Suppose the bank has a portfolio of risky assets that cost 100 at t=0. The bank finances
Question:
Suppose the bank has a portfolio of risky assets that cost 100 at t=0. The bank finances the portfolio with debt (d) and equity (e), where d + e = 100. Suppose (approximation) the return R from the risky portfolio has a Normal distribution with mean µ and standard deviation at t = 1, with µ = 110 and = 10.
a) Assume the value of bank debt outstanding is 97. What is the probability the bank will default?
b) The bank wants to keep the probability of failure at a maximum of 5%. Calculate economic capital.
c) The regulator wants to keep the probability of default at 1%. Calculate regulatory capital.
d) How does the bank’s default probability change with its leverage (d/e) and the riskiness of the assets?
Income Tax Fundamentals 2013
ISBN: 9781285586618
31st Edition
Authors: Gerald E. Whittenburg, Martha Altus Buller, Steven L Gill