Exam 10: Credit Risk: Individual Loans

The payoff function of a loan to a debt holder is similar to writing a call option on the value of the borrower's assets with the face value of the debt as the exercise price.

Suppose that the financial ratios of a potential borrowing firm took the following values: X₁ = 0.30 X₂ = 0 X₃ = -0.30 X₄ = 0.15 X₅ = 2.1 Altman's discriminant function takes the form: Z = 1.2 X₁ + 1.4 X₂ + 3.3 X₃ + 0.6 X₄ + 1.0 X₅ Suppose X₃ = 0.2 instead of -0.30. According to Altman's credit scoring model, the firm would fall under which default risk classification?

The exact interest rate to be charged on a fixed-rate loan is agreed upon by all parties at the time the commitment is negotiated.

The duration of a soon to be approved loan of $10 million is four years. The 99^th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the estimated risk-adjusted return on capital (RAROC) of this loan.

What is the least important factor determining bankruptcy, according to the Altman Z-score model?

Confidence Bank has made a loan to Risky Corporation. The loan terms include a default risk-free borrowing rate of 8 percent, a risk premium of 3 percent, an origination fee of 0.1875 percent, and a 9 percent compensating balance requirement. Required reserves are 6 percent. What is the expected or promised gross return on the loan?

The following represents two yield curves. What is the expected probability of default in year 2 of two-year maturity B - rated debt?

Commercial paper typically is secured by specific assets of the borrower.

Which of the following is NOT characteristic of the real estate portfolio for most banks?

Which of the following statements involving the promised return on a loan is NOT true?

Which of the following observations concerning floating-rate loans is NOT true?

Which of the following loan applicant characteristics is not relevant in the credit approval decision?

The risk premium, or spread, between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

Which of the following is not a characteristic of a loan commitment?

The following is information on current spot and forward term structures (assume the corporate debt pays interest annually): Using the term structure of default probabilities, the implied default probability for BBB corporate debt during the second year is

Commercial real estate mortgages have been the fastest growing component of real estate loans.

Cumulative default probability refers to

Because they are secured by homes, residential mortgages have demonstrated very little credit risk for FIs.

The duration of a soon to be approved loan of $10 million is four years. The 99^th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the capital (loan) risk of the loan if the current average level of interest rates for this category of bonds is 12 percent?

Commercial paper has become an acceptable substitute source for bank loans for many large corporations.