IGNOU BECE 144 Solved Assignment 2022-23

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Submission Date :

31st March 2033 (if enrolled in the July 2033 Session)
30th Sept, 2033 (if enrolled in the January 2033 session).

Answer all the questions.

Assignment A

A. Long Answer Questions (word limit-500 words)

1) Explain the significance of the financial system. What are important functions of financial institutions?

Financial development

Financial sector is the set of institutions, instruments, markets, as well as the legal and regulatory framework that permit transactions to be made by extending credit. Fundamentally, financial sector development is about overcoming “costs” incurred in the financial system. This process of reducing the costs of acquiring information, enforcing contracts, and making transactions resulted in the emergence of financial contracts, markets, and intermediaries. Different types and combinations of information, enforcement, and transaction costs in conjunction with different legal, regulatory, and tax systems have motivated distinct financial contracts, markets, and intermediaries across countries and throughout history.

The five key functions of a financial system are: (i) producing information ex ante about possible investments and allocate capital; (ii) monitoring investments and exerting corporate governance after providing finance; (iii) facilitating the trading, diversification, and management of risk; (iv) mobilizing and pooling savings; and (v) easing the exchange of goods and services.

Financial sector development thus occurs when financial instruments, markets, and intermediaries ease the effects of information, enforcement, and transactions costs and therefore do a correspondingly better job at providing the key functions of the financial sector in the economy.

Importance of financial development

A large body of evidence suggests that financial sector development plays a huge role in economic development. It promotes economic growth through capital accumulation and technological progress by increasing the savings rate, mobilizing and pooling savings, producing information about investment, facilitating and encouraging the inflows of foreign capital, as well as optimizing the allocation of capital.

Countries with better-developed financial systems tend to grow faster over long periods of time, and a large body of evidence suggests that this effect is causal: financial development is not simply an outcome of economic growth; it contributes to this growth.

Additionally, it reduces poverty and inequality by broadening access to finance to the poor and vulnerable groups, facilitating risk management by reducing their vulnerability to shocks, and increasing investment and productivity that result in higher income generation.

Financial sector development can help with the growth of small and medium sized enterprises (SMEs) by providing them with access to finance. SMEs are typically labor intensive and create more jobs than do large firms. They play a major role in economic development particularly in emerging economies.
Financial sector development goes beyond just having financial intermediaries and infrastructures in place. It entails having robust policies for regulation and supervision of all the important entities. The global financial crisis underscored the disastrous consequences of weak financial sector policies. The financial crisis has illustrated the potentially disastrous consequences of weak financial sector policies for financial development and their impact on the economic outcomes. Finance matters for development‐‐both when it functions well and when it malfunctions.

The crisis has challenged conventional thinking in financial sector policies and has led to much debate on how best to achieve sustainable development. Reassessing financial sector policies after the crisis in an important step in informing this process. To help achieve this, publications such as the World Bank’s Global Financial Development Report can play a role. Chapter 1 and the Statistical Appendix of the reportpresent data and knowledge on financial development around the world.

Measurement of financial development

A good measurement of financial development is crucial to assess the development of the financial sector and understand the impact of financial development on economic growth and poverty reduction.
In practice, however, it is difficult to measure financial development as it is a vast concept and has several dimensions. Empirical work done so far is usually based on standard quantitative indicators available for a long time series for a broad range of countries. For instance, ratio of financial institutions’ assets to GDP, ratio of liquid liabilities to GDP, and ratio of deposits to GDP.

Nevertheless, as the financial sector of a country comprises a variety of financial institutions, markets, and products, these measures are rough estimation and do not capture all aspects of financial development.
The World Bank’s Global Financial Development Database developed a comprehensive yet relatively simple conceptual 4×2 framework to measure financial development around the world. This framework identifies four sets of proxy variables characterizing a well-functioning financial system: financial depth, access, efficiency, and stability.

2) What are the important features of fixed income securities?

Introduction

Fixed-income securities constitute the most prevalent means of raising capital globally based on total market value. These instruments allow governments, companies, and other issuers to borrow from investors, promising future interest payments and the return of principal, which are contractual (legal) obligations of the issuer. Fixed-income securities are the largest source of capital for government, not-for-profit, and other entities that do not issue equity. For private companies, fixed-income investors differ from shareholders in not having ownership rights. Payments of interest and repayment of principal (amount borrowed) are a higher priority claim on the company’s earnings and assets compared with the claim of common shareholders. Since fixed-income claims rank above shareholder claims in the capital structure, a company’s fixed-income securities have, in theory, lower risk than their common shares.

Financial analysts who master these and other fixed-income concepts have a distinct edge over their peers for several reasons. First, given the nature of fixed-income cash flows and their preponderance across issuers and regions, these instruments form the basis for risk versus return comparisons both across and within specific jurisdictions. For example, as bonds issued by the US Treasury and other developed market central governments are viewed as having little to no default risk, they serve as building blocks in determining the time value of money for less certain cash flows. Fixed-income securities also fulfill an important role in portfolio management as a prime means by which individual and institutional investors can fund known future obligations, such as tuition payments or retirement obligations. Finally, while the correlation of fixed-income returns with common share returns varies, adding fixed-income securities to portfolios that include common shares can be an effective way of obtaining diversification benefits.

Among the questions to be addressed are the following:

Which features define a fixed-income security, and how do they determine the scheduled cash flows?
What are the legal, regulatory, and tax considerations associated with a fixed-income security, and why are they important for investors?
What are the common interest and principal payment structures?
What types of provisions may affect the disposal or redemption of fixed-income securities?

Note that the terms “fixed-income securities,” “debt securities,” and “bonds” are often used interchangeably by experts and non-experts alike. We will also follow this convention, and where any nuance of meaning is intended, it will be made clear. Moreover, the term “fixed income” is not to be understood literally: Some fixed-income securities have interest payments that change over time.

The member should be able to:

describe basic features of a fixed-income security;
compare affirmative and negative covenants and identify examples of each;
describe how legal, regulatory, and tax considerations affect the issuance and trading of fixed-income securities;
describe how cash flows of fixed-income securities are structured;
describe contingency provisions affecting the timing and/or nature of cash flows of fixed-income securities and whether such provisions benefit the borrower or the lender.

Summary

This reading introduces the salient features of fixed-income securities while noting how these features vary among different types of securities. Important points include the following:

The three important elements that an investor needs to know when investing in a fixed-income security are: (1) the bond’s features, which determine its scheduled cash flows and thus the bondholder’s expected and actual return; (2) the legal, regulatory, and tax considerations that apply to the contractual agreement between the issuer and the bondholders; and (3) the contingency provisions that may affect the bond’s scheduled cash flows.
The basic features of a bond include the issuer, maturity, par value (or principal), coupon rate and frequency, and currency denomination.
Issuers of bonds include supranational organizations, sovereign governments, non-sovereign governments, quasi-government entities, and corporate issuers.
Bondholders are exposed to credit risk and may use bond credit ratings to assess the credit quality of a bond.
A bond’s principal is the amount the issuer agrees to pay the bondholder when the bond matures.
The coupon rate is the interest rate that the issuer agrees to pay to the bondholder each year. The coupon rate can be a fixed rate or a floating rate. Bonds may offer annual, semi-annual, quarterly, or monthly coupon payments depending on the type of bond and where the bond is issued.
Bonds can be issued in any currency. Such bonds as dual-currency bonds and currency option bonds are connected to two currencies.
The yield-to-maturity is the discount rate that equates the present value of the bond’s future cash flows until maturity to its price. Yield-to-maturity can be considered an estimate of the market’s expectation for the bond’s return.
A plain vanilla bond has a known cash flow pattern. It has a fixed maturity date and pays a fixed rate of interest over the bond’s life.
The bond indenture or trust deed is the legal contract that describes the form of the bond, the issuer’s obligations, and the investor’s rights. The indenture is usually held by a financial institution called a trustee, which performs various duties specified in the indenture.
The issuer is identified in the indenture by its legal name and is obligated to make timely payments of interest and repayment of principal.
For asset-backed securities, the legal obligation to repay bondholders often lies with a separate legal entity—that is, a bankruptcy-remote vehicle that uses the assets as guarantees to back a bond issue.

B. Medium Answer Questions (word limit-250 words)

3) Briefly discuss expected utility theory of decision-making

4) Explain the internal and external determinants that affect the formulation of corporate policy.

5) What is Debt Securitisation? Explain risks attached to debt securitization.

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C. Short Answer Questions (word limit 100 words)

6) Differentiate between:

(a) Allais paradox and Ellsberg paradox.
(b) Forwards and Futures
(c) Systematic risk and non-systematic risk

7) Write short notes on the following.
(a) Hedge Funds
(b) Internal Rate of Return
(c) Hypothesis testing.

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