Assignment

The ABC bank is considering a loan of $100M with a duration of 10 years. The loan rate discussed is 12%. There is also a fee of .25%. The bank plans to issue large CDs at 9% to finance the loan. According to bank data records, 500 loans of similar features were made by the bank in previous years which have now matured. The bank has sorted the observed changes in the credit risk premium of these 500 loans. The observations are that: 5th worst case had a credit risk increase of 5.5%, the 25th worst loan had an increase in credit risk premium of 3.75%, and the 50th worst casee had an increase of 1.25%:

a. Suppose the manager wants to make a decision on the loan such that the credit risk increase will be covered with a probability of 99%. Calculate the RAROC value. Should the bank approve the loan?

b. At what loan rate would you approve the loan?

c. If the loan rate cannot be raised, to what level should the CD rate fall for the loan to be approved?

d. Suppose the bank is willing to accept coverage of 95%. Calculate the RAROC value. Should the bank approve the loan? Suppose all the other assumptions in part a hold.

e. Suppose the bank is willing to accept coverage of 90%. Calculate the RAROC value. Should the bank approve the loan? Suppose all the other assumptions in part a hold.

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