Chapter 10 Post Quiz

Credit scoring models include all of the following broad types of models EXCEPT Linear discriminant models. Linear probability models. Term structure models. Logit models.

Term structure models.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.If the fee income on this loan is 0.4 percent and the spread over the cost of funds to the bank is 1 percent, what is the expected income on this loan for the current year? $40,000. $100,000. $140,000. $180,000. $280,000.

$140,000.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.What is the capital (loan) risk of the loan if the current average level of interest rates for this category of bonds is 12 percent? -$550,000. -$1,564,280. -$1,964,280. -$2,000,000. -$2,200,000.

-$1,964,280.

The following represents two yield curves. What spread is expected between the one-year maturity B-rated bond and the one-year Treasury bond in one year? 3.00 percent. 5.06 percent. 4.00 percent. 5.00 percent. 7.00 percent.

5.06 percent.

The duration of a soon to be approved loan of $10 million is four years. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent.What is the estimated risk-adjusted return on capital (RAROC) of this loan. 6.36 percent. 7.00 percent. 7.13 percent. 10.55 percent. 25.45 percent.

7.13 percent.

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 9 percent. 11 percent. 18 percent. 10 percent. 8 percent.

8 percent.

The following is information on current spot and forward term structures (assume the corporate debt pays interest annually): The cumulative probability of repayment of BBB corporate debt over the next two years is 99.84 percent. 92.10 percent. 4.45 percent. 95.70 percent. 7.90 percent.

99.84 percent.

According to Altman's credit scoring model, which of the following Z scores would indicate a low default risk firm? Less than 1.1. Between 1 and 1.81. Between 1.81 and 2.99. Greater than 2.99.

Greater than 2.99.

Which of the following observations is true of a spot loan? It involves a maximum size and a maximum period of time over which the borrower can withdraw funds. It involves immediate withdrawal of the entire loan amount by the borrower. It is an unsecured short-term debt instrument issued by corporations. It is a nonbank loan substitute. It is a line of credit.

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

Which of the following is true of commercial paper? It is a secured long-term debt instrument issued by corporations. It is always issued via an underwriter. It may help a corporation to raise funds often at rates below those banks charge. All corporations can tap the commercial paper market. Total commercial paper outstanding in the US is smaller than total C&I loans.

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. Most loan decisions at the retail level tend to be accept or reject decisions. Mortgage loans often are discriminated based on loan to price ratios rather than interest rates. Household borrowers require higher costs of information collection for lenders. Retail loans tend to be smaller than wholesale loans.

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? Working capital to assets ratio Retained earnings to assets ratio Earnings before interest and taxes to assets ratio Market value of equity to book value of long-term debt ratio Sales to assets ratio

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 maximum amount of the loan is negotiated at the time of the loan agreement. The interest rate on fixed-rate loans is determined at the time of the loan is actually taken down. Floating-rate loans transfer the interest rate risk to the borrower. The time period for which the loan is available is negotiated at the time of the loan agreement. In a floating-rate loan the borrower pays interest rate in force when the loan is actually taken down.

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

What does the Moody's Analytics model use as equivalent to holding a call option on the assets of the firm? The value of equity in a firm. Total liabilities of a firm. Net income of a firm. Dividend yield of investments.

The value of equity in a firm.

From the lender's point of view, debt can be evaluated as writing a call option on the borrower's assets with the exercise price equal to the face value of the debt. buying a call option on the borrower's liabilities with the exercise price equal to the market value of the debt. buying a put option on the borrower's assets with the exercise price equal to the face value of the debt. writing a put option on the borrower's assets with the exercise price equal to the face value of the debt. writing a put option on the borrower's liabilities with the exercise price equal to the market value of the debt.

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

What is the essential idea behind RAROC? Evaluating the actual or contractually promised annual ROA on a loan. Analyzing historic or past default risk experience. Balancing expected interest and fee income less the cost of funds against the loan's expected risk. Extracting expected default rates from the current term structure of interest rates. Dividing net interest and fees by the amount lent.

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

How can discriminant analysis be used to make credit decisions? By discriminating between good and bad borrowers. By using statistical analysis to predict the default probabilities. By using statistical analysis to isolate and weight factors to arrive at default risk classification of a commercial borrower. By using statistical analysis to bypass qualitative credit decision making. By updating FI bankruptcy experiences.

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

Which of the following refers to restrictions in loan and bond agreements that encourage or forbid certain actions by the borrower? Mortality rates. RAROC. Implicit contracts. Covenants. Credit rationing.

Covenants.

What refers to the risk that the borrower is unable or unwilling to fulfill the terms promised under the loan contract? Liquidity risk. Interest rate risk. Sovereign risk. Default risk. Solvency risk.

Default risk.

Which of the following is the major weakness of the linear probability model? The model is based on past data of the borrower. Measurement of the loan risk is difficult. Estimated probabilities of default may lie outside the interval 0 to 1. Neither the market value of a firm's assets nor the volatility of the firm's assets is directly observed. None of these is a weakness of the linear probability model.

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

Which of the following is NOT characteristic of the consumer loans at U.S. banks? Non revolving consumer loans is the largest class of loans. Credit card loans often have default rates between four and eight percent. Usury ceilings affect the rate structure for consumer loans. Consumer loans differ widely with respect to collateral, rates, maturity, and noninterest fees. Revolving consumer loans include new and used automobile loans, mobile home loans, and fixed-term consumer loans.

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 reputation of the borrower enhances the credit application. Whether the current debt-equity ratio is sufficiently low to not impact the probability of repayment. Whether the debt can be secured by specific property. Whether the position of the economy in the business cycle phase would affect the probability of borrower default. Whether the volatility of earnings could present a period where the periodic payment of interest and principal would be at risk.

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

Suppose that the financial ratios of a potential borrowing firm took the following values:X1 = 0.30X2 = 0X3 = -0.30X4 = 0.15X5 = 2.1Altman's discriminant function takes the form:Z = 1.2 X1+ 1.4 X2 + 3.3 X3 + 0.6 X4 + 1.0 X5According to Altman's credit scoring model, this firm should be considered a high default risk firm. an indeterminant default risk firm. a low default risk firm. a lowest risk customer. Either a low default risk firm or a lowest risk customer.

a high default risk firm.

Cumulative default probability refers to probability that a borrower will default over a specified multiyear period. expected maximum change in the loan rate due to a change in the risk factor on the loan. historic default rate experience of a bond or loan. expected maximum change in the loan rate due to a change in the credit premium. probability that a borrower will default in any given year.

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

Credit rationing by an FI involves restricting the quantity of loans made available to individual borrowers. results from a positive linear relationship between interest rates and expected loan returns. is not used by FIs at the retail level. involves rationing consumer loans using price or interest rate differences.is only relevant to banks.

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

Borrower reputation is important in assessing credit quality because good past payment performance perfectly predicts future behavior. preservation of a good customer/FI relationship acts as an additional incentive to encourage loan repayment. FIs only lend to customers they know. customers with poor credit histories always default on their loans. a reputation for honesty is important in credit appraisal.

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 over a specified multiyear period. marginal increase in the default probability due to a change in credit premium. historic default rate experience of a bond or loan. expected maximum change in the loan rate due to a change in the credit premium. probability that a borrower will default in any given year.

probability that a borrower will default in any given year.