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Questions and Answers of
Banking
Consider the coefficients of Altman’s Z-score. Can you tell by the size of the coefficients which ratio appears most important in assessing the creditworthiness of a loan applicant? Explain.
If the rate on one-year Treasury strips currently is 6 percent, what is the repayment probability for each of the following two securities? Assume that if the loan is defaulted, no payments are
A bank has made a loan charging a base lending rate of 10 percent. It expects a probability of default of 5 percent. If the loan is defaulted, the bank expects to recover 50 percent of its money
Assume a one-year Treasury strip is currently yielding 5.5 percent and an AAA-rated discount bond with similar maturity is yielding 8.5 percent. a. If the expected recovery from collateral in the
What is meant by the phrase marginal default probability? How does this term differ from cumulative default probability? How are the two terms related?
Suppose an FI manager wants to find the probability of default on a two-year loan. For the one-year loan, 1 - p1 = 0.03 is the marginal and total or cumulative probability (Cp) of default in year 1.
From the Treasury strip yield curve, the current required yields on one- and two-year Treasuries are i1 = 4.65 percent and i2 = 5.50 percent, respectively. Further, the current yield curve indicates
Calculate the term structure of default probabilities over three years using the following spot rates from the Treasury strip and corporate bond (pure discount) yield curves. Be sure to calculate
The bond equivalent yields for U.S. Treasury and A-rated corporate bonds with maturities of 93 and 175 days are given below:a. What are the implied forward rates for both an 82-day Treasury and an
What is the mortality rate of a bond or loan? What are some of the problems with using a mortality rate approach to determine the probability of default of a given bond issue?
The following is a schedule of historical defaults (yearly and cumulative) experienced by an FI manager on a portfolio of commercial and mortgage loans.a. Complete the blank spaces in the table.b.
The table below shows the dollar amounts of outstanding bonds and corresponding default amounts for every year over the past five years. Note that the default figures are in millions, while those
What is RAROC? How does this model use the concept of duration to measure the risk exposure of a loan? How is the expected change in the credit risk premium measured? What precisely is (LN in the
An FI wants to evaluate the credit risk of a $5 million loan with a duration of 4.3 years to a AAA borrower. There are currently 500 publicly traded bonds in that class (i.e., bonds issued by firms
A bank is planning to make a loan of $5,000,000 to a firm in the steel industry. It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years with a duration of 7.5
Calculate the value of and interest rate on a loan using the option model and the following information. Face value of loan (B) = $500,000Length of time remaining to loan maturity (τ) = 4
A firm is issuing a two-year loan in the amount of $200,000. The current market value of the borrower’s assets is $300,000. The risk-free rate is 4 percent and the standard deviation of the rate of
A firm has assets of $200,000 and total debts of $175,000. With an option pricing model, the implied volatility of the value of the firm’s assets is estimated at $10,730. Under the Moody’s
Carman County Bank (CCB) has a $5 million face value outstanding adjustable-rate loan to a company that has a leverage ratio of 80 percent. The current risk-free rate is 6 percent and the time to
Consider the following company balance sheet and income statement.For this company, calculate the following:a. Current ratio.b. Number of days' sales in receivables.c. Sales to total assets.d. Number
Industrial Corporation has an income-to-sales (profit margin) ratio of 0.03, a sales to assets (asset utilization) ratio of 1.5, and a debt to asset ratio of 0.66. What is Industrial’s return on
What are the primary characteristics of residential mortgage loans? Why does the ratio of adjustable-rate mortgages to fixed-rate mortgages in the economy vary over an interest rate cycle? When
What are the two major classes of consumer loans at U.S. banks? How do revolving loans differ from nonrevolving loans?
Why are rates on credit card loans generally higher than rates on car loans?
Suppose that a bank does the following:1. Sets a loan rate on a prospective loan at 8 percent (where BR = 5% and ϕ = 3%). 2. Charges a 1/10 percent (or 0.10 percent) loan origination fee to the
As a senior loan officer at MC Financial Corp, you have a loan application from a firm in the biotech industry. While the loan has been approved on the basis of an individual loan, you must evaluate
What is the minimum risk portfolio? Why is this portfolio usually not the portfolio chosen by FIs to optimize the return-risk tradeoff?
The obvious benefit to holding a diversified portfolio of loans is to spread risk exposures so that a single event does not result in a great loss to an FI. Are there any benefits to not being
A bank vice president is attempting to rank, in terms of the risk-reward trade-off, the loan portfolios of three loan officers. Information on the portfolios is noted below. How would you rank the
Suppose that an FI holds two loans with the following characteristics.Calculate of the return and risk on the two-asset portfolio using Moodys Analytics Portfolio Manager.
CountrySide Bank uses the Moody’s Analytics Portfolio Manager model to evaluate the risk-return characteristics of the loans in its portfolio. A specific $10 million loan earns 2 percent per year
Suppose that an FI holds two loans with the following characteristics.The return on loan 1 is R1 = 6.25%, the risk on loan 2 is σ2 = 1.8233%, and the return of the portfolio is Rp = 4.555%.
What databases are available that contain loan information at national and regional levels? How can they be used to analyze credit concentration risk?
Information concerning the allocation of loan portfolios to different market sectors is given below:a. Which bank is further away from the national average?b. Is a large standard deviation
Assume that, on average, national banks engaged primarily in mortgage lending have their assets diversified in the following proportions: 60 percent residential, 15 percent commercial, 5 percent
Over the past 10 years, a bank has experienced the following loan losses on its C&I loans, consumer loans, and total loan portfolio.Using regression analysis on these historical loan losses, the bank
What is migration analysis? How do FIs use it to measure credit risk concentration? What are its shortcomings?
What reasons did the Federal Reserve Board offer for recommending the use of subjective evaluations of credit concentration risk instead of quantitative models? How did this change in 2006?
What rules on credit concentrations has the National Association of Insurance Commissioners enacted? How are they related to modern portfolio theory?
An FI is limited to holding no more than 8 percent of its assets in securities of a single issuer. What is the minimum number of securities it should hold to meet this requirement? What if the
From Table 11A-1, what is the probability of a loan upgrade? A loan downgrade? The probability of an upgrade is 5.95% + 0.33% + 0.02% = 6.30%. The probability of a downgrade is 5.30% + 1.17% + 0.12%
A five-year fixed-rate loan of $100 million carries a 7 percent annual interest rate. The borrower is rated BB. Based on hypothetical historical data, the probability distribution given below has
How does the Credit Risk+ model of Credit Suisse Financial Products differ from the CreditMetrics model of J.P. Morgan Chase?
An FI has a loan portfolio of 10,000 loans of $10,000 each. The loans have a historical average default rate of 4 percent and the severity of loss is 40 cents per dollar. a. Over the next year, what
What does loan concentration risk mean?
A manager decides not to lend to any firm in sectors that generate losses in excess of 5 percent of capital. a. If the average historical losses in the automobile sector total 8 percent, what is the
An FI has set a maximum loss of 2 percent of total capital as a basis for setting concentration limits on loans to individual firms. If it has set a concentration limit of 25 percent to a firm, what
Suppose that an FI holds two loans with the following characteristics:Calculate the return and risk of the portfolio.
The Bank of Tinytown has two $20,000 loans that have the following characteristics. Loan A has an expected return of 10 percent and a standard deviation of returns of 10 percent. The expected
Why is it difficult for small banks and thrifts to measure credit risk using modern portfolio theory?
A DI has the following balance sheet (in millions).The DI€™s securities portfolio includes $16 million in T-bills and $10 million in GNMA securities. The DI has a $20 million line of credit to
A DI has assets of $10 million consisting of $1 million in cash and $9 million in loans. The DI has core deposits of $6 million, subordinated debt of $2 million, and equity of $2 million. Increases
A DI has $10 million in T-bills, a $5 million line of credit to borrow in the repo market, and $5 million in excess cash reserves (above reserve requirements) with the Fed. The DI currently has
A DI has the following assets in its portfolio: $10 million in cash reserves with the Fed, $25 million in T-bills, and $65 million in mortgage loans. If the DI has to liquidate the assets today, it
A DI has the following assets in its portfolio: $20 million in cash reserves with the Fed, $20 million in T-bills, and $50 million in mortgage loans. If the assets need to be liquidated at short
Conglomerate Corporation has acquired Acme Corporation. To help finance the takeover, Conglomerate will liquidate the overfunded portion of Acmes pension fund. The face values and current
Plainbank has $10 million in cash and equivalents, $30 million in loans, and $15 in core deposits. a. Calculate the financing gap.b. What is the financing requirement?c. How can the financing gap be
How can an FI’s liquidity plan help reduce the effects of liquidity shortages? What are the components of a liquidity plan?
The following is the balance sheet of a DI (in millions):The asset-liability management committee has estimated that the loans, whose average interest rate is 6 percent and whose average life is
What are the levels of defense against liquidity risk for a life insurance company? How does liquidity risk for a property-casualty insurer differ from that for a life insurance company?
A mutual fund has the following assets in its portfolio: $40 million in fixed-income securities and $40 million in stocks at current market values. In the event of a liquidity crisis, the fund can
A mutual fund has $1 million in cash and $9 million invested in securities. It currently has 1 million shares outstanding. a. What is the net asset value (NAV) of this fund?b. Assume that some of the
A DI with the following balance sheet (in millions) expects a net deposit drain of $15 million.Show the DI's balance sheet if the following conditions occur:a. The DI purchases liabilities to
AllStarBank has the following balance sheet (in millions):a. Stored liquidity management.b. Purchased liquidity management.
Calculate the dollar proceeds from the FIs loan portfolio at the end of the year, the return on the FIs loan portfolio, and the net interest margin for the FI if the spot
Calculate the dollar proceeds from the FIs loan portfolio at the end of the year, the return on the FIs loan portfolio, and the net interest margin for the FI if the pound
Suppose that instead of funding the $300 million investment in 8 percent British loans with U.S. CDs, the FI manager funds the British loans with $300 million equivalent one-year pound CDs at a rate
Using the information in part 4, calculate the return on the FI€™s loan portfolio, the average cost of funds, and the net interest margin for the FI if the pound spot foreign exchange rate falls
Using the information in part 4, calculate the return on the FIs loan portfolio, the average cost of funds, and the net interest margin for the FI if the pound spot foreign exchange rate
Suppose that instead of funding the $300 million investment in 8 percent British loans with CDs issued in the United Kingdom, the FI manager hedges the foreign exchange risk on the British loans by
What are four FX risks faced by FIs?
City Bank issued $200 million of one-year CDs in the United States at a rate of 6.50 percent. It invested part of this money, $100 million, in the purchase of a one-year bond issued by a U.S. firm at
Sun Bank USA purchased a 16 million one-year euro loan that pays 12 percent interest annually. The spot rate of U.S. dollars per euro is 1.25. Sun Bank has funded this loan by accepting a British
Bank USA just made a one-year $10 million loan that pays 10 percent interest annually. The loan was funded with a Swiss franc-denominated one-year deposit at an annual rate of 6 percent. The current
Suppose that instead of funding the $100 million investment in 12 percent British loans with U.S. CDs, the FI manager in problem 15 funds the British loans with $100 million equivalent one-year pound
Suppose that instead of funding the $100 million investment in 12 percent British loans with CDs issued in the United Kingdom, the FI manager in problem 16 hedges the foreign exchange risk on the
North Bank has been borrowing in the U.S. markets and lending abroad, thus incurring foreign exchange risk. In a recent transaction, it issued a one-year, $2 million CD at 6 percent and funded a loan
A bank purchases a six-month, $1 million Eurodollar deposit at an annual interest rate of 6.5 percent. It invests the funds in a six-month Swedish krone AA-rated bond paying 7.5 percent per year. The
How does the lack of perfect correlation of economic returns between international financial markets affect the risk-return opportunities for FIs holding multicurrency assets and liabilities? Refer
What is the relationship between the real interest rate, the expected inflation rate, and the nominal interest rate on fixed-income securities in any particular country? What factors may be the
What is economic integration? What impact does the extent of economic integration of international markets have on the investment opportunities for FIs?
Refer to Table 13-1. a. What was the spot exchange rate of Canadian dollars for U.S. dollars on July 4, 2012? b. What was the six-month forward exchange rate of Japanese yen for U.S. dollars on
An FI has $100,000 of net positions outstanding in British pounds (£) and -$30,000 in Swiss francs (SF). The standard deviation of the net positions as a result of exchange rate changes is 1
A money market mutual fund manager is looking for some profitable investment opportunities and observes the following one-year interest rates on government securities and exchange rates: rUS = 12%,
Refer to Table 13-1. a. On June 4, 2012, you purchased a British pound-denominated CD by converting $1 million to pounds at a rate of 0.6435 pounds for U.S. dollars. It is now July 4, 2012. Has the
On July 4, 2012, you convert $500,000 U.S. dollars to Japanese yen in the spot foreign exchange market and purchase a one-month forward contract to convert yen into dollars. How much will you
X-IM Bank has ¥14 million in assets and ¥23 million in liabilities and has sold ¥8 million in foreign currency trading. What is the net exposure for X-IM? For what type of exchange rate movement
The following are the foreign currency positions of an FI, expressed in the foreign currency.The exchange rate of dollars per SFs is 0.9301, of dollars per British pounds is 1.6400, and of dollars
What are the four FX trading activities undertaken by FIs? How do FIs profit from these activities?
What risks are incurred in making loans to borrowers based in foreign countries? Explain.
What shortcomings are introduced by using traditional CRA models and techniques? In each case, what adjustments are made in the estimation techniques to compensate for the problems?
What is systematic risk in terms of sovereign risk? Which of the variables often used in statistical models tend to have high systematic risk? Which variables tend to have low systematic risk?
The average (2ER (or VAREX = variance of export revenue) of a group of countries has been estimated at 20 percent. The individual VAREXes of two countries in the group, the Netherlands and Singapore,
What are the benefits and costs of rescheduling to the following? a. A borrower. b. A lender.
Who are the primary sellers of LDC and EM debt? Who are the buyers? Why are FIs often both sellers and buyers of LDC and EM debt in the secondary markets?
Identify and describe the three market segments of the secondary market for LDC And EM debt.
What are the risks to an investing company participating in a debt-for-equity swap?
Chase Bank holds a $200 million loan to Argentina. The loans are being traded at bid-offer prices of 91-93 per 100 in the London secondary market. a. If Chase has an opportunity to sell this loan to
Zlick Company plans to invest $20 million in Chile to expand its subsidiary’s manufacturing output. Zlick has two options. It can convert the $20 million at the current exchange rate of 410 pesos
What is concessionality in the process of rescheduling a loan?
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