Credit risk loan

[Francesca]

Hi David,

I'm coming back again to you because I need you precious help.

Actually I have some, but small questions regarding the credit risk assessment for loan.
1-what's teh difference between the RESERVE REQUIREMENT and the COMPENSATING BALANCE? at the end are both reserve, but required by different subjects?
2-Can I say that the probability of NOT repay is E(r) = 1-p(1+k) ?
3- Who is the counterparty covered by the "cross default provision" in the sovereign risk?
4- How we can define the "grace period" in the rescheduling of a foreign loan?
5- in the Merton model is said that the degts are less sensible at the r variation respect to the equity, during a financial distress? Are not both equal?
6-Why the ptf EL is lower than the UL?
7-to recognize a SPV, based on the FAS140, that has to be diveded by the originator. Is this rule linked to the definition of a loan sell on "partecipation basis"?
and last....what is the rule of VIES on the FIN46R?

I would really apprecate an your feedback!!!
Thanks ,
Francesca

 

[David Harper CFA FRM]

Hi Francesca,

1. "at the end are both reserve, but required by different subjects." Economically, yes, that's sort of how i look at it. In Saunders the denominator in gross return is 1 - (b[1-RR]). The (b) is par of the loan not given to the borrow, held by the bank, compensating balance ("Here I will lend you $10 but I am going to hold onto $1, but i am charging you on $10"). The RR is a reserve too, but from the Fed to the bank. So it "erodes" the gain on the (b). That is, CB is reserve for the bank's benefit (boosts banks return) but is offset by Fed's reserve requirement

2. I don't think so. In Saunders, p = prob of repay. So, (1-p) is probably of not repay (default). E(r) = expected return = p(1+k) - 1. Start with 1+k, that is the promised return. But now we probability adjust, two possible outcomes:

borrow repays. Expected payoff = p(1+k)
borrow does not repay. Expected payoff= (1-p)(0)

Weighted average payoff = p(1+k)+(1-p)(0) = p(1+k), then -1 to covert to a return

3. Not sure i follow. Cross default provisions trigger default when another creditor defaults (if i am a creditor, i don't want to be left out of creditor negotiations). Counterparty here sounds like the lender to a country (?)

4. I am not sure, sorry
5. I don't follow this, apologies.
6. What is 'ptf?' I don't know what to make of this, this is not the best way to look at UL. UL is volatilty around the EL. UL = VaR() - EL.
7. This is a a big a topic, For the FRM you need Culp's Chapter 16 on Securitization. I'll be glad to try and help i think you might try his intro first?

thanks, David