Question 1

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

Accepted Answer

A) True 
 B)False  True

Question 2

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

Accepted Answer

A) True 
 B)False  False

Question 3

The condition of no arbitrage profits implies that profits cannot be made without taking some risk.

Accepted Answer

A) True 
 B)False  True

Question 4

Borrower reputation is important in assessing credit quality because

Accepted Answer

A) good past payment performance perfectly predicts future behavior. 
B) preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment. 
C) FIs only lend to customers they know. 
D) customers with poor credit histories always default on their loans. 
A) good past payment performance perfectly predicts future behavior. 
B) preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment. 
C) FIs only lend to customers they know. 
D) customers with poor credit histories always default on their loans.

Question 5

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

Accepted Answer

A) True 
 B)False

Question 6

Marginal default probability refers to the

Accepted Answer

A) probability that a borrower will default over a specified multi-year period. 
B) marginal increase in the default probability due to a change in credit premium. 
C) historic default rate experience of a bond or loan. 
D) expected maximum change in the loan rate due to a change in the credit premium. 
E) probability that a borrower will default in any given year. 
A) probability that a borrower will default over a specified multi-year period. 
B) marginal increase in the default probability due to a change in credit premium. 
C) historic default rate experience of a bond or loan. 
D) expected maximum change in the loan rate due to a change in the credit premium. 
E) probability that a borrower will default in any given year.

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

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. 
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.

Question 9

During the decade of the 1990s the asset quality of U.S.banks continued to improve.

Accepted Answer

A) True 
 B)False

Question 10

From the lender's point of view,debt can be evaluated as

Accepted Answer

A) writing a call option on the borrower's assets with the exercise price equal to the face value of the debt. 
B) buying a call option on the borrower's liabilities with the exercise price equal to the market value of the debt. 
C) buying a put option on the borrower's assets with the exercise price equal to the face value of the debt. 
D) writing a put option on the borrower's assets with the exercise price equal to the face value of the debt. 
A) writing a call option on the borrower's assets with the exercise price equal to the face value of the debt. 
B) buying a call option on the borrower's liabilities with the exercise price equal to the market value of the debt. 
C) buying a put option on the borrower's assets with the exercise price equal to the face value of the debt. 
D) writing a put option on the borrower's assets with the exercise price equal to the face value of the debt.

Question 11

The following is information on current spot and forward term structures (assume the corporate debt pays interest annually):
  
-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 estimated risk-adjusted return on capital (RAROC)of this loan.

Accepted Answer

A) 6.36 percent. 
B) 7.00 percent. 
C) 7.13 percent. 
D) 10.55 percent. 
A) 6.36 percent. 
B) 7.00 percent. 
C) 7.13 percent. 
D) 10.55 percent.

Question 12

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 current year is

Accepted Answer

A) 98.0 percent. 
B) 2.35 percent. 
C) 4.19 percent. 
D) 3.90 percent. 
A) 98.0 percent. 
B) 2.35 percent. 
C) 4.19 percent. 
D) 3.90 percent.

Question 13

The cumulative default probability of a borrower in a given time period is one minus the product of the marginal default probabilities for all time periods up to that time period.

Accepted Answer

A) True 
 B)False

Question 14

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
The Z score for the firm would be

Accepted Answer

A) 1.64. 
B) 1.56. 
C) 2.1. 
D) 3.54. 
A) 1.64. 
B) 1.56. 
C) 2.1. 
D) 3.54.

Question 15

Which of the following is true of commercial paper?

Accepted Answer

A) It is a secured long-term debt instrument issued by corporations. 
B) It is always issued via an underwriter. 
C) It may help a corporation to raise funds often at rates below those banks charge. 
D) All corporations can tap the commercial paper market. 
A) It is a secured long-term debt instrument issued by corporations. 
B) It is always issued via an underwriter. 
C) It may help a corporation to raise funds often at rates below those banks charge. 
D) All corporations can tap the commercial paper market.

Question 16

Using a modified discriminant function similar to Altman's,Burger Bank estimates the following coefficients for its portfolio of loans:

Z = 1.4X1 + 1.09X2 + 1.5X3
where X1 = debt to asset ratio;X2 = net income and X3 = dividend payout ratio.

Using Z = 1.682 as the cut-off rate,what should be the debt to asset ratio of the firm in order for the bank to approve the loan?

Accepted Answer

A) 40.0 percent. 
B) 46.5 percent. 
C) 51.5 percent. 
D) 54.0 percent. 
A) 40.0 percent. 
B) 46.5 percent. 
C) 51.5 percent. 
D) 54.0 percent.

Question 17

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
According to Altman's credit scoring model,this firm should be considered

Accepted Answer

A) a high default risk firm. 
B) an indeterminant default risk firm. 
C) a low default risk firm. 
D) a lowest risk customer. 
A) a high default risk firm. 
B) an indeterminant default risk firm. 
C) a low default risk firm. 
D) a lowest risk customer.

Question 18

One of the weaknesses of estimating expected default rates is that the analysis is based on historic data.

Accepted Answer

A) True 
 B)False

Question 19

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 20

Which of the following is NOT a valid conceptual or application problem of the mortality rate approach to estimate default risk?

Accepted Answer

A) Implied future probabilities are sensitive to the period over which MMRs are calculated. 
B) The estimates are sensitive to the number of issues in each investment grade. 
C) Syndicated loans seem to have higher mortality rates than corporate bonds. 
D) The estimated probability values are historic or backward-looking measures. 
A) Implied future probabilities are sensitive to the period over which MMRs are calculated. 
B) The estimates are sensitive to the number of issues in each investment grade. 
C) Syndicated loans seem to have higher mortality rates than corporate bonds. 
D) The estimated probability values are historic or backward-looking measures.

Exam 10: Credit Risk: Individual Loan Risk

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

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

The condition of no arbitrage profits implies that profits cannot be made without taking some risk.

Borrower reputation is important in assessing credit quality because

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

Marginal default probability refers to the

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

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

During the decade of the 1990s the asset quality of U.S.banks continued to improve.

From the lender's point of view,debt can be evaluated as

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 current year is

The cumulative default probability of a borrower in a given time period is one minus the product of the marginal default probabilities for all time periods up to that time period.

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 The Z score for the firm would be

Which of the following is true of commercial paper?

One of the weaknesses of estimating expected default rates is that the analysis is based on historic data.

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

Which of the following is NOT a valid conceptual or application problem of the mortality rate approach to estimate default risk?

Why Are Financial Institutions Special

Financial Services: Depository Institutions

Financial Services: Finance Companies

Financial Services: Securities Firms and Investment Banks

Financial Services: Mutual Fund and Hedge Fund Companies

Financial Services: Insurance Companies

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

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

Filters

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 The Z score for the firm would be