FINM3404 Financial Institutions and Credit Risk Analysis
Financial Institutions and Credit Risk Analysis
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FINM3404
Financial Institutions and Credit Risk Analysis
Part A: MCQ Questions
1. A loan covenant is:
A. a legal clause in a borrowing contract that requires the lender to avoid certain
actions
B. a legal clause in a borrowing contract that requires the lender to take certain actions
C. a legal clause in a borrowing contract that requires the borrower to take certain
actions
D. a legal clause in a borrowing contract that requires the borrower to either take
certain actions or avoid certain actions
E. Both A and B
2. FIs perform their intermediary function in two ways:
A. They specialise as brokers between savers and users and they directly control the
quantity of outside money in the economy.
B. They serve as asset transformers by purchasing primary securities and issuing
secondary securities and by purchasing secondary securities and issuing primary
securities.
C. They serve as asset transformers by purchasing secondary securities and issuing
primary securities and they directly control the quantity of outside money in the
economy.
D. They specialise as brokers between savers and users and they serve as asset
transformers by purchasing primary securities and issuing secondary securities.
E. They serve as brokers by purchasing secondary securities and issuing primary
securities.
Objectives - The importance and significance of FIs
- Different types of loans
- How to perform credit analyses
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3. Which of the following statements is true?
A. Household savers are likely to be attracted to direct investments in corporate
securities because of lower monitoring costs compared to using financial
intermediaries.
B. Household savers are likely to be attracted to direct investments in corporate
securities because of lower liquidity costs compared to using financial
intermediaries.
C. Household savers are likely to be attracted to direct investments in corporate
securities because of lower price risk compared to using financial intermediaries.
D. Household savers are likely to be attracted to direct investments in corporate
securities because of lower interest rate risk compared to using financial
intermediaries.
E. None of the listed options are correct.
4. The key factors entering into the credit decision include:
A. borrower-specific factors that are idiosyncratic to the individual borrower
B. market-specific factors that have an impact on all borrowers at the time of the credit
decision
C. global-economic factors that have an impact on all FIs at the time of credit decision
D. borrower-specific factors that are idiosyncratic to the individual borrower and
market-specific factors that have an impact on all borrowers at the time of the credit
decision
E. Only lender specific factors that are idiosyncratic to the FI
5. Consider the following data of a prospective borrower.
What is this company's Z-score?
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A. 3.71
B. 2.80
C. 2.90
D. 3.00
E. 3.50
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Part B: Discussion questions
Question 1
If financial markets operated perfectly and without cost, would there be a need for FIs?
Question 2
Explain how you believe economic activity would be affected if there were no financial
institutions.
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Question 3
What is moral hazard? Do you think this is a big issue for financial institutions?
Question 4
Discuss the benefits of intermediation services.
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Question 5
What is denomination intermediation? How do FIs assist in this process?
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Question 6
Differentiate between a secured and an unsecured loan. Who bears most of the risk in a fixed-
rate loan? Why would FI managers prefer to charge floating rates, especially for longer
maturity loans?
Part C: Decision problems
Question 7 - Pricing Commercial Loans
Finch Corporation is a new business client for First Commerce National Bank and has asked
for a one-year, $10 million loan at an annual interest rate of 6%. The company plans to keep
a 4.25%, $3 million CD with the bank for the loan’s duration. The loan officer in charge of the
case recommends at least a 4% annual before-tax rate of return over all costs. Using customer
profitability analysis (CPA) the loan committee hopes to estimate the following revenues and
expenses which it will project using the amount of the loan requested as a base for the
calculations:
Estimated Revenues: Estimated Expenses:
Interest income from loan ? Interest to be paid on customer’s $3 million deposit ?
Loan commitment fee (0.75%) ? Expected cost of additional funds needed
to support the loan (4%) ?
Cash management fees (3%) ? Labor costs and other operating expenses
(on an annual average of associated with monitoring
$15 million) the customer’s loan (2%) ?
Cost of processing the loan (1.5%) ?
a) Should this loan be approved on the basis of the suggested terms?
b) What adjustments could be made to improve this loan’s projected return?