FINANCE 365 Chapter 10

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 (1 +R2)^2 / (1 + R1)

1.08

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

A high default risk firm

How can discriminant analysis be used to make credit decisions?

By using statistical analysis to isolate and weight factors to arrive at default risk classification of a commercial borrower.

Which of the following is the major weakness of the probability model?

Estimated probabilities of default may lie outside the interval 0 to 1.

Credit rationing by an FI:

Involves restricting the quantity of loans made available to individual borrowers.

Which of the following is true of commercial paper?

It may help a corporation to raise funds often at rates below those banks charge.

Which of the following statements does not reflect credit decisions at the retail level?

Loans to retail customers are more likely to be rationed through interest rates than loan quantity restrictions.

What is the least important factor determining bankruptcy, according to the Altman z score model?

Market value of equity to book value of long-term debt ratio.

Which of the following is not a characteristic of a loan commitment?

The interest rate on fixed-rate loans is determined at the timed of the loan is actually taken down.

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

The value of equity in a firm.

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

Greater than 2.99

What is the essential idea behind RAROC?

Balancing expected interest and fee income less the cost of funds against the loan's expected risk.

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower?

Covenants

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract?

Default risk

Which of the following observations is true of a spot loan?

It involves immediate withdrawal of the entire loan amount by the borrower.

Which of the following is not characteristic of the consumer loans at US banks?

Revolving consumer loans include new and used automobile loans, mobile home loans, and fixed term consumer loans.

In making credit decisions, which of the following items is considered a market-specific factor?

Whether the position of the economy in the business cycle phase would affect the probability of borrower default.

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

Writing a put option on the borrower's assets with the exercise price equal to the face value of the debt.

Credit scoring models include all of the following types of models except

term structure models

Borrower reputation is important in assessing credit quality because:

preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment.

Marginal default probability refers to the

probability that a borrower will default in any given year.

Cumulative default probability refers to

probability that a borrower will default over a specified multiyear period.