Acfi1003 Practice Questions

ACFI1003 Practice Questions

These practice questions do not include all the topic matter that may be examined in the actual final examination, and the practice questions may not appear in the actual final examination.

Consequently, your success or otherwise with the practice questions may not necessarily indicate your likely level of success in the actual final examination.

All topic matter covered in this course is examinable. As a result, in preparation for the final examination this must include revision of the entire course.

Your revision should not be limited to completing these practice questions only. It should incorporate a comprehensive revision of the entire course that includes the:

• lecture notes
• activities as a part of the lecture notes on Blackboard
• workshop questions and activities
• textbook readings, and
• online quizzes with feedback

Topic 1 – An Introduction to the Financial System

1. Explain what is meant by “surplus units” and “deficit units”.

Surplus units refer to savers. Savers give up consumption now to increase future consumption. Savers invest or buy financial instruments.

Deficit units refers to borrowers. Borrowers will increase their consumption now but need to reduce future consumption. Borrowers sell financial instruments

1. What is the financial system and describe the functions of the financial system?

The financial system comprises financial institutions, instruments and markets. The financial system facilitates the exchange of goods and services by bringing parties together and establishing prices

1. Identify and describe 2 categories of financial institution.

Banks (authorised deposit taking institutions) – take savings from depositors and make loans.

Investment banks and merchant banks – provide advisory services to corporate and government clients and earn fee income.

Contractual savings institutions (life insurance, general insurance, superannuation) – insurance companies receive regular insurance premiums in return for insuring against a specific risk and superannuation funds receive regular superannuation contributions which are then invested.

Finance companies – raise funds by issuing securities and then make loans and provide lease finance to household and business customers.

Unit trusts – raise funds by selling units. Funds are then pooled and invested into an asset class.

1. List and describe the 3 categories of financial instrument.

Equity – an ownership interest in an asset for example company shares

Debt – a contractual claim to interest payments and repayment of principle (e.g. loan or bond)

Derivatives – an instrument that derives its value from a physical market commodity or financial security (e.g. option or futures contract)

1. How are the money market and capital market different?

The money market is the market for issuing and trading short term securities (maturity of one year or less). Allows participants to manage liquidity.

The capital market is the market for issuing and trading long term securities (equity, corporate debt and government debt). Securities have a maturity of greater than one year. The capital market is supported by the foreign exchange and derivatives markets.

Topic 2 - Banks

1. Explain the difference between “asset management” and “liability management”. Which one do banks currently practice?
   

Under asset management the loans portfolio is adjusted and tailored to the available deposit base. Under liability management the deposit base and other sources of funding are managed to fund loan demand and banks will borrow directly from domestic and international capital markets.

Banks have been practicing liability management since the 1980’s

1. List and describe the sources of funds for a bank.

1. Current account deposits – funds held in a cheque account, highly liquid
2. Call or demand deposits – funds held in savings accounts that can be withdrawn on demand, highly liquid
3. Term deposits – funds lodged in an account for a specific period of time at a specified interest rate
4. Negotiable CDs – paper issued by a bank in its own name at a discount to face vale and can be sold
5. Bill acceptance liabilities – securities issued in the money market at a discount to face value
6. Debt liabilities – the bank sells medium to long term debt instruments to investors
7. Foreign currency liabilities – the bank sells debt instruments into the international capital market denominated in a foreign currency
8. Loan capital and shareholders’ equity – bank can issue equity securities and subordinated debt

1. List and describe the uses of funds for a bank.

1. Personal and housing finance – such as mortgages, fixed term loans and credit cards
2. Commercial lending – lending to business and other financial insitutions
3. Lending to government – purchasing government securities such as T-notes and T-bonds
4. Other bank assets – such as electronic network infrastructure

1. What is off balance sheet business for a bank?

Off balance sheet business or OBS business for a bank are transactions that do not create an asset or liability on the bank’s balance sheet.

1. List the 4 categories of off balance sheet business.

1. Direct credit substitutes
2. Trade and performance related items
3. Commitments
4. Foreign exchange, interest rates and other market rate related contracts

1. What is the purpose of the capital adequacy standards for banks and what is the minimum risk-based capital ratio that the banks should maintain?

The capital adequacy standards are designed to promote stability within the financial system. The minimum risk-based capital ratio that banks should maintain is 8% (i.e. capital should be at least 8% of risk weighted assets).

Topic 3 – Non-Bank Financial Institutions

1. List 4 non-bank financial institutions.

1. Investment and merchant banks
2. Managed funds (including superannuation) and trusts
3. Life and general insurance companies
4. Finance companies
5. Building societies
6. Credit unions

1. For 2 non-bank financial institutions describe its purpose and a source and use of funds.

Investment and merchant banks: primarily provide off balance sheet advisory services and earn fee income.

Source of funds: securities issued into international money markets and capital markets

Use of funds: limited lending

Managed funds: Investment vehicle for investing the pooled savings of individuals in various asset classes in domestic and international money and capital markets by fund managers

Sources of funds: Funding derived from specific contractual commitments of investors, e.g. periodic payments for superannuation

Uses of funds: invest in asset types authorised under the trust deed of a particular fund

Trusts: managed fund established under a trust deed

Sources of funds: money from investors purchasing units in the trust or investing in the trust

Uses of funds: professional managers invest in asset types authorised under the trust deed

Life and general insurance companies: pool the risk of loss and provides payment if a loss occurs

Sources of funds: premiums paid for insurance policies

Uses of funds: life insurance offices invest mainly in capital market securities while general insurance invests mainly in shorter term highly marketable securities