A bank is evaluating two loan proposals: Proposal X and Proposal Y. Proposal X is a five-year
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A bank is evaluating two loan proposals: Proposal X and Proposal Y. Proposal X is a five-year loan with an interest rate of 8% per annum. Proposal Y is a seven-year loan with an interest rate of 10% per annum. The bank wants to determine which loan proposal is riskier and what the potential loss could be for each proposal if the borrower defaults. The bank has the following information:
- Proposal X has a principal amount of $1,000,000, and the borrower has a credit score of 750.
- Proposal Y has a principal amount of $1,500,000, and the borrower has a credit score of 650.
- The probability of default for Proposal X is 10%, and the probability of default for Proposal Y is 20%.
- In the event of default, the bank expects to recover 50% of the outstanding principal amount for Proposal X and 30% of the outstanding principal amount for Proposal Y.
Assuming a normal distribution, calculate the standard deviation of the potential loss for each proposal and determine which proposal is riskier.
Related Book For
Fundamentals of Corporate Finance
ISBN: 978-1259024962
6th Canadian edition
Authors: Richard Brealey, Stewart Myers, Alan Marcus, Devashis Mitra, Elizabeth Maynes, William Lim
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