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Lecture 6: Credit risk - Individual loans - Coggle Diagram
Lecture 6: Credit risk - Individual loans
Credit risk
risk of default by the borrowers
loss of value of assets due to deterioration in credit quality
importance of credit measurement
set appropriate limits on amount of credit
price/ value a loan/bond
Types of loans
Housing or real estate loans: primarily mortgages
Consumer loans
revolving loans
non- revolving loans
higher default rates on credit cards
Business loans (C & I loans)
often
syndicated loans
: provided by a group of FIs
secured or assets backed loans
riskier
Other loans(p16: margin loans, alternatives loans, ...)
Calculating the return on a loan
The contractually promised return on a loan
prime lending rate
charged to the lowest- risky customers
known as base rate
global loans
add premium over LIBOR
The expected return on a loan
E(r) = p(1 + k)
higher k => higher default risk (
credit rationing
)
Retail vs wholesale credit decisions
Retail
small dollar size loans
higher information costs
credit risk controlled through
credit rationing
- different loan to value ratio
measure of credit risk:
collected internally
or
purchased
from external credit agencies
Wholesale
credit risk control used
uses of interest rates
credit quantities
measure of credit risk: publicly available information
Default risk models
Qualitative models
Borrower- specific factors (reputation, leverage, collateral, covenants, ...)
Market systematic factors (business cycle - luxuries vs necessaries, level of interest rates)
Quantitative models
Term structure derivation of credit risk
advantages: forward looking, based on market expectations, easy to use if markets are liquid
disadvantages: market for treasuries deep but
corporate bonds not actively traded
Marginal mortality rates (p.52)
problems: backward looking, highly sensitive to sample period,
highly sensitive to number and size of issues
Credit scoring models
logit models (p.36)
linear probability models (p.34)
linear discriminant models (p.37)
RAROC models
Default probability on multi- period debt instrument
Marginal default probability: the likelihood that a borrower will default in
any given year
Cumulative default probability: the likelihood that a borrower will default over a
specified multi- year time horizon