FINA 365 Chapter 10 True/False

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Junk bonds are bonds that are rated less than investment grade by bond-rating agencies.

T

One of the problems with estimating expected default rates is that the analysis is based on historic data.

T

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

T

During the decade of the 1990s the asset quality of U.S. banks continued to improve.

T

Unsecured debt is considered to be senior to secured debt.

F

Usury ceilings are maximum rates imposed by federal legislation that FIs can charge on consumer and mortgage debt.

F

A borrower's reputation is an example of a market-specific factor in the credit decision.

F

A major advantage of discriminant models is the stability of the coefficient weights over time.

F

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.

F

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

F

Commercial paper typically is secured by specific assets of the borrower.

F

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

F

Default by a large corporation is seldom a problem for FIs since these corporations have many different sources of borrowed funds.

F

Generally, at the retail level, an FI controls credit risks solely by using a range of interest rates or prices and not by credit rationing.

F

In terms of rating agencies such as S&P, investment grade companies are those whose bond ratings are grade B or above.

F

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

F

Long-term loans are more likely to be made under a loan commitment agreement than short-term loans.

F

RAROC is a measure of a firm's cost of debt.

F

Residential mortgages are the smallest component of bank real estate loan portfolios.

F

Since their introduction, the proportion of ARMs to fixed-rate residential mortgages has remained very stable over interest rate cycles.

F

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

F

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.

F

The primary difficulty in arranging a syndicated loan is having all of the various lending and borrowing parties reach agreement on terms, rates, and collateral.

F

There is a positive relationship between the interest rate charged on a retail loan and the expected return on the loan.

F

Credit scoring models are advantageous because of their ability to sort borrowers into different default risk classes.

T

A loan commitment is an agreement involving the amount of loan available and the amount of time during which the loan can be initiated.

T

A major problem in estimating RAROC is the measurement of loan risk.

T

A secured loan has a claim to specific assets of the borrower in the case of default.

T

Adjustable rate mortgages have interest rates that adjust periodically according to the movement in some index.

T

Adjusting interest rates, fees, and other terms upward for increasing amounts of default risk is a way to attempt to realize the expected return on the loan.

T

At some point, further increases in interest rates on specific loans may decrease expected loan returns because of increased probability of default by the borrower.

T

Because a compensating balance is the proportion of a loan that must be kept on deposit at the lending institution, the actual return to the lender on the usable portion of these loans is higher.

T

Commercial loans have been decreasing in importance in bank loan portfolios.

T

Commercial paper has become an acceptable substitute source for bank loans formany large corporations.

T

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

T

Covenants are restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower.

T

Credit rationing is a form of managing credit risk.

T

Discriminant models often ignore hard-to-quantify factors in the credit decision.

T

Relationship pricing involves pricing for specific services which depend, in part, on the amount or number of services that are used by the customer.

T

Sustained credit quality problems can drain an FI's capital and net worth.

T

The amount of leverage of a borrower and the probability of default are positively related, but only after some minimum level of debt.

T

The amount of security or collateral on a loan and the interest rate or risk premium on a loan normally are negatively related.

T

The condition of no arbitrage profits implies that profits cannot be made without taking some risk.

T

The cumulative default probability of a borrower in a given time period is one minus the product of the marginal default probabilities for all time periods up to that time period.

T

The exact interest rate to be charged on a fixed-rate loan is agreed upon by all parties at the time the commitment is negotiated.

T

The marginal mortality rate is the probability of a bond or loan defaulting in any given year after it is issued.

T

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

T

The risk premium, or spread, between corporate bonds and Treasury securities tends to increase as the time to maturity increases.

T

The traditional duration equation can be used to measure the capital at risk on the loan.

T

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

T


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