JAIIB Paper 1 Module D Quiz 8

Direct exposures such as interbank loans, derivatives and securities holdings can transmit losses when one institution is distressed. Indirect channels include confidence and common-asset price effects.

Funding liquidity risk concerns access to cash or funding to meet obligations. It differs from market liquidity risk, which concerns selling an asset without a large price impact.

Market liquidity risk arises when the trader cannot execute a sale quickly at a reasonable price. Funding liquidity risk instead concerns the ability to raise cash or meet payments.

Rates and FX markets are linked through capital flows, funding costs, expectations and hedging. A bank’s exposures can therefore move together or offset, requiring an integrated view of risk.

Arbitrage is constrained by costs, balance-sheet capacity, short-selling limits, timing, settlement and risk. Therefore price differences may persist even when markets are connected.

Fragmentation can divide orders and liquidity among venues, potentially widening spreads or complicating execution. However, multiple venues may also increase competition and provide choice.

Systemic risk is the possibility that distress spreads or disrupts core financial functions across institutions and markets. Interconnectedness, leverage, common exposures and confidence effects can amplify it.

A central counterparty becomes the buyer to each seller and seller to each buyer, using margin and default-management mechanisms. This can reduce bilateral exposures but concentrates risk and requires robust safeguards.

Margin calls arise when market movements cause losses or collateral falls below required levels. Failure to meet a call can lead to position close-out or other actions under the agreement.

Integration can improve price discovery and capital allocation, but it can also transmit shocks and contagion. Risk management, supervision and resilience arrangements remain important.

A producer expecting to sell an asset may hedge price declines by selling futures, subject to contract suitability and basis risk. The hedge may not perfectly match the crop, timing or local price.

An importer with a future dollar payable can buy dollars forward, fixing the exchange rate for the agreed amount and date. This reduces adverse exchange-rate uncertainty but creates a contractual obligation.

The option premium is paid to the seller for granting the option right. A buyer’s maximum loss on a purchased option is generally the premium, excluding fees and related hedges, while the seller can face substantially larger exposure.

The notional amount is a reference amount used to calculate swap payments. In a plain-vanilla interest-rate swap it is generally not exchanged, although some other swap structures exchange principal.

Basis risk arises when the hedging instrument does not perfectly track the exposure in price, tenor, location or other attributes. A hedge can reduce risk without eliminating it.

Without-recourse forfaiting generally transfers specified buyer payment risk to the forfaiter. Contractual warranties, fraud, disputes or other exceptions can still create seller liability.

TReDS is intended to facilitate financing of eligible MSME receivables through participating financiers. Earlier cash flow can help working capital, but financing costs and eligibility requirements still apply.

Disputes, returns, credit notes or fraud can reduce the value of receivables. Financiers use verification, buyer acceptance, contractual protections and platform controls to manage such risks.

Notice and acknowledgement requirements depend on the contract and applicable law. They can help ensure the buyer pays the assignee and reduce the risk of payment to the wrong party.

A longer period until payment generally means funds are tied up longer and can affect discount charges and credit exposure. Pricing also depends on buyer risk, liquidity, recourse, fees and market conditions.