Principles of Banking and Finance
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Section A
Answer ONE (1) question from this section and not more than further TWO (2)
questions.
1. (a) Discuss the main reasons for regulating banks and critically examine the role of the
safety net arrangements put in place in most banking systems.
(15 marks)
(b) Distinguish between micro- and macro-prudential regulation and give examples of
how macro-prudential regulation might work in practice.
(10 marks)
2. (a) Critically examine the role of conflicting requirements of lenders and borrowers
and transaction costs in explaining financial intermediation
(10 marks)
(b) Consider the role of delegated monitoring (Diamond model) in explaining financial
intermediation.
(15 marks)
3. (a) Explain the difference between valuation, informational and allocative efficiency.
(8 marks)
(b) Explain the joint-hypothesis problem encountered when testing for informational
efficiency of a market.
(7 marks)
(c) Explain the ‘January effect’ in stock markets and discuss the evidence for this effect.
(10 marks)
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4. (a) Discuss the risks arising from both the banking book (intermediation business) and
trading book of banks.
(8 marks)
(b) Explain how Value at Risk models can be used by a bank to manage its market risk
exposure. Discuss the problems with these models.
(10 marks)
(c) Explain how interest rate risk can impact a bank.
(7 marks)
Section B
Answer ONE (1) question from this section and not more than a further TWO (2)
questions.
5. (a) Distinguish between income gap and duration gap analysis in managing interest
rate risk. Critically examine the limitations of each.
(10 marks)
(b) Consider the following balance sheet of Unibank:
Assets (£) Duration Liabilities (£) Duration
Variable-rate Money market
mortgages 1400 8.1 deposits 1000 1.3
Fixed-rate
mortgages 1200 4.1 Savings deposits 3000 2.3
Commercial loans 4000 3.2 Variable-rate CD
(>1 year) 1000 1.2
Physical capital 1400 Equity 3000
Total 8000 Total 8000
Estimate the impact of an increase in interest rates from 3% to 4% on the equity of
Unibank.
(7 marks)
(c) Explain why the answer calculated in part (b) is an estimate.
(4 marks)
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(d) Explain what a duration gap of zero implies for a bank and discuss why banks
generally do not operate with duration gaps of zero.