26 - Chapter Twenty SIX Loan Sales and Other Credit Risk...

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Chapter Twenty SIX Loan Sales and Other Credit Risk Management Techniques Chapter Outline Introduction Loan Sales The Bank Loan Sales Market Definition of a Loan Sale Types of Loan Sales Types of Loan Sales Contracts The Buyers and the Sellers Why Banks and Other FIs Sell Loans Reserve Requirements Fee Income Capital Costs Liquidity Risk Factors Deterring Loan Sales Growth in the Future Access to the Commercial Paper Market Customer Relationship Effects Legal Concerns Factors Encouraging Loan Sales Growth in the Future BIS Capital Requirements Market Value Accounting Asset Brokerage and Loan Trading Government Loan Sales Credit Ratings Purchase and Sale of Foreign Bank Loans Summary 89
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Solutions for End-of-Chapter Questions and Problems: Chapter Twenty Seven 1. What is the difference between loans sold with recourse and loans sold without recourse from the perspective of both sellers and buyers? Loans sold without recourse means that the credit risk is transferred entirely to the buyer. In the event the loan is defaulted, the buyer of the loan has no recourse to the seller for any claims. Thus the originator of the loan can take it off the balance sheet after selling the loan. In the case of a sale with recourse, credit risk is still present for the originator because the buyer could transfer ownership of the loan back to the originator. Thus, from the perspective of the buyer, loans with recourse bear the least amount of credit risk. 2. A bank has made a three-year $10 million dollar loan that pays annual interest of 8 percent. The principal is due at the end of the third year. a. The bank is willing to sell this loan with recourse at an interest rate 8.5 percent? What price should it receive for this loan? If the bank sells with recourse, it should expect: PVA n=3, k=8.5 *(0.80) + PV n=3, k=8.5 *(10) = $9.8723 million b. The bank has the option to sell this loan without recourse at a discount rate of 8.75 percent. What price should it receive for this loan? If the bank sells without recourse, it should expect: PVA n=3, k=8.75 *(0.80) + PV n=3, k=8.75 *(10) = $9.8093 million c. If the bank expects a 0.5 percent probability of default on this loan, is it better to selling this loan with or without recourse? It expects to receive no interest payments or principal if the loan is defaulted. If sold with recourse and the expected probability of default is taken into account, it should expect to receive (0.995)*$9.8723 = $9.8229, which is still higher than selling it without recourse. So, it should sell it with recourse. 3. What are some of the key features of short-term loan sales? Short-term loan sales usually consist of maturities between one and three months and are secured by the assets of a firm. They usually are sold in units of $1 million or more and are made to firms that have investment grade credit ratings. Banks have originated and disposed of short-term loans as an effective substitute for commercial paper, which has similar characteristics to short-term
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This note was uploaded on 10/25/2010 for the course FIN 398 taught by Professor Ray,jackson during the Spring '10 term at UMass Dartmouth.

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26 - Chapter Twenty SIX Loan Sales and Other Credit Risk...

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