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RSK4804 Assignment 1 Memo | Due 30 May 2025. All questions fully answered. Question 1 [10]
a.
Explain the two most important drivers of credit risk and how those relate to the probability of default (PD). (5)
b.
As head of credit risk at Daspoort Investment Bank, you are considering approval of a five-year credit asset (business term loan) with a bullet (balloon) repayment at the end of a term. The term loan shows a marginal probability of default of 1.3%, 1.5%, 1.2%, 1.7%, and 2.2% for each of the five years, respectively. How would you find the cumulative probability of default over the five-year period for pricing purposes?
Question 2 [10]
The Merton model, which was proposed in 1974 by economist Robert C. Merton, is a mathematical formula that stock analysts and commercial loan officers, among others, can use to judge a corporation’s risk of credit default and ability to retain solvency. This model assesses the structural credit risk of a company by modeling its equity as a call option on its assets.
With the above statement in mind, the current value of the assets of Sibasa Agricultural Holdings is R130 million. The assets are financed by a mix of equity and zero-coupon debt. The current value of the zero-coupon debt is R75 million, and the final amount to be paid on maturity after five years is R120 million, with an effective interest rate of 13.25%. The volatility in Sibasa Agricultural Holdings’ asset value is 23%. The following is required:
a.
Compute the probability of default (PD) of Sibasa Agricultural Holdings based on the Merton model. (5)
b.
What is the impact on probability of default (PD) if the volatility suddenly decreases to 21%? (5)
Question 3 [15]
Internal rating systems deployed by banks and financial institutions differ from organisation to organisation. As a potential future credit risk analyst, you are required to identify a local or international financial (lending) institution or a retailer who extends credit facilities to new and existing clients. Your focus must include but not be limited to the following: –
•
Understanding of the organisation’s internal rating systems
•
A process that has been put in place
•
Decision to deny or approve a credit line to a customer
•
How the credit quality of a client’s portfolio is maintained
Document your visit/call and provide feedback relating to your findings.
Conditions:
(a)
Physical visit to the entity or telephonic contact is a must – originality is required. Also, it is mandatory to provide the name of the company (organisation), place, business type, name of the person interviewed, and the date.
(b)
Any “cut and paste” from resources will not attract marks.
Question 4 (15)
In credit assessment, Porter’s Five Forces Model is a tool that can be used to give insight into forces that affect the revenue and profitability of a business. As a credit analyst for Meadowbank Limited, use the Porter’s Model to assess the potential, in terms of performance, of a company of your choice, locally or internationally, in sectors of retail, automotive, aviation, and food services. You can begin by giving a brief background of the company and the sector of operation.
TOTAL MARKS: 50
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