BUS308 TJ 2021 Exam Paper PDF

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Notes are given by Mudoch/Kaplan lectures. Study this before your final exams...

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MURDOCH UNIVERSITY Fi nalEx ami na t i onTJ A202 1 STUDENT NAME:

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STUDENT NUMBER:

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STUDENT SIGNATURE: UNIT CODE: BUS308 UNIT TITLE: Credit and Lending Decisions TIME ALLOWED: Open Book. Available from Tuesday 1st June 8.00 a.m. and must be uploaded to LMS by Wednesday 2nd June 10.00 p.m. NOTE: In opening this exam paper and submitting these questions you are declaring that you have completed the exam yourself, under examination conditions. Note: Submissions that are overdue will not be marked. INSTRUCTIONS THIS TAKE-HOME EXAM CONSISTS OF THREE SECTIONS AND EIGHT (8) QUESTIONS. ATTEMPT ALL QUESTIONS Open and read the article located on LMS. SECTIONS I & II: Please answer questions 1-7 on the test paper attached (in the spaces provided). Show all calculations. Answers should be concise. SECTION III: After reading the article answer Question 8. Please answer this question on the exam paper attached in the space provided. The answer should be concise. The total mark is 100 SECTION I Q1 Q2 Q3 SUBTOTAL

SECTION II SECTION III Q4 /10 Q8 Q5 /20 Q6 /20 Q7 /15 /20 SUBTOTAL /65 SUBTOTAL TOTAL .................................. /100 /05 /05 /10

/15

/15

EXAMINATION AIDS ALLOWED Provided by the University

NIL Provided by the Candidate

CALCULATOR LEVEL 3 – FINANCIAL, EXCEL

BUS308 Credit and Lending Decisions Trimester TJ 2021 Supplementary/Deferred Exam

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SECTION I – 20 MARKS ANSWER THESE QUESTIONS IN THE SPACE PROVIDED QUESTION 1

[5 Marks]

Using regression analysis on historical loan losses, a bank has estimated the following: X PMC =0.002+1.5 X PM and X PMR =0.002+ 2.75 X PM where

X PMC

equals the profit margin in the commercial sector and

profit margin in the retail sector and

X PM

X PMR

equals the

equals profit margin for its total loan

portfolio. The senior bank manager questions this regression result. However, based on the regression analysis alone what sector should the bank limit its loans. Reconcile the existence of both retail and commercial loans.

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QUESTION 2 [5 Marks] Discuss how a contract design, which uses the multi-period borrower-lender relationship, avoids the under-investment problem. Be specific.

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QUESTION 3a [ 3 Marks] Suppose the estimated logit model is

Z =6 .1563 −5. 3551 X 1 −3 .1454 X 2 +error where X 1 is cash flow to debt ratio and X 2 is current assets to current liability

What is the probability of default for the respective borrowers? X1 X2 Borrower Borrower A 0.1379 2.6123 Borrower B 0.3703 1.9941

Probability of Default

QUESTION 3b [ 3 Marks] What other information would be needed for the loan approval decision using this model?

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QUESTION 3c [ 4 Marks] What other information would be needed for the loan approval decision?

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SECTION II – 65 MARKS ANSWER THESE QUESTIONS IN THE SPACE PROVIDED SHOW ALL WORKINGS QUESTION 4 a [ 8 Marks] The Bank of Tinytown has two loans that have the following characteristics. If the covariance between A and B is 0.065, what are the expected return and standard deviation of this portfolio? Given the covariance, can the calculation be simplified? What will the risk of the portfolio be, given the simplification? Loan Loan A Loan B

Size

million) $ 1,600.0 $ 800.0

($

Return (%)

Variance (%)

7.50 12.0

5.0 9.5

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QUESTION 4b [ 2 Marks] Briefly describe any way(s) that the risk of this portfolio may be reduced? Be specific.

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QUESTION 5 Consider a borrow a that can choose between two projects, S and R, each of which will pay off a random amount one period hence. Project S will yield $280 with probability all 0.8 and zero with probability 0.2 one period hence. Project R will yield $340 with probability 0.5 and $60 with probability 0.5 one period hence. As a banker you cannot control the borrowers project choice. Assume the bank’s cost of funds is equal to zero and the bank officer assumes universal risk neutrality. Moreover, you can charge a borrower 400 basis points above your break-even interest rate before the borrower switches to another bank. Compute the expected payoffs of the borrower and the bank under the following two scenarios: (i)

the bank and the borrower can contract with each other however over only one period and the borrower will request a single line of $150.

(ii)

the borrower will need a sequence of two $150 loans, with the ability to choose between S and R in each period.

QUESTION 5a [ 6 Marks] Scenario (i)

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QUESTION 5a [ 6 Marks] (continued)

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QUESTION 5b [ 12 Marks] Scenario (ii)

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QUESTION 5b [ 12 Marks] (continued)

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QUESTION 5c [ 2 Marks] What should be the choice of the contracting horizon? Will the bank obtain its return?

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QUESTION 6a [ 10 Marks] Co ns i d e rafir m ma n a g e db ya ne n t r e pr e n e u r .Th efir mh a st woki n dsofde btou t s t a n di n g : s e n i o rd e b tu nd e rwh i c hi to we s$1 , 25 0t obo nd ho l de r s ,a ndas u bo r d i na t e dba nkl o a nt ha t r e q ui r e sar e pa yme ntof$2 , 55 0.Thefir m’ sa s s e t sha v eac u r r e ntl i q ui d a t i onv a l ueof $ 2, 8 00bu ti ft hefir mc on t i nu e st oop e r a t e ,i twi l lbewor t h$3 , 75 0wi t hpr ob a bi l i t y0. 8 a nd$1 00wi t hpr o ba bi l i t y0. 2o nepe r i odhe nc e .Toma n a g et hefir mf ora na d di t i on a l p e r i od ,t hee n t r e p r e ne uri nc ur sap e r s on a lc o s tof$4 00 .Thee nt r e pr e ne urha sde c l a r e d t ha ts he wi s he st o fil ef o rb a n kr up t c ya nd h a sc on t a c t e d bo t ht h e ba n ka nd t he b on dh ol d e r ’ st r u s t e e .Th eb on dh ol de r swi s ht ol i q u i da t et hefir mi mme di a t e l y .As s ume r i s ka v e r s i onb yt hepa r t i c i pa nt sa nde xp l a i nt hee ffe c tone a c hpa r t i c i pa nt .Ho w wou l d y our e c omme nds ol vi n gt hi sp r o bl e m?Wh a ts h ou l dt heb a nkd o?J u s t i f yy ou ra ns we r .

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QUESTION 6a [ 10 Marks] (continued)

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QUESTION 6b [ 5 Marks] Suppose the estimated Altman discriminant analysis model is

Z =1. 2 X 1 +1 . 4 X 2 +3. 3 X 3 +0 .6 X 4 +1. 0 X 5 where X 1 is working capital/total assets ratio; X 2 is the retained earnings/total assets ratio; X 3 is EBIT/total assets ratio; X 4 is market value of equity /book value of long term debt; and X 5 is sales/total assets .

Borrower Borrower A Borrower B

X1 0.20 0.15

X2 0.00 0.10

X3 -0.20 0.20

X4 0.10 0.40

X5 2.00 1.50

What is the Z score for borrower A and borrower B respectively? Given no other information which borrower is more creditworthy? Why? Be specific.

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QUESTION 6b [ 5 Marks] (continued)

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QUESTION 6c [ 5 Marks] Consider the cost of funds - the risk adjusted return on capital (RAROC benchmark) for a bank and identify some of the limitations of using this approach. Use the RAROC formula to inform your limitations.

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QUESTION 7a [ 7 Marks] Consider the following loan categories: Loan Type

Real Estate Commercial Industrial Consumer Travel and Hospitality Other

Singapore Bank A Bank B Banks ($b) ($b) Total ($b) 4,800 21 10,200 171 3,200 42 2,800 18 4,000 20 15,000 48

Bank C ($b) 20 24 20 16 30 20

Bank D ($b) * 10 12 10 8 45 10

* Bank D is only investing in short-term government securities. Whi c hba nkh a st hemos tdi v e r s i fie dpo r t f o l i o?Sho wa l lc a l c ul a t i on s .[ Hi nt :Us et h e f or mul ap r e s e nt e di nt hec ou r s e . ]

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QUESTION 7b [ 8 Marks] Exp l a i nwh yt hea pp r oa c ht ha ty oue mp l o y e di nQu e s t i on7 aha sbe ne fit sa ndl i mi t a t i on s . Ens u r et ha tt hebe ne fit sa ndl i mi t a t i on sa r ej us t i fie da n dc l e a r l ye xp l a i ne d .Wha ti mp a c t wo ul dCOVI D19h a v eony ou ra ns we r .

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SECTION III – 15 MARKS QUESTION 8 [ 15 Marks] Ensure you have read: Laurent, Plantefeve, Tjada and Weyenbergh, (2020). Banking models after COVID-19: Taking model-risk management to the next level, McKinsey & Company, 1-5. available from the LMS site before attempting this question.

Analyse the article, Laurent et al. (2020) “Banking models after COVID-19: Taking model-risk management to the next level” and compare and contrast the article with the specific material presented in the BUS308 Credit and Lending course. Please write within the space provided below.

NOTE: This has a strict word limit of 750 words so plan your response carefully.

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QUESTION 8 [ 15 Marks] (continued)

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QUESTION 8 [ 15 Marks] (continued)

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Formulae You may use the formulae provided below to assist you in answering the questions. You should show all workings to gain credit for partly correct answers in your examination.

FV  PV (1  rt )

FVn PV 1  i 

i

  1 

n

PV =

j m  1 m

PVAP 

(1+i )n

PMT i

 1  PVA  PMT  1 i  1i  n 

PMT   FVAn  1i  n  1    i

[

FV n

]

1−( 1+i )−n FV + PV =Coupon∗ i ( 1+i )n s j=

√

n

∑ ( x ij− x i )2 i=1

n

Prob Default=

1 1+e−Z

Ri =AIS i−E ( Li )= AIS i− [ EDF i × LGD i ]

σ i =ULi =σ Di ×LGD i= √ EDF i ×( 1− EDFi )× LGD i σ P= √ x21 σ21+ x22 σ 22 +2 x 1 x2 ρ12 σ 1 σ 2 2

x 1=

σ 2 −σ 1 ×σ 2× ρ 12 σ 12 +σ22−2 ×σ 1 ×σ 2 ×ρ 12

Δ LN =−D LN ×LN∗ RAROC=

ΔR 1+R

One year net income on loan Loan Risk

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END OF EXAMINATION

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