Lecture_7_and_8_Questions

Lecture_7_and_8_Questions - fundamental factor driving the...

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Fin 353—Lecture 7 and 8 Questions and Answers 1. Suppose a bank charges a 12% loan origination fee (f) to the borrower, and imposes an 8% compensating balance requirement (b) to be held as non-interest-bearing demand deposits. The bank also sets aside reserves (R) at a rate of 10% of deposits, held at the Federal Reserve. Suppose further that the base lending rate (BR) is 15% and risk premium (m) is 4%. a) Calculate the return on assets (ROA) per dollar lent. k=(0.12+0.15+0.04)/[1-0.08(1-0.1)]=33% b) Now assume that fees (f) are zero, with everything else staying the same. Calculate the ROA again. k=0.19/(1-0.072)=20.4% c) Now assume that the compensating balance (b) is zero, with everything else staying the same. Calculate the ROA again. k=0.31/1=31% d) Now assume both fees (f) and compensating balance (b) are zero, with everything else staying the same. Calculate the ROA again. Interpret your results. k=0.19/1=19% Interpretation: When fees and compensating balance are zero, credit risk premium is the
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Unformatted text preview: fundamental factor driving the promised return on a loan. e) What other ways are there to evaluate the return on a loan? Explain briefly. There’s RAROC (risk adjusted return on a capital) which can be calculated by dividing the one-year income on a loan by loan (asset) risk or value at risk. 2. Suppose that the change in the value of a portfolio over a 1 month time horizon is normal with a mean of 0 and a standard deviation of $50 million. What’s the 1 month 99% VaR? 1 month 99% VaR=50*2.325=116.25 million 3. Suppose that the standard deviation of daily changes in the value of a portfolio is 5 million and the 1 st order autocorrelation of daily changes is 0.2. a) What’s the standard deviation that would go in the 5-day 99% VaR? The standard deviation to be used in the VaR formula is: Std=Sqrt(25*[5+2*(5-1)*0.2+2*(5-2)*0.2*0.2+2*(5-3)*0.2*0.2*0.2+2*(5-4)*0.2*0.2*0.2*0.2]) Std=Sqrt(171.88)=13.11...
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