Question 1

Cumulative default probability refers to

Accepted Answer

A) probability that a borrower will default over a specified multiyear period. 
B) expected maximum change in the loan rate due to a change in the risk factor on the loan. 
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 multiyear period. 
B) expected maximum change in the loan rate due to a change in the risk factor on the loan. 
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 2

The following is information on current spot and forward term structures (assume the corporate debt pays interest annually): $$\begin{array} { | l | l | l | c | } 
\hline & \text { Spot 1 Year } & \text { Spot 2 Year } & \begin{array} { l } 
\text { (1-year maturity) } \
\text { Forward 1-year }
\end{array} \
\hline \text { Treasury } & 3.0 \text { percent } & 4.75 \text { percent } & \mathrm { X } \
\hline \text { BBB Corporate Debt } & 7.5 \text { percent } & 9.15 \text { percent } & \mathrm { Y } \
\hline
\end{array}$$
-Calculate the value of y (the implied forward rate on one-year maturity BBB corporate debt to be delivered in one year).

Accepted Answer

A) 6.53 percent. 
B) 10.83 percent. 
C) 5.75 percent. 
D) 6.925 percent. 
E) 1.017 percent. 
A) 6.53 percent. 
B) 10.83 percent. 
C) 5.75 percent. 
D) 6.925 percent. 
E) 1.017 percent.

Question 3

Recessionary phases in the business cycle typically cause greater hardship on companies that borrow large amounts.

Accepted Answer

A) True 
 B)False

Question 4

The mortality rate is the past default experience of all loans, regardless of quality.

Accepted Answer

A) True 
 B)False

Question 5

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 6

Because of compensating balances and fees used to increase return on a loan, the credit risk premium is not the fundamental factor driving the promised return once the base rate on the loan has been set.

Accepted Answer

A) True 
 B)False

Question 7

The probability that a borrower would default in any specific time period is a marginal default probability.

Accepted Answer

A) True 
 B)False

Question 8

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 9

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 10

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 11

Willingness to post collateral may be a signal of more rather than less credit risk on the part of the borrower.

Accepted Answer

A) True 
 B)False

Question 12

Credit risk applies only to bond investment and loan portfolios of FIs and banks.

Accepted Answer

A) True 
 B)False

Question 13

Use the following information and the option valuation model for the next two problems. Onyx Corporation has a $200,000 loan that will mature in one year. The risk free interest rate is 6 percent. The standard deviation in the rate of change in the underlying asset's value is 12 percent, and the leverage ratio for Onyx is 0.8 (80 percent). The value for N(h1) is 0.02743, and the value for N(h2) is 0.96406.
-What is the current market value of the loan?

Accepted Answer

A) $160,000. 
B) $189,932. 
C) $200,000. 
D) $188,352. 
E) $178,571. 
A) $160,000. 
B) $189,932. 
C) $200,000. 
D) $188,352. 
E) $178,571.

Question 14

The payoff function of a loan to a debt holder is similar to writing a call option on the value of the borrower's assets with the face value of the debt as the exercise price.

Accepted Answer

A) True 
 B)False

Question 15

Because they are secured by homes, residential mortgages have demonstrated very little credit risk for FIs.

Accepted Answer

A) True 
 B)False

Question 16

Commercial real estate mortgages have been the fastest growing component of real estate loans.

Accepted Answer

A) True 
 B)False

Question 17

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. 
E) The estimates are sensitive to the relative size of issues in each investment grade. 
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. 
E) The estimates are sensitive to the relative size of issues in each investment grade.

Question 18

LIBOR, the London Interbank Offered Rate, is the rate for short-term interbank dollar loans in the domestic money-center bank market.

Accepted Answer

A) True 
 B)False

Question 19

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 20

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.

Exam 10: Credit Risk: Individual Loan Risk

Cumulative default probability refers to

Recessionary phases in the business cycle typically cause greater hardship on companies that borrow large amounts.

The mortality rate is the past default experience of all loans, regardless of quality.

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

Because of compensating balances and fees used to increase return on a loan, the credit risk premium is not the fundamental factor driving the promised return once the base rate on the loan has been set.

The probability that a borrower would default in any specific time period is a marginal default probability.

What is the essential idea behind RAROC?

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

Willingness to post collateral may be a signal of more rather than less credit risk on the part of the borrower.

Credit risk applies only to bond investment and loan portfolios of FIs and banks.

The payoff function of a loan to a debt holder is similar to writing a call option on the value of the borrower's assets with the face value of the debt as the exercise price.

Because they are secured by homes, residential mortgages have demonstrated very little credit risk for FIs.

Commercial real estate mortgages have been the fastest growing component of real estate loans.

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

LIBOR, the London Interbank Offered Rate, is the rate for short-term interbank dollar loans in the domestic money-center bank market.

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

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

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