Consider a two period model with credit market imperfections. More specifically, lenders face a pool of...

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Consider a two period model with credit market imperfections. More specifically, lenders face a pool of borrowers with different risk factors. For simplicity, suppose that fractiona of borrowers is risky and they never pay their debt back. Fraction 1-a of the borrowers is risk-free and they pay back their debt. However, the lenders cannot distinguish between the riskyand risk-free borrowers. Therefore, they charge the same interest rate to both type ofborrowers. Given that the lending rate is r, using the zero-profit condition for the lenders, compute the borrowing rate, r, as a function of the lending rate r and the fraction of riskyborrowers, a. What happens to the borrowing rate r if the fraction of risky borrowers, a, increases? Explain. Determine the effect of an increase in the fraction of risky borrowers onequilibrium prices (real interest rate (lending rate) and wages) and quantities (output,consumption, employment and investment) within the context of a two-period realintertemporal model with credit market imperfections. QUESTION 3B. CREDIT RISK AND LOAN PRICING (6 MARKS) Loan concentration risk can be managed via migration analysis. (i) Explain the concept of migration analysis. (2 marks) (ii) Use the following table to provide one (1) specific example on how a bank can make decisions about a loan portfolio based on credit grade migration. (4 marks) Risk grade at end of year AAA-A BBB-B CCC-C D AAAA 0.85 0.10 0.04 0.01 Risk grade at beginning of year BBB-B 0.12 0.83 0.03 0.02 CCC-C 0.03 0.13 0.80 0.04 D=default QUESTION 3A. CREDIT RISK AND LOAN PRICING (6 MARKS) What is meant by "credit scoring" in the context of banks' credit risk management? Detail one (1) type of credit scoring models used in practice. QUESTION 2 a. Define the term credit risk and risk mitigation in credit management. (25 MARKS) (4 marks) (CLO1:PLO1:C1) b. Which of the credit decision models are subjective and objective and under what circumstances will the objective model be appropriate? (7 marks) (CLO1:PLO1:C1) Explain the main factor in evaluating applicant's credit worthiness and how it is determined. d. List SIX (6) sources of credit information. e. Briefly explain the role of credit bureau. (4 marks) (CLO3:PLO4:C4) (6 marks) (CLO1:PLO1:C1) (4 marks) QUESTION (CLO1:PLO1:C1) Consider a two period model with credit market imperfections. More specifically, lenders face a pool of borrowers with different risk factors. For simplicity, suppose that fractiona of borrowers is risky and they never pay their debt back. Fraction 1-a of the borrowers is risk-free and they pay back their debt. However, the lenders cannot distinguish between the riskyand risk-free borrowers. Therefore, they charge the same interest rate to both type ofborrowers. Given that the lending rate is r, using the zero-profit condition for the lenders, compute the borrowing rate, r, as a function of the lending rate r and the fraction of riskyborrowers, a. What happens to the borrowing rate r if the fraction of risky borrowers, a, increases? Explain. Determine the effect of an increase in the fraction of risky borrowers onequilibrium prices (real interest rate (lending rate) and wages) and quantities (output,consumption, employment and investment) within the context of a two-period realintertemporal model with credit market imperfections. QUESTION 3B. CREDIT RISK AND LOAN PRICING (6 MARKS) Loan concentration risk can be managed via migration analysis. (i) Explain the concept of migration analysis. (2 marks) (ii) Use the following table to provide one (1) specific example on how a bank can make decisions about a loan portfolio based on credit grade migration. (4 marks) Risk grade at end of year AAA-A BBB-B CCC-C D AAAA 0.85 0.10 0.04 0.01 Risk grade at beginning of year BBB-B 0.12 0.83 0.03 0.02 CCC-C 0.03 0.13 0.80 0.04 D=default QUESTION 3A. CREDIT RISK AND LOAN PRICING (6 MARKS) What is meant by "credit scoring" in the context of banks' credit risk management? Detail one (1) type of credit scoring models used in practice. QUESTION 2 a. Define the term credit risk and risk mitigation in credit management. (25 MARKS) (4 marks) (CLO1:PLO1:C1) b. Which of the credit decision models are subjective and objective and under what circumstances will the objective model be appropriate? (7 marks) (CLO1:PLO1:C1) Explain the main factor in evaluating applicant's credit worthiness and how it is determined. d. List SIX (6) sources of credit information. e. Briefly explain the role of credit bureau. (4 marks) (CLO3:PLO4:C4) (6 marks) (CLO1:PLO1:C1) (4 marks) QUESTION (CLO1:PLO1:C1)