Reference no: EM132210497

Financial Management Questions -

Q1. a. Describe how modern portfolio theory can be applied to manage the credit risk of a loan portfolio.

b. Explain how Moody Analytics alters standard portfolio theory for managing the credit risk of a loan portfolio.

Q2. What risk premium will a financial institution require on a $25 million loan given the following information?

the financial institution needs an expected return of 6.75% in order to generate the desired profit for its investors;

the expected default rate on loans of this type is 3%;

if the borrower defaults on the loan, the financial institution expects to recover 70% of the total return;

the financial institution's base rate covers its costs of funds (2.5%) and overhead (2%); and

the lender charges an origination fee of 0.375% of the loan amount.

Q3. Select 5 of the following. Describe the liquidity characteristics of each (that is, whether the item provides liquidity and/or creates liquidity risk, and why). For items that provide liquidity, indicate how liquid the item is, and whether the liquidity it provides is stored or purchased.

a. Deposits that a financial institution's deposits holds at other financial institutions.

b. A financial institution's obligation to its depositors.

c. Treasury bills.

d. Mortgage backed securities.

e. Commercial loans.

f. Fed funds.

g. Insurance policies issued by an insurance company.

h. Repurchase agreements.

i. Loan commitments.

j. Shares issued by a mutual fund.

Q4. A financial institution is considering a customer's request for a 12-year $15 million loan, with annual interest payments and the principal due at maturity. The financial institution requires a 18.75% risk adjusted return on capital for this loan. It will use 3.875% as the cost of funds for this loan and charge a 2% risk premium. Historically, the worst 1% of comparable loans experience an 87.5 basis point increase in the credit risk premium. The financial institution's typical origination fee for this type of loan is 1.0% and similar loans yield 6.125%. (The loan has a duration of 8.9).

a. If the financial institution charges its standard origination fee and the uses the yield on similar loans as the coupon rate, what risk adjusted return on capital will the loan generate?

b. Identify three ways, the financial institution could adjust the terms of the loan in order to realize a higher risk adjusted return on capital. For each of those ways, describe how that change will affect the numerator and the denominator of formula used to compute the risk adjusted return on capital.

Q5. If the contract rate for a one period loan is 11.65%, the expected recovery in event of default is 20%, and the financial institution requires that the expected return on the loan equal the risk free rate of 3.125%, what is the probability of default on the loan?

Q6. A company has assets worth $336.11 million. It has debt with a total face value of $204.5 million. If the risk free interest rate is 2.75% and the standard deviation of monthly returns on the company's stock is 0.158, what is the likelihood the company will be unable to repay the debt in three years when it is due?

Q7. The following table presents information for the company from question 6:

net working capital	-61753
retained earnings	-1284703
earnings before interest and taxes	6542
book value of debt	204498
market value of equity	184590
sales	419003
total assets	234684

Calculate Atman's Z statistic for this company and interpret the result.

Q8. Identify three different regulatory requirements or regulatory mechanisms that are designed to reduce a depository institution's liquidity risk.

Q9. How do minimum capital requirements reduce a financial institution's insolvency risk?

Q10. If a commercial bank with assets as indicated in the table below is required to have tier 1 capital equal to 8% of its risk-adjusted assets in order to be considered adequately capitalized, and only the bank's common stock qualifies as tier 1 equity, how much equity capital must the bank have? Where does this appear on the bank's financial statements?

risk category	assets	value
0%	Cash	5000
	Reserves	7500
	US treasury and agency securities	20000
20%	Items in collection	1200
	Securities conditionally guaranteed by the US or its agencies	15600
	claims on US banks	3200
	state and local government general obligation bonds	11400
35%	1-4 family first mortgages	10400
50%	1-4 family first mortgages	20500
	multifamily mortgages	15700
	construction loans	5300
	state and local government revenue bonds	4800
	securities issued by foreign governments or banks	600
100%	commercial loans	65000
	consumer loans	25200
	non-financial assets (premises and other fixed assets)	18600
150%	loans more than 90 days past due	5900

Q11. a. Barclays Ltd has a market capitalization of $40 billion. The book value of its equity is $64 billion. Under SEC regulations, what is its maximum indebtedness?

b. Assume Barclay's total liabilities equal $600 billion, what must be true of its assets?

Q12. Describe how capital adequacy requirements for an insurance company differ from those for depository institutions. (You may select either life insurance companies or property and casualty insurance companies).

Q13. Explain how the insurance regime designed to protect depositors from a bank's insolvency differs from the insurance regime designed to protect insurance policy holders from an insurance company's insolvency. Identify at least two differences.