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Exam 20: Managing Credit Risk on the Balance Sheet

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Question 31

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Interest is Big Valley's only fixed cash charge. Big Valley's market value of equity to book value of debt ratio = 1.5. Big Valley's use of debt to finance assets indicates that Big Valley has ________ the typical firm in the industry.

A) more long-term solvency risk than
B) the same long-term solvency risk as
C) less interest expense than
D) less long-term solvency risk than
E) a lower market value of equity to book value of equity ratio than

F) A) and E)
G) A) and C)

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Question 32

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Which one of the following is usually the better predictor of default?

A) Standard & Poor's credit rating
B) Moody's credit rating
C) Altman Z-score
D) Moody's Analytics EDF
E) All of these choices are correct.

F) A) and D)
G) A) and B)

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Question 33

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Management of credit risk is achieved through diversification effect by combining numerous loans in a portfolio.

Why is bank lending to large corporations more difficult than making loans to small or mid-size firms? What additional factors are involved? Do banks have some additional tools to help in assessing credit risk of large firms? What are some examples?

The five Cs of credit are financial capacity,collateral,conditions,connections with the bank,and capital.

Mid-market commercial lending may be typically defined as borrowers I. with sales revenue between $5 million and $100 million. II. with a recognizable corporate structure. III. with ready access to deep and liquid capital markets.

Collateral on a mortgage is normally only considered if the applicant has enough income to service the loan.

In analyzing credit risk for a loan to a major diversified corporation,the bank typically has which of the following advantages? I. Market-based models to analyze credit risk II. Greater negotiating power due to the size of the loan required III. Ratings agency measures of default risk

Why won't a loan officer usually approve a loan solely on the basis of collateral?

A corporate loan applicant has had a growing cash account for the last three years,but cash flow from operations has been negative in every year. Would this concern you if you were the loan officer charged with approving the loan? If so,why? If not,why not?

Gross debt service usually must be greater than 30 percent before a residential mortgage will be approved.

If you were a loan officer evaluating a small business credit application for a loan secured by working capital,you would generally want to see a higher (rather than lower)number of days in inventory and number of days' sales in receivables.

Explain what each ratio in the Altman credit model measures and explain why higher values of each of the variables predict lower default probability.

________ is the process of taking possession of the mortgaged property to satisfy the debt in the event of failure to repay the mortgage and foregoing claim to any deficiency.

Interest is Big Valley's only fixed cash charge. Big Valley's market value of equity to book value of debt ratio = 1.5. Big Valley has a times interest earned ratio that is ________,which indicates that Big Valley has ________ long-term insolvency risk than the typical firm in the industry.

Credit scoring models are probabilistic models based on economic and financial borrower characteristics aiming to determining the likelihood of default of a borrower.

The more variable a borrower's cash flows are,the lower the fixed charge coverage ratio should be to limit risk.

The conditions specified in a credit agreement that must be fulfilled before a drawdown is allowed are called

Business credit-scoring models suffer from several weaknesses. These include which of the following? I. Credit-score models are not statistically sound tools to use in making a lending decision. I. The appropriate weights on a credit-score model are likely to change unpredictably over time. II. These models ignore non-quantifiable behavioral factors,such as a relationship with the bank and reputation. IV. Credit-scoring models discriminate against minorities.

Interest is Big Valley's only fixed cash charge. Big Valley's market value of equity to book value of debt ratio = 1.5. Altman's Z-score model is Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5. X1 = Working Capital/Total Assets X2 = Retained Earnings/Total Assets X3 = EBIT/Total Assets X4 = Market Value Equity/Book Value Long-Term Debt X5 = Sales/Total Assets Using the Altman's Z model,Big Valley's Z-score is