Question 1

Adjusting interest rates, fees, and other terms upward for increasing amounts of default risk is a way to attempt to realize the expected return on the loan.

Accepted Answer

A) True 
 B)False

Question 2

There is a positive relationship between the interest rate charged on a retail loan and the expected return on the loan.

Accepted Answer

A) True 
 B)False

Question 3

What is the essential idea behind RAROC?

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 4

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

Accepted Answer

A) True 
 B)False

Question 5

Credit rationing by an FI

Accepted Answer

A) involves restricting the quantity of loans made available to individual borrowers. 
B) results from a positive linear relationship between interest rates and expected loan returns. 
C) is not used by FIs at the retail level. 
D) involves rationing consumer loans using price or interest rate differences. 
E) is only relevant to banks. 
A) involves restricting the quantity of loans made available to individual borrowers. 
B) results from a positive linear relationship between interest rates and expected loan returns. 
C) is not used by FIs at the retail level. 
D) involves rationing consumer loans using price or interest rate differences. 
E) is only relevant to banks.

Question 6

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 7

Long-term loans are more likely to be made under a loan commitment agreement than short-term loans.

Accepted Answer

A) True 
 B)False

Question 8

Which of the following is the major weakness of the linear probability model?

Accepted Answer

A) The model is based on past data of the borrower. 
B) Measurement of the loan risk is difficult. 
C) Estimated probabilities of default may lie outside the interval 0 to 1. 
D) Neither the market value of a firm's assets nor the volatility of the firm's assets is directly observed. 
E) None of these is a weakness of the linear probability model. 
A) The model is based on past data of the borrower. 
B) Measurement of the loan risk is difficult. 
C) Estimated probabilities of default may lie outside the interval 0 to 1. 
D) Neither the market value of a firm's assets nor the volatility of the firm's assets is directly observed. 
E) None of these is a weakness of the linear probability model.

Question 9

A major advantage of discriminant models is the stability of the coefficient weights over time.

Accepted Answer

A) True 
 B)False

Question 10

Sustained credit quality problems can drain an FI's capital and net worth.

Accepted Answer

A) True 
 B)False

Question 11

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

Accepted Answer

A) True 
 B)False

Question 12

In terms of rating agencies such as S&P, investment grade companies are those whose bond ratings are grade B or above.

Accepted Answer

A) True 
 B)False

Question 13

The following represents two yield curves.   What is the implied probability of repayment on one-year B - rated debt?

Accepted Answer

A) 95.00 percent. 
B) 97.17 percent. 
C) 94.00 percent. 
D) 97.00 percent. 
E) 97.09 percent. 
A) 95.00 percent. 
B) 97.17 percent. 
C) 94.00 percent. 
D) 97.00 percent. 
E) 97.09 percent.

Question 14

Credit scoring models include all of the following broad types of models EXCEPT

Accepted Answer

A) Linear discriminant models. 
B) Linear probability models. 
C) Term structure models. 
D) Logit models. 
E) None of these. 
A) Linear discriminant models. 
B) Linear probability models. 
C) Term structure models. 
D) Logit models. 
E) None of these.

Question 15

Which of the following is a problem in using discriminant analysis to evaluate credit risk?

Accepted Answer

A) It does not consider gradations of default. 
B) The weights in the discriminant function are assumed to be dynamic. 
C) It can include hard-to-quantify factors. 
D) Data on loan specific information of banks are readily available. 
E) It does not assume that variables are independent of one another. 
A) It does not consider gradations of default. 
B) The weights in the discriminant function are assumed to be dynamic. 
C) It can include hard-to-quantify factors. 
D) Data on loan specific information of banks are readily available. 
E) It does not assume that variables are independent of one another.

Question 16

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

Accepted Answer

A) True 
 B)False

Question 17

A major problem in estimating RAROC is the measurement of loan risk.

Accepted Answer

A) True 
 B)False

Question 18

The amount of security or collateral on a loan and the interest rate or risk premium on a loan normally are negatively related.

Accepted Answer

A) True 
 B)False

Question 19

A secured loan has a claim to specific assets of the borrower in the case of default.

Accepted Answer

A) True 
 B)False

Question 20

The following represents two yield curves.   What is the probability that two-year B-rated corporate debt will be fully repaid?

Accepted Answer

A) 92.9 percent. 
B) 95.6 percent. 
C) 97.2 percent. 
D) 7.10 percent. 
E) 4.40 percent. 
A) 92.9 percent. 
B) 95.6 percent. 
C) 97.2 percent. 
D) 7.10 percent. 
E) 4.40 percent.

Exam 10: Credit Risk: Individual Loans

Adjusting interest rates, fees, and other terms upward for increasing amounts of default risk is a way to attempt to realize the expected return on the loan.

There is a positive relationship between the interest rate charged on a retail loan and the expected return on the loan.

What is the essential idea behind RAROC?

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

Credit rationing by an FI

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

Long-term loans are more likely to be made under a loan commitment agreement than short-term loans.

Which of the following is the major weakness of the linear probability model?

A major advantage of discriminant models is the stability of the coefficient weights over time.

Sustained credit quality problems can drain an FI's capital and net worth.

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

In terms of rating agencies such as S&P, investment grade companies are those whose bond ratings are grade B or above.

The following represents two yield curves. What is the implied probability of repayment on one-year B - rated debt?

Credit scoring models include all of the following broad types of models EXCEPT

Which of the following is a problem in using discriminant analysis to evaluate credit risk?

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

A major problem in estimating RAROC is the measurement of loan risk.

The amount of security or collateral on a loan and the interest rate or risk premium on a loan normally are negatively related.

A secured loan has a claim to specific assets of the borrower in the case of default.

The following represents two yield curves. What is the probability that two-year B-rated corporate debt will be fully repaid?

Why Are Financial Institutions Special

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Liability and Liquidity Management

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