1. The DEAR for a bank is $6,500. What is the VAR for an 8-day period? A 16-day period? Why is the VAR for a 16-day period not twice as much as that for a 8-day period?
formula VAR = DEAR x [N]½.
8 days = 6500*8^0.5 = 18384.78
16 days = 6500*8^0.5 = 26000
The 16 days VAR is not twice that of 8 days because as the risk involved in a day is not related to the risk involved in the next day. The volatility of risk involved is not same for all day and as the days increased, the risk element is lesser.
2. Bank Y has an inventory of 14-year zero-coupon bonds with a face value of $400 million. The bonds currently are yielding 8.5 percent in the over-the-counter market.
a. What is the modified duration of these bonds?
14/1.085 = 12.9032
b. What is the price volatility if the potential adverse move in yields is 25 basis points?
1.65 = 1.65 x 0.0025 = .004125
c. What is the DEAR?
400*12.9032*.004125 = $21.29 million
3. X Inc., a publicly traded manufacturing firm in the United States, has provided the following financial information in its application for a loan. All numbers are in thousands of dollars. Assets Liabilities and Equity Cash $ 20 Accounts payable $ 30 Accounts receivables 87 Notes payable 90 Inventory 93 Accruals 30 Long-term debt 150 Plant and equipment 500 Equity (ret. earnings = $0) 400 Total assets $700 Total liabilities and equity $700 Also assume sales = $550,000, cost of goods sold = $360,000, taxes = $56,000, interest payments = $40,000, net income = $42,000, the dividend payout ratio is 50 percent, and the market value of equity is equal to the book value.
a. What is the Altman discriminant function value for X Inc.?
Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
B = Retained Earnings/Total Assets / 0/700 / 0 / 0
C = Earnings Before Interest & Tax/Total Assets / 138/700 / 0.197143 / 0.650571
D = Market Value of Equity/Total Liabilities / 400/300 / 1.333333 / 0.8
E = Sales/Total Assets / 550/700 / 0.785714 / 0.785714
2.322
b. Should you approve X Inc.'s application to your bank for a $500,000 capital expansion loan?
As the ratio is between 1.8 and 3, therefore the loan may be granted as it is not heading toward bankruptcy as the Z score is not below 1.8, but it has to be carefully watch in future as it is not at 3.
c. If sales for X were $300,000, the market value of equity was only half of book value, and the cost of goods sold, interest, and tax rate were unchanged, what would be the net income for X? Assume the tax credit can be used to offset other tax liabilities incurred by other divisions of the firm. Would your credit decision change?
Sales / 300 / 550COGS / 360 / 360
Operating Expense / 52 / 52
EBIT / -112 / 138
Interest / 40 / 40
EBT / -152 / 98
Tax / -87 / 56
Net Income / -65 / 42
A = Working Capital/Total Assets / 50/700 / 0.071429 / 0.085714
B = Retained Earnings/Total Assets / 0/700 / 0 / 0
C = Earnings Before Interest & Tax/Total Assets / -112/700 / -0.16 / -0.528
D = Market Value of Equity/Total Liabilities / 200/300 / 0.666667 / 0.4
E = Sales/Total Assets / 300/700 / 0.428571 / 0.428571
0.386286
Yes the loan should not be given as the company is heading towards bankruptcy.
4. A FI has issued a one-year loan commitment of $3 million for an up-front fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FI requires a compensating balance of 6 percent as demand deposits. The FI’s cost of funds is 7 percent, the interest rate on the loan is 11 percent, and reserve requirements on demand deposits are 8 percent. The customer is expected to draw down 80 percent of the commitment at the beginning of the year. a. What is the expected return on the loan without taking future values into consideration?
Loan amount / 3Upfront cost 3*.0025 / 0.0075
Bacnk hand fee 3*.001*.2 / 0.0006
Spread income .11-.07*3*.8 / 0.096
Total Income / 0.1041
Amount Ivnested / 3
less demand deposit / 0.18
add reserve / 0.0144
Amount invested / 2.8344
Retrun on Investment / 3.67%
b. What is the expected return using future values? That is, the net fee and interest income are evaluated at the end of the year when the loan is due?
Future value at 7% = .1041*1.07 = 0.1114
Expected return = .1114/2.8344 = 3.93%
5. C Bank holds a $100 million loan to Country X. The loans are being traded at bid-offer prices of 91-93 per 100 in the London secondary market. a. If C has an opportunity to sell this loan to an investment bank at a 4 percent discount, what are the savings after taxes compared with the revenue from selling the loan in the secondary market? Assume the tax rate is 40 percent.
Will be sold at 93 million the loss will be 7 million
Will be sold to bank at 96.15 million the loss will be 3.85
Net saving before tax = 3.15
After tax = 3.15*.6 = 1.89 million
b. The investment bank in turn sells the debt at a 6 percent discount to a real estate company. What is the profit after taxes to the investment bank?
100/1.06= 94.34
96.15-94.34 = 1.81*.6 = 1.086 million
6. What are the components of the KMV Portfolio Manager Model ?
It comprises of default risk and assets value and market volatility. It also includes the measurement of portfolio diversification and then the correlation of default risk and assets and market values are found.
7. Contrast debt repudiation with debt rescheduling.
The repudiation of debts means when a borrower can not honor the agreement for payment of interest and or principal, while rescheduling is the change in agreement for payment of interest or principal. Under repudiation the borrower does not pay at all, while under rescheduling the borrower pays but not as agreed earlier.
8. Do you believe that capital adequacy requirements in the commercial banking and thrift industries have been strengthened over time ? Why or why or not ?
Yes it has been increased to make sure that the depositors money is protected. The requirement has been increased due to the financial crisis of Lehman Bros and other banks in the past, few years ago.
9. Contrast economies of scale with economies of scope.
The economies of scales is the advantage of addition product due to fixed cost which will remain constant at some relevant range, and the economies of scope is the decline in averge total cost of production due to additional production. Suppose if the company has the capacity to produce 20000 units but at current producing only 10000 units, the rent of the factory is $100000 and the material cost is $5 per unit, therefore the toal cost will be 100000/10000+5=15 per unit. Under the economies of scale concept when the company will produce 10000 additional units the rent will not to be paid and under economies of scope, the average total cost will be 100000/20000+5 = $10 per unit.
10. Discuss the regulatory issues pertaining to technology and operational risks.
There is a New Basel Capital Accord to regularize the risk other than credit and market risk. The regulation has been made for minimum capital requirement, the supervisory review process and market discipline.