Sample BFM Nov15

Sure Success Series
Bank
Financial Management
( For CAIIB Examination)
3rd Edition
Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi
By: Vaibhav Awasthi

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The content of this book has been developed keeping in view courseware for
the Second paper of Bank Financial Management of CAIIB.
An attempt has been made to cover fully the syllabus prescribed for each
module/subject and the presentation of topics may not always be in the same
sequence as given in the syllabus. Candidates are also expected to take note of
all the latest developments relating to the subjects covered in the syllabus by
referring to RBI circulars, financial papers, economic journals, latest books and
publications in the subjects concerned.
Although due care has been taken in publishing this study material, yet the
possibility of errors, omissions and/or discrepancies cannot be ruled out.
We welcome suggestion for improving the book and its contents. You may write
back to us at jaiibcaiibadmission@gmail.com
About the Author:
Vaibhav Awasthi,is a professional banker and has experience of 11 years
in Banking. He has done his graduation from Kanpur University and MBA
(Finance) from Delhi. He also holds the distinction of being part of maiden
batch of Certified Banking Compliance Professional conducted by IIBF
& ICSI.
He has been mentoring students for JAIIB/CAIIB since last 8 years and
presently works as Senior Manager with a leading Public Sector Bank. He
can be reached at Vaibhav.awasthi16@gmail.com
All rights reserved. No part of this publication may be reproduced or transmitted, in any form or by
any means, without permission. Any person who does any unauthorized act in relation to this
publication may be liable to criminal proceedings and civil claim for damages.
This book is meant for educational and learning purpose. The author of this book has taken all reasonable care to ensure that the
contents of the book do not violate any existing copyright or other intellectual property rights of any person in any manner
whatsoever.
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To the thought
We all live under the same sky, but we all don't have the same horizon
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Preface
Dear Students,
Bank Financial Management is the second paper of CAIIB exam. Typically this is considered
as the toughest paper amongst all the three paper of CAIIB because of the numerical portion
which often occupy as much as 60% of the question paper.
The subject is divided into four module and questions are evenly asked from all the modules.
Thus while preparing students must not ignore any module.
Having said that, Module B, C & D are inter related and having understanding of one module
is necessary for progressing to another.
Aim of BFM subject is to enable student to have high level of understanding of how banks
operate on Macro level, how funds are managed, how capital is arranged and managed and
how treasury operates and helps the bank in making profits.
When students take up this subject, they are worried about the numerical and how they will
solve it. We assure you that numerical asked in BFM are of very basic nature and little
understanding will make sure that you not only crack but enjoy the numerical part.
The book has been written based on our experience about prior year question papers. We
have tried to keep the book concise and most relevant by explaining all the important points
chapter wise along with case studies and numerical.
The aim of our Sure Success Series- is to make sure that students are able to finish the
course in minimum possible time.
To boost their preparation students may stay in touch with us by visiting our website
www.jaiibcaiib.co.in. They can also join us on facebook for regular updates and questions
We wish you all the best for your exams.
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Module A
International Banking
What to Focus in this module
Module A is based on Foreign exchange. Students are expected to know
various facilities available to NRIs, various kinds of deposits like NRE, NRO,
FCNR along with details of foreign exchange which can be remitted.
Another important area to be focussed is foreign trade and role of LC in it.
Students should understand in deep, concept of LC and various articles
governing it
Foreign trade means export and import. Export requires funds which are
granted in the form of pre shipment and post shipment finance. Students should
understand various financial facilities like PCFC, PSFC, etc. which can be
given. Import involves giving away of valuable foreign exchange. There are
various guidelines on release of funds and how to monitor it. Students should
be aware of it.
Finally Forex numerical. They essentially require calculation of correct rate to
be quoted to export and import customer for various kind of transactionsspot/forward. We have covered various types of numerical calculation to give
student a clear picture of how to calculate the various rates.
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Unit-1 Exchange Rates and Forex Business

Foreign Exchange Management Act (FEMA), 1999, (Section 2) defines foreign exchange as:
"Foreign Exchange means foreign currency, and includes:
(i) All deposits, credits and balances payable in foreign currency, and any drafts, traveler's
cheques, letters of credit and bills of exchange, expressed or drawn in Indian currency and
payable in any foreign currency,
(ii) Any instrument payable at the option of the drawee or holder, thereof or any other party
thereto, either in Indian currency or in foreign currency, or partly in one and partly in the other."
Thus, broadly speaking, foreign exchange is all claims payable abroad, whether consisting
funds held in foreign currency with banks abroad or bills, checks payable abroad.
Major participants of forex markets are:
(i) Central Banks
(ii) Commercial Banks
(iii) Investment Funds/Banks
(iv) Forex Brokers
(v) Corporations
(vi) Individuals
Major Factors which affect exchange rates are:
(1) Fundamental reasons- relate to general economic condition and include balance of
payment, interest rates, economic growth, political conditions etc.
(2) Technical reasons: Capital moves from low yielding currency to high yielding currency
(3) Speculation
Exchange rate mechanism: The delivery of FX deals can be settled in one or more of the
following ways:
Ready or Cash: Settlement of funds takes place on the same day (date of deal),
Tom: Settlement of funds takes place on the next working day of the date of deal
Spot: Settlement of funds takes place on the second working day after/following the date of
Contract/deal.
Forward Delivery of funds takes place on any day after Spot date.
Forward rate = Spot rate + Premium (or - Discount).
If the value of the currency is more than that being quoted for Spot, then it is said to be at a
Premium, while if the currency is cheaper at a later date than spot, than it is called at a
Discount
The forward price of a currency against another can be worked out with the following factors:
(i) Spot price of the currencies involved.
(ii) The interest rate differentials for the currencies.
(iii) The term, i.e., the future period for which the price is worked out
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Direct and Indirect Quotes

In direct quotes, the local currency is variable, say as in India, 1 USD = Rs 48.10. The rates
are called direct, as the rupee cost of foreign currency is known directly. These quotes are also
called Home Currency or Price Quotations. On the other hand, under indirect method, the local
currency remains fixed, while the number of units of foreign currency varies. For example, Rs
100 = 2.05 USD
Cross Rates When we deal in a market where rates for a particular currency pair are not
directly available, the price for the said currency pair is then obtained indirectly with the help of
cross rate mechanism
Fixed vs. Floating Rates
The fixed exchange rate is the official rate set by the monetary authorities for one or more
currencies. It is usually pegged to one or more currencies. Under floating exchange rate, the
value of the currency is decided by supply and demand factors for a particular currency
Bid and Offered Rates
The buying rates and selling rates are also referred to as bid and offered rates
RBI/FEDAI GUIDELINES
Authorised Person - Category I: Authorised Dealer Banks, Financial Institutions, and other
entities allowed to handle all types of foreign exchange transactions. (Earlier known as
Authorised dealers).
Authorised Person - Category II: Money changers, allowed to undertake sale/purchase of
foreign currency notes, travellers cheques, as also handle foreign exchange transactions
relating to remittance facilities allowed to residents, like Travel abroad, studies abroad, medical
needs, gifts, donations, etc. (Earlier known as Full fledged Money Changers-FFMCs).
Authorised Person - Category III: Entities allowed to undertake only purchase of foreign
currency notes and traveller's cheques, (Earlier these entities known as Restricted Money
Changers-RMCs)
Foreign Exchange Dealers Association of India. FEDAl, is a non-profit making body,
formed in 1958 with the approval of Reserve Bank of India, consisting of Authorised dealers as
members.
FEDAI Guidelines relating to Forex business:
1. All export bills to be allowed standard transit period.
2. Export bills drawn in foreign currency, purchased/discounted/negotiated, must be
crystallized into rupee liability, in case of delay in realization of export bills. The same would be
done at TT selling rate. The prescription of crystallisation of export bills on the 30 th day from
the due date /notional due date, has since been relaxed for bank's to decide on the days for
crystallisation on their own , based on nature of commodity, country of export etc. The
crystallisation period can vary from bank to bank, customers to customers, etc, but cannot
exceed 60 days.
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Unit 2 Basics of Forex Derivatives

Types of Risks in foreign business are given as under:
(1) Exchange Risk: Exchange risk means risk on account of adverse movement in prices
which affects your position. There can be two position overbought and oversold. Understand
through an example. A merchant buys 100 dollars @ Rs 50 but is able to sell only 60 at the
end of the day. He has 40 dollars which he has not been able to sell. This is overbought
position. Now lets say price of dollar next day is Rs 49 only. This means he faces loss of Rs 1
on each 40 dollar. This is exchange risk
Another case can be a deal buys 100 dollars but enters into a contract to sell 120 dollars. Here
his position is oversold.
Foreign exchange exposure has been classified into:
(i) Transaction Exposure: Arising due to normal business operations consequent to which the
value of transactions will be affected. This is affected by the transactions undertaken which
may expose the company/firm to currency risk, when compared to the value in home currency.
(ii) Translation Exposure: This arises when firms have to revalue their assets and liabilities or
receivables and payables in home currency, at the end of each accounting period. Also arises
due to consolidating the accounts of all foreign operations. These are not actual costs or gains,
but notional, as the actual loss or gain is booked at the time of actual translation of the
exposure.
(iii) Operating Exposure: This affects the bottom-line of the firm /company, not directly due to
any foreign exchange exposure of the firm /company, but due to other external factors in the
market/ economy, like changes in competition, reduction in import duty increasing competition
from imported goods, reduction in prices by other country exporters- effecting exports,
increase in import duty by other country -trade tariff, etc.- causing reduction in exports, etc.
(2) Settlement Risk: When one party of trade fails to performs its part due to difference in time is
called settlement risk
(3) Liquidity Risk: when one party is unable to meet its funding requirement
(4)Country Risk /Sovereign Risk:
(5) Interest Rate Risk
(6) Operational Risk
(7) Legal Risk
RBI has issued Internal Control Guidelines (ICG) for foreign exchange business, Under ICG,
banks are required to put in place various dealing limits for their forex operations, which can be
briefly summarized as under:
(i) Ovenight limit: Maximum amount of open position or exposure, a bank can keep ovenight,
when markets in its time zone are closed. Open position means overbought or oversold
position
(ii) Daylight limit: Maximum amount of open position or exposure, the bank can expose itself
at any time during the day, to meet customers' needs or for its trading operations.
(iii)Gap limits: Maximum interperiod/month exposures which a bank can keep, are called gap
limits.
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(iv) Counter party limit: Maximum amount that a bank can expose itself to a particular counter
party.
(v) Country risk: Maximum exposure on a single country.
(vi) Dealer limits: Maximum amount a dealer can keep exposure during the operating hours.
(vii) Stop loss limit: Maximum movement of rates against the position held, so as to trigger
the limit - or say maximum loss limit for adverse movement of rates.
(viii) Settlement risk: Maximum amount of exposure to any entity, maturing on a single day.
(ix) Deal size limit: Highest amount for which a deal can be entered. The limits is fixed to
restrict the operational risk on large deals.
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Unit 4- Documentary Letter of Credit

It is an instrument by which a bank undertakes to make payment to a seller on production of
documents stipulated in the credit (Refer to article 2 of UCPDC)..
Parties to LCs
a: Applicant: - The Buyer or importer of the goods.
b: Issuing bank: - Importers or buyers bank who lends its name or credit.
c: Advising bank: - Issuing banks branch (or correspondent in exporters country)
to whom the letter of credit is sent for onwards transmission to the seller or
beneficiary, after authentication of genuineness of the credit.
d: Beneficiary :- The Party to whom the credit is addressed i.e. seller or supplier or
exporter.
e: Negotiating bank: - The Bank to whom the beneficiary presents his documents
for negotiation or acceptance under the credit.
f:
Reimbursing bank: - Third bank which repays, settles or funds the negotiating
bank at the request of its principal, the issuing bank.
g: Confirming bank: - The bank adding confirmation to the credit. Which under
takes the responsibility of payment by the issuing bank and on his failure to pay.
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Operation of letter of credit

1.
Buyer and seller enter into a contract for sale of goods or providing of services.
The transaction is Covered by L.C.
2.
On request of the buyer i.e. applicant, LC is issued by Opening Bank in favors

of Beneficiary and sent to advising bank instead of sending directly to
beneficiary.
3.
After authentication of LC, the advising bank sends the LC to beneficiary.
4.
After receiving LC, the beneficiary manufactures the goods and makes
shipments and prepares documents as mentioned in LC.
5.
Documents are Presented by beneficiary to nominated bank for negotiation.

Negotiating Bank makes payment against these documents and claims
payment on due date from opening bank.
6.
Opening bank makes payment to negotiating bank and recovers the payment
from applicant.
TYPES OF LETTERS OF CREDIT

Documents
against DP LCs or Sight LCs is those where the payment is made against
Payment LC or Sight documents on presentation.

LC
(DA = Documents against acceptance)

(DP = Documents against payment)
Documents
against DA LCs or Acceptance LCs is those, where the payment is made
acceptance
or on the maturity date in terms of the credit. The documents of title to
usance
goods are delivered to applicant merely on acceptance of documents

for payment.
Deferred Payment LC It is similar to usance LC but there is no bill of exchange or draft. It is

payable on a future date if documents as per LC are submitted.
Irrevocable
revocable credits
and The Issuing bank can amend or cancel the undertaking if the
beneficiary consents.
A revocable credit is one that can be Cancelled or amended at any
time without the prior knowledge of the seller. If the negotiating bank
makes a payment to the seller prior to receiving notice to cancellation
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or amendment, the issuing bank must honor the liability.

With or without
Where the beneficiary holds himself liable to the holder of the bill if
re-course
dishonoured, it is considered to be with-recourse. Where he does

not hold himself liable, the credit is said to be without-recourse. As
per RBI directive dated Jan 23,2003 banks should not open LCs and
purchase / discount / negotiate bills beating the without recourse
clause.
Restricted LCs
A restricted LC is one wherein a specified bank is designated to pay,

accept or negotiate.
Confirmed Credits
A credit to which the advising or other bank at the request of the

issuing bank adds confirmation that payment will be made. By
such additions, the confirming bank steps into the shoes of the
issuing bank and thus the confirming bank negotiates
documents if tendered by the beneficiary.
Transferable Credit
The beneficiary is entitled to request the paying, accepting or

negotiating bank to make available in whole or part, the credit to
one or more other parties (Article 48 of UCPDC). For partial
transfer to one or more second beneficiary/ies the Credit must
provide for partial shipment. Transferable credit can be
transferred only once.
Bank to Bank Credit
A back to back credit is one where an exporter received a

documentary credit opened by a buyer in his favour. He tenders
the same to the bank in his country as a cover for opening
another LC in favour of his local suppliers. The terms of such
credit would be identical except that the price may be lower and
validity earlier.
Red Clause Credit
A red clause credit also referred to a packing or anticipatory

credit has a clause permitting the correspondent bank in the
exporter's country to grant advance to beneficiary at issuing
bank's responsibility. These advances are adjusted from
proceeds of the bills negotiated.
Green Clause Credit
A green clause LC permits the advances for storage of goods in

a warehouse in addition to pre-shipment advance.
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.
ARTICLES OF UCPDC-600
Article-1: UCPDC-600 applies to any LC when its text expressly indicates that it is subject
to these rules. The rules are binding on all parties thereto unless expressly modified or
excluded by the credit.
Article-2: It contains important Definitions such as: Advising bank, Applicant, Banking
day, Beneficiary, Complying presentation, Confirmation, Confirming bank, Credit, Honour,
Issuing bank, Negotiation, Nominated, Presentation and Presenter.
Article-3 It contains Interpretations of various terms given as under:
A credit is irrevocable even if there is no indication to that effect.
Branches of a bank in different countries are separate banks.
The expression "on or about" will be interpreted as an event to occur during a period of
5 calendar days before until 5 calendar days after the specified date, both start and
end dates included.
The terms "first half' and "second half' of a month shall be construed respectively as
the 1st to the 15th and the 16th to the last day of the month, all dates inclusive.
The terms "beginning", "middle" and "end" of a month shall be construed respectively
as the 1st to the 1Oth, the 11th to the 20th and the 21st to the last day of the month, all
dates inclusive.
Article-4Credits vs Contracts: A credit is a separate transaction from the sale contract

between the beneficiary and issuer of LC. Banks are not concerned with or bound by such
contract, even if any reference is included in the LC.
Article-5 Documents vs. Goods: Banks deal with documents and not with goods,
services or performance to which documents relate.

Article-36 Force Majeure: A bank assumes no responsibility for consequences arising out of
the interruption of its business by Acts of God, riots, and civil commotions, Insurrections, wars,
acts of terrorism, or by any strikes or lockouts or causes beyond its control.
Export of goods not involving any foreign exchange transaction directly or indirectly requires
the waiver of GR/PP procedure from the Reserve Bank.
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Numerical on Foreign exchange

Direct quote is when a unit of foreign currency is expressed in terms of home currency
e.g.
SD/INR 45.00. Indirect quotes is when a unit of home currency is expressed in terms of a foreign
currency e.g. 1 unit of euro is equal to USD 1.40 only a few currencieslike
GBP/Euro,
Euro/USD and AUD/USD are quoted in this manner.
In cross currency quotes where home currency (say, INR) is not involved, the currency to the right
side of the quote is known as terms currency and the currency to the left side is base currency.
The usage applies to direct as well as indirect quotes.
TOD (or cash) is delivery on the same day (today) and TOM is delivery next day (tomorrow)
All the rates quoted by banks are interbank rates i.e. these rates are applicable between banks.
For a customer margin is added or deducted When a customer wishes to buy currency
Base currency is the currency which is being bought and sold and the other currency is incidental.
Forwards are quoted as follows
Spot/1 month 17/18
Spot/ 2 months 35/37
Spot/ 3 months 53/56
If forward differentials are in the ascending order (1st figure is lower than the 2nd) the base
currency is at premium.
Fedai prescribed types of rates of merchant transactions:
TT (buying)- clean inward remittances
Bill (buying)- purchase/discount of export bills
TT (selling) clean outward remittances
Bill (selling) remittance for import bills
Numericals
1. Based on the data given below answer the questions from (i) to (iii)
Following are interbank quotes on certain date Spot USD/INR 45.70/75
1 month 5/7
2 month 8/10
3 month 12/15
Spot GBP/USD 1.8000/8010
1 month 30/25
2 month 50/45
3 month 60/65
Margin of the bank is 3 paise
(i) An exporter presents a sight bill. What rate will be quoted to the exporter.
Ans. Spot USD/INR is 45.70/75. This means bank is willing to buy USD at 45.70 and sell at 45.75.
When an export customer goes to bank he will be selling currency to bank thus bank will be
buying currency from the customer. The basic principle followed by bank is buy low sell high.
Whenever bank buys currency it deducts margin from the spot so that it has to pay lower
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to the customer. In this case bank will buy at Spot Margin ie. 45.70 -0.05 = 45.65. Thus
rate quoted to the customer will be 45.65
(ii) Another exporter submitted 3 month usance bill. What rate will be quoted to the
customer.
Ans: Usance bills mean payment will be made after a specified period. 3 month export usance
bill means foreign exchange will be received by the bank 3 months from now. To arrive at this
forward rate add premium to the spot rate ie 45.70+0.12 = 45.82 from this deduct margin hence
rate given to customer will be 45.79
(iii) Calculate GBP/INR rate

Question 4. USD 1 = Rs 48.05/48.20
London GBP 1 = USD 1.6000/1.6500
At what rate the bank will sell GBP 10000 if it wants to make a profit of 25 paise per GBP?
Answer : First find the sell rate = 48.20 * 1.6500 = 79.53
Since bank wants to make profit of 25 paise add 0.25 to the above rate = 79.53+0.25 = 79.78
Question 5: You are required to negotiate for an export bill for USD 250,000 drawn at 60
days after sight under an irrevocable letter of credit. USD = 36.200- 38.2500
One month forward premium 0.0800/0.1000
Two months forward premium 0.1500/0.1650
Three months forward premium 0.2300/0.2400
Calculate the exchange rate to be quoted bearing in mind that you require
(i) exchange margin of 0.150%
(ii) Normal transit period is 20 days
(iii) Interest to be collected at 11% p.a at the time of negotiation
Exchange rate to be quoted nearest to four decimals in multiples of 25 paise and amount
payable to be rounded off to nearest rupee.

Calculation of Rates:
Illustration 1: Spot USD is Rs 44.80/85. If forward premium is given as under
1M 0234/0239
2M-0303/0307
3M 0323/0327
What rate will be quoted to an export customer who books 1 month forward contract .
Ans 1: Spot rate is given as 44.80/85 here 44.80 is the bid rate and 44.85 is the ask rate.
Now always remember that questions here are to be solved from the point of view of bank
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and not of customer. 44.80 which is bid rate means bank is willing to buy one dollar for Rs
44.80 from a customer but will sell one dollar for Rs 44.85 to a customer.
Now always remember export customer means a customer who has made exports and
receives foreign exchange. He will go to bank to sell this foreign exchange to the bank which
in other language means bank will buy foreign exchange from the exporter.
So when quoting rates to an exporter buy rate of bank is to be considered which Rs 44.80
in this case. However forward contract for 1month to be booked which means bank will buy
this exchange one month from now and hence one month rate is to be arrived.
The premium for one month is 0234.
We will add this premium to the spot rate to arrive at one month forward rate, thus one month
forward rate at which contract is to be booked is
Spot rate --- ------------ 44.8000
Add- 1M Premium----- 0.0234
------------44.8234

Illustration 5: Your customer wants to remit JPY 10 million for paying an import bill. If
USD/INR is 44.50/55 and USD/JPY is 91.30/34. If margin is 5 paise what rate will be quoted
to the customer.
Ans: This is again a question of calculation of cross rate however with a twist. We need to find
JPY/INR but we have
&
to find JPY/INR we need to put =
But here in lies the question USD/JPY is 91.30/34 is given with two rates 91.30 and 91.34
which rate should be used?
To understand this, first under what this rate means. USD/JPY =91.30/34 means bank will
buy USD for 91.30 JPY. This also means bank will sell JPY for 91.30. Since in our case Bank
wants to sell JPY to import customer we will choose 91.30. Now this 91.30 is the bid rate so
we will take sell rated of USD/INR which is 44.55 thus final cross rate is arrived as
44.55
= 91.30 = 0.4879
. JPY is quoted per 100 so we will multiply by 100
so answer would be 48.7951. Add margin of 5 paisa and final rate quoted to the customer will
be Rs 48.8451
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Module B
Risk Management
Module B is based on Risk in banking sector. It tracks the evolution of Basel
and various risks defined as per Basel accord and how they are to be handled
by Banks.
The most important pillar of Basel accord is keeping of minimum capital.
Students must get themselves fully acquainted with various components of
capital and how to calculate eligible capital as numerical are asked from it.
There are three major risks faced by banks (i) Credit risk (ii) Market risk & (iii)
Operational risk. This unit dwells in detail upon all these risks and how they are
calculated.
Numerical from this portion are based on calculation of capital, calculation of
Risk weights, calculating capital charge for market and operational risk.
At the end of this unit student must be fully aware about Basel II accord and
how it affects the banking Industry in terms of risk management. Remember this
unit is precursor to module D so students should be fully conversant with this
unit before they move ahead.
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Unit-8 Risk and Basic Risk Management Framework

What is risk? To understand it in financial terms, a business is done keeping in mind certain
expected cash flows. These cash flows represent money which will be generated by doing that
business. The money generated should cover all costs incurred and estimated profits. Now
lets say a business is expecting the following net flows which will cover all its costs and give
required profits for survival and expansion:
Year
Expected
flow
1.
2.
3.
4.
1.
2.
3.
4.
5.
6.
I
net 1000
II
III
IV
2000
3000
4000
Actual net flow
1100
1900
3100
3500
Variance
100
(100)
100
(500)
As can be seen cash flows in Year I & III is more than expected but cash flow in Year II & IV is
lower than expected. Why cash flows are different from as projected? Because of various
uncertainties, these uncertainties can either be favourable or unfavorable, only the
unfavourable variance in cash flow is known as risk.
Few points need to be understood in this regard:
Risk is not bad.
Risk cannot be completely eliminated
Risk needs to be managed.
Higher the risk, higher the return and thus higher is the capital.
First to understand that risk is not bad. Risk also returns in higher reward and often results in
better and unique methods to do a business. Secondly risk cannot be completely eliminated
while doing a business, risk will always be there, it is for a firm to decide its goal and risk
appetite. Why risk needs to be managed? Reckless risk taking can result into losses which
cannot be afforded and business has to shut down. How risk and capital are related? Capital
represents that amount of fund in the business which is necessary to start and grow the
business and which is assumed to be in the business as long as the business is run. Capital is
necessary to absorb losses. If a business involves high risk, losses could be high and thus
capital needed would be high to cover those losses.
Basic Risk Management Framework:
As already explained earlier, risk cannot be eliminated altogether and thus it has to be
managed based upon the risk appetite of the firm. For this there must be a risk management
framework, the basic spirit of which is common to all organizations. From now, onwards we will
study risk management framework with respect to banks.
A risk management framework basically involves the following 6 steps:
Organization for risk management:
Risk Identification
Risk measurement
Risk pricing
Risk Monitoring and control
Risk Mitigation.
Page 17
Unit 9- Risks in Banking Business

Banking business can be divided into three lines:
1. Banking book: Includes advances, deposits of the banks. They also represents fixed assets of
the banks and any borrowings made by them .The banking book is exposed to credit risk,
operational risk, liquidity risk and interest rate risk. They are normally held till maturity and
accrual system of accounting is applied.
2. Trading Book: These generally consists assets which are exposed to markets. For e.g.
Treasury Department of the Bank invests in various government bonds, stock, foreign currency
and corporate bonds. Trading book apart from credit, operational, market and liquidity is also
exposed to market risk. They are normally not held until maturity and positions are
liquidated in the market after holding it for a period and mark to market system is
followed.
3. Off Balance Sheet exposure: These are exposures which may convert into asset or liability
based upon the happening of a certain event. These do not appear in Balance sheet but are
shown as notes to Balance sheet. For example, Bank issues guarantees on behalf of their
customers, in case that guarantee is invoked by the beneficiary, bank will have to immediately
make payment to beneficiary then it will become liability of the bank and reflect in Balance
sheet.
Can off balance sheet exposures be asset too? Yes, suppose a Bank is involved in litigation
and judgment comes in favor of Bank and Court directs the other party to pay some amount as
compensation to Bank then that will result as asset. Off balance sheet exposures may convert
into exposure of banking book or trading book depending upon the nature of off balance sheet
exposure.
Before we go any further and understand various risks faced by Bank, we need to understand
certain concepts which are related with valuation of assets and liabilities.
1. Mark to Market: Mark to market simply means that assets and liabilities should be shown at
their market value.
Mark to market relates to trading book in banks. Banks hold government securities, bonds,
stocks their prices changes daily, Suppose a Bank holds a government bond valued at Rs
1000 on 01.01.2014, on 01.02.2014 it is valued at Rs 1200, now this Rs 200 is profit and must
be recognized as profit and bond must now be shown in books at Rs 1200.This procedure of
showing the securities at their market price is known as mark to market.
There are 6 types of investments held by a bank
(i) Government Securities
(ii) Other Approved Securities
(iii) Shares
(iv) Debentures and Bonds
(v) Investments in Subsidiaries/Joint Ventures
(vi) Other Investments.
Page 18
Risk in Banking
1. Liquidity Risk: It arises because long term assets (loans) are financed by short term
liabilities (deposits). For e.g. a Bank has Rs 1 crore FD for 3 years. Now Bank gives Rs 1 crore
loan for 5 years. After 3 years bank has to repay this FD amount but loan will be repaid only
after 5 years, so how will bank pay back this amount to depositor? This is known as liquidity
risk.
Liquidity risk is of 3 types
(i) Funding risk: Now suppose in the above example bank has given loan for 3 years only, but
depositor withdraws the FD after 1 year then how to fund this is known as funding risk
(ii) Time risk: If loan repayment is not regular, i.e. cash inflows are not regular it is known as
time risk.
(iii) Call risk: If off balance sheet exposures or contingent liabilities crystalize it is known as
call risk. Lets say bank has issued bank guarantee of Rs 1 lakh on behalf of its customer.
Guarantee is issued after obtaining a specific margin for a fee. Now if the guarantee is invoked
by the beneficiary bank will have to make payment of Rs 1 lakh, but how to have money for this
Rs 1 lakh, this is known as call risk.
2. Interest rate risk: If interest rates changes, banks income will change which will affect
profit, this is known as interest rate risk. They can be classified into following 6 categories
(i) Gap or mismatch risk: It arises because of difference in time, amount, etc of assets and
liabilities
(ii) Basis risk. Suppose repo rate is reduced by 1 % now this will mean that loan rates need
to be reduced by lets say 0.5 % but banks may not be able to reduce deposit rate by 0.5 %.
This is called basis risk that same reduction or increase in interest rate will affect price of
deposits and advances differently.

Page 19
Unit 10- Risk Regulations in Banking Industry

Capital is divided into Tier I capital also known as Core capital and Tier II capital
Tier I Capital:
1. Paid up equity capital, statutory reserves and other disclosed free reserves
2. Capital Reserves arising out of sale proceeds of assets
3. Innovative Perpetual Debt Instruments (IPDIs) which meet the regulatory requirements
advised by RBI for the purpose limited to maximum 15% of total Tier-1 capital as on 31st march
of the previous financial year.
4. Perpetual non-cumulative preference shares (PNCPS), which meet the regulatory
requirements advised by RBI for the purpose subject to a limit such that total of IPDIs and
PNCPS doesnt exceed 40% of Tier I capital at any point of time.
Tier II Capital:
1. Revaluation reserves at a discount of 55 %
2. General provision on standard assets, floating provisions, provisions held for country
exposure, investment reserve accounts and excess provision subject to a maximum of 1.25%
of total RWA
3. Upper Tier II capital which includes PNCPs, redeemable non-cumulative preference shares
(RNCPS) and redeemable cumulative preference shares (RCPS) issued in accordance with
the regulatory guidelines for the purpose.
4. Subordinated dents issued and computed in accordance with the regulatory guidelines for
the purpose.
5. IPDI and PNCPS held in the books in excess of prescribed limit and not included for
computing Tier I capital
The Tier II capital cannot be more than Tier I capital
Numerical & Case Studies - Calculation of Capital:

Case 1. Bank of Indians had paid up capital of Rs 500 crore, Reserves of Rs 250 cr, ,
Revaluation reserve of Rs 100 cr, Perpetual non-cumulative preference shares (PNCPS) of Rs
50 cr and subordinated debts of Rs 200 cr. Calculate Tier I and Tier II capital of Bank of
Indians and total capital fund of the Bank.
Tier I capital of the Bank = Paid up capital + Reserves+ PNCPS
= 500 + 250+ 50 = 800 cr
Tier II Capital =
Revaluation reserves at the discount of 55% + Subordinated Debt
=
45* 100+ 200 = 245 cr
*(Remember 55% of discount means, only 45% of revaluation reserve will be considered)
Total Capital of Bank
= 800+245 = 1145 cr
Page 20
Case 2.Lena Bank has paid up capital of Rs 800 crore and Free reserves of Rs 500 cr. Bank
during the year sold one of its building recording profit of Rs 50 cr which were capitalized. Bank
also had general provision and contingency reserves of Rs 400 cr. RWA for credit and
operational risk for Bank were 7000 cr and RWA for market risk was 2000 cr. Subordinate debt
stood at 250 cr. Calculate Tier I, II and total capital of Bank.
Tier I = Paid up capital+ Free reserve + capital reserve arising out of sale proceeds of assets
= 800 + 500 + 50 = 1350 cr
Tier II = Provisions for Contingency reserves + Subordinated Debt
= 112.50 + 250 = Rs 362.50
Total Capital funds = 1712.50 cr
Unit- 11 Market Risk

Market risk means risk of reduction in the value of securities held in the portfolio due to fall in
the prices of securities.
A bank in its trading books holds the following financial instruments
(i) Debt securities
(ii) Equity
(iii) Foreign Exchange
(iv)Commodities
(v) Derivatives held for trading.
(ii) Duration :Duration (also known as Macaulay Duration) of a bond is a measure of the time
taken to recover the initial investment in present value terms. In simplest form, duration refers
to the payback period of a bond to break even, i.e., the time taken for a bond to repay its own
purchase price. Duration is expressed in number of years.
Calculation for Duration
First, each of the future cash flows is discounted to its respective present value for each
period. Since the coupons are paid out every six months, a single period is equal to six months
and a bond with two years maturity will have four time periods.
Second, the present values of future cash flows are multiplied with their respective time
periods (these are the weights). That is the PV of the first coupon is multiplied by 1, PV of
second coupon by 2 and so on.
Third, the above weighted PVs of all cash flows is added and the sum is divided by the current
price (total of the PVs in step 1) of the bond. The resultant value is the duration in no. of
periods. Since one period equals to six months, to get the duration in no. of year, divide it by
two. This is the time period within which the bond is expected to pay back its own value if held
till maturity.
Page 21
Illustration:
Taking a bond having 2 years maturity, and 10% coupon, and current price of Rs.102, the cash
flows will be (prevailing 2 year yield being 9%):
Total
Time period (years)
Inflows (Rs.Cr)
105
PV at an yield of 9%
4.78
4.58
4.38
88.05
101.79
PV*time
4.78
9.16
13.14
352.20
379.28
Duration in number of periods = 379.28/101.79

=3.73
Duration in years = 3.73/2 = 1.86 years
Unit 13 Operational Risk & Integrated Risk Management

Operational risk has been defined by the BCBS (Basel Committee on Banking Supervision)as
the risk of loss resulting from inadequate or failed internal processes, people and systems or
from external events. This definition includes legal risk, but excludes strategic and reputational
risk.
The Basel Committee has identified the following types of operational risk events:
(i) Internal fraud. For example, intentional misreporting of positions, employee theft, and
insider trading on an employees own account.
(ii)External fraud. For example, robbery, forgery, cheque kiting, and damage from computer
hacking.
(iii) Employment practices and workplace safety. For example, workers compensation
claims, violation of employee health and safety rules, organised labour activities, discrimination
claims, and general liability.
Page 22
Operational Risk Quantification:

Quantification of Operational risk (OR) is a difficult task and Basel II has provided three options
for allocating capital for the same.
.
(2) Standardised approach: Under this approach banks activities are divided into 8 business
lines and each line is assigned a factor known as beta.
Business line
Beta Factor
Corporate finance
18%
Trading and sales
18%
Retail banking
12%
Commercial banking
15%
Payment and settlement
18%
Agency services
15%
Asset management
12%
Retail brokerage
12%
Case Studies and Numerical Problems- Module B

1. Position of The Western Bank of India as on 31.03.2013 is given as under:
Paid up capital of Rs 300 crore, Statutory reserves of Rs 400 crore, Tier I Capital as on
31.03.11 and 31.03.12 is Rs 800 crore and 900 crore. IPDI as on 31.03.13 is Rs 300 crore.
PNCPS is Rs 200 crore. Revaluation reserve of Rs 250 crore and Subordinated debt of Rs
400 crore.
Calculate (i) Tier I capital of the Bank (ii) Tier II capital of the Bank (iii) Total capital of the Bank
Solution: This is a sample Preview. All pages of the book not displayed.
3. Position of Rashtriya Woman Bank as on 31.03.13 is given as under:
Paid up capital Rs 400 crore, Free Reserves Rs 400 Crore, IPDI eligible for inclusion
under Tier I capital Rs 200 cr, PNCPS- Rs 600 crore, Revaluation reserve 400 cr and
Subordinated debt- Rs 300 crore.
Calculate (i) Tier I capital of the Bank (ii) Tier II capital of the Bank (iii) Total capital of
the Bank
Ans. (i) Rs 1334 cr (ii) Rs 746 cr (iii) Rs 2080 cr
Solution: This is a sample Preview. All pages of the book not displayed.
Page 23
Module C
Treasury Management
Module C is based on Treasury Management. As ordinary bankers working as
desk officers, assistant, we fail to see what role treasury plays in the growth of
Banks.
So did you ever wonder, how profitability of your bank is decided? What
happens to the deposits you have mobilized? How banks never fall short of
cash? How CRR & SLR are maintained?
This module gives a glimpse of that to student. Structure of CAIIB exams is
such that it tends to give sufficient knowledge to students on various topics
without delving much into the deeper nuances.
This module will also introduce students to newer concepts of derivatives.
Various types of derivatives, their payoff, their risks. Students should enjoy
knowing about this new aspects of banking.
Questions in this module are asked for calculation of CRR, SLR, Structural
liquidity statements, Bonds options etc,
Treasury is one area of banking business where risk can be so great that it can
cause collapse of whole banking systems. Students should take out some time
and read about derivative trader Nick Leeson. Nick Leeson, a derivative trader
caused loss of 827 million ($1.3 billion) to 233 year old Barings banks forcing it
to be sold for 1 to ING in 1995
Page 24
Unit 14 Introduction to Treasury Management

Suppose a bank receives Rs 100 in the form of FD for 3 years and bank pays 10 % RoI on it.
Bank must lend this money in the form of loan to some borrower. However it is not always
possible to lend the money received instantly, however Bank cannot keep this money idle, so
traditionally bank would invest it in money market instruments for short term till it finds suitable
opportunity to lend it. This function of deploying surplus fund is performed by treasury
department. Now suppose bank finds a borrower and lends this Rs 100 to that borrower for 3
years. But after 1 year the depositor comes into the Bank and asks for premature withdrawal of
FD. Bank must pay Rs 100 to borrower, but bank has given that money as loan. In this
condition treasury must borrow the money from money market and pay back the borrower.
So traditionally treasury was involved in managing liquidity aspect of the bank. Also treasury
was required to comply with the requirement of maintenance of CRR & SLR.
Even today managing liquidity is the important function of the treasury, however due to
availability of various investment avenue treasury has moved from being a cost center to a
profit center.
Integrated Treasury: Integrated treasury in a banking set up refers to integration of money
market, securities markets and foreign exchange operations. With Economic reforms ushered
in 1992, foreign investors invest in India, also Banks now have option to lend in foreign
markets, also various financial markets like debt market, money market, forex market, mutual
fund market, capital market have grown over the years and have provided an alternative
investment opportunities to the Banks, and bank through its treasury department operates in
these markets.
Unit 15 Treasury Products

(2) Money Market Products:
(a) Call money, notice money and term money: The market is for raising and deploying short term
resources not exceeding one year. Call money is for placement of funds for 1 day. Rate used for this is
Overnight Mumbai Interbank offered rate (O/N MIBOR). Notice money is for period not exceeding 14
days and term money is for period more than 14 days but not exceeding one year.
(b) Treasury bills: They are short term money market instruments issued by GOI through RBI for
maturity of 91-day, 182 day and 364-day. There are no treasury bills issued by state governments.
Minimum amount is Rs 25,00 and in multiples of Rs 25,000. T Bills are issued at discount and
redeemed at par. For example T Bill of 91 day will be available for purchase at 99.26 yielding interest at
5.16% p.a. and after 91 days it can be redeemed for Rs 100. They are held in SGL account which is
maintained with RBI by each banks. Secondary market of t bills takes place through Clearing
Corporation of India Ltd (CCIL).
(c) Commercial paper: Commercial Paper (CP) is an unsecured money market instrument issued in
the form of a promissory note. It was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers to diversify their sources of short-term borrowings and to provide an additional
instrument to investors. Subsequently, primary dealers and all-India financial institutions were also
permitted to issue CP to enable them to meet their short-term funding requirements for their operations.
Page 25
(3) Securities Market Products:

(i) Government securities: Known as G-Sec, treasury invests in these G-secs to comply with SLR
requirements. There are also other approved securities such as priority sector bonds issued by SIDBI
and NABARD. G-sec are issued by Public Debt office of the RBI. They can be upto 1 year in forms of
T-bills or more than 1 year in form of dated securities. At present dated securities upto 30 years can be
issued.
(ii) Corporate debt paper: refers to medium and long term bonds and debentures issued by
corporates and financial institutions which are tradable. They are also referred to as non- SLR
securities, to distinguish the corporate debt from government debt. Tier II capital bonds issued by
banks also fall under this category. The yield on these bonds is higher than government securities
Unit 16 Funding and Regulatory aspects

Cash Reserve Ratio (CRR) is the amount of funds that all Scheduled Commercial Banks (SCB)
excluding Regional Rural Banks (RRB) are required to maintain without any floor or ceiling rate with RBI
with reference to their total net Demand and Time Liabilities (DTL) to ensure the liquidity and solvency
of Banks (Section 42 (1) of RBI Act 1934).
Computation of DTL
Demand Liabilities are liabilities which are payable on demand and Time Liabilities are those which are
payable otherwise than on demand. The components for computation of DTL include Demand
Liabilities, Time Liabilities and Other Demand & Time Liabilities (ODTL) as under:a)Demand Liabilities:Current Deposits, Savings bank deposits, Margins held against letters of credit/guarantees, Balances in
overdue fixed deposits, Outstanding TTs, MTs, DDs, Unclaimed deposits, Credit balances in the Cash
Credit account and deposits held as security for advances which are payable on demand, & Money at
Call and Short Notice from outside the Banking System (Liability to others).
b)Time Liabilities:Fixed deposits, cash certificates, cumulative and recurring deposits, time liabilities portion of savings
bank deposits, staff security deposits, margin held against letters of credit, if not payable on demand, &
deposits held as securities for advances which are not payable on demand and Gold deposits.
c)Other Demand and Time Liabilities (ODTL):Interest accrued on deposits, bills payable, unpaid dividends, suspense account balances representing
amounts due to other banks or public, net credit balances in branch adjustment account, any amounts
due to the banking system which are not in the nature of deposits or borrowing.Participation Certificates
issued to other banks, the balances outstanding in the blocked account pertaining to segregated
outstanding credit entries for more than 5 years in inter-branch adjustment account, the margin money
on bills purchased / discounted and gold borrowed by banks from abroad, Cash collaterals received
under collateralized derivative transactions and Loans/borrowings from abroad.
Liabilities not included under DTL/ODTL
Paid up capital, reserves, credit balance in the Profit & Loss Account, loan taken from the RBI,
refinance taken from Exim Bank, NHB, NABARD, SIDBI;
Net income tax provision;
Amount received from DICGC towards claims pending adjustments thereof;
Amount received from ECGC
Amount received from insurance company on ad-hoc settlement of claims pending judgment of the
Court;
Amount received from the Court Receiver;

Page 26
Unit 19 Treasury and Asset Liability Management

In ALM, assets yield income, hence are shown as cash inflows, while liabilities need to be
repaid, hence are shown as cash outflows. Asset-liability mismatch is therefore, a cash flow
mismatch, with excess inflow or outflow of funds. If part of inflow or outflow is denominated in
foreign currency, there is also currency mismatch which needs to be managed by the
Treasury.
Liquidity : The difference between sources and uses of funds in specific time bands is known
as liquidity gap which may be positive or negative. The liquidity gap arises out of mismatch of
assets and liabilities of the bank. RBI has prescribed 11 time buckets in which assets and
liability are placed . An example of maturity bucket is given as below.
Maturity
Bucket
1 day
2-7 days
8-14 days
15-28 days
28
days3months
3
months-6
mnth
> 6 mnth to 12m
12 m to 3year
3 year to 5 year
Above 5 year
Assets
Liability
Gap
500
400
700
850
1200
550
600
800
950
1100
-50
-200
-100
-100
100
Cumulative
Gap
-50
-250
-350
-450
-350
1500
1700
-200
-550
1600
2000
2100
2000
1800
1700
1800
1850
-200
300
300
150
-750
-450
-150
0
Interest rate: Net interest income (NII) of the bank is the difference between interest earning
and interest payments in a given accounting period. Interest rate risk is defined as the risk of
erosion of NII on account of interest rate movements in the market. Suppose a bank has taken
FD of Rs 100 crore for 1 years @ 6 % and lends the same for loan at 8 % fixed rate for 5
years. Now in the first year bank will have NII of 2 %. In the next year lets say old deposit is
withdrawn and new deposit is taken @ 7 % now NII will be reduced to 1 %. In third year lets
say cost of deposit become 10 % now bank will have negative NII of -2 %. Interest rate
mismatch is also known as repricing risk.
Page 27
Case studies and Numerical Module C

A. Q1. Major Bank has following assets and liabilities in its balance sheet as on
31.03.2010.
Capital Rs 4000 cr, Reserves- Rs 8200 cr, demand deposits Rs 22000 cr , Saving Bank
Deposit- Rs 30,000, Fixed Deposit Rs 50,000. Borrowings from Financial Institutions- Rs
700 cr, NABARD Refinace Rs 800 cr, Bills Payable-Rs 300 cr, Interest accrued Rs 50
cr, Subordinated Debt- Rs 900 cr and Suspense account Rs 200 cr. Total liability of the
Bank is 1,20,000. Calculate the following
a) What is the amount that will not be included in NDTL for calculation of CRR
b) What is the amount of NDTL on which CRR is to be maintained.
c) if CRR to be maintained is 4 % what is the average balance to be maintained with RBI.
d) What is the minimum balance in CRR account with RBI, in the above situation which should
be available.
Ans- This is a sample Preview. All pages of the book not displayed.
C. How is the yield of a Treasury Bill calculated?
It is calculated as per the following formula
Wherein;
P-Purchase Price
D Days to maturity
Day Count: For Treasury Bills, D = [actual number of days to maturity/365]
Illustration
Assuming that the price of a 91 day Treasury bill at issue is Rs.98.20, the yield on the same
would be
After say, 41 days, if the same Treasury bill is trading at a price of Rs. 99, the yield would then
be
Page 28
Note that the remaining maturity of the treasury bill is 50 days (91-41).
Illustration 2 : Modern Bank has following repricing assets and liabilities
Call money Rs 300 cr , Cash Credit loans- Rs 800 cr, Cash in Hand- Rs 300 cr , Saving
Bank- 1000 cr , Fixed Deposit Rs 800 cr , Current Deposit- Rs 200 cr.
a) What is the adjusted gap in repricing asset and liabilities

b) What is the change in net interest income, if interest falls by 2 % for all assets and liabilities
c) What is the change in net interest income, if interest rate rises by 2 % for all assets and
liabilities
d) If interest rate falls on call money by 1 % , on cash credit by 0.5 %, on saving bank by 0.4 %
and on FD by 0.5 % what will be the change in net interest income
e) In question no d what will be the change in net interest income ,if interest rate falls by 1.5 %
on call money,on cash credit by 0.5 %, on saving bank by 0.4 % and on FD by 0.5 %
Ans : This is a sample Preview. All pages of the book not displayed.
Page 29
Module-D
Balance Sheet
Management
Page 30
Unit- 20. Components of Assets and Liabilities in Bank's Balance

Sheet and their Management
Sources of Funds
Capital Reserves Deposits Borrowings
Other Liabilities and provisions
Application of Funds
Cash In Hand and Balance with RBI
Balances with Banks and Money at Call and Short Notice
Investments
Advance
Fixed Assets
Other Assets
Reasons for growing significance of Asset Liability Management:
(i) Volatility Deregulation of financial system changed the dynamics of financial markets it is reflected in
volatility interest rate structures, money supply and the overall credit position of the market, the
exchange rates and price levels.
(ii) Product Innovation: Growth of new products like derivatives and growth of money markets etc.
(iii) Regulatory Environment: Focus to regulate market risk.
(iv) Management Recognition: Importance of treasury as profit centre.
Unit 23- Pillar II Supervisory review

The objective of the SRP is to ensure that the banks have adequate capital to support all the
risks in their business as also to encourage them to develop and use better risk
management techniques for monitoring and managing their risks.
The main aspects to be addressed under the SRP, and therefore, under the ICAAP, would
include:
(a) the risks that are not fully captured by the minimum capital ratio prescribed under Pillar 1
(b) the risks that are not at all taken into account by the Pillar 1
(c) the factors external to the bank
Illustratively, some of the risks that the banks are generally exposed to but which are
not captured or not fully captured in the regulatory CRAR would include:
(a) Interest rate risk in the banking book
(b) Credit concentration risk
(c) Liquidity risk
(d) Settlement risk
(e) Reputational risk
(f) Strategic risk
(g) Risk of under-estimadon of credit risk under the Standardised approach
(h) "Model risk" i.e., the risk of under-estimation of credit risk under the IRB approaches
(i) Risk of weakness in the credit-risk mitigants
(j) Residual risk of securitisation, etc.
Page 31
Mock Questions I
01. One of the following is not a function of dealing room of treasury
a. Taking a proprietary position in derivatives
b. Booking a forward contract for a customer
c. managing nostro accounts
d. issuing foreign currency draft
02. Mismatch in fund position creates
a. Operational risk
c. credit risk
b. legal risk
d. interest rate risk
03. Mismatch in currency position may cause

a. exchange risk
b. interest rate risk
c. operational risk
d. credit risk
04. Reconciliation of nostro account is responsibility of

a. ALM
b. Head office
c. Treasury
d. Foreign office of the bank
05. FEDAI was formed in the year

a. 1949
c. 1958
b. 1969
d. none of the above
06. ABC bank Ltd purchased an export bill. The crystallization period for this bill can not exceed
a. 30 days
b. 10 days
c. 7 days
d. 60 days
07. Sight bills drawn under import L/C should be crystallized within
a. 30 days from the date of acceptance
b. 7th day from the expiry of bill
c. 10th day from the date of receipt
d. as per approved policy of bank
08. Cancellation of forward contracts should be done on .
a. 7th day from the date of maturity
b. 30 days from the date of maturity
c. 60 days from the date of maturity
d. 10th day from the date of maturity
09. Cancellation of forward purchase contract should be done at
a. bills buying rate
c. TT buying rate
10. Derivatives are used for
a. Hedging and trading
c. hedging & investment
b. bills selling rate

d. TT selling rate
b. trading and investment

d. all of above
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www.jaiibcaiib.co.in. You can also call us on 07600273309 for any assistance.
Page 32
Mock Questions- II
A bank raises a floating rate corporate deposit of Rs 50 crs for 2 years at a rate 50BPS over 91 days T
bill rates that gets re priced at every calendar quarter. The proceeds of deposits is used to finance
(a) a project of loan of Rs 25 crs for a period of 5 years having moratorium of 2 years. Interest rate is set
at 300 BPS over 5 years GOI bond with reset date at the end of each calendar year
(b) the balance of Rs 25 crs is invested in 5 years GOI bond with remaining period of 2 years.
These transactions stood in the books of the bank as on 01.01.2010
1. The bank may see variation in its net interest income over 1 year in respect of asset a because the
transaction is associated with
a. gap risk
c. basis risk
b. yield curve risk

d. market risk
2. a bank has disbursed 6 months loan at a fixed rate of 12 % and raised the funds through 6 months
CDs of same amount. Bank is exposed to
a. no risk
c. operational risk & call risk
b. default risk and operation risk

d. default, operational & embedded option risk
3. a bank funds its loans through composite liabilities. In a scenario where interest rate changes across
the board the bank stands exposed to
a. yield curve risk
b. basis risk
c. both a& b
d. neither a nor b
4. RBI has introduced RTGS to eliminate
a. Herstatt risk
b. counterparty risk
c. systemic risk
d. settlement risk
5. Articulating interest rate view of the bank is responsibility of
a. Board of Directors
b. Risk Management committee
c. ALCO
d. CMD
6. a 5 year 9 % semi annual bond @ market yield of 7.65 has a price of Rs 108.20 which rises to
109.00 when yield falls to 7.35. What is the BPV of the bond
a. Rs 0.26 per Rs 1000 book value
b. Rs 2.6 per Rs 1000 book value
c. Rs 26.67 per Rs 1000 book value
d. none of the above
7. A 8 year, 9 % semi annual bond @ market yield of 7.20 % has 5 years remaining for maturity.
McCaulay duration of the bond is 3.2 years. What is the approximate change in price if market yield
goes upto 7.50 %
a. price increase by 0.93 %
b. price increases by 0.96 %
c. price decreases by 0.93 %
d. price decreases by 0.96 %
Page 33
Case Case
Studies
Studies
Most important Part of
BFM
Remains
the
Numerical. Throughout the
book we have incorporate
the numerical module wise
so that students understand
what is expected of them.
Based on feedback of
students and demand for
more and more case
studies, we have decided to
add more than 100 solved
case studies to enable
students to understand the
numerical part and solve
any type of numerical with
ease
We have also covered
numerical and questions
asked in last examination.
Hope it serves your purpose
and enables you to crack all
kind of numerical.
1. Mr. Amit purchases a call option for 100 shares of Deliance Company
with strike price of Rs. 100 having maturity after 03 months at a premium of
Rs. 40. On maturity, shares of A were priced at Rs. 160. Taking interest cost
@ 12% p.a. What is the profit/loss for the individual on the transaction?
a. Gain of Rs. 2000
c. Gain of Rs. 680
b. Gain of Rs. 4000

d. Gain of Rs. 1880
Ans - d
Explanation. We need to understand that call option or put option is simply
a financial product which can be purchased by paying its price. The price in
this case is known as premium.
In the above case Amit has purchased 100 call option. Price of each option
is Rs 40. Thus total price paid by Amit for buying these 100 call options is
100* 40 = Rs 4000.
This amount he has taken on a loan of 12%. Thus total interest which needs
to be paid back is 4000*3/12 * 12/100 = Rs 120 after 3 months.
On maturity the stock is priced at Rs 160. Thus gain on each call option is
Rs 60. However since premium of Rs 40 is paid on each option net gain is
Rs 20. Thus Gain of Rs 20 on each option so gain of Rs 2000 on total
transaction.
However, he needs to return back interest of Rs 120 thus his net gain would
be Rs 1880.
Q2. LIC of India buys a specified no of futures at NSE on a stock at strike
price of Rs 100 each when spot price of the stocks is Rs 110. At the
maturity of the contract the FI takes delivery of the shares. During the
period, the spot price of the stock decreases by Rs 3. What is the
acquisition cost to the FI per share?
a. Rs. 107
c. Rs. 100
b. Rs. 103
d. Rs. 97
Ans : c
Explanation: LIC has closed the deal at Rs 100. Now at the time of delivery market price i.e. spot price
is Rs 107 (fall of Rs 3 from current price) but since the strike price is Rs 100, LIC will take the delivery at
Rs 100.
Q3. Ms Neha purchases a put option for 200 shares of Star Company with strike price of Rs. 220 having
maturity after 02 months for Rs. 50 each. On maturity, shares of A were priced at Rs. 230. What is the
profit/loss for the individual on the transaction (without taking the interest cost and exchange
commission into calculation)?
a. Profit of Rs. 6000
c. Loss of Rs. 10,000
b. Profit of Rs. 10,000

d. Loss of Rs. 16000
Ans - c
Page 34
Explanation. Total amount spent by Neha on buying this put option is Rs 10,000. Ie. Rs 50 * 200.
Now on the maturity date Price of the stock is Rs 230. Neha has an option to sell the stock Rs 220,
however market price is Rs 230 which means if she does not uses this option she can sell this stock at
the price of Rs 230. Thus Neha will let this option expire and thus total loss on this transaction would be
the loss of the premium amount which is Rs 10,000.
Q4. Ms Neha purchases a put option for 200 shares of Star Company with strike price of Rs. 220 having
maturity after 02 months for Rs. 50. On maturity, shares of A were priced at Rs. 190. What is the
profit/loss for the individual on the transaction (without taking the interest cost and exchange
commission into calculation)?
a. Profit of Rs. 6000
c. Loss of Rs. 10,000
b. Profit of Rs. 10,000

d. Loss of Rs. 6000
Ans - d
Explanation. Total amount spent by Neha on buying this put option is Rs 10,000. Ie. Rs 50 * 200.
Now on the maturity date Price of the stock is Rs 190. Neha has an option to sell the stock Rs 220,
when market price is Rs 190 which means she will earn Rs 20 on each option. Thus total gain here
would be Rs 4000. However she has also paid premium of Rs 10,000. Thus overall she would incur a
loss of Rs 6000.
Q5. A bank borrows US $ for 03 months @ 3.0% and swaps the same in to INR for 03 months for
deployment in CPs @ 5%. The 3 months premium on US $ is 0.5%. What is the margin(gain/loss)
generated by the bank in the transaction?
a. 2%
b. 3%
c. 1.5%
d. 2.5%
Ans - c
Explanation : Bank borrow US $ for 3 months @ 3% same will be invested in CP for 3 months @ 5%
So, it gains 2% by interest rate margin here. But when bank repay its borrowing in $, it has to pay 0.5%
extra because US $ will be costly by 0.5% as US $ is at premium. So it will reduce bank gain by 0.5%.
2.0% - 0.5 % == 1.5%
Given below in the first table is the 1 year rating migration probability and in table II number of
accounts at the beginning of the year. Answer the following questions
Page 35
Rating category
No.
Accounts
at
the
beginning of the year
AAA
3200
AA
4500
A
7000
BBB
8400
BB
9300
B
1200
CCC
1400
Default
1000
Q66. Bank has credit exposure of Rs 10,000 crore to CCC rated borrower at the start of the year. What
will be the amount of default at the end of the period?
a. Rs 2194 crore
b. Rs 6396 crore.
c. Rs 10,000 crore.
d. data insufficient
Ans d
Explanation: Data insufficient. Please note that rating migration % is for number of accounts. So lets
say accounts in AAA are 3200 it is assumed that 5.83% of accounts will move to AA ie 187 . Loan
amount given to these accounts will be different and cannot be calculated from the given data.
Q67.What will be the number of accounts in CCC at the end of the year, assuming no new
accounts were added during the year.
a. 1227
b. 765
c. 1054
d. data insufficient
Ans : C
Explanation: Now just go through the table. Understand what it implies. 63.96% of accounts have
retained their rating of CCC. This means out of 1400 accounts at the start 895 (63.96% of 1400) have
remained in CCC and remaining have moved to other categories. But this is not the final answer as
from other ratings also accounts have moved to CCC
Rating category
% Moved to CCC
In number moved to CCC
AAA
0.00
0.00
AA
0.02
1
A
0.01
1
BBB
0.16
13
BB
1.05
98
B
3.87
46
CCC
63.96
895
Default
0.00
0
Total
1054
Thus accounts in CCC category at the end of the year is 1054
Q 98-100 are based upon the information given below for Bank of Mumbai. Based upon this answer the
following
Net Worth
RSA
RSL
DA Weighted Modified duration of asset
DL Weighted modified duration of liability
1280
27650
24570
1.89
1.32
*****************************END OF FREEE PREVIEW*******************************

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Sure Success Series

By: Vaibhav Awasthi

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Unit-1 Exchange Rates and Forex Business

Direct and Indirect Quotes

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Unit 2 Basics of Forex Derivatives

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Unit 4- Documentary Letter of Credit

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Operation of letter of credit

On request of the buyer i.e. applicant, LC is issued by Opening Bank in favors

After authentication of LC, the advising bank sends the LC to beneficiary.

Documents are Presented by beneficiary to nominated bank for negotiation.

TYPES OF LETTERS OF CREDIT

Payment LC or Sight documents on presentation.

(DA = Documents against acceptance)

against DA LCs or Acceptance LCs is those, where the payment is made

or on the maturity date in terms of the credit. The documents of title to

goods are delivered to applicant merely on acceptance of documents

Deferred Payment LC It is similar to usance LC but there is no bill of exchange or draft. It is

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

or amendment, the issuing bank must honor the liability.

dishonoured, it is considered to be with-recourse. Where he does

A restricted LC is one wherein a specified bank is designated to pay,

A credit to which the advising or other bank at the request of the

The beneficiary is entitled to request the paying, accepting or

Bank to Bank Credit

A back to back credit is one where an exporter received a

Red Clause Credit

A red clause credit also referred to a packing or anticipatory

Green Clause Credit

A green clause LC permits the advances for storage of goods in

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

This is a sample Preview. All pages of the book not displayed.

A credit is irrevocable even if there is no indication to that effect.

Branches of a bank in different countries are separate banks.

Article-4Credits vs Contracts: A credit is a separate transaction from the sale contract

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Numerical on Foreign exchange

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Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

This is a sample Preview. All pages of the book not displayed.

. JPY is quoted per 100 so we will multiply by 100

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Unit-8 Risk and Basic Risk Management Framework

Actual net flow

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Unit 9- Risks in Banking Business

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Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

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Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

Unit 10- Risk Regulations in Banking Industry

Numerical & Case Studies - Calculation of Capital:

Sure Success Series- CAIIB- Bank Financial Management -Vaibhav Awasthi

This is a sample Preview. All pages of the book not displayed.

Unit- 11 Market Risk

*END OF FREEE PREVIEW***