ECS2605 EXAM PACK.

ECS2605 EXAM PACK. ECS2605 - South African Financial System. What is a credit rating? (2) A credit rating is an evaluation of the credit risk of a prospective debtor, predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor defaulting. (b) Why does South Africa’s recent sovereign credit rating downgrade imply higher funding costs for the government? (2) Clients need to know that there is a direct correlation between the level of long-term interest rates and the depth of junk status. This means the further South Africa falls into junk status, the more long-term interest rates will tend to rise. Simply put, investors will most likely demand a higher rate of interest for lending, which will raise borrowing costs. (c) Explain the differences in objectives between the lender-of-last-resort function of the SARB and its accommodation policy. (4) The Reserve Bank provides liquidity to banks during periods of temporary shortages of cash. This function is referred to as the Bank's “lender-of-last-resort lending activities”. This function implies giving assistance to a bank facing liquidity problems. Accommodative monetary policy, also known as loose credit or easy monetary policy, occurs when a central bank (such as the South African Reserve Bank) attempts to expand the overall money supply to boost the economy when growth is slowing (as S - The Marketplace to Buy and Sell your Study Material Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material measured by GDP). The policy is implemented to allow the money supply to rise in line with national income and the demand for money. (d) Describe exchange-rate risk and explain how a currency swap can be used to hedge against exchange-rate risk. (3) Foreign exchange risk is a financial risk that exists when a financial transaction is denominated in a currency other than the domestic currency of the company. It is an unavoidable risk of foreign investment, but it can be mitigated considerably through hedging techniques. The exchange rate risk is caused by fluctuations in the investor's local currency compared to the foreign-investment currency. Currency Swap is a spot sale of a currency combined with a forward repurchase of the same currency. Most interbank trading involving the purchase or sale of currencies for future delivery is done by forward exchanged contracts combined with spot transactions in the form of currency swaps and this mitigates the the exchange rate risk as forward repurchase rate (forward rate) is agreed upon today. (e) Describe the role of the Basel Committee on Banking Supervision (BCBS). (2) The Basel Committee on Banking Supervision (BCBS) is a group of international banking authorities who work to strengthen the regulation, supervision and practices of banks and improve financial stability worldwide. (f) Explain how the retirement benefit is calculated under both a defined benefit and a defined contribution retirement fund. (2) Retirement benefit = total contribution + investment value. (g) Name three key objectives of regulators in the financial system. (3) Regulatory bodies are established by governments or other organizations to oversee the functioning and fairness of financial markets and the firms that engage in financial activity. The goal of regulation is to prevent and investigate fraud, keep markets efficient and transparent, and make sure customers and clients are treated fairly and honestly. In South Africa there is the Prudential Authority; and the Financial Sector Conduct Authority (“FSCA”). (h) Explain how the SARB uses its own debentures to manage the liquidity deficit in the banking system. (2) One of the instruments that the SARB uses for draining excess liquidity from the market is issuing its own debentures. Market participants tender for the amounts and interest rates on SARB debentures, which are then allocated in ascending order of the interest rates bid, until the amount on tender is fully allotted. Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material Ecs2605/ep/gd EXAMPACK The South African Financial System ECS2605 Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS] Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material 1 LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS] Contents SOUTH AFRICAN RESERVE BANK......................................................................................................7 The Role of the SARB........................................................................................................................... 7 Independence......................................................................................................................................... 7 Functions of the SARB.......................................................................................................................... 8 Bank supervision................................................................................................................................. 10 Implementing Monetary Policy.......................................................................................................... 12 Liquidity management.........................................................................................................................15 The Corporation for Public Deposits................................................................................................ 20 INDIVIDUAL BANKS...............................................................................................................................22 Their Functions.................................................................................................................................... 22 Functions of a commercial bank....................................................................................................... 24 Functions of investment banks..........................................................................................................25 Regulation of banks............................................................................................................................ 27 The South African Banks Act.............................................................................................................27 Prudential requirements..................................................................................................................... 28 Liquid asset requirements..................................................................................................................29 Cash reserve........................................................................................................................................29 FICA 2001.............................................................................................................................................30 FAIS Act 2002......................................................................................................................................30 Other relevant legislation....................................................................................................................31 National Credit Bill...............................................................................................................................31 Asset and liability structure and management................................................................................31 Financing a deficit SG p15.................................................................................................................33 Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material 2 LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS] Classification of financial intermediaries: VZ p7.............................................................................35 Role of financial intermediaries SG p17.......................................................................................... 36 Other financial bodies playing part in the economy, exchanges..................................................37 The Financial Services Board (FSB) ............................................................................................. 38 Departments of the FSB.............................................................................................................. 39 Basic terminology and calculations ..............................................................................................74 Annual yield ...................................................................................................................................... 74 INTEREST ADD-ON INSTRUMENTS VZ p242..................................................................77 REPURCHASE AGREEMENTS ....................................................................................................78 BOND INSTRUMENTS ...................................................................................................................79 Classification of money market securities VZ p234.........................................................82 Participants VZ p231.......................................................................................................................84 CALCULATIONS ...............................................................................................................................99 SUGGESTED SOLUTIONS to exam questions ....................................................................... 114 Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material 3 LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS] Banki ng Secto r SAR B Individu al Banks Non- Banki ng FS B All institutions regulated Structure of the financial system Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material 4 LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS] General definations of basic terms in the financial system  Financial System A set of conventions surrounding the lending and borrowing of funds by nonfinancial units, and the intermediation of this function by financial institutions - to facilitate the transfer of funds; - to create additional money when required and - to create markets in debt instruments so that the price and allocation of funds are determined efficiently  Direct financing Takes place where no intermediary is involved in a financial transaction; however a broker may be involved, e.g. an underwriting house in selling corporate bonds to raise cash, is a facilitator not an intermediary. is when a deficit economic unit (borrower) issues financial instruments and sells these to the surplus units in the economy  Indirect financing takes place where an intermediary matches a borrower with a lender, thus satisfying both parties. His fee is the difference or margin between the two. Is when an intermediary concludes a transaction between a borrower and a lender  Direct securities are financial instruments sold for the first time Downloaded by: dominic20 | Distribution of this document is illegal S - The Marketplace to Buy and Sell your Study Material 5 LUCIANO SCHOOL OF LAW & SOCIAL SCIENCES [LSLSS]  Secondary securities are those which have been sold at least once and are re-sold  Primary securities Represent a financial transaction/obligation between an intermediary and a borrower  Indirect securities represent a financial transaction/obligation between a lender and an intermediary  NonReversible instruments must be held until their expiry date and may not be re-sold, like Insurance policies, mortgage bonds  Reversible or Negotiable instruments may be sold as required, e.g. shares  A Treasury Bill is a short-term paper with a term of 3 months The Treasury (Government) may use this instrument to raise short-term money to relieve cashflow shortfalls caused by the fact that its expenses are monthly but its income is annual or twice annually, or monthly in the case of VAT (but not enough to cover the salary bill). Treasury bills are marketable.