Applied Banking and Finance Knowledge (IABF Revision)
Core concepts
This domain rewards fluency with the financial arithmetic and balance-sheet logic behind banking. Know the time value of money (present/future value, discounting), simple vs compound interest, yield vs coupon, and how interest rate changes affect asset values. Understand the bank balance sheet: assets (loans, securities), liabilities (deposits, borrowings), and equity; and the drivers of net interest income (interest earned minus interest paid). Grasp liquidity (ability to meet obligations as they fall due) versus solvency (assets exceed liabilities), and the capital adequacy logic that equity absorbs losses. Be comfortable with credit risk fundamentals: probability of default, exposure, and loss given default, and with ratio analysis (e.g., loan-to-deposit, liquidity, capital ratios).
Traps in questions
- Mixing yield and coupon: if a bond is bought below par, yield exceeds coupon.
- Confusing liquidity with solvency: a solvent bank can still fail from a liquidity run.
- Forgetting that a rise in market rates generally reduces the price of fixed-rate assets.
- Using nominal rather than effective rates when compounding frequency differs.
Worked example
Deposit GBP 10,000 at 5% compounded annually for two years: 10,000 x 1.05 x 1.05 = GBP 11,025. Simple interest would give 10,000 + (10,000 x 0.05 x 2) = GBP 11,000. The GBP 25 difference is compounding - a classic distractor.
Rule of thumb
Discounting is compounding in reverse: divide by (1 + r)^n to bring future cash to today.