Answers to technical Questions

14. OPEN MARKET OPERATIONS OF SBP:

Open market operations (OMO) refers to the buying and selling of government securities in the open market in order
to expand or contract the amount of money in the banking system, facilitated by the Federal Reserve (Fed).
Purchases inject money into the banking system and stimulate growth, while sales of securities do the opposite and
contract the economy. The Fed's goal in using this technique is to adjust and manipulate the federal funds rate, which
is the rate at which banks borrow reserves from one another.

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15. MONETARY POLICY OF SBP:

About Monetary Policy

Monetary policy involves central banks use of instruments to influence interest rates and/or money
supply in the economy with the objective to keep overall prices and financial markets stable.
Monetary policy is essentially a stabilization or demand management policy that cannot impact
long-term growth potential of an economy. Preamble to SBP Act, 1956 envisages monetary policy
to secure monetary stability and attain fuller utilization of economys productive resources. In
SBPs view, the best way to achieve these objectives on a sustainable basis is to keep inflation low
and stable.

Low and stable inflation provides favorable conditions for sustainable growth and employment
generation over time. It reduces uncertainties about future prices of goods and services and helps
households and businesses to make economically important decisions such as consumption,
savings and investments with more confidence. This, in turn, facilitates higher growth and creates
employment opportunities over the medium term leading to overall economic well-being in the
country.

In practice, SBPs monetary policy strives to strike a balance among multiple and often competing
considerations. These include: controlling inflation, ensuring payment system and financial
stability, preserving foreign exchange reserves, and supporting private investment.

How does Monetary Policy Work?

SBP signals its monetary policy stance through adjustments in the policy rate; that is, the SBP
Target Rate for the overnight money market repo rate. Changes in the policy rate impact demand
in the economy through several channels and with a lag. In the first place, changes in policy rate
influence the interest rates determined in the interbank market at which financial institutions lend
or borrow from each other. The market interest rates are also influenced by central bank
interventions in money and foreign exchange markets as well as by its communication.

The changes in market interest rates influence the borrowing cost for consumers and businesses as
well as the return on deposits for the savers. Generally, lower interest rates encourage people to
save less and consume/invest more, and vice versa. Changes in the policy rate also influence the
value of financial and real assets, impacting peoples wealth and thus their spending. The
adjustment in demand finally affects the general price level and thus inflation in the economy.

16. TOOLS OF MONETARY POLICY:

 Monetary policy mainly aims at controlling the volume of credit in the country and sometimes also the direction
of its use. It is not possible to describe in detail the methods by which this is done, for which reference may be
made to any good book on the theory of money and banking. A brief mention of them, however must be made for
completeness of our discussion.
Monetary policy may achieve credit control in various ways depending upon whether the control desired is
quantitative control or qualitative control. The former refers to the volume of purchasing power and latter to the
use to which it may be put.
(a) QUANTITATIVE CONTROL
The methods of quantitative control include the following.
(i) Bank Rate Policy: The Central Bank of the country raises or lowers as needed, its Bank Rate (discount rate) for
first calls paper thus influencing other interest rate sin the money market. A higher rate discouraged and lower
rate encourages bank loans ad hence credit expansion. Thus is regulates and controls the volume of purchasing
power in the economy for carrying on economic activities.
(ii) Open Market Operations: The Central Bank buys or sells, as the need may be, Government securities in the
open market. By purchasing the securities it adds to the balances of commercial banks with itself and by selling
them it reduces such balances. Balances with the Central Bank being as good as cash, such operations expand
and restrict respectively the power of commercial banks to create credit when they sell of buy such securities.
(iii) Variable Reserve Ratios: The Central Bank requires a certain percentage of the liabilities of commercial banks
(or member banks) to be kept in form of reserves with it under the law. This ratio can be increased when credit
contraction is desired and decreased when the object is to expand credit.
(iv) Credit Rationing: The Central Bank may put limits on the issue of credit (overall or for particular purposes) on
the part of the member banks. These limits may be increased or decreased as needed by the monetary situation
in the country.
(b) QUALITATIVE CONTROL
It includes following.
(i) Moral Suasion: Central Bank through direct advice or persuasion may influence the banks to follow particular
lines of policy considered necessary to meet a particular situation.
(ii) Consumer Credit Regulation: In times of inflationary pressure the Central Bank may put restrictions on loans to
consumers. If consumption needs encouragement the Central Bank may allow commercial banks to advance
loans for consumption.
(iii) Publicity: This method is used usually accelerating the pace of economic development. This implies issuing of
weekly statistics, periodical reviews about money market conditions, public finance, trade, industry, weekly
balance sheet etc for the information of commercial banks, this convincing them of the desirability of following
particular lines of policy.
(iv) Variable Margin Requirements: Margin requirements may be increased if the object is to discourage, and
decreased if the aim is to encourage credit only for speculative activities in the stock exchange.
(v) Direct Action: This method is used by Central Bank usually to rediscount bills of banks following policies which
are inconsistent with the Central Banking policy. This method is rarely used and only as last resort.
To be fully effective in achieving their aims these methods pre-suppose a well-developed money market which is
sensitive to the actions taken by the Central Bank. If there is a large non-monelised sector and net of banking
institutions is not wide enough to cover the country, or there is absence of organised banks prepared to cooperate
in the national interest monetary policy will face difficulties in achieving its objectives.

17. FISCAL POLICY:

Is the means by which a government adjusts its spending levels and tax rates to monitor and influence a nation's
economy. It is the sister strategy to monetary policy through which a central bank influences a nation's money
supply. These two policies are used in various combinations to direct a country's economic goals. Here we look
at how fiscal policy works, how it must be monitored and how its implementation may affect different people in an
economy.

Before the Great Depression, which lasted from Sept. 4, 1929 to the late 1930s or early 1940s, the government's
approach to the economy was laissez-faire. Following World War II, it was determined that the government had to
take a proactive role in the economy to regulate unemployment, business cycles, inflation and the cost of money.
By using a mix of monetary and fiscal policies (depending on the political orientations and the philosophies of
those in power at a particular time, one policy may dominate over another), governments are able to control
economic phenomena.http://www.investopedia.com/articles/04/051904.asp#ixzz4MNcVFP00
18. GAAPS VS IFRS:

Generally accepted accounting principles (GAAP) are a common set of accounting principles, standards and
procedures that companies must follow when they compile their financial statements. GAAP is a combination of
 authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting
accounting information. GAAP improves the clarity of the communication of financial information.
GAAP vs. IFRS

GAAP is focused on the practices of U.S. companies. The Financial Accounting Standards Board (FASB) issues
GAAP. The international alternative to GAAP is the International Financial Reporting Standards (IFRS) set by the
International Accounting Standards Board (IASB). The IASB and the FASB have been working on the convergence of
IFRS and GAAP since 2002. Due to the progress achieved in this partnership, in 2007, the SEC removed the
requirement for non-U.S. companies registered in America to reconcile their financial reports with GAAP if their
accounts already complied with IFRS. This was a big achievement, because prior to the ruling, non-U.S. companies
trading on U.S. exchanges had to provide GAAP-compliant financial statements.

19. DISCLAIMER:

a statement that denies something, especially responsibility.

20. RELATION BETWEEN FISCAL AND MONETARY POLICY:

Monetary policy and fiscal policy refer to the two most widely recognized "tools" used to influence a nation's economic
activity. Monetary policy is primarily concerned with the management of interest rates and the total supply of money
in circulation and is generally carried out by central banks such as the Federal Reserve. Fiscal policy is the collective
term for the taxing and spending actions of governments. In the United States, national fiscal policy is determined by
the Executive and Legislative Branches.
Fiscal policy and monetary policy are the two tools used by the state to achieve its macroeconomic objectives. While for
many countries the main objective of fiscal policy is to increase the aggregate output of the economy, the main objective of
the monetary policies is to control the interest and inflation rates. The IS/LM model is one of the models used to depict the
effect of policy interactions on aggregate output and interest rates. The fiscal policies have a direct impact on the goods
market and the monetary policies have a direct impact on the asset markets; since the two markets are connected to each
other via the two macrovariables output and interest rates, the policies interact while influencing output and interest rates.

21.LIBOR:

LIBOR or ICE LIBOR (previously BBA LIBOR) is a benchmark rate that some of the worlds leading banks charge
each other for short-term loans. It stands for IntercontinentalExchange London Interbank Offered Rate and serves as
the first step to calculating interest rates on various loans throughout the world. LIBOR is administered by the ICE
Benchmark Administration (IBA), and is based on five currencies: U.S. dollar (USD), Euro (EUR), pound sterling
(GBP), Japanese yen (JPY) and Swiss franc (CHF), and serves seven different maturities: overnight, one week, and
1, 2, 3, 6 and 12 months. There are a total of 35 different LIBOR rates each business day. The most commonly
quoted rate is the three-month U.S. dollar rate.

22. BASIC F/S AND USES:

Income statement. Presents the revenues, expenses, and profits/losses generated during the
reporting period. This is usually considered the most important of the financial statements, since it
presents the operational results of an entity.
Balance sheet. Presents the assets, liabilities, and equity of the entity as of the reporting date. Thus,
the information presented is as of a specific point in time. The report format is structured so that the
total of all assets equals the total of all liabilities and equity (known as the accounting equation). This
is typically considered the second most important financial statement, since it provides information
about the liquidity and capitalization of an organization.
Statement of cash flows. Presents the cash inflows and outflows that occurred during the reporting
period. This can provide a useful comparison to the income statement, especially when the amount of
profit or loss reported does not reflect the cash flows experienced by the business. This statement
may be presented when issuing financial statements to outside parties.
Statement of retained earnings. Presents changes in equity during the reporting period. The report
format varies, but can include the sale or repurchase of stock, dividend payments, and changes
caused by reported profits or losses. This is the least used of the financial statements, and is
commonly only included in the audited financial statement package.

When the financial statements are issued internally, the management team usually only sees the
income statement and balance sheet, since these documents are relatively easy to prepare.

23. WHEN F/S ARE PREPARED:

Financial statements show how well a company has performed over the year and the level of profit achieved.
Investors and regulators may make decisions about a small business based on the information provided by
financial statements. Financial statements must be prepared in sequence because the information in one is
needed for the next. The sequence of financial statements is: income statement, statement of retained earnings,
balance sheet and statement of cash flows.
Income Statement
The purpose of the income statement is to report the company's income and revenue for the year, including net
income. Net income is revenue less expenses. Some companies use a single-step method while others use a multi-
step method when preparing the statement. The multi-step method would be used by companies with a more
complex financial situation while the single-step method by small companies with uncomplicated finances.
Statement of Retained Earnings
The statement of retained earnings explains the changes in retained earnings for the company from net income or
loss during the year. Retained earnings are income that is retained by the company to be reinvested instead of
being paid out as dividends to stockholders. The steps in the process are listing the beginning retained earnings,
subtracting or adding net income or loss and then subtracting any dividends paid out. The result is the retained
earnings statement for the company.
Balance Sheet
A balance sheet summarizes and lists the organization's assets, liabilities and shareholder equity at a particular
point in time. It is a snapshot of a company's overall financial situation. The formula for a balance sheet is:
liabilities plus equity equals assets. The balance sheet lists a total of all assets, including cash, accounts receivable,
inventory and fixed assets. Liabilities such as bank notes and accounts payable are listed, along with the owner's
capital invested. The last line of the balance sheet gives the total amount of liabilities and equities, which must be
equal to the total assets.
Statement of Cash Flows
The statement of cash flows identifies changes in cash flow generated from operating, investing and financing
activities. These three activities, along with any noncash investing and financing activities, make up the statement
of cash flows. The statement of cash flows is used to measure a company's financial stability and its ability to pay
its creditors.
24. DOLLAR RATE CHANGE AND EFFECT ON ECONOMY:
One of the crucial reasons behind the devaluation of money in Pakistan is because of high inflation in the country.
Due to immense inflation the State Bank of Pakistan has felt the urgency of issuing more currency and notes in the
local public and commercial sectors to meet up the high inflation, but the national bank of any state cant issue notes
and currency until or unless they have the equal amount of reserves of Precious Metals which includes Gold and
Silver. Pakistan does not have such high reserves of precious metals so they cant issue worthy and high value
currency. Due to this reason the only possible solution for this query is that they have reduced the worth of the
currency and can dispatch high quantity notes and currency which international value is not that much high.

Such high values of loans and debt has also played its role in the devaluation of the national currency of Pakistan.
The International currency is getting stronger and stronger and the hub is the Dollar which has reached its record
value in the last decade or so. The negative balance of payment which means the deficit is the budget that makes the
value of import more than the value of export has also contributed in the devaluation of Pakistani rupee and with the
same time immense and high unemployment has made the scenario worse for Pakistan. To improve the value of the
currency the economy of the state should get improved and the financial budgeting should be made in positive
balance of payments.

25. T BIILLS SIZE AND DENOMINATION:

 Treasury bills are zero coupon instruments issued by the Government of Pakistanand sold through the State
Bank of Pakistan via fortnightly auctions. T-Bills are issued with maturities of 3-months, 6-months and 1 Year
and are priced at a discount.

Treasury bills are an Obligation of government representing floating debt to finance short term gap between
government receipts and expenditures and are usually issued with the maturities of 3, 6 months and 1 year. These are
sold at discount and repaid at par after maturity in an open auction and the rate of discount is quoted by the bidders.
Moreover they are negotiable, non interest bearing and non redeemable.

Is a negotiable debt instrument issued by State Bank of Pakistan on behalf of the Government of Pakistan and backed by its full
faith and credit. Treasury bills are usually sold through auctions on a discount basis with a yield equal to the difference between the
purchase price and the maturity value.
Salient Features are

Issuer: Government of Pakistan

Coupon: Zero Coupon (Issued at discount)

Tenor: 3, 6 & 12 Month

Denominations : Multiple of 5,000 Pak rupees

Withholding Tax : Deducted at source (Currently at 10%)

Sale of Bills : Through designated Primary Dealers

Redemption: Bills shall not be redeemable before maturity

Tradable: Bills are script less & traded freely in the Secondary Market and are
transferable.

Custodianship As the T-Bills are script less instruments, clients holding are held in the
Investor Portfolio Services (IPS) Account managed through Subsidiary
General Ledger Accounts with banks
26. PLEDGE VS HYPOTHETICATION:

Pledge:
Pledge is used when the lender (pledgee) takes actual possession of assets i.e. certificates, goods ). Such securities or
goods are movable securities. In this case the pledgee retains the possession of the goods until the pledgor (i.e.
borrower) repays the entire debt amount. In case there is default by the borrower, the pledgee has a right to sell the
goods in his possession and adjust its proceeds towards the amount due (i.e. principal and interest amount). Some
examples of pledge are Gold /Jewellery Loans, Advance against goods,/stock, Advances against National Saving
Certificates etc.

Hypothecation:
Hypothecation is used for creating charge against the security of movable assets, but here the possession of the
security remains with the borrower itself. Thus, in case of default by the borrower, the lender (i.e. to whom the goods
/ security has been hypothecated) will have to first take possession of the security and then sell the same. The best
example of this type of arrangement are Car Loans. In this case Car / Vehicle remains with the borrower but the
same is hypothecated to the bank / financer.

Mortgage :
Mortgage is used for creating charge against immovable property which includes land, buildings or anything that is
attached to the earth or permanently fastened to anything attached to the earth (However, it does not include growing
crops or grass as they can be easily detached from the earth). The best example when mortage is created is when
someone takes a Housing Loan / Home Loan. In this case house is mortgaged in favour of the bank / financer but
remains in possession of the borrower, which he uses for himself or even may give on rent.
Lien:
It is defined to be a right of detaining the property of another until some claim be satisfied.

27. DELIVERY ORDER :

A Delivery Order (abbreviated D/O) is a document from a Consignee, or an owner or his agent of freight
Carrier which orders the release of the transportation of cargo to another party.

28. SMALL & MEDUIM ENTERPRISE DEF:

As defined by State Bank of Pakistan

A small Enterprise (SE) is a business entity which does not employ (including contract employees) more than 50 persons

and annual sales turnover is up to Rs.150 million.

Small Enterprises can be extended finances up to Rs.25 Million.

Medium Enterprise (ME) is a business entity, ideally not a public limited company which employs (including contract

employees) more than 50 employees and less than 100 employees in case of trading establishments. In case of

manufacturing & service establishments, employs more than 50 employees (including contract employees) and less than

250 employees. For all MEs annual sales turnover is over Rs.150 million and up to Rs.800 million.

Medium Enterprises can be extended finances over Rs.25 Million to Rs.200 Million.

29. BOTTOM LINE IN I/S :

A company's bottom line is its net income, or the "bottom" figure on a company'sincome statement. More
specifically, the bottom line is a company's income after all expenses have been deducted from revenues.
These expenses include interest charges paid on loans, general and administrative costs and income taxes.
Red bottom line indicates net loss.

30. CAPM AND BETA IN CAPM :

The capital asset pricing model (CAPM) is a model that describes the relationship between systematic risk
and expected return for assets, particularly stocks. CAPM is widely used throughout finance for the pricing of
risky securities, generating expected returns for assets given the risk of those assets and calculating costs of capital.

BETA IN CAPM- Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison
to the market as a whole. Beta is used in the capital asset pricing model (CAPM), which calculates the
expected return of an asset based on its betaand expected market returns.

31. ACCOUNTING EQUATTION:

The equation that is the foundation of double entry accounting. The accounting equation displays that all assets are
either financed by borrowing money or paying with the money of the company's shareholders. Thus, the accounting
equation is: Assets = Liabilities + Shareholder Equity. The balance sheet is a complex display of this equation,
showing that the total assets of a company are equal to the total of liabilities and shareholder equity.

32. A SOLE PROPRIETOR DRAWS 10000 OUT WHATS ENTRY:

Capital 10000
Drawing 10000
33. IRR & NPV :

Internal rate of return (IRR) is a metric used in capital budgeting measuring the profitability of potential investments.
Internal rate of return is a discount rate that makes the net present value (NPV) of all cash flows from a
particular project equal to zero. IRR calculations rely on the same formula as NPV does.

The following is the formula for calculating NPV:

where:

Ct = net cash inflow during the period t

Co= total initial investment costs

r = discount rate, and

t = number of time periods

To calculate IRR using the formula, one would set NPV equal to zero and solve for the discount rate r, which is here
the IRR. Because of the nature of the formula, however, IRR cannot be calculated analytically, and must instead be
calculated either through trial-and-error or using software programmed to calculate IRR.

Generally speaking, the higher a project's internal rate of return, the more desirable it is to undertake the project. IRR
is uniform for investments of varying types and, as such, IRR can be used to rank multiple prospective projects
a firm is considering on a relatively even basis. Assuming the costs of investment are equal among the various
projects, the project with the highest IRR would probably be considered the best and undertaken first.

IRR is sometimes referred to as "economic rate of return (ERR).

Net Present Value (NPV) is the difference between the present value of cash inflows and the present
value of cash outflows. NPV is used in capital budgeting to analyze the profitability of a
projected investment or project.

The following is the formula for calculating NPV:

where

Ct = net cash inflow during the period t

Co = total initial investment costs

r = discount rate, and

t = number of time periods

A positive net present value indicates that the projected earnings generated by a project or investment (in
present dollars) exceeds the anticipated costs (also in present dollars). Generally, an investment with a
positive NPV will be a profitable one and one with a negative NPV will result in a net loss. This concept is
the basis for the Net Present Value Rule, which dictates that the only investments that should be made
are those with positive NPV values.

When the investment in question is an acquisition or a merger, one might also use the Discounted Cash
Flow (DCF) metric.

Apart from the formula itself, net present value can often be calculated using tables, spreadsheets such
as Microsoft Excel or Investopedias own NPV calculator.

34. OBJECTIVE OF ACCOUNITNG:

The objective of business financial reporting is to provide information that is useful for making business and
economic decisions.
35. MATCHING CONCEPT:

The matching concept is anaccounting practice whereby expenses are recognized in the same accounting period
as the related revenues are recognized. The period's revenues, that is, are reported along with the expenses that
brought them.

The purpose of the matchingconcept is to avoid misstating earnings for a period. Reporting revenues for a period
without reporting all the expenses that brought them could result in overstated or understated profits.

Applying the concept requires accrual accounting, the practice of recognizing revenues when they are earned and
expenses when they are incurrednot necessarily when cash actually flows in those transactions.

36. CONSISTENCY CONCEPT:

The consistency principle states that, once you adopt an accounting principle or method, continue to follow
it consistently in future accounting periods. Only change an accounting principle or method if the new version
in some way improves reported financial results.

37. SHAPE OF DEMAND CURVE:

The demand curve of a monopolistic competitive market slopes downward. This means that as price
decreases, the quantity demanded for that good increases. While this appears to be relatively
straightforward, the shape of the demand curve has several important implications for firms in a
monopolistic competitive market.
38. HEDGING:

A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of
taking an offsetting position in a related security, such as a futures contract.

BREAKING DOWN 'Hedge'

Hedging is analogous to taking out an insurance policy. If you own a home in a flood-prone area, you will want to
protect that asset from the risk of flooding to hedge it, in other words by taking out flood insurance. There is a risk-
reward tradeoff inherent in hedging; while it reduces potential risk, it also chips away at potential gains. Put simply,
hedging isn't free. In the case of the flood insurance policy, the monthly payments add up, and if the flood never
comes, the policy holder receives no payout. Still, most people would choose to take that predictable, circumscribed
loss rather than suddenly lose the roof over their head.

A perfect hedge is one that eliminates all risk in a position or portfolio. In other words, the hedge is 100% inversely
correlated to the vulnerable asset. This is more an ideal than a reality on the ground, and even the hypothetical
perfect hedge is not without cost. Basis risk refers to the risk that an asset and a hedge will not move in opposite
directions as expected; "basis" refers to the discrepancy.

39. COMMERCIAL BANKING VS CENTRAL BANKING;

Central Bank:
1. Work for the public welfare and economic development of a country. A central bank is
governed by the government of a country.

2. Controls and regulates the entries banking system of a country.

3. Does not deal directly with the public. It issue guidelines to commercial banks for the
economical development of the country.

4. Issues currency and control the supply of money in the Market.

5. Acts as a state owned institution.

6. Act as a custodian of a foreign exchange of the country.

7. Act as a banker to the Government.

8. Controls credit creations in the economy, thus acts as a clearing house of other banks.

Commercial Bank:
1. Operates for Profit Motive. The Majority of Stake is held by the government as well as
the private sector.
2. Operates under the direct control and supervision of the central bank. In India all the
commercial banks works under the guidelines issued by RBI.

3. Deals directly with the Public. It serves the financial requirement of the public by
providing short and medium terms loans and depositing and securing money that can
be drawn on demand.

4. Does not Issue currency, but only adds to the approval of the central bank.

5. Acts as a state or private owned institution.

6. Perform foreign exchange business only on the approval of the central bank.

7. Acts as agents of the central bank.

8. Acts as a clearing house only as a agent of the central bank.

40. WHY EVERY COUNTRY HAS ITS OWN CURRENCY ?

Currencies function as a storers of value. The dollar and other global currencies serve this purpose in
international trade, but sovereign countries need to have their own currencies for political reasons such as
independent policy making. They also need to have their own currencies for economic reasons : to be able
to maniplulate the supply of money in order to stimulate the economy when needed by offering cheap
money or restraining it when it overhheats by reducing its supply. This role is entrusted to the central
bank of each country.

This is the reason why the European financial crisis have been exacerbated: the use of a common currency
meant that the decision to perform such financial trickery rested beyond the control of the nations who
were struggling and became a consenes that must be reached by all the Euro countries.
Different currencies exist because different countries have different economic realities. For example, an
export oriented country will seek to maintain a low-value currency so as to maintain their trade
advantage. However, a country seeking to boost consumer spending and investment will want a currency
that is appreciating in value. Putting these two countries in a currency union will lead to conflict as they
have opposing monetary policies.

The Eurozone is a good example of this conflict. For Germany, the Euro is undervalued, which helps
exports, but stifles consumer spending. For Greece, the Euro is overvalued, which hurts exports and leads
to unsustainable consumption. Since both countries are on the Euro and influence its value, the value of
the Euro stays in the unhappy middle ground where it is neither beneficial to Germany or Greece.