Question 1

Credit rationing is a form of managing credit risk.

Accepted Answer

A) True 
 B)False

Question 2

According to Altman's credit scoring model, which of the following Z scores would indicate a low default risk firm?

Accepted Answer

A) Less than 1. 
B) 1. 
C) Between 1 and 1.81. 
D) Between 1.81 and 2.99. 
E) Greater than 2.99. 
A) Less than 1. 
B) 1. 
C) Between 1 and 1.81. 
D) Between 1.81 and 2.99. 
E) Greater than 2.99.

Question 3

What does the Moody's Analytics model use as equivalent to holding a call option on the assets of the firm?

Accepted Answer

A) The value of equity in a firm. 
B) Total liabilities of a firm. 
C) Net income of a firm. 
D) Dividend yield of investments. 
E) Short-term debt liabilities of a firm. 
A) The value of equity in a firm. 
B) Total liabilities of a firm. 
C) Net income of a firm. 
D) Dividend yield of investments. 
E) Short-term debt liabilities of a firm.

Question 4

A major difficulty in estimating RAROC for a loan is the measurement of individual loan risk.

Accepted Answer

A) True 
 B)False

Question 5

What is the expected probability of default in year 2 of two-year maturity B-rated debt?

Accepted Answer

A) 2.83 percent. 
B) 3.00 percent. 
C) 4.43 percent. 
D) 2.68 percent. 
E) 5.00 percent. [Refer to: 10-107] 
A) 2.83 percent. 
B) 3.00 percent. 
C) 4.43 percent. 
D) 2.68 percent. 
E) 5.00 percent. [Refer to: 10-107]

Question 6

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower?

Accepted Answer

A) Mortality rates. 
B) RAROC. 
C) Implicit contracts. 
D) Covenants. 
E) Credit rationing. 
A) Mortality rates. 
B) RAROC. 
C) Implicit contracts. 
D) Covenants. 
E) Credit rationing.

Question 7

The cumulative probability of repayment of BBB corporate debt over the next two years is

Accepted Answer

A) 99.84 percent. 
B) 92.10 percent. 
C) 4.45 percent. 
D) 95.70 percent. 
E) 7.90 percent. [Refer to: 10-114] 
A) 99.84 percent. 
B) 92.10 percent. 
C) 4.45 percent. 
D) 95.70 percent. 
E) 7.90 percent. [Refer to: 10-114]

Question 8

If the spot interest rate on a prime-rated one-month CD is 6 percent today and the market rate on a two-month maturity prime-rated CD is 7 percent today, the implied forward rate on a one-month CD to be delivered one month from today is

Accepted Answer

A) 9 percent. 
B) 11 percent. 
C) 18 percent. 
D) 10 percent. 
E) 8 percent. 
A) 9 percent. 
B) 11 percent. 
C) 18 percent. 
D) 10 percent. 
E) 8 percent.

Question 9

The duration of a soon to be approved loan of $10 million is four years.The 99th 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?

Accepted Answer

A) -$550,000. 
B) -$1,564,280. 
C) -$1,964,280. 
D) -$2,000,000. 
E) -$2,200,000. 
A) -$550,000. 
B) -$1,564,280. 
C) -$1,964,280. 
D) -$2,000,000. 
E) -$2,200,000.

Question 10

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

Accepted Answer

A) Working capital to assets ratio. 
B) Retained earnings to assets ratio. 
C) Earnings before interest and taxes to assets ratio. 
D) Market value of equity to book value of long-term debt ratio. 
E) Sales to assets ratio. 
A) Working capital to assets ratio. 
B) Retained earnings to assets ratio. 
C) Earnings before interest and taxes to assets ratio. 
D) Market value of equity to book value of long-term debt ratio. 
E) Sales to assets ratio.

Question 11

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract?

Accepted Answer

A) Liquidity risk. 
B) Interest rate risk. 
C) Sovereign risk. 
D) Default risk. 
E) Solvency risk. 
A) Liquidity risk. 
B) Interest rate risk. 
C) Sovereign risk. 
D) Default risk. 
E) Solvency risk.

Question 12

All other things equal, longer term loans are more likely to be

Accepted Answer

A) variable-rate loans. 
B) fixed-rate loans. 
C) commitment loans. 
D) lowest risk category loans. 
E) high interest rate loans. 
A) variable-rate loans. 
B) fixed-rate loans. 
C) commitment loans. 
D) lowest risk category loans. 
E) high interest rate loans.

Question 13

Junk bonds are bonds that are rated less than investment grade by bond-rating agencies.

Accepted Answer

A) True 
 B)False

Question 14

The duration of a soon to be approved loan of $10 million is four years.The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. If the fee income on this loan is 0.4 percent and the spread over the cost of funds to the bank is 1 percent, what is the expected income on this loan for the current year?

Accepted Answer

A) $40,000. 
B) $100,000. 
C) $140,000. 
D) $180,000. 
E) $280,000. 
A) $40,000. 
B) $100,000. 
C) $140,000. 
D) $180,000. 
E) $280,000.

Question 15

RAROC (Risk-adjusted return on capital) is a measure of a firm's cost of debt.

Accepted Answer

A) True 
 B)False

Question 16

Equity holders of a levered corporation have no incentive to invest the borrowed funds in risky capital investments.

Accepted Answer

A) True 
 B)False

Question 17

Discriminant models often ignore hard-to-quantify factors in the credit decision.

Accepted Answer

A) True 
 B)False

Question 18

Simulations conducted by Moody's Analytics have shown that expected default frequency (EDF) models outperform Z-score type models in predicting borrower failure or financial distress.

Accepted Answer

A) True 
 B)False

Question 19

What is the essential idea behind Risk-adjusted return on capital (RAROC) models?

Accepted Answer

A) Evaluating the actual or contractually promised annual ROA on a loan. 
B) Analyzing historic or past default risk experience. 
C) Balancing expected interest and fee income less the cost of funds against the loan's expected risk. 
D) Extracting expected default rates from the current term structure of interest rates. 
E) Dividing net interest and fees by the amount lent. 
A) Evaluating the actual or contractually promised annual ROA on a loan. 
B) Analyzing historic or past default risk experience. 
C) Balancing expected interest and fee income less the cost of funds against the loan's expected risk. 
D) Extracting expected default rates from the current term structure of interest rates. 
E) Dividing net interest and fees by the amount lent.

Question 20

A borrower's reputation is an example of a market-specific factor in the credit decision.

Accepted Answer

A) True 
 B)False

Exam 10: Credit Risk: Individual Loan Risk

Credit rationing is a form of managing credit risk.

According to Altman's credit scoring model, which of the following Z scores would indicate a low default risk firm?

What does the Moody's Analytics model use as equivalent to holding a call option on the assets of the firm?

A major difficulty in estimating RAROC for a loan is the measurement of individual loan risk.

What is the expected probability of default in year 2 of two-year maturity B-rated debt?

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower?

The cumulative probability of repayment of BBB corporate debt over the next two years is

If the spot interest rate on a prime-rated one-month CD is 6 percent today and the market rate on a two-month maturity prime-rated CD is 7 percent today, the implied forward rate on a one-month CD to be delivered one month from today is

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

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract?

All other things equal, longer term loans are more likely to be

Junk bonds are bonds that are rated less than investment grade by bond-rating agencies.

RAROC (Risk-adjusted return on capital) is a measure of a firm's cost of debt.

Equity holders of a levered corporation have no incentive to invest the borrowed funds in risky capital investments.

Discriminant models often ignore hard-to-quantify factors in the credit decision.

Simulations conducted by Moody's Analytics have shown that expected default frequency (EDF) models outperform Z-score type models in predicting borrower failure or financial distress.

What is the essential idea behind Risk-adjusted return on capital (RAROC) models?

A borrower's reputation is an example of a market-specific factor in the credit decision.

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Brokerage and Investment Banking

Financial Services: Mutual Funds and Hedge Funds

Financial Services: Insurance

Risks of Financial Institutions

Interest Rate Risk I

Interest Rate Risk II

Credit Risk: Loan Portfolio and Concentration Risk

Liquidity Risk

Foreign Exchange Risk

Sovereign Risk

Market Risk

Off-Balance-Sheet Risk

Technology and Other Operational Risks

Fintech Risks

Liability and Liquidity Management

Deposit Insurance and Other Liability Guarantees

Capital Adequacy

Product and Geographic Expansion

Futures and Forwards

Options, Caps, Floors, and Collars

Swaps

Loan Sales

Securitization

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