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1. (Risk Adjusted Expected Return) Financial institution A wants to evaluate the credit risk of a potential 1-year loan to a AA-rated borrower XYZ. The
1. (Risk Adjusted Expected Return) Financial institution A wants to evaluate the credit risk of a potential 1-year loan to a AA-rated borrower XYZ. The contractual loan amount is $1 million, the base lending rate is 10%, and the loan margin rate is currently set to be 2%. The loan origination fee rate 0.1%, the compensating balance and the reserve requirement rates are both 10%, and the discount rate is 9%. (a) What is the Annual Gross Return (not considering the default risk of borrower)? (b) The institution then estimates the borrower's default probability as the 1-year default probability extracted from the price of the corporate zero- coupon bond issued by the borrower XYZ. The following information is collected: Maturity Price per $100 (Year face value (8) US Treasury zero coupon bond 91.74 US Treasury zero coupon bond 84.17 Corporate zero coupon bond from XYZ 1 90.91 Corporate zero coupon bond from XYZ 2 82.64 The financial institution estimates that no value can be recovered once the borrower defaults. What is the estimated 1-year default probability? (c) Based on (a) and (b), what is the Annual Expected Return Per Actual Dollar Lent of this potential loan? (d) The financial institution is looking for an Annual Expected Return Per Actual Dollar Lent that is greater than or equal to 12% by negotiating the loan margin rate (while keeping other parameters unchanged). What is the minimum level of loan margin rate required? 1. (Risk Adjusted Expected Return) Financial institution A wants to evaluate the credit risk of a potential 1-year loan to a AA-rated borrower XYZ. The contractual loan amount is $1 million, the base lending rate is 10%, and the loan margin rate is currently set to be 2%. The loan origination fee rate 0.1%, the compensating balance and the reserve requirement rates are both 10%, and the discount rate is 9%. (a) What is the Annual Gross Return (not considering the default risk of borrower)? (b) The institution then estimates the borrower's default probability as the 1-year default probability extracted from the price of the corporate zero- coupon bond issued by the borrower XYZ. The following information is collected: Maturity Price per $100 (Year face value (8) US Treasury zero coupon bond 91.74 US Treasury zero coupon bond 84.17 Corporate zero coupon bond from XYZ 1 90.91 Corporate zero coupon bond from XYZ 2 82.64 The financial institution estimates that no value can be recovered once the borrower defaults. What is the estimated 1-year default probability? (c) Based on (a) and (b), what is the Annual Expected Return Per Actual Dollar Lent of this potential loan? (d) The financial institution is looking for an Annual Expected Return Per Actual Dollar Lent that is greater than or equal to 12% by negotiating the loan margin rate (while keeping other parameters unchanged). What is the minimum level of loan margin rate required
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