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Suppose that an FI holds two loans with the following characteristics. Annual Spread Between Loss to FI Expected Loan Rate and FI=s Annual Given Default

Suppose that an FI holds two loans with the following characteristics.

Annual

Spread Between Loss to FI Expected

Loan Rate and FI=s Annual Given Default

Loan i Cost of Funds Fees Default Frequency

1 0.55 5.25% 1.85% 12% 1.5%

2 0.45 2.75% 0.65% 15% 0.75%

Calculate the return and risk on the two-asset portfolio using KMV Portfolio Manager. Assume the correlation coefficient between the two loans is -0.25

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