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Credit risk measurement and management of the loan portfolio (chap 11) -…
Credit risk measurement and management of the loan portfolio (chap 11)
Credit risk measurement
Altman’s Z Score = 1.2 X1+ 1.4 X2+ 3.3 X3+ 0.6 X4+ 1.0 X5
X3= EBIT / total assets
X5= sales / total assets
X1= working capital / total assets,
X4= market value of equity / nook value debt
X2= retained earnings / total assets
Using stock price
Expected Default Probability = No of Default firms/ all firms of sample
Distance to Default = ((Mkt value of asset)-(default point)/ ((Mkt value of asset) * (asset volatility)
Portfolio management
Risk-Adjusted Return on Capital (RAROC)
RAROC = Income from loan for 1 year / Capital at risk
Capital at risk
Altman’s Sharpe Index Approach
Step 2: Calculate variance of the portfolio
Step 3: Maximise the relationship which is the Sharpe Index
Step 1: Calculate return on portfolio
Managing the portfolio
Pass-Through Structures
Pay-Through Structures
Loan pricing
Credit Costs
Expected Losses = Default Probability x (1 – Recovery Rate)
Unexpected Losses: Generally reflects volatility of Expected Losses
Loan Pricing
Noncredit Risk Costs