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Finance CIA 3 - Ankita
Finance CIA 3 - Ankita
2000910700007
CIA 3 – Assignment
Part A
Answer 1
Fedwire is a real-time gross settlement funds transfer system operated by the United States
Federal Reserve Banks that allows financial institutions to electronically transfer funds
between its participants.
Answer 2
Hedge is an investment that is made with the intention of reducing the risk of adverse price
movements in an asset. Normally, a hedge consists of taking an offsetting or opposite
position in a related security.
Answer 3
SWIFT is the fastest and most secure mode of transmission of financial messages between
Banks and Institutions. Banks are using SWIFT to provides the service to its customers for
transmission of foreign currency funds to anywhere in the world.
Answer 4
Interest rate risk is the risk that changes in interest rates (in the U.S. or other world markets)
may reduce (or increase) the market value of a bond you hold. Interest rate risk—also
referred to as market risk—increases the longer you hold a bond.
Answer 5
Translation exposure (also known as translation risk) is the risk that a company's equities, assets,
liabilities, or income will change in value as a result of exchange rate changes. This occurs when a
firm denominates a portion of its equities, assets, liabilities, or income in a foreign currency.
Part B
Answer 6 (a)
1. Transaction exposure
The transaction exposure component of the foreign exchange rates is also referred to as a
short-term economic exposure. This relates to the risk attached to specific contracts in which
the company has already entered that result in foreign exchange exposures.
Ex - A company may have a transaction exposure if it is either on the buy side or sell side of
a business transaction. Any transaction that leads to an inflow or outflow of a foreign
currency results in a transaction exposure. For example, Company A located in the United
States has a contract for purchasing raw material from Company B located in the United
kingdom for the next two years at a product price fixed today.In this case, Company A is the
foreign exchange payer and is exposed to a transaction risk from movements in the pound
rate relative to dollar. If the pound sterling depreciates, Company A has to make a smaller
payment in dollar terms, but if the pound appreciates, Company A has to pay a larger amount
in dollar terms leading to foreign currency exposure.
2. Economic exposure
Exposure to foreign exchange results in an impact on the market value of the company as the
risk is inherent to the company and impacts its profitability over the years.
Ex- A beer manufacturer in Argentina that has its market concentration in the United States is
continuously exposed to the movements in the dollar rate and is said to have an economic
foreign exchange exposure.
3. Translation Exposure
1. Current/Non-Current Method
In this method, current assets and liabilities are valued at the currency rate, while non-current
assets and liabilities are valued as per the historical rate. All amounts from income statements
are value based on the currency exchange rate, or in some cases, an approximated weighted
average can be used in case there are no significant fluctuations over the financial periods.
2 – Monetary/Non-Monetary Method
In this method, all monetary accounts in balance sheets such as Cash/Bank, bills payable are
valued at the current rate of foreign exchange, while remaining non-monetary items in the
balance sheet and shareholder’s equity is calculated at the historical rate of foreign exchange
when the account was recorded.
3 – Temporal Method
In this method, current and non-current accounts that are monetary in the balance sheet are
converted at the current foreign exchange rate. In addition, non-monetary items are converted
at historical rates. All accounts of a foreign subsidiary company are converted into the parent
company’s domestic currency. The basis of this method is items are translated in a way they
are carried as per the firm’s books to date.
By this method, all items in the balance sheet except shareholder’s equity are converted at the
current exchange rate. All items in income statements are converted at an exchange rate at the
time of their occurrence.
Answer 7 (a)
The Market imperfections for derivatives that characterize the Indian Markets
1. Stock prices
2. Exchange rates
3. Interest rates.
Derivatives have the characteristic of Leverage or Gearing. With a small initial outlay of
funds (a small percentage of the entire contract value) one can deal big volumes.Pricing and
trading in derivatives are complex and a thor-ough understanding of the price behaviour and
product structure of the underlying is an essential pre-requisite before one can venture into
dealing in these products. Derivatives, by themselves, have no independent value. Their value
is derived out of the underlying instruments.
Answer 7 (b)
If all transactions between the countries are properly included, then the payments and receipts
between the two countries will be equal. For example if a country exports an item then it
technically imports foreign capital as payment for the item exported. However sometimes it
pays from its reserves to make payments. When this happens the country has a balance of
payment deficit.
For calculations of BOP sum of country’s exports and imports is calculated. And exports are
written on credit entry and imports are written as debit entry. The balance of payments
(BOP), also known as the balance of international payments, is a statement of all transactions
made between entities in one country and the rest of the world over a defined period, such as
a quarter or a year. It summarizes all transactions that a country's individuals, companies, and
government bodies complete with individuals, companies, and government bodies outside the
country.
Answer 8 (a)
Correlation is a statistical measure of how two variables relate to one another. The greater the
correlation coefficient, the more closely aligned they are. Currency correlations or forex
correlations are a statistical measure of the extent that currency pairs are related in value and
will move together. If two currency pairs go up at the same time, this represents a positive
correlation, while if one appreciates and the other depreciates, this is a negative correlation.
For example, if data points as closing prices for each day or hour. The closing price of x (and
y) is compared to the average closing price of x (and y), so a trader can enter closing and
averaged values into the formula to extract how the pairs move together. To get the average
requires tracking multiple closing prices in a program such as Microsoft’s Excel spreadsheet.
Once multiple closing prices have been recorded, an average can be determined, which is
continually updated as new prices come in. This is plugged into the formula along with new
values for x.
or simplicity, let's assume we have monthly stock closing prices of $1 through $10. For
example, month one is $1, month two is $2, and so on. To calculate variance, follow the five
steps below.
Find the mean of the data set. This means adding each value and then dividing it by the
number of values. If we add, $1, plus $2, plus $3, all the way to up to $10, we get $55. This is
divided by 10 because we have 10 numbers in our data set. This provides a mean, or average
price, of $5.50.
Calculate the difference between each data value and the mean. This is often called deviation.
For example, we take $10 - $5.50 = $4.50, then $9 - $5.50 = $3.50. This continues all the
way down to the first data value of $1. Negative numbers are allowed. Since we need each
value, these calculations are frequently done in a spreadsheet.
Add the squared deviations together. In our example, this equals 82.5.
Divide the sum of the squared deviations (82.5) by the number of data values.
In this case, the resulting variance is $8.25. The square root is taken to get the standard
deviation. This equals $2.87. This is a measure of risk and shows how values are spread out
around the average price. It gives traders an idea of how far the price may deviate from the
average.
Answer 8 (b)
Answer 1
Systemic risk is the possibility that an event at the company level could trigger severe
instability or collapse an entire industry or economy.
Answer 2
Answer 3
Systems audit is the focus is on the management systems and practices, including systems of
internal control, used by an organization to achieve, maintain, demonstrate, and improve the
efficiency of its services or operations.
Answer 4
Credit analysis is the process of determining the ability of a company or person to repay their
debt obligations. In other words, it is a process that determines a potential borrower’s credit
risk or default risk.
Answer 5
Financial leverage arises when a firm decides to finance the majority of its assets by taking
on debt uncertainty with respect to Such leverage that has the potential to negatively affect is known
as Risk of leverage
Part B
Answer 6
Integrity
integrity means doing the right thing and providing honest, objective assurance and advice,
even when doing so is uncomfortable or difficult and avoiding an issue might be easier
Undue Influence
Internal audit and auditor are Straight forward to those who has interest in company Audit
Should not affected by any inappropriate pressure from management, whether in risk
assessment, selecting which audits to perform, the staffing of those audits, or how the results
are communicated.
Effectively
Audit process and Auditor must by effective for stakeholder and management Meetings with
management where a two-way discussion can be held, with questions asked and answered as
necessary to build a common understanding of the situation, its condition, and what needs to
be done, are far more important and valuable than a written report.
Internal audit should do is such a way which provides the risk Associated with enterprise risk
Assurance should be one of the primary products of internal audit work.
Answer 7
The whistle blower policy gives authority to employees to raise their concern in case they
come across any type of improper act or violation of code of conduct which includes Fraud,
scam etc.
1. Positive objectives.
2. Accessibility
3. Availability.
4. Transparency.
5. Security.
The objective of Whistle Blower Policy is to build and strengthen a culture of transparency
and trust in the organization and to provide employees with a framework / procedure for
responsible and secure reporting of improper activities (whistle blowing) within the company.
c. The person who is a whistleblower may or may not disclose his/her identity.d. Even in case
of whistleblower has not revealed the identity, the complaint will be taken with utmost
seriousness. For better investigation it is suggested to disclosed identity, the final decision
however is taken by the whistleblower. The identity of whistleblower is kept confidential in
all cases. This is to be noted that any false allegations on any employee by other employees,
vendor or contractor or any other stakeholder will result in strict disciplinary action as per the
rules framed under the whistleblowing policy in the workplace.
Answer 8
Operational Risks
Operational risk is the risk of losses caused by flawed or failed processes, policies, systems or
events that disrupt business operations. Employee errors, criminal activity such as fraud, and
physical events are among the factors that can trigger operational risk.
Most organizations accept that their people and processes will inherently incur errors and
contribute to ineffective operations. In evaluating operational risk, practical remedial steps
should be emphasized to eliminate exposures and ensure successful responses.
If left unaddressed, the incurrence of operational risk can cause monetary loss, competitive
disadvantage, employee- or customer-related problems, and business failure.
new laws or regulatory requirements -- e.g., California Consumer Privacy Act or General
Data Protection Regulation;
failure to adhere to the company's policies or procedures or, conversely, a failure to enforce
policies;
product defects;
People and decisions made by people (human error) tend to cause most operational risks.
The above-mentioned causes of operational risks may result in one of more of the following
outcomes:
safety hazards;
reputational damage;
IT infrastructure damage;
customer churn;
employee churn;
legal liability or regulatory fines for harm caused by employees intentionally or negligently;
legal liability or regulatory fines for harm caused by external bad actors; and
competitive disadvantage.
Two things are generally required to measure operational risk: key risk indicators (KRIs) and
data. Measurement, however, can be especially challenging when organizations are unable to
integrate all the diverse types of data required to understand the organization's operational
risk. This might be due to the absence of software that enables the collection of data from
different systems and the analysis of that data or to data silos erected by organizational
fiefdoms, among other factors.
As organizations become increasingly digital, thereby utilizing more data, operational risk
managers should continually monitor and assess risks in real time to minimize their potential
impact.
What key risk indicators should businesses track? That depends on the industry in which they
operate. For example, banks follow guidance from the Basel Committee on Banking
Supervision (BCBS), which lays out approaches for measuring operational risk and requires
banks to allocate a certain amount of capital to cover losses from operational risk. Some of
the ways companies can measure operational risk, not all of which are ideal, are the
following:
using scorecards;
performing scenario analyses in cooperation with risk management experts and experts in
lines of business to evaluate the cost and probability of specific risks;
Part C
Answer 9
The goal of financial analysis is to analyze whether an entity is stable, solvent, liquid, or
profitable enough to warrant a monetary investment. It is used to evaluate economic trends,
set financial policy, build long-term plans for business activity, and identify projects or
companies for investment
Financial analysis can be conducted in both corporate finance and investment finance
settings. A financial analyst will thoroughly examine a company's financial statements—the
income statement, balance sheet, and cash flow statement. One of the most common ways to
analyze financial data is to calculate ratios from the data in the financial statements to
compare against those of other companies or against the company's own historical
performance. A key area of corporate financial analysis involves extrapolating a company's
past performance, such as net earnings or profit margin, into an estimate of the company's
future performance.
Financial Derivatives
Part A
Answer 1
Commodity Bullions
Commodity bullions are where the precious metals like gold and silver are traded. Bullion
refers to physical gold and silver of high purity that is often kept in the form of bars, ingots,
or coins.
Answer 2
Swaps have been termed as private agreements between the two parties to exchange cash
flows in the future according to a prearranged formula. In simple words, a swap is an
agreement to exchange payments of two different kinds in the future.
Answer 3
LIBOR
LIBOR is the benchmark interest rate at which major global banks lend to one another.
LIBOR is administered by the Intercontinental Exchange, which asks major global banks
how much they would charge other banks for short-term loans.
Answer 4
Forward rate agreements, also known as future rate agreements refer to a technique for
locking in future short-term interest rates. They are just like forward interest rate contract
Answer 5
Currency Swap
A swap deal can also be arranged across currencies. It is an oldest technique in swap market.
In swap, the two payment streams being exchanged are denominated in two different
currencies.
Part B
Answer 6
Crude oil
Crude Oil is one of the most sought-after commodities. With several by products such as
petroleum and diesel, the demand for crude oil is increasing every day, especially due to the
boom in demand for automobiles.
Gold
Gold has always been an anchor for most people. When we see the price value of the US
dollar fall, we start buying more gold for security and when the price value of the dollar goes
up, gold prices tend to fall; they share an inverse relationship.
Soybean
Soyabean is also one of the top commodities, but is often impacted by factors like weather,
demand for dollars and demand for biodiesel.
Natural gas
Natural Gas is a traded commodity with many industrial and commercial applications. Being
a fossil fuel by definition, it goes through rendering and filtering processes to filter and
remove other substances before turning it commercially viable.
Answer 7
The contract price on a forward contract stays fixed for the life of the contract, while a futures
contract is rewritten every day. The value of a futures contract is zero at the start of each day.
The expected change in the futures price satisfies a formula like the capital asset pricing
model. If changes in the futures price are independent of the return on the market, the futures
price is the expected spot price. The futures market is not unique in its ability to shift risk,
since corporations can do that too. The futures market is unique in the guidance it provides
for producers, distributors, and users of commodities. Using assumptions like those used in
deriving the original option formula, we find formulas for the values of forward contracts and
commodity options in terms of the futures price and other variables.
Answer 8
A commodity index tracks prices and returns on a basket of underlying commodities. These
underlying could be a combination of commodities or a single commodity. These indices
when available for trading are listed on an exchange. Prices of these indices are based on the
underlying set of commodities.
MCX iCOMDEX Base Metals Index is one of the sectoral indices in the MCX, and the index
includes the liquid Base Metal futures contracts traded on MCX, viz. futures of Aluminium,
Copper, Lead, Nickel and Zinc.
MCX iCOMDEX Energy Index is one of the sectoral indices in the MCX iCOMDEX family,
and the index is based on the liquid Crude oil and natural gas futures contracts traded on
MCX. The Index is an efficient tool for investors looking to manage their investments in
energy sector and, being an excess returns index, it is ideal for benchmarking and trading.
It is the first such index to be launched in India. Based on the components of the spot price
index, NCDEX also displays the national index futures- essentially, the no-arbitrage price if
one were to buy futures on the spot index. This price is derived by tracking the futures prices
of the index components at the same weightage as the spot index. Currently, index futures are
not allowed in India under the FCRA (Forward Contracts Regulation Act, 1952), which
requires compulsory physical settlement of futures contracts.
Part C
Answer 9
As per the statement the gold manufacture will sell July future at the price of
RS.1068 per ounce. If the Gold price come between 1052-1068 , than there is no impact
on manufacturer because they neutral their position by hedging.
Gold futures are standardized, exchange-traded contracts in which the contract buyer
agrees to take delivery, from the seller, a specific quantity of gold at a predetermined
price on a future delivery date.
Gold manufacturer can hedge against falling gold prices by shorting gold futures
contracts to lock in a future selling price. The benefits of hedging are clear: it hedges
against the bear market in gold.