Question

1.Describe the advantages and disadvantages of financial intermediation compared to direct finance.

2.Describe the two different ways in which an ADI may be exposed to interest rate risk.  What would it do – in respect of the two different aspects of interest rate risk – if it thought interest rates were going to increase in the near future and wanted to take advantage of this prediction?  Explain how these actions will be of benefit if interest rates do increase as predicted?

3.Describe how a bank could use derivatives to hedge an exposure to decreasing interest rates

Answer 1

1.)

Fiancial intermediation is a process in which the organisation incurs liabilities on its own account by taking loans from financial institutions, banks etc.,	Direct Fiance is method of using own fund for doing business
More risky as organisation has to comapulsorily pay irrespective of earning	Less Risky
Financial Intermediation result in owners losing control over the organisation	There is no such loss of control
In case organisations continously fails in paying the installements it may be wound by court order	There is no such problem in case of Direct Financing

3.)The Bank may use a Interst Rate Swap to hedge the risk for the purpose of decreasing Interest Rates