the process of identifying and analyzing potential issues that could negatively impact key business initiative or critical projects in order to help organizations avoid or mitigate those risks.
    BANK CAPITAL ADEQUACY
    A Capital requirement (also known as regulatory capital or capital adequacy) is the amount of capital a bank or other financial institution has to hold as required by its financial regulator. This is usually expressed as a capital adequacy ratio of equity that must be held as a percentage of risk-weighted asset .
    BANK EARNING
    Banks are companies (normally listed on the stock market) and are therefore owned by and run for their shareholders. Banks need to make enough money to pay their employees, maintain the buildings and run the business.
    BALANCE SHEET MANAGEMENT
    This is concerned with the co-ordinated management of the entire balance sheet and its interrelationships. It incorporates the concept of liability management with relevant aspect of asset management approaches.
    LIQUIDITY CONCEPT AND POLICIES
    This simply means being readily convertible to cash without loss and hence the bank ability to pay its depositors on demand. It is judged by the ease with which an asset can be exchanged for money.
    LENDING POLICIES
    Lending policies is a set guidelines and criteria developed and used by a lending institution or bank and its employees to reach a decision on a loan application.
    INVESTMENT INSTRUMENT AND POLICIES
    Investment banks are specialized money and securities market institution or ‘universal banks’ establish for the promotion of securities and money markets and thus embrace merchant banks but exclude development banks.
    COMPARATIVE FINANCIAL SYSTEM
    Financial system consist of a set of institutional and other arrangements governing the transfer of savings from those generating them to those generating them to those wishing to use them, across national frontiers.

  16. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT

    1. RISK Analysis
    Risk is the possibility, likelihood or chance that something unpleasant or unwelcomed will happen that is capable of damaging an asset, or all of the original investment or the possibility of financial loss. More precisely, risk is the possibility of damage or any other negative occurrence that is caused by external or internal vulnerabilities, which may be avoided through pre-emptive action. Risk is commonly associated with uncertainty, as the event may or may not happen. It is an essential part of business, because enterprises cannot function without taking risks as business grows through risk taking. Hence, risk is related with opportunities and threat, which may harmfully affect an action or expected outcome.
    Types of Risk
    In financial terms, risk can be categorized into two main groups, viz.,
    Systemic (Non-Diversifiable) and
    Un-systemic (Diversifiable) risk) as depicted below:
    a) Systemic Risk/Non-diversifiable – Systemic risk also referred to as undiversified or market risk, can be defined as risk that cannot be eliminated or avoided by diversification; it can only be mitigated through hedging. This type of risk cannot be controlled and virtually impossible for any organization to protect itself from it.. It cannot be planned for, as it normally arises due to the influence of external factor on enterprises. Systemic risk is also macro in nature as it affects a large number of firms. It influences a large number of assets. Interest rates, recession, war or any important political event, for example, could affect several assets in a portfolio.
    b) Un-systemic Risk/Diversifiable – Sometimes known as "specific risk" or diversified risk, diversifiable risk is the risk that can be eliminated by diversification. Unlike systemic risk, un-systemic risk occur mostly as a result of internal factors prevalent in an organization. This type of risk is controllable; hence, it can be planned. In effect, it is micro in nature as it affects only a particular organization. Thus, diversification is used to protect business from un-systemic risk. This class of risk affects a very small group of assets. Examples of this category of risk includes: operational risk, business risk, financial risk and liquidity risk.
    Financially, risk usually refers to as the probability that there may be difference between the actual return and the expected return (Rose and Hudgins, 2010).
    The banks’ financial intermediation function through funds mobilization and application of funds makes risks to be part and parcel of the banking system. Risk is very important particularly when it comes to investment decisions (Rose & Hudgins, 2010).
    Therefore, the ability of a bank to efficiently manage its risks determines its survival and success in the banking business. As failure of substantial number of banks emanating from liquidity risk may destabilize the whole financial system and impair the growth of the economy in general. Greuning & Bratonovic (2003) generally, classified banking crisis into four broad categories, namely:
    i. financial risk,
    ii. operational risk,
    iii. business risk and
    iv. event risk
    Regardless of the type, Chorafas (2007) affirmed that banking risk and its probability are a function of the following;
    i. The type of loss that is addressed.
    ii. Risk factor(s) characterizing loss likelihood.
    iii. Prevailing market volatility and
    iv. Amount of leverage behind the transaction or inventoried position.
    Although, all these risks are of great importance to the banks, however liquidity risk represents the cumulative effects of other risks and of a surge in its importance owing to the ongoing global financial crisis.

  17. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT

    2. Bank Capital Adequacy
    The capital adequacy of banks is regulated worldwide in order to better ensure the stability of the financial system and the global economy. It also provides additional protection for depositors. In the United States, banks are regulated at the federal level by the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve Board and the Office of the Comptroller of the Currency (OCC). Additionally, state-chartered banks are subject to state regulatory authorities. Regulation and solvency of banks is considered to be critical because of the unique importance of the banking industry to the functioning of the economy as a whole.
    Monitoring the financial condition of banks is also important because banks have to deal with a mismatch in liquidity between their assets and liabilities. On the liabilities side of a bank's balance sheet are very liquid accounts, such as demand deposits. However, a bank's assets primarily consist of rather illiquid loans. While loans can be (and frequently are) sold by banks, they can only quickly be converted to cash by selling them at a substantial discount.
    Assessing Capital Adequacy
    The most commonly used assessment of a bank's capital adequacy is the capital adequacy ratio. However, many analysts and banking industry professionals prefer the economic capital measure. Additionally, analysts or investors may look at the Tier 1 leverage ratio or basic liquidity ratios when examining a bank's financial health.
    Capital Adequacy Ratio
    Banks are required to maintain a minimum capital adequacy ratio. The capital adequacy ratio represents the risk-weighted credit exposure of a bank.
    The ratio measures two kinds of capital:
    1. Tier 1 capital is ordinary share capital that can absorb losses without requiring the bank to cease operations.
    2. Tier 2 capital is subordinated debt, which can absorb losses in the event of a winding up of a bank.
    Some analysts are critical of the risk-weighting aspect of the capital adequacy ratio and have pointed out that the majority of loan defaults that occurred during the financial crisis of 2008 were on loans assigned a very low-risk weighting, while many loans carrying the heaviest weighting for risk did not default.
    Tier 1 Leverage Ratio
    A related capital adequacy ratio sometimes considered is the Tier 1 leverage ratio. The Tier 1 leverage ratio is the relationship between a bank's core capital and its total assets. It is calculated by dividing Tier 1 capital by a bank's average total consolidated assets and certain off-balance sheet exposures.
    The higher the Tier 1 leverage ratio is, the more likely a bank can withstand negative shocks to its balance sheet.
    Economic Capital Measure
    Many analysts and bank executives consider the economic capital measure to be a more accurate and reliable assessment of a bank's financial soundness and risk exposure than the capital adequacy ratio.
    The calculation of economic capital, which estimates the amount of capital a bank needs to have on hand to ensure its ability to handle its current outstanding risk, is based on the bank's financial health, credit rating, expected losses and confidence level of solvency. By including such economic realities as expected losses, this measure is considered to represent a more realistic appraisal of a bank's actual financial health and risk level.
    Liquidity Ratios
    Investors or market analysts can also examine banks by using standard equity evaluations that assess the financial health of companies in any industry. These alternative evaluation metrics include liquidity ratios such as the current ratio, the cash ratio or the quick ratio

  18. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
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    3. Bank Earnings
    Gross earnings are income before taxes or adjustments, it is calculated as revenues minus expenses. Bank’s gross earnings is one measure among many of how well it uses its resources to produce a profit. In this educational article, we list the 2018 top banks in Nigeria by earnings.
    A company’s gross earnings are reported periodically on its income statement. The first line of the income statement reports a company’s total sales and revenues for a given time period, while the COGS and gross earnings often appear on the second and third lines of many income statements. The difference between revenue and the COGS is a company’s gross earnings. The COGS includes costs directly related to the company’s product such as materials for manufacturing, inventory for shops and labor costs. Indirect costs are not included in the COGS.
    Once a business has calculated its gross earnings, it may then subtract the rest of its business expenses including costs such as utilities, loan repayments, office supplies, contractor fees and many other expenses. The difference between the business’s gross earnings and its operating and capital expenses is its profit.
    Why Bank earnings are important
    Even if you don't own a bank stock you should be paying to attention to their earnings, as ActionAlertsPLUS Research Analyst, Zev Fima, explains:
    "Bank earnings provide a unique perspective on both the domestic and global economic backdrop. Banks are uniquely positioned to discuss consumer and business sentiment across industries because they are the money centers extending lines of credit. As a result of this they have direct insight into demand for borrowing, and you don't borrow more when you are fearful of an economic slowdown."
    A few of the metrics that investors should watch out for are Net Interest Margin, Tangible Book Value, and Loan Growth.
    When it comes to the banks themselves, something investors are going to want to look out for is investments in technology and digitization. Fintech is increasingly pushing deeper into what has traditionally been the banking industries space. As a result, banks need to compete by investing more in technology, which is a key reason Goldman Sachs and MasterCard (MA – Get Report) teamed up with Apple (AAPL – Get Report) to create the Apple Card.

  19. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT

    4. Balance Sheet Management
    In a nutshell, the Balance Sheet is a snapshot of a company at a particular point in time. which shows the Assets, Liabilities, and Equity of the company as at that point in time. There are of course more sophisticated definitions, but this simple definition serves our purpose. From experience with a wide range of companies, it is clear that few small business owners truly understand the concept, and even fewer understand the purpose.
    Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company.
    Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole.
    The Purpose of Balance Sheet Management is to position a company to have adequate resources for current operations and for financing future growth.
    The objective of managing a balance sheet is to optimize reward versus risk. This requires:
    • An assessment and statement of the firm’s appetite for risk leading to the establishment of Key Risk Indicators (KRIs) within a Risk Appetite framework.
    • A determination by the firm’s Board of a target range for measures of success – such as Return on Assets, Return on Equity, Return on Risk Adjusted Risk Assets etc., referred to as Key Performance Indicators (KPIs) that will be judged acceptable by the stakeholders.
    Managing the success of this optimization is achieved by the development of complementary longterm strategic and short-term operating plans; and monitoring the actual outcome of KRIs and KPIs against the forecast.
    However, this optimization process is complex for several reasons:
    • The strategy will optimize KPIs constrained by KRIs (risk appetite targets) and will be run under a ‘business as usual’ scenario, but
    • The management will have to take into consideration also the capability of the bank to manage KRIs (risk capacity and risk tolerance) under stressed scenarios, to meet regulatory constraints.

  20. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT

    5. Liquidity Concepts and Definitions
    Liquidity is a company's ability to convert its assets to cash in order to pay its liabilities when they are due.
    Liquidity describes the degree to which an asset or security can be quickly bought or sold in the market at a price reflecting its intrinsic value. In other words: the ease of converting it to cash. Liquidity reflects whether there is a ready market for an asset—the ease of converting it to cash.
    Cash is universally considered the most liquid asset, while tangible assets, such as real estate, fine art, and collectibles, are all relatively illiquid. Other financial assets, ranging from equities to partnership units, fall at various places on the liquidity spectrum. are several ratios that express accounting liquidity highlighted below
    There are different ways to measure liquidity, including market liquidity and accounting liquidity.
    Evaluating Liquidity
    Liquidity depends on
    1) the speed at which the assets should be turning to cash, or
    2) the assets' nearness to cash.
    For example, some temporary investments are marketable and can be converted to cash very quickly. Accounts receivable may be converted to cash in 10 to 40 days. However, inventory may require several months to be sold and the money collected. Hence, inventory is not considered to be a "quick asset."
    To assist in evaluating a company's liquidity, the financial ratio known as the quick ratio or acid-test ratio is calculated by dividing the amount of the company's quick assets (cash, temporary investments, and accounts receivable) by the amount of the company's current liabilities
    In investment terms, assessing accounting liquidity means comparing liquid assets to current liabilities, or financial obligations that come due within one year. There are a number of ratios that measure accounting liquidity, which differ in how strictly they define "liquid assets." Analysts and investors use these to identify companies with strong liquidity.
    Liquidity is of paramount importance being a core issue of banking (Caruana and Kodres, 2008). Therefore, viability and efficiency of a bank is greatly influenced by the availability of liquidity in sufficient amount at all times. Banks must meet their due obligations and execute payments on the exact day they are due, otherwise, the banks stand the risk of being declared illiquid (Crocket, 2008).
    Traditionally, banks basically function as financial intermediaries and collecting points of fund for different groups within the society. Therefore, banks are expected to maintain adequate liquidity in order to efficiently perform their daily obligations such as meeting depositors’ demand or withdrawals, settling wholesale commitments and provision of funds when borrowers draw on committed credit facilities (FSC, 2010). They must also ensure sufficient funds in order to be able to finance increase in assets (Bank, 2004). Hence, banks automatically transform short-term, liquid liabilities into long-term illiquid assets (ECB, 2002). This function serves to protect customers against liquidity problems, but, however, exposes banks themselves to such risk which in extreme case or worst scenario is capable of causing bank runs regardless of soundness of the bank (ECB, 2002).
    The Central Bank argued that such liquidity problem in a bank is capable of spreading to the other banks and thereby causing a real bank panic. The term liquidity is characterized by ambiguity due to so many facets and definitions, therefore, to use it productively and purposely, it needs further and clear definitions (Goodhart, 2008). Literature on finance agrees that in the real sense, liquidity is easy to identify than to define. In economics literature, the understanding of liquidity represents an economic agent’s ability to exchange his/her current wealth for assets or others such as goods and services. Two important issues are emphasized in this meaning of liquidity.

  21. NWOKOCHA NNEBUIHE IHECHI
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    6. Lending Policies
    Lending policy is a set of guidelines and criteria developed and used by a lending institution or bank and its employees to reach a decision on a loan application.
    The examiner's evaluation of the loan portfolio involves much more than merely appraising individual loans.
    Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies, are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation.
    Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio.
    Certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location include the following,
    i. General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    ii. Lending authority of each loan officer;
    iii. Lending authority of a loan or executive committee, if any;
    iv. Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    v. Guidelines under which unsecured loans will be granted;
    vi. Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    vii. Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    viii. Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    ix. Maintenance and review of complete and current credit files on each borrower;
    x. Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    xi. Limitations on the maximum volume of loans in relation to total assets;
    xii. Limitations on the extension of credit through overdrafts;
    xiii. Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    xiv. Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    xv. Guidelines addressing the bank's loan review and grading system ("Watch list");
    xvi. Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    xvii. Guidelines for adequate safeguards to minimize potential environmental liability.
    The above are only as guidelines for areas that should be considered during the loan policy evaluation. Examiners should also encourage management to develop specific guidelines for each lending department or function. As with overall lending policies, it is not the FDIC's intent to suggest universal or standard loan policies for specific types of credit. The establishment of these policies is the responsibility of each bank's Board and management.
    Therefore, the basic principles applicable to various types of credit will not include acceptable ratios, levels, comparisons or terms.

  22. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT

    7. Investment Instrument Policies
    Investment instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded. Most types of investment instruments provide efficient flow and transfer of capital all throughout the world's investors. These assets can be cash, a contractual right to deliver or receive cash or another type of financial instrument, or evidence of one's ownership of an entity.
    Understanding Financial Instruments
    Financial instruments can be real or virtual documents representing a legal agreement involving any kind of monetary value. Equity-based financial instruments represent ownership of an asset. Debt-based financial instruments represent a loan made by an investor to the owner of the asset.
    Foreign exchange instruments comprise a third, unique type of financial instrument. Different subcategories of each instrument type exist, such as preferred share equity and common share equity.
    Types of Financial Instruments
    Financial instruments may be divided into two types: cash instruments and derivative instruments.
    Cash Instruments
    • The values of cash instruments are directly influenced and determined by the markets. These can be securities that are easily transferable.
    • Cash instruments may also be deposits and loans agreed upon by borrowers and lenders.
    Derivative Instruments
    • The value and characteristics of derivative instruments are based on the vehicle’s underlying components, such as assets, interest rates, or indices.
    • These can be over-the-counter (OTC) derivatives or exchange-traded derivatives.
    Types of Asset Classes of Financial Instruments
    Financial instruments may also be divided according to an asset class, which depends on whether they are debt-based or equity-based.
    Debt-Based Financial Instruments
    Short-term debt-based financial instruments last for one year or less. Securities of this kind come in the form of T-bills and commercial paper. Cash of this kind can be deposits and certificates of deposit (CDs).
    Exchange-traded derivatives under short-term, debt-based financial instruments can be short-term interest rate futures. OTC derivatives are forward rate agreements.
    Long-term debt-based financial instruments last for more than a year. Under securities, these are bonds. Cash equivalents are loans. Exchange-traded derivatives are bond futures and options on bond futures. OTC derivatives are interest rate swaps, interest rate caps and floors, interest rate options, and exotic derivatives.
    Equity-Based Financial Instruments
    Securities under equity-based financial instruments are stocks. Exchange-traded derivatives in this category include stock options and equity futures. The OTC derivatives are stock options and exotic derivatives.
    Special Considerations
    There are no securities under foreign exchange. Cash equivalents come in spot foreign exchange. Exchange-traded derivatives under foreign exchange are currency futures. OTC derivatives come in foreign exchange options, outright forwards, and foreign exchange swaps.

  23. NAME: ANENECHUKWU JENNIFER EBELE
    REG NUMBER: PG/MSC/17/00139

    COURSE CODE: ECO 521

    DATE: 30:04:2019

    7. INVESTMENT INSTRUMENT AND POLICIES
    This refers to Document such as a share certificate, promissory note, or bond, used as means to acquire equity capital or loan capital. Also called financing instrument.
    Investors can choose from a wide range of assets for their investment portfolios. The two basic types of investment instruments are fixed-income and equity. Fixed-income assets provide relative safety of capital and regular interest payments, while equity provides the potential for long-term capital appreciation. The asset mix depends on short-term cash flow needs, long-term financial objectives and tolerance for market risk.
    Types of investment instruments include cash instruments, bond issues, equity investments, mutual funds and ETFs, commodities and precious metals, real estate and businesses, and derivatives.
    – SHARES as an investment instrument
    From Investopedia: “A share is a unit of ownership interest in a corporation or financial asset”.
    Owning one or more shares of a company literally means to be a member of that organization, then to have the right to vote, but, above all, the right to earn from the profit produced by that company, usually in proportion to the number of shares held.
    So, if you own the 1% of a company’s shares, when and if it will decide to distribute the so-called dividends, you will cash out the 1%. However, the peculiarities might be many, and not all companies pay the dividends to its shareholders. In that case, the shareholder will be able to make money from his investment gaining from the growth in value of its shares, and the subsequent sale to another investor. A company’s shares are subject to the fundamental market laws of supply and demand, so, in general, the more a society is strong, the more its shares will be required and therefore the more their value will go up. Conversely, the more a company is weak, the more its shares will be unattractive, people will not want them and they will lose value. This means that if shares pay no dividends, you can only gain from the fact that they increase in value, which in other words means to speculate on the difference between the sale and the purchase price. The percentages of return on the investment can be very high, but on the other hand, there are also many risks that the share’s value simply doesn’t rise up in value, or even that it goes down.

  24. NWOKOCHA NNEBUIHE IHECHI
    PG/MSc/17/03025
    ECO 521 ASSIGNMENT
    8. Comparative Financial Systems
    A 'financial system' is a system that allows the exchange of funds between lenders, investors, and borrowers. Financial systems operate at national and global levels.[1] They consist of complex, closely related services, markets, and institutions intended to provide an efficient and regular linkage between investors and depositors.[2]
    A financial system no matter how rudimentary is a complex system. It is complex in its operation such that neither the system itself nor its operation can be measured accurately. Because of this complexity a simple definition cannot adequately capture what a financial system is. A financial system comprises financial institutions, financial markets, financial instruments, rules, conventions, and norms that facilitate the flow of funds and other financial services within and outside the national economy. The financial system can be described as a whole system of all institutions, individuals, markets and regulatory authorities that exist and interact in a given economy.
    Money, credit, and finance are used as medium of exchange in financial systems. They serve as a medium of known value for which goods and services can be exchanged as an alternative to bartering.[3] A modern financial system may include banks (public sector or private sector), financial markets, financial instruments, and financial services. Financial systems allow funds to be allocated, invested, or moved between economic sectors. They enable individuals and companies to share the associated risks

    The institutions, government and individuals form the participants in various markets; money markets (including foreign exchange) and capital markets (including security) markets. The participant buy (borrow) and sell (lend) money to different parties at a price (interest or dividend) within the market, which is determined by the forces of demand and supply. In a broader aspect a financial system can also be defined as a system that allows the transfer of money between savers (and investors) and borrowers operating on a global, regional or firm specific level. According to Gurusam, it is a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions. The components of financial system include;

    Money is used as a medium to buy goods & services. It also is a standard unit of measurement and acts as a store of value. However, money may not be a good store of value since it loses value with inflation.
    Financial Instruments are formal obligations that entitle one party to receive payments or a share of assets from another party. Examples of tradable financial instruments include loans, stocks, and bonds. Financial Institutions are firms that connect borrowers and lenders, provide savers and borrowers access to financial instruments & markets. There are two types of Financial Markets; the primary market and the secondary market. Central Banks are large financial institutions that handle government finances, they regulate the supply of money, and they serve as banks to commercial banks. A Financial Market is a place or network where financial instruments can be sold quickly & cheaply

  25. UNIVERSITY OF NIGERIA, NSUKKA
    FACULTY OF THE SOCIAL SCIENCES
    DEPARTMENT OF ECONOMICS

    TOPIC
    Discuss and analyze the following concepts in Monetary Economics; Risk analysis, Bank capital adequacy, Bank lending, Balance sheet management, Liquidity concepts and policies, Lending policies, Investment instrument and policies and Comparative financial system.

    AN ASSIGNMENT
    Submitted in partial fulfillment of the course Eco 521 (Monetary Economics)

    BY
    EZE AFAMEFUNA ANGUS
    PG/M.Sc/17/02956

    LECTURER: DR. ANTHONY ORJI.

    APRIL, 2019

  26. RISK ANAYSIS
    Risk analysis is the process of identifying and analyzing potential issues that could negatively impact key business initiatives or critical projects in order to help organizations avoid or mitigate those risks.
    Performing a risk analysis includes considering the probability of adverse events caused by either natural processes, like severe storms, earthquakes or floods, or adverse events caused by malicious or inadvertent human activities; an important part of risk analysis is identifying the potential for harm from these events, as well as the likelihood that they will occur.
    Enterprises and other organizations use risk analysis to:
    • anticipate and reduce the effect of harmful results from adverse events;
    • evaluate whether the potential risks of a project are balanced by its benefits to aid in the decision process when evaluating whether to move forward with the project;
    • plan responses for technology or equipment failure or loss from adverse events, both natural and human-caused; and
    • Identify the impact of and prepare for changes in the enterprise environment, including the likelihood of new competitors entering the market or changes to government regulatory policy.
    Benefits of risk analysis
    Organizations must understand the risks associated with the use of their information systems to effectively and efficiently protect their information assets.
    Risk analysis can help an organization improve its security in a number of ways. Depending on the type and extent of the risk analysis, organizations can use the results to help:
    • identify, rate and compare the overall impact of risks to the organization, in terms of both financial and organizational impacts;
    • identify gaps in security and determine the next steps to eliminate the weaknesses and strengthen security;
    • enhance communication and decision-making processes as they relate to information security;
    • improve security policies and procedures and develop cost-effective methods for implementing these information security policies and procedures;
    • put security controls in place to mitigate the most important risks;
    • increase employee awareness about security measures and risks by highlighting best practices during the risk analysis process; and
    • understand the financial impacts of potential security risks.

  27. Done well, risk analysis is an important tool for managing costs associated with risks, as well as for aiding an organization's decision-making process.
    Steps in risk analysis process
    The risk analysis process usually follows these basic steps:
    1. Conduct a risk assessment survey: This first step, getting input from management and department heads, is critical to the risk assessment process. The risk assessment survey is a way to begin documenting specific risks or threats within each department.
    2. Identify the risks: The reason for performing risk assessment is to evaluate an IT system or other aspect of the organization and then ask: What are the risks to the software, hardware, data and IT employees? What are the possible adverse events that could occur, such as human error, fire, flooding or earthquakes? What is the potential that the integrity of the system will be compromised or that it won't be available?
    3. Analyze the risks: Once the risks are identified, the risk analysis process should determine the likelihood that each risk will occur, as well as the consequences linked to each risk and how they might affect the objectives of a project.
    4. Develop a risk management plan: Based on an analysis of which assets are valuable and which threats will probably affect those assets negatively, the risk analysis should produce control recommendations that can be used to mitigate, transfer, accept or avoid the risk.
    5. Implement the risk management plan: The ultimate goal of risk assessment is to implement measures to remove or reduce the risks. Starting with the highest-priority risk, resolve or at least mitigate each risk so it's no longer a threat.
    6. Monitor the risks: The ongoing process of identifying, treating and managing risks should be an important part of any risk analysis process.
    The focus of the analysis, as well as the format of the results, will vary depending on the type of risk analysis being carried out.
    BANK CAPITAL ADEQUACY
    After examining the major areas of risk exposure facing a modern financial institution manger. These risks can emanate from both on-and off- balance sheet (OBS) activities and can be either domestic or international in source. To ensure survival, a financial institution manager needs to protect the institution against the risk of insolvency, that is, shield it from risks sufficiently large to cause the institution to fail. The primary means of protection against the risk of insolvency and failure is a financial institution’s capital. This leads to the first function of capital, namely:
     To absorb unanticipated losses with enough margin to inspire confidence and enable the financial institution to continue as a going concern. In addition, capital protects non-equity liability holders-especially those uninsured by an external guarantor such as the FDIC- against losses. This leads to the second function of capital.

  28.  To protect uninsured depositors, bondholders, and creditors in the event of insolvency, and liquidation. When financial institutions fail, regulators such as the FDIC have to intervene to protect insured claimants. The capital of a financial institution offers protection to insurance funds and ultimately the taxpayers who bear the cost of insurance fund insolvency. This leads to the third function of capital:
     To protect financial institution insurance funds and taxpayers. At this time, each of the government deposit insurance funds is fully funded. By holding capital and reducing the risk of insolvency, a financial intermediary protects the industry larger insurance premiums. Such premiums are paid out of the net profits of the financial institution. Thus, a fourth function of capital is as follows;
     To protect the financial institution owners against increases in insurance premiums. Finally, just as for any other firm, equity or capital is an important source of financing for a financial institution. In particular, subject to regulatory constraints, financial institutions have a choice between debt and equity to finance new projects and business expansion.
    Percentage ratio of a financial institution's primary capital to its assets (loans and investments), used as a measure of its financial strength and stability. According to the Capital Adequacy Standard set by Bank for International Settlements (BIS), banks must have a primary capital base equal at least to eight percent of their assets: a bank that lends 12 dollars for every dollar of its capital is within the prescribed limits. Fundamental objective for holding adequate capital by banks
    Strengthen the soundness of banks.
    Stability of the banking system
    Provide a stable resource to absorb losses
    Loss absorption capacity based on the business risk
    BANK EARNING
    Banks are companies (normally listed on the stock market) and are therefore owned by, and run for, their shareholders. Banks need to make enough money to pay their employees, maintain the buildings and run the business.
    There are three main ways banks make money: by charging interest on money that they lend, by charging fees for services they provide and by trading financial instruments in the financial markets.
    Retail and commercial banks need lots of customers to deposit their money with them, as the banks use these deposits to earn enough money to stay in business.
    To encourage people to keep their money in a bank, the bank will pay them a small amount of money (interest). This interest is paid from the money the bank earns by lending out the deposited money to other customers.

  29. Banks also lend to each other on a huge scale. Most of this lending is on a short-term basis, usually no longer than three months, often just overnight
    If a bank has a surplus of liquid (available) assets then the bank can make money by lending these assets to other banks in the interbank market. As money flows in and out, banks will both lend and borrow money on the interbank market as needs require.
    The banks lend money to customers at a higher rate than they pay to depositors or than they borrow it. The difference, known as the margin or turn, is kept by the bank. For example, if a bank pays 1% interest on deposits, they may charge 6% interest on loans.
    Lending takes the form of overdrafts, bank loans, mortgages (loans secured on property) and credit card facilities. The bank will work out the cost of making the funds available to the borrower and add a profit margin.
    Loans approved by banks will vary in size, and may have fixed or variable interest rates but, in all cases, the bank will lend the money to the customer at a higher rate than they borrow it.
    Deposits are the banks' liabilities. If everyone was to demand their money back at once, the bank would not be able to pay. Because they lend money out, banks are required to carry a cushion of capital so they have sufficient money to pay those customers likely to withdraw their money at any time.

  30. BANK EARNING
    Banks are companies (normally listed on the stock market) and are therefore owned by, and run for, their shareholders. Banks need to make enough money to pay their employees, maintain the buildings and run the business.
    There are three main ways banks make money: by charging interest on money that they lend, by charging fees for services they provide and by trading financial instruments in the financial markets.
    Retail and commercial banks need lots of customers to deposit their money with them, as the banks use these deposits to earn enough money to stay in business.
    To encourage people to keep their money in a bank, the bank will pay them a small amount of money (interest). This interest is paid from the money the bank earns by lending out the deposited money to other customers.
    Banks also lend to each other on a huge scale. Most of this lending is on a short-term basis, usually no longer than three months, often just overnight
    If a bank has a surplus of liquid (available) assets then the bank can make money by lending these assets to other banks in the interbank market. As money flows in and out, banks will both lend and borrow money on the interbank market as needs require.
    The banks lend money to customers at a higher rate than they pay to depositors or than they borrow it. The difference, known as the margin or turn, is kept by the bank. For example, if a bank pays 1% interest on deposits, they may charge 6% interest on loans.
    Lending takes the form of overdrafts, bank loans, mortgages (loans secured on property) and credit card facilities. The bank will work out the cost of making the funds available to the borrower and add a profit margin.
    Loans approved by banks will vary in size, and may have fixed or variable interest rates but, in all cases, the bank will lend the money to the customer at a higher rate than they borrow it.
    Deposits are the banks' liabilities. If everyone was to demand their money back at once, the bank would not be able to pay. Because they lend money out, banks are required to carry a cushion of capital so they have sufficient money to pay those customers likely to withdraw their money at any time.
    Another way banks make money is through charging fees. Most retail and commercial banks will charge for specific services, for example, for processing cheques, for other transactions and for unauthorized borrowing e.g. if a client exceeds an overdraft limit.
    Investment banks earn huge fees for advising large companies and public institutions on issuing bonds and shares (securities), and from underwriting these issues.
    Investment banks charge fees for advising clients wanting to bid for other companies in mergers and acquisitions, or management buy-outs. These deals can be very complex and provide an important source of income as well as an opportunity to underwrite shares related to these deals.
    Investment banks also make their money by trading securities in the secondary markets. Their aim is to sell these securities for more than they pay for them or purchase them for less than they sold them. The difference, called the turn, is kept by the bank.
    Banks also buy and sell currencies of all the nations of the world, trying to take advantage of the different prices of these currencies against each other, which are changing all the time.

  31. Balance Sheet Management
    Balance Sheet Management is aimed at the determination of the optimal composition of different funding elements such as debt, mezzanine and equity for a company. Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company. Balance Sheet Management covers regulatory policy for investment securities, Bank-Owned Life Insurance (BOLI), liquidity risk, and interest rate risk for national banks, as well as the assessment of interest rate risk and liquidity risk for the national banking system as a whole. Balance Sheet Management is the process of planning, coordinating, and directing business activities that directly determine the Assets, Liabilities, and Equity of a company.
    Purpose of Balance Sheet Management
    The Purpose of Balance Sheet Management is to position a company to have adequate resources for current operations and for financing future growth.
    LIGUIDITY CONCEPTS AND POLICIES
    Liquidity is of paramount importance being a core issue of banking (Caruana and Kodres, 2008). Therefore, viability and efficiency of a bank is greatly influenced by the availability of liquidity in sufficient amount at all times. Banks must meet their due obligations and execute payments on the exact day they are due, otherwise, the banks stand the risk of being declared illiquid (Crocket, 2008).

  32. Traditionally, banks basically function as financial intermediaries and collecting points of fund for different groups within the society. Therefore, banks are expected to maintain adequate liquidity in order to efficiently perform their daily obligations such as meeting depositors’ demand or withdrawals, settling wholesale commitments and provision of funds when borrowers draw on committed credit facilities (FSC, 2010). They must also ensure sufficient funds in order to be able to finance increase in assets (Bank, 2004). Hence, banks automatically transform short-term, liquid liabilities into long-term illiquid assets (ECB, 2002). This function serves to protect customers against liquidity problems, but, however, exposes banks themselves to such risk which in extreme case or worst scenario is capable of causing bank runs regardless of soundness of the bank (ECB, 2002). The Central
    Bank argued that such liquidity problem in a bank is capable of spreading to the other banks and thereby causing a real bank panic.
    The term liquidity is characterized by ambiguity due to so many facets and definitions, therefore, to use it productively and purposely, it needs further and clear definitions (Goodhart, 2008). Literature on finance agrees that in the real sense, liquidity is easy to identify than to define. In economics literature, the understanding of liquidity represents an economic agent’s ability to exchange his/her current wealth for assets or others such as goods and services. Two important issues are emphasized in this meaning of liquidity. The first one describes liquidity as a flow concept while the second issue relates liquidity to the ability to realize these flows (ECB, 2002). Failure to achieve this would render the financial entity/firm illiquid. The Basel Committee on Banking Supervision (2006) describes liquidity as a reservoir of funds that management can readily have access to in order to meet funding requirements and business opportunities.
    However, the Swiss Takeover Board in 2007 argued that there is no precise definition for liquidity, and the issue of definition should be left open. Hence, the Board suggests that, it should be the Supervisory authority’s prerogative to define liquidity in its jurisdiction and decide the criteria to be used for determining the liquidity and illiquidity of a security and a firm and should publish a report to clarify the liquidity concepts. In a similar vein, both Vento and Ganga (2009) and David (2007) agreed that in financial parlance, liquidity has multiple connotations. However, Vento & Ganga (2009) went further to define liquidity in a broader sense as “the amplitude of a financial firm to keep up all the time a balance between the financial inflows and outflows over time.”
    Market Liquidity
    The last two decades witnessed increasing banks’ usage of the financial markets as a means of financing long-term assets such as loan (Deutsche Bundesbank, 2008). Banks have also, increasingly used both the interbank markets through which banks source for funds among themselves, and the markets for innovative financial instruments such as repurchase agreements, credit derivatives and securitizations to complement their traditional sources of finance such as savings deposits (Deutsche Bundesbank, 2008).

  33. Traditionally, the general belief is that a market which provides an investor the ability to buy and sell a sizeable amount of assets without appreciably affecting the price of the asset is a liquid market (Caruana & Kodres, 2008). The liquidity of the market is an important dimension of market conditions as it is the center point of stability of financial system because it is a precondition for market efficiency, while, its disappearance or insufficiency is capable of causing financial instability which may lead to systemic risk (Berves, 2008). A perfect liquid market would therefore, guarantee a simple bid/ask price at all times irrespective of the quantity of assets/securities being traded (Berves, 2008). Therefore, achieving a smooth functioning and liquid market entails availability of liquidity in the market as well as its continuous enhancement. There are several market structural factors that ensure the availability of liquidity and its enhancement in the market.
    Some of these factors enumerated by David (2007) and Caruana & Kodres, (2008) include: (i) there is high chance that liquidity will be enhanced if there is symmetrical distribution of information about the values of assets in the market among the potential buyers and sellers and the intermediaries; (ii) liquidity in the market can be enhanced by the availability of large amount of the assets to be bought or sold compared to the number of the investors who desired to trade and (iii) the appearance of new market players who are very active attracts new capitals to the markets, thereby, increases their liquidity. Another important factor of the market structure that enhances liquidity of financial market is advances in technology. Also, of equal importance is the introduction of new and innovative financial instruments into the market. As noted by David (2009), liquidity of a financial market is normally supported by the financial innovations enabled by technological advancement, which lowers the trading costs and increases transparency and competition in price, resulting in greater liquidity.
    Furthermore, a very important factor is the mode of business transaction between buyers and sellers either physically or electronically. A well-managed environment which allows buyers and sellers to meet and well established methods of documenting prices encourages easier transaction than over the counter (OTC) markets, where a party has to find another party to trade with. Though, this problem is being reduced through the aid of technology, yet, a formal clearing house that documents transactions and guarantees the performance of the opposing parties is still lacking (Caruana and Kodres, 2008).
    From the aforementioned, it could be inferred that the market liquidity is a feature of market which allows assets such as loans and securities to be sold at any time without adverse effects on assets prices (Deutsche Bundesbank, 2008). However, recent literature on financial market liquidity defines market liquidity as “the ability to trade an asset at short notice, at low cost and with little impact on its price” (Nikolaou, 2009). Based on the definition Nikolaou stressed that market liquidity should be assessed on several grounds and emphasized that the most glaring one is the ability to trade.
    Giving credence to Nikolaou’s opinion Kolja (2006), Deutsche Bundesbank (2008) and Berves (2008) enumerate basic and essential criteria which should be the basis on which the degree of liquidity of a market should be measured. The criteria are as follows;

  34. i. Tightness of the market: – it is measured using the bid-ask spread and it determines the cost of unwinding a position at short notice for a standard amount.
    ii. Depth of the market: – this assesses the actual transaction volume that can be instantly executed without affecting the market prices.
    iii. Market resilience: – this describes the momentum at which the market price recuperates to their equilibrium position after a major shock from the transaction.

    Central bank liquidity
    Central bank liquidity is the ability of the central bank to supply the liquidity needed to the financial system. It is typically measured as the liquidity supplied to the economy by the central bank, i.e. the .ow of monetary base3 from the central bank to the financial system. It relates to central bank operations liquidity, which refers to the amount of liquidity provided through the central bank auctions to the money market according to the monetary policy stance. The latter rejects the prevailing value of the operational target, i.e. the control variable of the central bank. In practice, the central bank strategy determines the monetary policy stance, that is, decides on the level of the operational target (usually the key policy rate). In order to implement this target, the central bank uses its monetary policy instruments (conducts open market operations) to regulate the liquidity in the money markets so that the interbank rate is closely aligned to the operational target rate set by the prevailing monetary policy stance.
    More technically, central bank liquidity, a synonym for the supply of base money, results from managing the central bank assets in its balance sheet, in accordance to the monetary policy stance4. Consider the balance sheet of a central bank. In the liabilities side, the main components are the autonomous factors and the reserves. The autonomous factors contain transactions which are not controlled by the monetary policy function of the central bank6. The reserves refer to balances owned by credit institutions and held with the central bank in order to meet settlement obligations from interbank transactions and to fulfil reserve requirements, i.e. the minimum balances that banks are required to hold with the central bank. The need for banknotes and the obligations of banks to fulfil the reserve requirements create an aggregate liquidity deficit in the system, thereby making it reliant on refinancing from the central bank. The central bank, being the monopoly provider of the monetary base, provides liquidity to the financial system through its open market operations. Thus, these operations appear in the asset side of the central bank’s balance sheet. The liquidity provided by the central bank through its operations, i.e. its assets, should balance the liquidity deficit of the system, i.e. its liabilities. Therefore, the central bank provides liquidity equal to the sum of the autonomous factors8 plus the reserves. The central bank manages its market operations so that the inter-bank short-term lending rates remain closely aligned to the target policy rate.
    Funding liquidity
    The Basel Committee of Banking supervision defines funding liquidity as the ability of banks to meet their liabilities, unwind or settle their positions as they come due(BIS, 2008)11.

  35. Similarly, the IMF provides a definition of funding liquidity as the ability of solvent institutions to make agreed upon payments in a timely fashion.
    However, references to funding liquidity have also been made from the point of view of traders (Brunnemeier and Pedersen, 2007) or investors (Strahan, 2008), where funding liquidity relates to their ability to raise funding (capital or cash) in short notice. All definitions are compatible (see a relevant discussion in Drehmann and Nikolaou, 2008). This can be clearly seen in practice, where funding liquidity, being a flow concept, can be understood in terms of a budget constraint. Namely, an entity is liquid as long as inflows are bigger or at least equal to outflows. This can hold for firms, banks, investors and traders. This paper mainly focuses on the funding liquidity of banks, given their importance in distributing liquidity in the financial system.
    It is therefore useful to consider the liquidity sources for banks. A first one is, as already seen, the depositors, who entrust their money to the bank. A second is the market. A bank can always go to the asset market and sell its assets or generate liquidity through securitization, loan syndication and the secondary market for loans, in its role as .originator and distributor.12. Moreover, the bank can get liquidity from the interbank market13, arguably the most important source of liquidity. Finally, a bank can also choose to get funding liquidity directly from the central bank. In the euro system, this is possible by bidding in the open market operations of the ECB (see Drehmann and Nikolaou, 2008 for an extended analysis of the sources and their importance). Knowledge of these sources is important in order to better understand the liquidity linkages.

    LENDING POLICIES
    Lending (also known as "financing") in its most general sense is the temporary giving of money or property to another person with the expectation that it will be repaid. In a business and financial context, lending includes many different types of commercial loans.
    Prudent management and administration of the overall loan account, including establishment of sound lending and collection policies, are of vital importance if the bank is to be continuously operated in an acceptable manner.
    Lending policies should be clearly defined and set forth in such a manner as to provide effective supervision by the directors and senior officers. The board of directors of every bank has the legal responsibility to formulate lending policies and to supervise their implementation. Therefore examiners should encourage establishment and maintenance of written, up-to-date lending policies which have been approved by the board of directors. A lending policy should not be a static document, but must be reviewed periodically and revised in light of changing circumstances surrounding the borrowing needs of the bank's customers as well as changes that may occur within the bank itself. To a large extent, the economy of the community served by the bank dictates the composition of the loan portfolio. The widely divergent circumstances of regional economies and the considerable variance in characteristics of individual loans preclude establishment of standard or universal lending policies.

  36. There are, however, certain broad areas of consideration and concern that should be addressed in the lending policies of all banks regardless of size or location. These include the following, as minimums:
    • General fields of lending in which the bank will engage and the kinds or types of loans within each general field;
    • Lending authority of each loan officer;
    • Lending authority of a loan or executive committee, if any;
    • Responsibility of the board of directors in reviewing, ratifying, or approving loans;
    • Guidelines under which unsecured loans will be granted;
    • Guidelines for rates of interest and the terms of repayment for secured and unsecured loans;
    • Limitations on the amount advanced in relation to the value of the collateral and the documentation required by the bank for each type of secured loan;
    • Guidelines for obtaining and reviewing real estate appraisals as well as for ordering reappraisals, when needed;
    • Maintenance and review of complete and current credit files on each borrower;
    • Appropriate and adequate collection procedures including, but not limited to, actions to be taken against borrowers who fail to make timely payments;
    • Limitations on the maximum volume of loans in relation to total assets;
    • Limitations on the extension of credit through overdrafts;
    • Description of the bank's normal trade area and circumstances under which the bank may extend credit outside of such area;
    • Guidelines, which at a minimum, address the goals for portfolio mix and risk diversification and cover the bank's plans for monitoring and taking appropriate corrective action, if deemed necessary, on any concentrations that may exist;
    • Guidelines addressing the bank's loan review and grading system ("Watch list");
    • Guidelines addressing the bank's review of the Allowance for Loan and Lease Losses (ALLL); and
    • Guidelines for adequate safeguards to minimize potential environmental liability.

  37. Investment instrument

    In general, this is a document such as a share certificate, promissory note, or bond, used as means to acquire equity capital or loan capital. Also called financing instrument.
    Refers to certain financial products, including:

    a share in the body, or a debenture in a body
    a derivative
    a foreign exchange contract that is not a derivative
    an interest in, or a unit in an interest in, a managed investment scheme
    a unity in a share in a body, and
    a financial product traded on the financial market that is operated in accordance with an Australian market licence or exempt from the operation of Part 7.2 of the Corporations Act 2001;
    but does not include:

    the creation or transfer of a right to payment in connection with interest in land (where the written evidence of the transfer does not specifically identify the land)
    a document of title
    an intermediated security, and
    a negotiable instrument.
    There are many types of investments and investing styles to choose from. Mutual funds, ETFs, individual stocks and bonds, closed-end mutual funds, real estate, various alternative investments and owning all or part of a business are just a few examples.
    Stocks
    Buying shares of stock gives the buyer the opportunity to participate in the company’s success via increases in the stock’s price and dividends that the company might declare. Shareholders have a claim on the company’s assets in the event of liquidation, but do not own the assets.
    Holders of common stock have voting rights at shareholders’ meetings and the right to receive dividends if they are declared. Holders of preferred stock don’t have voting rights, but do receive preference in terms of the payment of any dividends over common shareholders. They also have a higher claim on company assets than holders of common stock.

  38. Bonds
    Bonds are debt instruments whereby an investor effectively is loaning money to a company or agency (the issuer) in exchange for periodic interest payments plus the return of the bond’s face amount when the bond matures. Bonds are issued by corporations, the federal government plus many states, municipalities and governmental agencies. A typical corporate bond might have a face value of $1,000 and pay interest semi-annually. Interest on these bonds are fully taxable, but interest on municipal bonds is exempt from federal taxes and may be exempt from state taxes for residents of the issuing state. Interest on Treasuries are taxed at the federal level only. Bonds can
    be purchased as new offerings or on the secondary market, just like stocks. A bond’s value can rise and fall based on a number of factors, the most important being the direction of interest rates. Bond prices move inversely with the direction of interest rates.

    Mutual funds
    A mutual fund is a pooled investment vehicle managed by an investment manager that allows investors to have their money invested in stocks, bonds or other investment vehicles as stated in the fund’s prospectus. Mutual funds are valued at the end of trading day and any transactions to buy or sell shares are executed after the market close as well. Mutual funds can passively track stock or bond market indexes such as the S&P 500, the Barclay’s Aggregate Bond Index and many others. Other mutual funds are actively managed where the manager actively selects the stocks, bonds or other investments held by the fund. Actively managed mutual funds are generally more costly to own. A fund’s underlying expenses serve to reduce the net investment returns to the mutual fund shareholders. Mutual funds can make distributions in the form of dividends, interest and capital gains. These distributions will be taxable if held in a non-retirement account. Selling a mutual fund can result in a gain or loss on the investment, just as with individual stocks or bonds. Mutual funds allow small investors to instantly buy diversified exposure to a number of investment holdings within the fund’s investment objective. For instance, a foreign stock mutual might hold 50 or 100 or more different foreign stocks in the portfolio. An initial investment as low as $1,000 (or less in some cases) might allow an investor to own all the underlying holdings of the fund. Mutual funds are a great way for investors large and small to achieve a level of instant diversification.

  39. ETFs
    ETFs or exchange-traded funds are like mutual funds in many respects, but are traded on the stock exchange during the trading day just like shares of stock. Unlike mutual funds which are valued at the end of each trading day, ETFs are valued constantly while the markets are open. Many ETFs track passive market indexes like the S&P 500, the Barclay’s Aggregate Bond Index, and the Russell 2000 index of small cap stocks and many others. In recent years, actively managed ETFs have come into being, as have so-called smart beta ETFs which create indexes based on “factors” such as quality, low volatility and momentum.
    Alternative investments
    Beyond stocks, bonds, mutual funds and ETFs, there are many other ways to invest. We will discuss a few of these here. Real estate investments can be made by buying a commercial or residential property directly. Real estate investment trusts (REITs) pool investor’s money and purchase properties. REITS are traded like stocks. There are mutual funds and ETFs that invest in REITs as well. Hedge funds and private equity also fall into the category of alternative investments, although they are only open to those who meet the income and net worth requirements of being an accredited investor. Hedge funds may invest almost anywhere and may hold up better than conventional investment vehicles in turbulent markets. Private equity allows companies to raise capital without going public. There are also private real estate funds that offer shares to investors in a pool of properties. Often alternatives have restrictions in terms of how often investors can have access to their money. In recent years, alternative strategies have been introduced in mutual fund and ETF formats, allowing for lower minimum investments and great liquidity for investors. These vehicles are known as liquid alternatives.
    COMPARATIVE FINANCIAL SYSTEM
    One of the striking features of financial systems around the world is the extent to which they differ across countries. First the size of financial systems varies appreciably across countries.

  40. Table 2.1: Net sources of finance for corporations in Germany, Japan, the UK, and the US, average 1970–98
    Germany Japan UK US
    Internal 78.9 69.9 93.3 96.1
    Bank finance 11.9 26.7 14.6 11.1
    Bonds −1.0 4.0 4.2 15.4
    New equity 0.1 3.5 −4.6 −7.6
    Trade credit −1.2 −5.0 −0.9 −2.4
    Capital transfers 8.7 — 1.7 —
    Other 1.4 1.0 0.0 −4.4
    Statistical adjustment 1.2 0.0 −8.4 −8.3
    Source: J Corbett and T Jenkinson, ‘How is Investment Financed? A Study of Germany, Japan, the United Kingdom and the United States’ (1997)
    One reason for the pronounced variation in the size and nature of financial systems is the different functions that they perform. In particular, the way in which corporate sectors finance themselves varies appreciably among countries. For example, stock markets play an important part in corporate financing in some but not all countries, whereas banks tend to be of considerable significance in most countries. Similarly, the significance of bond markets for the financing of corporations varies from the US, where it is critically important, to some Continental European countries, where it remains of modest importance. Table 2.2 shows the way in which corporations funded their activities over thirty years to the end of the last century in four countries: Germany, Japan, the UK, and the US. It records that the dominant source of finance is internal, namely the profits of businesses that are not distributed as dividends. These account for between three-quarters of corporate funding in Japan and Germany and over 90 per cent in the UK and the US. Most of that goes towards funding the replacement of the existing capital stock.

  41. Of external sources of funding, loans from banks are the most important in all countries. However, bond markets play a significant role in North America and increasingly in Europe since the development of the corporate bond market at the end of the 1990s and the first decade of this century. New equity is a small and in some cases negative source of finance for firms. The negative figures reflect the fact that corporations purchase as well as sell equity. In particular, they purchase equity in other firms when they take them over and buy the shares of the companies they are acquiring. They also repurchase their shares from their shareholders. Takeovers and share repurchases are particularly significant in the UK and the US—hence the negative figures in those two countries. While stock markets are not in aggregate a large net source of capital for corporate sectors in developed economies, they are very important for two particular groups of firms: first, new equity is a vital source of funding for start-ups and small companies; and second, they are a much larger source of funding of enterprises in developing and emerging markets than in developed economies. In other words, large well-established firms in developed economies tend to buy a lot of shares in acquisitions and repayment of capital whereas small start-up companies, particularly in developing and emerging economies, tend to raise a large amount of capital.
    An important source of finance for firms in their early stages of development is their own capital and that of families and friends. Informal sources of finance are the primary way in which firms get going. In some cases, they raise funding from wealthy private individuals, business angels that are often actively involved in the development of the firm. External early stage funding may come from venture capital firms that raise money from a variety of sources including institutional investors such as pension funds, life insurance companies, and university endowments. These investors frequently (p.43) seek a way of exiting from the investments within a period of five to seven years by selling the firms on stock markets as IPOs or trade sales to other firms.
    Once established, the main external source of finance for firms is bank borrowing. In evaluating the creditworthiness of a borrower, loan officers use several sources of information. These relate primarily to: (i) accounting data—balance sheets, profit and loss statements, and financial ratios of, for example, leverage, and earnings coverage of interest payments; (ii) projections of cash flows; (iii) information about the sector in which the firm is operating; (iv) the firm’s customers and suppliers; (v) the account history of the borrower; (vi) judgmental information on the quality of management; and (vii) collateral and personal security of the directors that can be provided in the event of a firm default.
    Another important cause of differences in the nature of financial systems is the way in which pension provisions for retired employees are structured. In some countries they are primarily provided by the state and the state uses tax revenues to fund retirement schemes. In other countries, such as Germany, corporations fund their own pension schemes.

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