You are reviewing the corporate credit portfolio of a local financial institution. The recent financial crisis has increased the credit risk of several borrowers in the Caribbean. You are evaluating the risk of a corporate loan over the next two years. The following table shows the expected return on the loan and the risk free rate. One year rate (%) Two Year rate (%) Risk free rate 2.50 3.25 Corporate Loan 5.00 6.25 Spread (risk premium) 2.50 3.00 a. The local financial institution is unwilling to hold the loan if the probability of default is greater than 2.25%. Should this loan be held over two years? (Assume no cash payments in the event of default) (3 marks) The risk manager thinks that the recovery rate on the loan is expected to be 80% in the event of default and is interested in holding the loan for one year. What do you recommend? Justify your decision. (4 marks) b. C. Why is the risk premium different from the credit risk? (3 marks) You are reviewing the corporate credit portfolio of a local financial institution. The recent financial crisis has increased the credit risk of several borrowers in the Caribbean. You are evaluating the risk of a corporate loan over the next two years. The following table shows the expected return on the loan and the risk free rate. One year rate (%) Two Year rate (%) Risk free rate 2.50 3.25 Corporate Loan 5.00 6.25 Spread (risk premium) 2.50 3.00 a. The local financial institution is unwilling to hold the loan if the probability of default is greater than 2.25%. Should this loan be held over two years? (Assume no cash payments in the event of default) (3 marks) The risk manager thinks that the recovery rate on the loan is expected to be 80% in the event of default and is interested in holding the loan for one year. What do you recommend? Justify your decision. (4 marks) b. C. Why is the risk premium different from the credit risk