Chapter 10

Question 1

Spot loan vs loan commitment

Answer 1

Spot loan: involves the immediate takedown of the loan by the borrower

Loan commitment: allows the borrower the option to take down the loan any time during a fixed period at a predetermined rate

Question 2

Compensating balances definition

Answer 2

Portion of a loan that a borrower must keep on deposit with the credit-granting FI

Question 3

Credit rationing definition

Answer 3

Restricting the amount of loans that are available to individual borrowers

Question 4

Credit scoring models def

Answer 4

Used to calculate the prob of default or to sort borrowers into different default risk classes

Question 5

Altman’s formula

Answer 5

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + X5

WREMS

If <3: firm is in the indeterminant default risk region -> should not make a loan to this borrower

Question 6

Expected return on a loan formula

Answer 6

E(r) = p(1+k) + (1-p)(1+k)*gamma

Where:

• p = prob of success
• k = base lending rate
• gamma = % of recovering if default

Question 7

Cumulative default prob formula (2 years)

Answer 7

CDP = 1 - (p1)*(p2)

where pt = 1 - MDP_t

Question 8

1-year forward rate on treasuries and corporate bond

Answer 8

Treasury: f1 = (1+i2)^2/(1+i1)

where i1, i2 = current required yield on 1- and 2-year treasuries

Corporate bond: c1 = (1+k2)^2/(1+k1)

where k1,k2 = yields of 1- and 2-year discount bonds

Question 9

Marginal prob of repayment on corporate bond in years 1 and 2

Answer 9

p1 = (1+i1)/(1+k1)

p2 = (1+i2)/(1+k2)

-> prob of default = 1 - p

where i1, i2 = current required yield on 1- and 2-year treasuries

and k1,k2 = yields of 1- and 2-year discount bonds