Credit risk Flashcards
what are some factors that impact upon promised return on loans?
- loan interests rate
- fees
- credit risk premium (m-margin)
- collateral
- other ie compensating balance
what is the symbol for compensating balance % in the 1+k formula to calculate return on loan?
b
what does the BR stand for in the formula to calculate return on loan? what is the m?
Base rate
credit risk premium the bank charges ie margin.
when calculating the expected return on a loan what does the p value stand for in the E(r) formula?
the probability of repayment
what is the relationship between the m value and the p value?
when m increases p decreases as the banks believe the risk of default increased.
what is the catch 22 regarding charging a higher m value?
banks need to protect themselves from default risk by charging a high enough m, however the higher the m value the more significant the decrease on the p value will be when calculating E(r)
for the Term Structure formula, what does 1+I stand for?
return on one year risk free government security
for the Term Structure formula, what does 1+k stand for?
promised return on a one year corp debt security
if you want to find the probability of repayment in the Term Structure formula what do you do? p of default?
1+I/1+k
1-(1+I/1+k)
in the k-i (required risk premium) formula for credit risk, what does the symbol gamma signify?
the percentage a bank can recover in the case of default?
what does RAROC tell us?
the amount of money at risk, based on the change in loan (sensitive to duration) and the yearly income from loan
What are the main features of the modern portfolio therom?
FIs can take advantage of their size to diversify their credit risk, as long as there is low correlation in the return from assets (close to 0 - negative is best)
create a portfolio that reduces the variance in return, however, low risk also equals low returns.
what does KMV tell us?
expected return on loan to borrower
risk of loan to borrower
correlation of default risks
