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Misc. Finance Problems Assignment




Question;1. County Bank offers one-year loans with a stated rate of 9 percent but requires acompensating balance of 10 percent. What is the true cost of this loan to the borrower? Howdoes the cost change if the compensating balance is 15 per-cent? If the compensating balanceis 20 percent? In each case, assume origination fees and the reserve requirement are zero.2. Why could a lenders expected return be lower when the risk premium is increased on aloan? In addition to the risk premium, how can a lender increase the expected return on awholesale loan? A retail loan?3. What are covenants in a loan agreement? What are the objectives of covenants? How canthese covenants be negative? Positive?4. Why is the degree of collateral as specified in the loan agreement of importance to alender? If the book value of the collateral is greater than or equal to the amount of the loan, isthe credit risk of a lender fully covered? Why or why not?5. Why are FIs consistently interested in the expected level of economic activity in the marketsin which they operate? Why is monetary policy of the Federal Reserve System important to FIs?6. Describe how a linear discriminant analysis model works. Identify and discuss the criticismswhich have been made regarding the use of this type of model to make credit risk evaluations.7. Suppose that the financial ratios of a potential borrowing firm take the following values:Working capital/total assets ratio (X 1) = 0.75Retained earnings/total assets ratio (X 2) = 0.10Earnings before interest and taxes/total assets ratio (X 3) = 0.05Market value of equity/book value of long-term debt ratio (X 4) = 0.10Sales/total assets ratio (X 5) = 0.658. Suppose that an FI holds two loans with the following characteristics.Loan:Xi:ExpectedAnnual Spread b/w Loan Rate andAnnual Fees:Loss toAnd FIs Cost of Funds:FI Given Default:Default:_____________________________________________________________________________________14.0%21.5?p(12)=- 0.10?4.0 %1.50%?%2.51.15?The return on loan 1 is R 1 = 6.25%, the risk on loan 2 is Sigma 2 = 1.8233%, and thereturn of the portfolio is R p = 4.555%. Calculate of the loss given default onloans 1 and 2, the proportions of loans 1 and 2 in the portfolio, and the risk ofthe portfolio, sigma p, using Moodys Analytics Portfolio Manager.


Paper#48394 | Written in 18-Jul-2015

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