Principles of Business for CSEC®

2nd edition

Answers to Chapter 8: Business finance

“Setting the scene” answers
1. A financial institution is an organisation that manages and supervises the provision of
finance in some way, e.g. the central bank supervises the financial system, commercial banks
look after the safe-keeping of deposits and make loans to customers, etc.
2. Trinidad and Tobago is a vibrant commercial economy with a population of 1.37 million
people (estimate for 2018). Businesses are able to raise finance from bank loans, mortgages
and other financial instruments. Businesses can also place their money for safe-keeping
with commercial banks. Households can deposit their wages and savings in a bank, and
can use the bank to withdraw funds, make payments, save money and borrow money.
Businesses and households will also want to insure their premises, goods and many other
things through insurance policies taken out with insurance companies. In Trinidad and
Tobago there is also a stock exchange which enables investors to invest in companies, and
companies to raise funds by selling shares. These are just some of the financial institutions
designed to facilitate the financial dealings of households, businesses and government.
3. Commercial banks seek to make a profit from taking in deposits (on which they pay out
interest) and making loans from bank funds (including deposits). The interest on loans
granted will be higher than the interest on deposits looked after by the bank. Banks will
also make money from providing a range of other services, e.g. through mortgages (for the
purchase of property), by looking after valuables (e.g. in a safe deposit box), by offering credit
cards which enable customers to purchase goods on credit terms, and many other services.
4. Pension funds accumulate their funds from workers who are saving up to receive an
occupational pension when they retire. The funds that a pension fund holds are managed
by one or more fund managers who will invest the funds in stocks and shares and other
investments, with the intention of seeing the value of the fund rise over time so that the
pension pot increases and there are sufficient funds to pay out pensions to pensioners when
they retire.
5. A student could benefit from many different financial institutions, for example:
• being able one day to borrow money to buy a house through a building society
• being able to save money in a credit union
• taking out insurance with an insurance company (e.g. insurance for a motorcycle)
• borrowing money from a bank
• buying shares in a public company through a market maker on the stock exchange, etc.

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“Now try these” answers

8.1 Identify various financial institutions
1. Answers will vary but may include: to print currency, notes and coins; to act as the
government’s bank; to establish overall interest rates in a country.
2. Central banks license other banks and financial institutions. They also control the monetary
system and therefore determine how much money is in circulation. They meet with heads of
financial institutions to discuss how they operate.
3. The main work of an insurance company is to provide insurance. Its main customers are
businesses and individuals. The main work of a building society is to hold savings, provide
mortgages and give other financial services. Its main customers are individuals.
4. Business in action: This will be unique for each student.

8.2 Describe the functions and services offered by

financial institutions
1. The main function of a bank is to transfer funds from those who want to save money to those
who want to borrow money. For those who want to save, banks provide savings accounts
where the customers earn interest on the money they put in the bank. For those wanting to
borrow money, the bank lends out money at a certain rate of interest.
2. Services designed to keep depositors’ money safe include night safe deposits, online
banking and the security that has been put in place around this service, advisory
services, etc.
3. Night safe deposits allow customers to make deposits even when the bank is closed.
Customers can also make deposits by cheque or cash within a bank.
4. A settlement service is used to settle obligations. For example, if person x owed person y a
payment, a settlement service can be used, such as writing a cheque which can then be paid
directly into the owed account. In contrast, remittance is for sending funds overseas.
5. Business in action: This will be unique for each student.

8.3 Describe the role and functions of financial regulatory bodies

1. Financial regulation is so important because it creates rules of fair play to ensure that the
financial system is in safe hands. The beneficiaries of financial regulations are customers of
financial institutions and the institutions themselves.
2. Answers will vary. One example is the control that regulatory bodies have over the financial
system. Regulatory bodies are able to control the activities of financial institutions by setting
out how much they can lend, the proportion of funds they must hold relative to their loans,
etc.
3. Regulators will want to regulate the lending of money, the proportion of funds held by the
institution, etc.
4. Business in action: This will be unique for each student.

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8.4 Describe the relationship between financial institutions and

regulatory bodies
1. The government may want to restrict bank lending in a country so that businesses do not
borrow more than they can reasonably pay off.
(a) The central bank may force banks to increase their liquidity ratio so that they increase
the ability to turn assets into cash. By doing this, they will reduce the amount they can
lend.
(b) If the central bank increases the bank rate, banks will owe more money on the accounts
they hold with the central bank, which in turn will raise interest rates charged by
commercial banks, meaning they can lend less.
(c) If banks are required to hold additional reserve deposits, this will tie up money and
therefore reduce the amount they can lend.
2. The government may want to increase bank lending to allow businesses to take out loans
so they can expand. The government could do this by lowering the bank rate, which in turn
would lower interest rates.
3. Business in action: This will be unique for each student.

8.5 Outline ways used by individuals to manage personal income

1. Some people invest in gold because it is valuable and there is a high chance that the price of
gold will remain stable or even rise. However, the drawbacks are that the price may fall, and
people may have to pay quite a lot to store the gold safely (if they have physically bought it).
2. When the value of company shares may have more of a potential to rise than the value of land.
3. A unit trust is a fund that purchases shares in several companies. Therefore, if one of the
companies does badly, the investors do not lose as much as if all of their money was invested
in that one company.
4. Business in action: This will be unique for each student.

8.6 Differentiate between savings and investments

1. Saving is putting money away (usually in a bank account) to keep it safe. The saver can
accumulate savings over time by adding to them. Investing is using the money to purchase
assets that will generate income over a period of time.
2. Answers will vary, but may include working out how risky the investment is, finding out when
the income from the investment will be generated, etc.
3. Government bonds are less risky and there is less chance of losing money with them.
4. Answers will vary. One suggestion is that as her aunt wants her to save the money, investing
in a five-year fixed term deposit account would give her the most interest, although it would
tie up the money for five years.
5. Business in action: This will be unique for each student.

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8.7 Explain the concepts of short-term and long-term financing

1. Answers will vary, but could include a commercial bank loan (money can be accessed
immediately once the loan is signed, but there may be a high level of interest due); a
promissory note (the company signs to promise payment in the future); and crowd funding
(there may be no interest to pay on the money, but the money may take time to come in).
2. Answers will vary, but one example is that the business could secure additional funding by
joining an indigenous credit system (adding money to a central pool and then waiting their
turn to access this pool).
3. Banks and governments may provide long-term finance for businesses. They would give
businesses time to use the money for investing in/expanding a business and to reap the
benefits before giving the money back.
4. Business in action: This will be unique for each student.

8.8 Identify personal sources of capital for setting up a business

1. Answers will vary but may include: personal savings and funds from friends and relatives may
be limited, and you risk personal grievances if the business fails. Venture capitalists may want
a say in the business in which they are investing.
2. Raising finance through equity would raise funds but reduce Vinod and Rohan’s share in
the company. Taking out a bank loan would mean they keep control of the company, but it
would mean paying back the money with interest when the loan is recalled.
3. Business in action: This will be unique for each student.

8.9 Identify the purposes of basic financial records for sole traders
1. An income statement would show them how well the company is doing, and therefore how
much money their investment will be giving them.
2. A statement of cash flow would would help to provide an overview of the cash flows in and
out of a business over a recent period of time. It would indicate whether the business is
generating sufficient cash flow from its operations or whether the business is losing a lot of
cash. The statement would also indicate cash flows from financing activities.
3. The sole trader would be able to find out the financial health of his or her business at a
particular moment in time from studying the statement of financial position. He or she
could see how much the business owns and how much it owes to lenders. The statement
of financial position would show whether the business has sufficient assets to cover its
liabilities as well as the extent of pressing current liabilities.
4. Business in action: Assets = capital + liabilities. Capital = assets – liabilities. Capital =
($100 000 + $30 000) – ($20 000 + $30 000). Capital = $80 000.

“Develop your exam skills” answers

Paper 1
1. The correct answer is C. Whereas commercial banks, insurance companies and unit trusts all
seek to make a profit, credit unions are mutual benefit associations that run on not-for-profit
lines.

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2. The correct answer is D. With an overdraft the customers can withdraw more from their
bank account than they currently hold in the account. They are charged on the amount
outstanding on a daily basis.
3. The correct answer is C. Depositors in commercial banks in the Caribbean will often have
their deposits insured up to a given limit under government schemes such as the Jamaica
Deposit Insurance Company scheme, to create confidence in the financial system.
4. The correct answer is C. Primary responsibility for regulating insurance companies and
pension funds is given to the financial services commission.
5. The correct answer is B. Commercial banks are given a licence to operate by the central bank
of a country.
6. The correct answer is B. Investment involves the purchase of a financial asset in the hope of
making a return from doing so, such as by purchasing units in a unit trust.
7. The correct answer is A. Remittances are sums of money earned by citizens from working
abroad, which they then send back to their own country.
8. The correct answer is C. The supervisor of insurance in a country is responsible for regulating
the insurance industry.
9. The correct answer is C. Equity capital is secured by the issuing of shares.
10. The correct answer is A. A mortgage to buy property may be for periods of up to 25 years. The
other examples all relate to short-term financing.

Paper 2
1. (a) Answers could include any two of the following:
• Trade credit
• Commercial bank loans
• Promissory notes
• Instalment credit
• Indigenous credit or private money lenders
• Advances from customers
• Factoring
• Venture capitalists
• Crowd funding
• Angel investors
(b) Answers could include one of the following:
• Commercial banks
• Credit unions
• Micro lending agencies
(c) Savings refer to the part of an income that is not spent. Investment occurs when assets
are purchased in order to generate income in the future. Savings are easily accessible
and have low risk involved. Investment carries higher risk and is not readily available.
• Examples of saving: sou sou arrangements, deposits in savings and short-term fixed
deposits
• Examples of investment: shares, securities, mutual funds

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2. (a) Answers could include two of the following:

• Central bank
• Financial Services Commission
• Deposit Insurance Corporation
(b) Answers could include two of the following:
• Central bank: licenses the banks and other financial institutions so they can be
established. The central bank also inspects the liquidity ratios to reduce the risk of
failure.
• Financial Services Commission: licenses companies that want to sell investments
such as insurance and pensions. This will protect unsuspecting investors.
• Deposit Insurance Corporation: guarantees the money held in banks. This will boost
confidence in the banking system.
(c) Answers could include the following points:
• Commercial banks accept deposits, provide loans, facilitate payments and provide
other services
• Credit unions are set up by a group in a community to benefit them through
promoting thrift
• Once an individual joins a credit union they are an owner because they must own
shares, whereas individuals with bank accounts do not own the bank
• Banks are motivated by profits while credit unions are normally not-for-profit and
are motivated to promote thrift
• Commercial banks tend to be private or public limited companies while credit
unions are co-operatives
3. (a) This is a financial plan designed for the future, e.g. the next 12 months, setting out the
expected income and expenditure for a given period.
(b) Answers could include any three of the following:
• friends and family
• personal savings
• government grants
• loans
• equity
• venture capital
• crowd funding
(c) Answers could include an explanation of any two of the following:
• Income statement (profit and loss) – this shows how much a business has earned
from selling its products or services, and how much it has paid out in costs. It is
prepared to determine if a net profit or loss has been made.
• Statement of financial position (balance sheet) – this shows the financial health of a
business at a particular moment in time. It lists the assets, liabilities and capital of a
business.
• Statement of cash flows – shows how cash moves into and out of a company over a
period of time.

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4. (a) Answers could include any two of the following:

• Credit unions
• Insurance companies
• Micro lending agencies
• Building societies
• Government agencies
(b) Answers could include an explanation of any two of the following:
• Credit unions – encourage members to save, and in return the unions provide
members with credit at relatively low rates of interest.
• Insurance companies – set up primarily to cover the risks of their customers and
provide compensation where a loss has occurred.
• Micro lending agencies – provide small loans and other banking services to
individuals who may find it difficult to get finance from banks.
• Building societies – pool funds of members in order to provide mortgages for
members (and other financial services), so that members can afford homes.
• Government agencies – provide low interest loans and grants to businesses who
might otherwise find it difficult to source funding.
(c) Answers could include an explanation of any two of the following:
• Night safes – these are found immediately outside of banks. Business owners are
given a key and can drop the day’s earnings in safely after hours.
• Online banking – enables a customer to log on and manage their bank account
through the Internet. It can be done from the comfort of home or conveniently on
the phone.
• Automated Teller Machines – these allow customers to carry out a limited range of
transactions at any time of day or night. Unfortunately, they might not be always
safe so customers need to be careful, and they do not always have money or
envelopes so some transactions cannot be carried out.

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