Learning objectives: Define credit risk and explain how it arises using examples. Explain the distinctions between insolvency, default, and bankruptcy. Identify and describe transactions that generate credit risk.
24.1.1. Jason applies for a credit card on January 15th with Chazz Bank. Chazz bank grants him a credit card on January 21st and gives him a $5,000 spending limit. Jason starts using the credit card immediately. Jason also bought a washer and dryer worth $2,500 on January 25th. Jason receives his first credit card bill on January 31st, with a due date of February 15th. Please note that (per the reading) we define credit risk broadly here to include exposure.
Based on the above scenario, which of the following statements is TRUE?
a. Jason creates credit risk for himself on January 15th.
b. Jason’s credit risk increased on January 21st.
c. Chazz Bank increased its credit risk on January 21st.
d. Chazz Bank did not increase its credit risk on January 25th.
24.1.2 This is Old Crow Corporation's balance sheet at the end of 2022:
In addition, let's assume the following information:
a. Old Crow defaulted on 1/1/2023, and the default could be due to illiquidity.
b. Old Crow went bankrupt on 12/31/2022 when its current assets exceeded its current liabilities.
c. Old Crow defaulted on 1/1/2023, and the default could be due to insolvency.
d. Old Crow was solvent on 12/31/2022.
24.1.3. Jason is a small business owner specializing in the wholesale of steel. Jason worked hard on his business, so he purchased insurance to help safeguard his company on January 4th, 2023. Later that month, on January 31st, he made a significant payment to secure a shipment of steel that will arrive on February 2nd, 2023. Jason delivered the steel to two clients on February 8th and 9th; however, he did not receive payment from the clients until February 13th. After receiving the proceeds Jason deposited the money at ABC bank.
Among these transaction dates, on which did Jason increase his credit risk?
a. None of the transactions increase his credit risk
b. His credit risk increased on the Jan dates (Jan 4th and 31st) but was unchanged on Feb dates (Feb 8th, 9th and 13th)
c. His credit risk increased on the Feb dates (Feb 8th, 9th, and 13th) but was unchanged on Jan dates (Jan 4th and 31st)
d. His credit risk increased on all of the cited transaction dates; i.e., both Jan dates (4th and 31st) and all Feb dates (8th, 9th, and 13th)
Answers here:
24.1.1. Jason applies for a credit card on January 15th with Chazz Bank. Chazz bank grants him a credit card on January 21st and gives him a $5,000 spending limit. Jason starts using the credit card immediately. Jason also bought a washer and dryer worth $2,500 on January 25th. Jason receives his first credit card bill on January 31st, with a due date of February 15th. Please note that (per the reading) we define credit risk broadly here to include exposure.
Based on the above scenario, which of the following statements is TRUE?
a. Jason creates credit risk for himself on January 15th.
b. Jason’s credit risk increased on January 21st.
c. Chazz Bank increased its credit risk on January 21st.
d. Chazz Bank did not increase its credit risk on January 25th.
24.1.2 This is Old Crow Corporation's balance sheet at the end of 2022:
In addition, let's assume the following information:
- Short-term debt refers to the current portion of an obligation to repay a loan extended by New Orleans Bank
- As of 1/1/2023, Old Crow was unable to repay its loan to New Orleans Bank.
a. Old Crow defaulted on 1/1/2023, and the default could be due to illiquidity.
b. Old Crow went bankrupt on 12/31/2022 when its current assets exceeded its current liabilities.
c. Old Crow defaulted on 1/1/2023, and the default could be due to insolvency.
d. Old Crow was solvent on 12/31/2022.
24.1.3. Jason is a small business owner specializing in the wholesale of steel. Jason worked hard on his business, so he purchased insurance to help safeguard his company on January 4th, 2023. Later that month, on January 31st, he made a significant payment to secure a shipment of steel that will arrive on February 2nd, 2023. Jason delivered the steel to two clients on February 8th and 9th; however, he did not receive payment from the clients until February 13th. After receiving the proceeds Jason deposited the money at ABC bank.
Among these transaction dates, on which did Jason increase his credit risk?
a. None of the transactions increase his credit risk
b. His credit risk increased on the Jan dates (Jan 4th and 31st) but was unchanged on Feb dates (Feb 8th, 9th and 13th)
c. His credit risk increased on the Feb dates (Feb 8th, 9th, and 13th) but was unchanged on Jan dates (Jan 4th and 31st)
d. His credit risk increased on all of the cited transaction dates; i.e., both Jan dates (4th and 31st) and all Feb dates (8th, 9th, and 13th)
Answers here:
