Chapter+09+Answers+to+end-of-chapter+questions

Chapter+09+Answers+to+end-of-chapter+questions - CHAPTER 9...

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CHAPTER 9 CREDIT RISK: LOAN PORTFOLIO AND CONCENTRATION RISK Chapter outline Simple Models of Loan Concentration Risk Loan Portfolio Diversification and Modern Portfolio Theory o KMV Portfolio Manager Model o Partial Applications of Portfolio Theory o Loan Loss –Ratio-based Models o Regulatory Models Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, Anderson, Thomson & Cornett 1
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Solutions for end-of-chapter questions QUESTIONS AND PROBLEMS 1. How do loan portfolio risks differ from individual loan risks? Loan portfolio risks refer to the risks of a portfolio of loans as opposed to the risks of a single loan. Inherent in the distinction is the elimination of some of the risks of individual loans because of benefits from diversification. 2. What is migration analysis? How do FIs use it to measure credit risk concentration? What are its shortcomings? Migration analysis uses information from the market to determine the credit risk of an individual loan or sectoral loans. For example, bankers can use S&P and Moody’s ratings to determine whether firms in a particular sector are experiencing repayment problems. This information can be used to either curtail lending in that sector or to reduce maturity and/or increase interest rates. A problem with migration analysis is that the information may be too late, because ratings agencies often downgrade issues only after the firm or industry has experienced a downturn. 3. What does loan concentration risk mean? Loan concentration risk refers to the extra risk borne by having too many loans concentrated with one firm, industry, geographical or economic sector. To the extent that a portfolio of loans represents loans made to a diverse cross-section of the economy, concentration risk is minimised. 4. A manager decides not to lend to any firm in sectors that generate losses on that part of the loan portfolio in excess of 5 per cent of equity. (a) If the average historical losses in the car sector total 8 per cent, what is the maximum loan a manager can lend to a firm in this sector as a percentage of total capital? Maximum limit = (Maximum loss as a % of capital) x (1/Loss rate) = 0.05 x 1/0.08 = 62.5 per cent is the maximum limit that can be lent to a firm in the automobile sector. (b) If the average historical losses in the mining sector total 15 per cent, what is the maximum loan a manager can lend to a firm in this sector as a percentage of total capital? Maximum limit = (Maximum loss as a % of capital) x (1/Loss rate) = .05 x 1/0.15 = 33.3 per cent is the maximum limit that can be lent to a firm in the mining sector. Instructor’s Resource Manual t/a Financial Institutions Management 2e by Lange, Saunders, Anderson, Thomson & Cornett 2
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5. An FI has set a maximum loss of 12 per cent of total capital as a basis for setting concentration limits on loans to individual firms. If it has set a concentration limit of 25 per cent to a firm, what is the expected loss rate for that firm? Maximum limit = (Maximum loss as a % of capital) x (1/Loss rate)
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This note was uploaded on 08/21/2009 for the course FINS 3630 taught by Professor Yip during the Three '09 term at University of New South Wales.

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Chapter+09+Answers+to+end-of-chapter+questions - CHAPTER 9...

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