Question 5 A. Assume you are working as a risk mitigation and management officer at YTM Financials. Write a short memo to your supervisor explaining the use of securitisation to manage YTM's risk exposures. Make sure that you consider interest rate and credit risks. [2 marks] B. Assume you are a commercial lending manager working at Maroon Bank. You have a meeting scheduled with a business client. The purpose of the meeting is to review the structure of the loans provided by Maroon Bank. The business client operates in the mining sector. Maroon Bank has already a very high exposure in the mining sector. You are also actively considering the possibility of a significant slowdown in the sector due to possible stagflation in 2022 and its impact on the client's timing of cash flows. The client wishes to discuss the relationship of its longer-term debt commitments and the forecast future cash flows being generated by the business. Within these contexts, what should be your evaluation of this loan client? Discuss in detail. [3 marks] C. Gilford Bank uses the Moody's Analytics Portfolio Manager model to evaluate the risk-return characteristics of the loans in its portfolio. Gilford has two loans with the following characteristics: Loan given to Joel Corporation (with an amount of $6 million) earns 1.5 percent per year in fees. For Gilford, the loan's cost of fund is 5 percent and return on loan is 10.50 percent. For collateral considerations, the loss to the bank if the borrower defaults will be 15 percent of the loan's face value. The expected probability of default is 2 percent. Loan given to Harvey Corporation (with an amount of $3.5 million) earns 1 percent per year in fees. For Gilford, the loan's cost of fund is 4 percent and return on loan is 7 percent. For collateral considerations, the loss to the bank if the borrower defaults will be 20 percent of the loan's face value. The expected probability of default is 3 percent. The default risk covariance between Joel and Harvey is 0.00032. Requirements: i. Calculate the percentage return on the loan portfolio [1 mark] Calculate the percentage risk of the loan portfolio [4 marks] ii. Question 5 A. Assume you are working as a risk mitigation and management officer at YTM Financials. Write a short memo to your supervisor explaining the use of securitisation to manage YTM's risk exposures. Make sure that you consider interest rate and credit risks. [2 marks] B. Assume you are a commercial lending manager working at Maroon Bank. You have a meeting scheduled with a business client. The purpose of the meeting is to review the structure of the loans provided by Maroon Bank. The business client operates in the mining sector. Maroon Bank has already a very high exposure in the mining sector. You are also actively considering the possibility of a significant slowdown in the sector due to possible stagflation in 2022 and its impact on the client's timing of cash flows. The client wishes to discuss the relationship of its longer-term debt commitments and the forecast future cash flows being generated by the business. Within these contexts, what should be your evaluation of this loan client? Discuss in detail. [3 marks] C. Gilford Bank uses the Moody's Analytics Portfolio Manager model to evaluate the risk-return characteristics of the loans in its portfolio. Gilford has two loans with the following characteristics: Loan given to Joel Corporation (with an amount of $6 million) earns 1.5 percent per year in fees. For Gilford, the loan's cost of fund is 5 percent and return on loan is 10.50 percent. For collateral considerations, the loss to the bank if the borrower defaults will be 15 percent of the loan's face value. The expected probability of default is 2 percent. Loan given to Harvey Corporation (with an amount of $3.5 million) earns 1 percent per year in fees. For Gilford, the loan's cost of fund is 4 percent and return on loan is 7 percent. For collateral considerations, the loss to the bank if the borrower defaults will be 20 percent of the loan's face value. The expected probability of default is 3 percent. The default risk covariance between Joel and Harvey is 0.00032. Requirements: i. Calculate the percentage return on the loan portfolio [1 mark] Calculate the percentage risk of the loan portfolio [4 marks]
