Subject: Credit Risk Assessment 1 (Iobm D204)
INSTITUTE OF BANKERS IN MALAWI
DIPLOMA IN BANKING EXAMINATION
SUBJECT: CREDIT RISK ASSESSMENT 1 (IOBM – D204)
Monday, 5th November 2012
Time Allocated: 3 hours (13:30 – 16:30 pm)
INSTRUCTIONS TO CANDIDATES
1 This paper consists of TWO Sections, A and B.
2 Section A consists of Multiple Choice Questions, each question carries 2 marks. Answer ALL questions.
3 Section B consists of 4 questions, each question carries 20 marks. Answer ANY TWO questions.
4You will be allowed 10 minutes to go through the paper before the start of the examination, you may write on this paper but not in the answer book.
5Begin each answer on a new page.
6Please write your examination number on each answer book used. Answer sheets without examination numbers will not be marked.
7DO NOT open this question paper until instructed to do so.
SECTION A(60 MARKS)
Answer ALL questions from this section.
QUESTION 1
(i)When financing a new business venture, bankers will always require to be provided with a Viability Study because:
a)It is part of the printed matter that banks like to display on their shelves
b)The Board Loan Committee insists on their submissions
c)It enables the banker to analyse and investigate, inter alia, products’ demand, profit generation ability and the break-even timeframe
d)It provides the banker with information required to make sound credit risk decisions.
(ii)To a lending banker, financial risk refers to:
a)The risk that the potential business they contemplate to finance may become bankrupt
b)The risk that the potential borrower might not be able to pay interest
c)The risk that the potential borrower might prematurely liquidate his obligations with the bank
d)The risk that the bank might be caught up with devaluation.
(iii)Business risk are always industry specific
a)True
b)False
(iv)Bankers regard the Break-Even Analysis as a valuable tool because:
a)It enable the banker to know if the potential borrower’s business is going to be profitable and viable in the long run
b)It provides an indication of the potential borrower’s ability to pay interest
c)It provides the answer regarding the potential borrower’s ability to generate sales and pay costs
d)Any of the above and/ or all the above.
(v)Break-Even Analysis is the method used to:
a)Determine the volume of sales required at a given selling price where the business will cover its costs
b)Measure the likelihood of a business breaking apart
c)Determine whether the bank will make substantial profits even when there are inadequate foreign reserves
d)All the above, a) through c)
(vi) Fixed costs are those costs that:
a)Are drilled through by the nail using a hammer
b)Vary with changes in the level of output or sales of a business
c)Finance directors wish to misdirect the general public that only the Board of Directors can change their nature
d)Do not vary with changes in the level of output or sales of a business.
(vii)An Operating budget is :
a)A zero-deficit budget
b)A budget that runs on automatic transmission
c)The sum total of all the operational activities for the new financial year expected in terms of money inflows and outflows
d)A budget that Heads Operations use
(viii)From the bankers’ perspective, it is important to look at the planning and budget of a business during the credit risk assessment process because:
a)The banker always wants to be sure that the potential borrowers are engaged in the planning processes
b)Most customers will repay their obligations from funds that will be generated in the future
c)It feels pretty good for a banker to be seen as a financial guru who will not leave any stone unturned
d)Bankers want to feel big and a pestering lot!
(ix) The importance of Working Capital to a business is that :
a)It determines the liquidity of the business
b)It determines the extent to which capital of a business can work
c)It determines the level of profits that a business might be able to generate
d)It determines the business’ level of employment during recession
(x)The criteria that determines the level of Working Capital in a business are:
a)The level of its overdraft at the bank
b)The level of sales, economic cycle, industry norm and cost of funds
c)The level of unsold inventory
d)Gut feelings by the Business’ Finance Directors
(xi) The adverse effects to a business that trades with excessively high levels of stock are:
a)It never runs short of stock
b)Banks tend to be very sympathetic with such businesses when it comes to considering their borrowing requests
c)It can be very expensive in terms of storage and insurance costs, risk of physical damage, obsolescence etc.
d)None of the above apply
(xii)Which of the following statements is not true with regard to the Aggressive Approach to working capital financing?
a)All fixed assets and only part of the permanent current assets are financed by means of long-term finance
b)The remaining permanent current assets and fluctuating current assets are financed by means of short term funds
c)Short term needs will be financed with short term funds and long term needs with long term funds
d)The risk of obtaining more short term funds and being unable to repay.
(xiii)Which of the following statements is incorrect with regard to what constitutes sources of working capital?
a)Sale of fixed assets
b)Issue of shares and other forms of capital contributions by owners
c)Profits ploughed back into the business
d)Industry norms can vary substantially in terms of working capital requirements.
(xiv)Which of the following statements is incorrect with regard to the reasons for managing working capital?
a)It is the measurement of a business liquidity
b)It is the measurement for the profitability of a business
c)It is a source of funds
d)It is critical for the success of a business
(xv)What do we mean when we try to warn a business of overtrading?
a)It is when the business tries to outsell every competitor in the neighbourhood
b)It is when the business is trading at a level that cannot be sustained by its resources capabilities
c)It is when the business tries to sell items that are outside its normal business line
d)It is when a business prepares itself for aggressive sales during Easter.
QUESTION 2
(i)Except in situations where the bank’s marketing drive overtakes the conventional lending wisdom, working capital would always be financed by means of:
a)Working capital term loans
b)Short term loans or overdrafts
c)Guarantees and letters of credit
d)Promissory notes issued by banks
(ii)Lending bankers’ endeavour to direct their attention to the finances of their business customers and not the actual detail of running them because:
a)That would be construed as interfering with those businesses
b)There are so many varieties of trades and industries and it is not realistically possible for a banker to have intimate knowledge of them all
c)They have not been trained in running businesses
d)They would not want to assume liability in the event of wrong decisions made
(iii)When a tobacco farmer in Malawi takes a loan from a bank for the construction of farm buildings, equipment etc., he would normally be expected to repay the loan from:
a)Tobacco proceeds at the end of that season
b)Sale of farm buildings and tractors that are deemed to be surplus to requirements
c)A loan obtained from another bank
d)Tobacco proceeds of future seasons as agreed with the bank
(iv)As a lending official of your bank, what would consider to be the best way forward when faced with a situation where your borrowing tobacco farmer’s proceeds at the end of the season are not sufficient to liquidate his seasonal overdraft?(a) will try to investigate cause for the sub-par performance (b) will consider that to be dishonesty on the part of the farmer (c) will just realize the security that the bank had taken (d) will not consider any further request to fund his next season’s farming requirements.
a)Will consider options (b), (c) and (d)
b)Will consider option (a)
c)Depending on circumstances, all the above options might be considered
d)Will not consider any of the above options
(v)Why is farming considered to be a more business risk from the lender’s viewpoint?
a)Most farmers are less educated and therefore do not plan adequately
b)You cannot tell quite easily what’s to be sold and what’s to be consumed by the farmer
c)The nature of the industry is subjected to unpredictable vagaries of nature
d)It’s by far the easiest and less taxing type of business, and by reason of this most farmers tend to relax and take the back seat.
(vi)If you can’t take a tobacco stop order over your farmer’s crop then whatever other form of security that you may hold is completely unrealizable
a)True
b)False
(vii)When you have the latest Farm Report from the bank’s ALO , then you are home and dry in as far as the repayment prospects are concerned
a)True
b)False
(viii)Why is it considered prudent to hold a cash cover of about 30% or 40% when lending to a tobacco farmer.
a)It contributes the farmer’s contribution towards the intended exposure
b)It reduces the level of bank’s risk in the event of crop failure
c)None of the above (a) or (b) would apply
d)Both of the above (a) and (b) would apply
(ix)Rank the following in the order of their preference from the lender’s viewpoint, especially when the crunch is in the offing : (a) tobacco stop order (b) fire insurance policy (c) Charges over properties in towns/cities (d) cash cover
a)Order of preference would be: (a), (b), (c) and (d)
b)Order of preference would be: (b), (a), (d) and (c)
c)Order of preference would be: (d), (c), (a) and (b)
d)Order of preference would be: (c), (b) (a) and (d)
(x)Why would Malawian banks still insist on the taking of J&S guarantees from the directors of your tobacco farming company?
a)As a reminder to the directors that their company owes the bank
b)As a fall-back position in the event there arises a shortfall in security realization
c)As a normal lending procedure
d) Possibly due to lack of a proper understanding of what a guarantee is.
(xi)When lending to a tobacco farmer it is always prudent that (a)the farmland should not be less than 30 ha, (b) the cropping programme should not be less than 10 ha, (c) customers should have carryover loans (d) the farmland should be a rented property
a)All the above would apply
b)Only (a) and (b) above would apply
c)None of the above would apply
d)Only (c) and (d) above would apply
(xii)Which of the following would you consider inappropriate to take a guarantee from in support of a borrowing of Mr Shangingi? (a) his illiterate wife (b) his minor son (c) his trading partner (d) his church pastor
a)(a) and (d) above
b)(b) and (d) above
c)(a), (b) and (d)
d)(c) above only
(xiii)When does the fire insurance policy become a piece of collateral worth to be relied upon when lending to a tobacco farmer?
a)When the farmer’s proceeds are inadequate to expunge the obligations
b)When hailstorms at the farm environment become the order of the day
c)When bush fires frequently threaten the neighbourhood’s environment
d)When the source of repayment i.e. tobacco leaf is ravaged by fire
(xiv)Without a cash flow obtained from a tobacco farmer you are as good as lending unsecured
a)True
b)False
(xv)When considering taking a third party security, you are always advised to obtain
a)A letter of credit from that third party
b)A guarantee from that third party
c)A letter of set-off from that third party
d)A letter of undertaking from that third party
QUESTION 3
(i)What does the abbreviation IFRS mean?
a)Internal Financial Reporting Standards
b)Interpol Focus on Riots Squad
c)Indigenous Fencing & Robotics Scheme
d)International Financial Reporting Standards
(ii)What does the abbreviation IAS mean?
a)Internal Accounting Setups
b)International Accounting Standards
c)Internal Audit Systems
d)Internal Audit Systems
(iii)The objective of the IFRS is to require entities to provide disclosures to their financial statements
a)True
b)False
(iv)The Chairman’s Report that accompanies the annual Financial Statements is also audited
a)True
b)False
(v)What would you likely find in a Qualified Auditors Report?
a)Qualifications of the members of the company’s Executive Committee
b)Agreement on stock valuation and depreciation methodologies
c)Disagreement on stock valuation and depreciation methodologies
d)Qualifications of the auditing firm members that conducted the audit
(vi)Audited financial statements provide a guarantee that the they are correct
a)True
b)False
(vii)How relevant is the director’s report to a lending banker?
a)It provides quantitative information giving context to the balance sheet and P&L
b)It provides qualitative information giving context to the balance sheet and P&L
c)It directs the company in the context of a new strategy
d)It provides succinct analyses of financial ratios and trends
(viii)How relevant is the auditor’s report to a lending banker?
a)It directs the banker and gives further insights on how to interpret accounts
b)It exposes concealed frauds perpetrated by company executives
c)It confirms whether financial statements have been audited or not
d)It provides guarantee that financial statements are 100% correct and reliable
(ix)It is not mandatory for the director’s report to include comparative figures for the current and previous years
a)True
b)False
(x)The company’s Income Statement reflects
a)Future profits and likely losses of the company
b)Financial history of the business
c)Combined expectations of directors and company’s executives
d)Hidden reserves that had remained fraudulently hidden for many years
(xi)Unappropriated profits for the year are
a)Profits that are not considered appropriate by the company executives
b)Profits that appear before taking into account taxation
c)Profits that have been transferred to General Reserves
d)Profits that represent that are retained in the business
(xii)Gross profits takes into account all expenses incurred by the company
a)True
b)False
(xiii)Depreciation involves an outlay of funds to external parties that owe the company
a)True
b)False
(xiv)Non-disclosure of turnover is permissible in the following circumstances:
a)When it becomes strategically vital for the public not to know
b)When competitors are likely to inflate their turnover
c)When the company is unable to account for all its sales during the accounting period
d)When it becomes strategically vital to evade tax
(xv)Operating income refers to:
a)Other non-core income generated during the accounting period
b)All income or subventions received by the company by way of donations
c)Income generated by the company in the course of normal business operations
d)Income received as a result of claims from insurance companies during the year
QUESTION 4
(i)What is credit risk? (a) inability or unwillingness to of a customer or counterparty to honour borrowing obligations (b) constitutes transaction risk or default risk and portfolio risk (c) probability of a borrowing customer having too much balance to his credit (d) inability of the account to swing into credit
a)Only (c) and (d) above
b)Only (a) and (b) above
c)None of (a) through (d) above
d)All of (a) through (d) above
(ii)Analysis of financial ratios is generally meant to:
a)Measure the qualitative aspects of the financial risk
b)Measure the subjective aspects of the financial risk
c)Measure the objective and quantitative aspects of financial risk
d)Management related risk that surrounds the borrowing customer
(iii)What would you do if you suspected that the financial statements presented by your potential borrowing customer have been presented for tax purposes?
a)Would just ask the customer to try another bank and stop trying me
b)Would tactfully request the customer to resubmit financial statements that have been audited by a reputable auditing firm
c)Would undertake audit of the financial statements with my credit officers
d) Would refer the matter to Credit Risk Management with my comments thereon
(iv)The amount and of provision for depreciation written off on fixed assets is a mandatory requirement in terms of minimum disclosure of expenses
a)True
b)False
(v)In terms of the Companies Act 1984, a Group of Companies refers to:
a)A cluster of companies that conduct their businesses in the same industry
b)A cluster of companies that appear to be related but are not
c)A relationship that exists between a holding company and a subsidiary company
d)A relationship that exists between one company and other associated companies.
(vi)Why is it necessary for a lending banker in Malawi to have an understanding of the financial statements of a farmer.
a)Because the banker would one day buy some crops from the farmer
b)Because this is a high risk sector to finance
c)Because it is important to know the rainfall pattern of the farmer’s area
d)Because most of these farmers are the least educated.
(vii)What would you do when your borrowing customer approaches you to provide more funds for diversification because the existing line of activity has not proved profitable enough.
a)Would need to subject the proposal to a thorough break-even analysis
b)Would be extremely hesitant to consider the request on account of the less than profitable outcomes that have already been demonstrated
c)Would ask for several years balance sheets and P&L accounts for the purpose of undertaking a trends analysis
d)Would forward the proposal to Credit Risk Management for their comments.
(viii)Cash budget is:
a)A zero-budget prepared for the purpose of operating the business strictly on cash basis
b)A budget that provides information on whether the flow of cash or near cash items is on account of operating/investing/financing activities of the enterprise
c)A forecast of receipts and repayments of an enterprise drawn at intervals
d) A tool that tracks the movement of funds of an organization on a wider time frame.
(ix)Which of the underlisted would enable you to establish a customer’s expected peak borrowing.
a)Balance sheet
b)Funds flow
c)Cash flow
d)Cash budget
(x)Why should a lending banker undertake a detailed analysis of financial statements which have been audited and scrutinized by reliable and qualified auditors?
a)Becausebanks’ credit policies across the entire globe stipulate so