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Assets Liabilities and Equity

This document contains 5 sections that describe various loan scenarios and request calculations related to loan terms, costs, risks, and acceptability. Section 1 asks about true loan costs given different compensating balance requirements. Section 2 provides details on a loan and asks about interest returns and impact of fees. Section 3 gives a probability of default model and asks for projections. Section 4 gives financial information on a company and asks for an Altman Z-score and credit decision. Section 5 provides loan details and asks RAROC calculations and risk premium adjustments needed for approval.

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usama siddiqui
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58 views2 pages

Assets Liabilities and Equity

This document contains 5 sections that describe various loan scenarios and request calculations related to loan terms, costs, risks, and acceptability. Section 1 asks about true loan costs given different compensating balance requirements. Section 2 provides details on a loan and asks about interest returns and impact of fees. Section 3 gives a probability of default model and asks for projections. Section 4 gives financial information on a company and asks for an Altman Z-score and credit decision. Section 5 provides loan details and asks RAROC calculations and risk premium adjustments needed for approval.

Uploaded by

usama siddiqui
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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1.

County Bank offers one-year loans with a stated rate of 9 percent but requires a
compensating balance of 10 percent. What is the true cost of this loan to the borrower?
How does the cost change if the compensating balance is 15 percent? If the compensating
balance is 20 percent? In each case, assume origination fees and the reserve requirement
are zero.

2. Metrobank offers one-year loans with a 9 percent stated or base rate, charges a 0.25 percent
loan origination fee, imposes a 10 percent compensating balance requirement, and must
pay a 6 percent reserve requirement to the Federal Reserve. The loans typically are repaid
at maturity.

a. If the risk premium for a given customer is 2.5 percent, what is the simple promised
interest return on the loan?

b. What is the contractually promised gross return on the loan per dollar lent?

c. Which of the fee items has the greatest impact on the gross return?

3. Suppose the estimated linear probability model is PD = 0.3X1 + 0.2X2 - .05X3 + error,
where X1 = 0.75 is the borrower's debt/equity ratio; X2 = 0.25 is the volatility of borrower
earnings; and X3 = 0.10 is the borrower’s profit ratio.

a. What is the projected probability of default for the borrower?

b. What is the projected probability of repayment if the debt/equity ratio is 2.5?

4. MNO, Inc., a publicly traded manufacturing firm in the United States, has provided the
following financial information in its application for a loan.

Assets Liabilities and Equity


Cash $ 20 Accounts payable $ 30
Accounts receivables 90 Notes payable 90
Inventory 90 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 = $500, cost of goods sold = $360, taxes = $56, interest payments = $40,
net income = $44, 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 MNO, Inc.? Recall that:

Net working capital = Current assets - Current liabilities.


Current assets = Cash + Accounts receivable + Inventories.
Current liabilities = Accounts payable + Accruals + Notes payable.

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EBIT = Revenues - Cost of goods sold - Depreciation.
Net income = EBIT - interest - taxes.
Retained earnings = Net income (1 - Dividend payout ratio)

Altman’s discriminant function is given by: Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

b. Should you approve MNO, Inc.'s application to your bank for a $500 capital expansion
loan?

c. If sales for MNO were $300, the market value of equity was only half of book value,
and the cost of goods sold and interest were unchanged, what would be the net income
for MNO? Assume the tax credit can be used to offset other tax liabilities incurred by
other divisions of the firm. Would your credit decision change?

5. A bank is planning to make a loan of $5,000,000 to a firm in the steel industry. It expects to
charge a servicing fee of 50 basis points. The loan has a maturity of 8 years and a duration
of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 percent.
Assume the bank has estimated the maximum change in the risk premium on the steel
manufacturing sector to be approximately 4.2 percent, based on two years of historical
data. The current market interest rate for loans in this sector is 12 percent.

a. Using the RAROC model, determine whether the bank should make the loan?

b. What should be the duration in order for this loan to be approved?

c. Assuming that duration cannot be changed, how much additional interest and fee
income would be necessary to make the loan acceptable?

d. Given the proposed income stream and the negotiated duration, what adjustment in the
risk premium would be necessary to make the loan acceptable?

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