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ECS2605 LATEST EXAM PACK
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ECS2605 EXAM PACK., ECS2605: The South African Financial System
May/June 2020 Memo
Compiled by Ralph
0680779615
SECTION A – COMPULSORY ESSAY QUESTIONS
Answer ALL of the following questions in the space provided. Section A counts
20 marks in total.
(a) What is a credit rating? (2)
A credit rating is an evaluation of the credit risk of a prospective debtor, predicting
their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor
defaulting.
(b) Why does South Africa’s recent sovereign credit rating downgrade imply
higher funding
costs for the government? (2)
Clients need to know that there is a direct correlation between the level of long-term
interest rates and the depth of junk status. This means the further South Africa falls
into junk status, the more long-term interest rates will tend to rise. Simply put,
investors will most likely demand a higher rate of interest for lending, which will raise
borrowing costs.
(c) Explain the differences in objectives between the lender-of-last-resort
function of the
SARB and its accommodation policy. (4)
The Reserve Bank provides liquidity to banks during periods of temporary shortages
of cash. This function is referred to as the Bank's “lender-of-last-resort lending
activities”. This function implies giving assistance to a bank facing liquidity problems.
Accommodative monetary policy, also known as loose credit or easy monetary policy,
occurs when a central bank (such as the South African Reserve Bank) attempts to
expand the overall money supply to boost the economy when growth is slowing (as
,measured by GDP). The policy is implemented to allow the money supply to rise in
line with national income and the demand for money.
(d) Describe exchange-rate risk and explain how a currency swap can be used
to hedge against exchange-rate risk. (3)
Foreign exchange risk is a financial risk that exists when a financial transaction is
denominated in a currency other than the domestic currency of the company. It is an
unavoidable risk of foreign investment, but it can be mitigated considerably through
hedging techniques. The exchange rate risk is caused by fluctuations in the investor's
local currency compared to the foreign-investment currency.
Currency Swap is a spot sale of a currency combined with a forward repurchase of
the same currency.
Most interbank trading involving the purchase or sale of currencies for future delivery
is done by forward exchanged contracts combined with spot transactions in the form
of currency swaps and this mitigates the the exchange rate risk as forward
repurchase rate (forward rate) is agreed upon today.
(e) Describe the role of the Basel Committee on Banking Supervision (BCBS).
(2)
The Basel Committee on Banking Supervision (BCBS) is a group of international
banking authorities who work to strengthen the regulation, supervision and practices
of banks and improve financial stability worldwide.
(f) Explain how the retirement benefit is calculated under both a defined benefit
and a defined contribution retirement fund. (2)
Retirement benefit = total contribution + investment value.
(g) Name three key objectives of regulators in the financial system. (3)
Regulatory bodies are established by governments or other organizations to oversee
the functioning and fairness of financial markets and the firms that engage in financial
activity.
The goal of regulation is to prevent and investigate fraud, keep markets efficient and
transparent, and make sure customers and clients are treated fairly and honestly. In
South Africa there is the Prudential Authority; and the Financial Sector Conduct
Authority (“FSCA”).
(h) Explain how the SARB uses its own debentures to manage the liquidity
deficit in the banking system. (2)
One of the instruments that the SARB uses for draining excess liquidity from the
market is issuing its own debentures. Market participants tender for the amounts and
interest rates on SARB debentures, which are then allocated in ascending order of the
interest rates bid, until the amount on tender is fully allotted.
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