Tulip Bank uses the Moodys Analytics Portfolio Manager model to evaluate the riskreturn characteristics of the loans in its portfolio. Tulip has two loans with the following characteristics:

Loan given to Marvel Corporation (with an amount of $6 million) earns 1 percent per year in fees, and the loan is priced at a 3 percent spread over the cost of funds for the bank. For collateral considerations, the loss to the bank if the borrower defaults will be 25 percent of the loans face value. The expected probability of default is 2 percent.

Loan given to Capcom Corporation (with an amount of $5 million) earns 1 percent per year in fees, and the loan is priced at a 4 percent spread over the cost of funds for the bank. For collateral considerations, the loss to the bank if the borrower defaults will be 20 percent of the loans face value. The expected probability of default is 3 percent.

The default risk correlation between Marvel and Capcom is 0.12.

Requirements:

iii. Discuss why Moody's Analytics Portfolio Manager model might be a good choice over using MPT based regular loan portfolio diversification model for ADIs and insurance companies [2 marks]