Management Chapter 12 1 The concentration limit method of managing credit risk concentration involves estimating the minimum loan amount to a single customer as a percent of capital

1. The concentration limit method of managing credit risk concentration involves estimating the minimum loan

amount to a single customer as a percent of capital.

2. Concentration limits are used to either reduce or increase exposure to specific industries.

3. The simple model of migration analysis tracks the credit ratings of companies that have borrowed from the

FI.

4. Migration analysis is not appropriate for an FI to use in the analysis of credit risk of consumer loans and

credit card portfolios.

5. In the past, data availability limited the use of sophisticated portfolio models to set concentration limits.

6. In the use of modern portfolio theory (MPT), the sum of the credit risks of loans under estimates the risk of

the whole portfolio.

7. The expected return of a portfolio of loans is equal to the weighted average of the expected returns of the

individual loans.

8. The variance of returns of a portfolio of loans normally is equal to the arithmetic average of the variance of

returns of the individual loans.

9. Portfolio risk can be reduced through diversification only if the returns of the loans in the portfolio are

negatively correlated.

10. One advantage of portfolio diversification methods is that they are applicable to all FIs, regardless of their

size.

11. A disadvantage to modern portfolio theory (MPT) is that small institutions generally hold significant

amounts of regionally specific and illiquid loans.

12. Most portfolio managers will accept some level of risk above the minimum risk portfolio if they expect to

receive higher returns.

13. Commercial bank call reports are provided by banks to the Federal Reserve and are useful in determining

the proportion of loans in different classifications for the entire banking system.

14. Comparing the loan mix of an individual FI to a national benchmark loan mix is useful in determining the

extent that the individual FI may differ from an efficient portfolio composition.

15. Banks whose loan portfolio composition deviates from the national benchmark should immediately

implement policies to move toward benchmark alignment.

16. The all-in-spread (AIS) used in the KMV model is the difference between the interest rate on a loan and the

prime lending rate at the time the loan was originated.

17. The KMV model includes recovery rates on defaulted loans.

18. Loan loss ratio models are based on historical loan loss ratios of specific sectors relative to the historic loan

loss ratios of the entire loan population.

19. Recent Federal Reserve policy for measuring credit concentration risk favors technical models over

subjective analysis.

20. General diversification limits established by life and property and casualty insurance regulators are based on

the concepts of modern portfolio theory.

21. Which of the following methods measure loan concentration risk by tracking credit ratings of firms in

particular sectors or ratings class for unusual downgrades?

22. Migration analysis is a tool to measure credit concentration risk and refers to

23. Which of the following observations concerning concentration limits is not true?

24. A weakness of migration analysis to evaluate credit concentration risk is that the

25. If the amount lost per dollar on a defaulted loan is 40 percent, then a bank that does not permit the loss of a

loan to exceed 10 percent of its bank capital should set its concentration limit (as a percentage of capital) to

26. If a bank’s concentration limit (as a percentage of capital) is 25.0 percent, and it does not permit a loss of

any loan to impact more than 10 percent of its capital, what is the expected recovery on loans that are

defaulted?

27. If a bank’s concentration limit (as a percent of capital) is 20 percent, and its expected recovery from

defaulted loans is 50 percent, what is the maximum loss it permits to affect its capital in the event of a default?

28. What does KMV’s Portfolio Manager Model use to identify the overall risk of the portfolio?

29. Any model that seeks to estimate an efficient frontier for loans, and thus the optimal proportions in which to

hold loans made to different borrowers, needs to determine and measure the

30. According to KMV, default correlations tend to be _____ and lie between ______.

31. A study by Citibank of 831 defaulted corporate loans and 89 asset-based loans found that, on average, an FI

can expect to recover approximately

32. As part of measuring unobservable default risk between borrowers, of the KMV model decomposes asset

returns into

33. The Federal Reserve Board in 1994 ruled against a proposal to use quantitative models to assess credit

concentration risk because

34. Matrix Bank has compiled the following migration matrix on consumer loans. Which of the following

statements accurately summarizes this data?

35. In the KMV portfolio model, the expected return on a loan is the

36. In the KMV portfolio model, the expected loss on a loan is

37. In the KMV portfolio model, the risk of a loan measures

38. In the KMV model, this is a function of the historical returns of the stock returns of the individual assets.

39. Identify the legislation that required bank regulators to incorporate credit concentration risk into their

evaluation of bank insolvency risk.

40. Which of the following is a source of loan volume data?

41. Which of the following is a measure of the sensitivity of loan losses in a particular business sector relative

to the losses in an FI’s loan portfolio?

42. Which model involves estimating the systematic loan loss risk of a particular sector or industry relative to

the loan loss risk of an FI’s total loan portfolio?

43. In applying the loan loss ratio models, the loss rate “b” for the whole loan portfolio is

44. Under which model does an FI compare its own allocation of loans in any specific area with the national

allocations across borrowers to measure the extent to which its loan portfolio deviates from the market portfolio

benchmark?

45. A Hypothetical Rating Migration, or Transition Matrix, reflects all of the following EXCEPT

46. Credit Risk + is a model developed by

47. What is the FI’s expected return on its loan portfolio?

48. What is the risk (standard deviation of returns) on the bank’s loan portfolio if loan returns are uncorrelated

(r= 0)?

49. What is Bank A’s standard deviation of its asset allocation proportions relative to the national banks

average? Use the formula in the textbook.

50. What is Bank B’s standard deviation of its asset allocation proportions relative to the national banks

average? Use the formula in the textbook.

51. If Bank A’s average return on its loan portfolio is lower than that of Bank B’s,

52. The results indicate that for the bank

53. The results can be interpreted as

54. What is the concentration limit (as a percent of capital) for unsecured loans made by Kansas Bank?

55. What is the concentration limit (as a % of capital) for secured loans made by this bank?

56. Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized) loan is 10 percent

(as a percent of capital). If it wishes to keep a concentration limit at 40 percent for secured loans, what is the

estimated amount lost per dollar of defaulted secured loan?

57. Estimate the standard deviation of Bank A’s asset allocation proportions relative to the national benchmark.

58. Estimate the standard deviation of Bank B’s asset allocation proportions relative to the national benchmark.

59. Using standard deviations, which bank is in a better position if the average earnings on the assets of Bank A

is 11 percent and Bank B is 12 percent (ignore all other factors)?

60. What is the expected return on the loan using the KMV model?

61. What is the risk of the loan using the KMV model?