Financial Markets And Specialised Institutions Revision Kit

SAMPLE WORK

TOPIC 1

MARKET ORGANISATION AND STRUCTURE

 

QUESTION 1

August 2025 Question One A&B

1. Outline FOUR characteristics of a well-functioning financial system
2. Explain THREE differences between “investment banks” and “retail banks” in the financial services industry.

MASOMO MSINGI ANSWER

A well-operating financial system is essential for economic growth and resilience. Four important traits are:

1. Efficiency – The system should enable funds to move from savers to borrowers at low cost, directing capital to its most valuable uses quickly and accurately. This includes both low transaction costs (operational efficiency) and prices that reflect all available information (informational efficiency).

2. Stability – It must withstand shocks—such as market downturns or economic crises—while maintaining public confidence. This requires strong regulation, sufficient capital reserves, and safeguards against systemic failures.

3. Transparency – All market participants need timely, accurate, and relevant information about financial products, associated risks, prices, and institutional performance. This reduces information imbalances and supports fair dealings.

4. Inclusivity – The system should offer a broad range of financial services—including credit, savings, insurance, and payments—to all people, especially small businesses and low-income individuals, thereby fostering wider economic participation (financial inclusion).

b) Differences Between Investment Banks and Retail Banks

Investment banks and retail banks serve distinct roles in the financial industry:

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QUESTION 2

August 2025 Question Two C

Examine FIVE functions of financial markets in an economy.

MASOMO MSINGI ANSWER

1. Mobilizing Savings – They offer various instruments (shares, bonds, funds) that channel individual and institutional savings into productive investments, preventing idle cash or less productive uses.

2. Price Determination (Discovery) – Through supply and demand, markets determine asset prices, providing accurate valuations for firms and signaling where capital is most needed.

3. Providing Liquidity – They enable investors to quickly convert assets into cash and vice versa, lowering risk and encouraging longer-term investment.

4. Risk Sharing and Transfer – Markets allow risks (credit, interest rate, currency) to be transferred from those unwilling to bear them to those willing, often via derivatives and insurance.

5. Reducing Transaction and Information Costs – By efficiently connecting buyers and sellers in a standardized environment, markets lower the cost of finding opportunities and assessing borrower creditworthiness.

 

QUESTION 3

August 2025 Question Four A

In relation to mortgage market, describe FOUR criteria used to establish the creditworthiness of a borrower.

MASOMO MSINGI ANSWER

1. Capacity – Ability to repay, measured primarily by income stability and debt-to-income (DTI) ratio.

2. Credit History/Score – Willingness to repay, shown by credit score (e.g., CRB report) reflecting past payment behavior.

3. Collateral – The property used as security, valued through an appraisal to determine the loan-to-value (LTV) ratio.

4. Capital/Cash Reserves – Borrower’s net worth and liquid funds after closing, providing a financial buffer against unexpected events.

QUESTION 4

August 2025 Question Four C

Explain THREE risks that could be associated with trading derivative contracts.

MASOMO MSINGI ANSWER

1. Leverage Risk – Small margin requirements can amplify both gains and losses, sometimes exceeding the initial investment.

2. Counterparty Risk – The other party in a bilateral contract (especially over-the-counter markets) may default on obligations.

3. Basis Risk – The derivative’s price may not move perfectly in line with the price of the underlying asset being hedged.

QUESTION 5

April 2025 Question Three C

Analyse FIVE participants in a financial market in your country, citing their various roles.

MASOMO MSINGI ANSWER

Kenya’s financial markets include diverse players with distinct functions:

1. Households / Individuals

   • Role: Mainly as savers and investors, supplying funds through bank deposits, share purchases, bonds, or unit trusts. Also borrow for consumer needs, mortgages, or education.

   • Example: Buying shares on the Nairobi Securities Exchange or saving in a commercial bank.

2. Firms / Corporations

   • Role: Primarily borrowers issuing securities (shares, bonds) to fund expansion or projects, or taking bank loans. May also invest surplus cash in money market instruments.

   • Example: Safaricom PLC issuing corporate bonds for network expansion, or Bidii Limited conducting a rights issue.

3. Government (National and County)

   • Role: Mainly a borrower to finance public spending, infrastructure, or deficits, issuing Treasury bills and bonds via the Central Bank of Kenya. Also regulates through bodies like the Capital Markets Authority (CMA).

   • Example: National Treasury issuing a Treasury bond for infrastructure development.

4. Financial Intermediaries (e.g., Banks, Saccos, Insurers)

   • Role: Channel funds from savers to borrowers.

     • Commercial banks: Accept deposits, provide loans, facilitate payments.

     • SACCOs: Mobilize member savings and offer credit.

     • Insurance companies: Collect premiums and invest in shares, bonds, real estate to meet future claims.

   • Example: KCB Bank lending to a small business; Britam Holdings investing policyholder funds in government securities.

5. Regulators (e.g., CMA, CBK, Retirement Benefits Authority)

   • Role: Supervise, license, and regulate markets to ensure stability, fairness, and investor protection. Set rules, monitor compliance, and enforce laws.

   • Example: CMA licensing a stockbroker or investigating insider trading; CBK implementing monetary policy and managing foreign reserves.

QUESTION 6

April 2025 Question One A

Summarise THREE features of derivative markets.

MASOMO MSINGI ANSWER

1. Leverage – A small upfront margin controls a much larger asset value, magnifying both profits and losses.

2. Hedging – Derivatives are widely used to protect against price changes in the underlying asset (e.g., a company using futures to lock in a future commodity price).

3. Price Discovery – Derivative prices reflect market expectations of future asset prices, aiding in efficient price formation.

QUESTION 7

December 2024 Question One A

Explain the following types of securities traded in organised markets:

• Government
• Corporate
• Currency

MASOMO MSINGI ANSWER

Financial Markets And Specialised Institutions past papers With Answers