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2. BA-FM 24P(2018)-A (LEC) Banking and Financial Institution > Chapter 7: Risks and Credit Risk Management > Flashcards

Chapter 7: Risks and Credit Risk Management Flashcards

1
Q

refers to the potential loss that a lender or investor may incur due to the failure of a borrower to repay a loan or meet their financial obligations as agreed upon.

a. Credit Risk
b. Insolvency Risk
c. Liquidity Risk

A

A.

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2
Q

It encompasses the probability of default by the borrower and the potential loss that the lender may face as a result.

A. Insolvency Risk
B. Liquidity Risk
C. Credit Risk

A

C. Credit Risk

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3
Q

is the risk that an entity may not be able to quickly sell its assets or obtain funding at a fair price to meet its short-term obligations or financial needs, potentially leading to financial losses or operational disruptions.

a. Interest Rate Risk
b. Liquidity Risk
c. Credit Risk

A

b. Liquidity Risk

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4
Q

is the risk that the value of an investment will decline due to changes in interest rates.

a. Interest Rate Risk
b. Market Risk
c. Credit Risk

A

a. Interest Rate Risk

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5
Q

This risk affects fixed-income securities, such as bonds, where fluctuations in inter est rates can impact their market prices and yields.

a. Insolvency Risk
b. Off-balance sheet risk
c. Interest rate risk

A

c. Interest rate risk

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6
Q

also known as systematic risk, is the risk of losses in investments due to factors such as changes in market prices, interest rates, currency exchange rates, or other external factors that affect the overall market.

a. Technology risk
b. Market Risk
c. Solvency Risk

A

b. Market Risk

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7
Q

It encompasses the uncertainty of returns caused by macroeconomic and geopolitical events that impact the entire market.

a. Market Risk
b. Off-balance sheet risk
c. Foreign Exchange Risk

A

a. Market Risk

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8
Q

refers to potential losses that a company may face from financial instruments or commitments that are not recorded on its balance sheet but still have the potential to affect its financial health.

a. Technology risk
b. Foreign Exchange risk
c. Off-balance sheet risk

A

c. Off-balance sheet risk

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9
Q

These include items such as contingent liabilities, guarantees, or off-balance-sheet financing arrangements, which may expose the company to financial obligations or losses not immediately apparent in its financial statements.

a. Off-balance sheet risk
b. Credit Risk
c. Market Risk

A

a. Off-balance sheet risk

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10
Q

also known as currency risk, is the risk that fluctuations in exchange rates will adversely affect the value of investments denominated in foreign currencies.

a. Market Risk
b. Off-balance sheet risk
c. Foreign Exchange Risk

A

c. Foreign Exchange Risk

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11
Q

It arises when a company or investor holds assets, liabilities, or operates in currencies other than their domestic currency, potentially leading to losses due to adverse movements in exchange rates.

a. Credit Risk
b. Foreign Excahange risk
c. Interest rate risk

A

b. Foreign Excahange risk

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12
Q

refers to the risk associated with investing in or lending to a specific country, stemming from factors such as political instability, economic volatility, regulatory changes, and potential for default on sovereign debt obligations.

a. Country or sovereign risk
b. foreign exchange risk
c. Interest rate risk

A

a. Country or sovereign risk

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13
Q

This risk can impact the financial performance of investments or loans tied to the economic well-being and stability of a particular nation.

A. Market Risk
B. Foreign Exchange risk
C. Country or sovereign risk

A

C. Country or sovereign risk

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14
Q

refers to the potential for adverse impacts on an organization’s operations, finances, or reputation resulting from failures, disruptions, or inadequacies in technology systems, infrastructure, or processes.

a. Solvency Risk
b. Technology Risk
c. Operational Risk

A

b. Technology Risk

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15
Q

This risk encompasses a wide range of issues, including cybersecurity threats, system failures, data breaches, technological obsolescence, and challenges in adapting to new technologies.

a. Operational Risk
b. Market Risk
c. Technology Risk

A

c. Technology Risk

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16
Q

refers to the risk of losses resulting from inadequate or failed internal processes, people, systems, or external events.

a. Operational Risk
b. Insolvency Risk
c. Liquidity Risk

A

a. Operational Risk

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17
Q

It encompasses a wide range of factors, including human error, system failures, fraud, legal and regulatory compliance issues, and disruptions in business operations.

a. Insolvency Risk
b. Operational Risk
c. Technology Risk

A

b. Operational Risk

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18
Q

refers to the likelihood that an individual or entity will become unable to meet its financial obligations and repay its debts as they become due.

a. Insolvency Risk
b. Market Risk
c. Credit Risk

A

a. Insolvency Risk

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19
Q

This risk indicates the potential for financial distress or bankruptcy due to insufficient liquidity, declining cash flows, or excessive debt burdens.

a. Operational Risk
b. Insolvency risk
c. Liquidity Risk

A

b. Insolvency risk

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20
Q

refers to the process of identifying, assessing, and managing the risks associated with lending money to individuals, businesses, or other entities.

A

Credit Risk management

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21
Q

Formula of Gross Debt service Ratio

A

Gross Debt Service ratio (GDS)

GDS = Annual mortgage payments + Property taxes
/ Annual Gross Income

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22
Q

Formula of Total Debt Service Ratio

A

TDS = Annual total debt payments
/ Annual Gross Income

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23
Q

Two Ratios in Credit Analysis

A
  1. Gross Debt Service Ratio
  2. Total Debt Service Ratio
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24
Q

True or False

FI consider an applicant the GDS and TDS ratio is less than an acceptable threshold.

A

True

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25
Q

The threshold is commonly _______________ for the GDS ratio and _________________ for the TDS ratio.

A

25 to 30 percent; 35 to 40 percent

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26
Q

A mathematical model that uses observed characteristics of the loan applicant to calculate a score that represents the applicant’s probability of default.

A

Credit Scoring System

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27
Q

In credit scoring system, if applicant’s total score:

< 120 = ?
> 190 = ?
120 - 190 = ?

A

< 120 = Reject

> 190 = Accept

120 - 190 = reviewed by a loan committee for a final decision

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28
Q

are those businesses with pre taxed earnings between $5 million to $250 million

A

Middle Market Companies

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29
Q

have a recognizable corporate structure unlike many small businesses but do not have ready access to deep and liquid capital markets.

A

Middle Market Companies

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30
Q

a term used to describe the flexible financing options the Middle Market Companies have at their disposal to take their businesses to the next level.

A

Industrial Lending

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31
Q

Two Sub-Categories of Middle Market Companies

A
  1. Lower Middle Market
  2. Upper Middle Market
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32
Q

are those companies with revenues slightly greater than small and medium-sized enterprises (SMEs)

A

Lower Middle Market Companies

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33
Q

are those companies that net annual revenues between $500 to $ 1 Billion

A

Upper Middle Market Companies

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34
Q

5’Cs of Credit

A

character
capacity
collateral
condition
capital

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35
Q

is a key tool for managing credit risk on the balance sheet.

A

Ratio Analysis

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36
Q

By calculating specific ratios, you can assess a borrower’s ability to repay debt and make informed lending decisions.

A

Ratio Analysis

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37
Q

are important tools lenders use to assess a loan applicant’s ability to meet short-term financial obligations.

a. Liquidity Ratios
b. Efficiency Ratio
c. Leverage Ratio

A

Liquidity ratios

38
Q

They don’t directly measure an applicant’s creditworthiness, but rather their capacity to handle upcoming debt payments.

a. Profitability Ratio
b. Efficiencey Ratio
c. Liquidity Ratio

A

c. Liquidity Ratio

39
Q

This is the most common liquidity ratio. It compares a company’s or individual’s current assets to their current liabilities.

A

Current Ratio

40
Q

This is a more conservative measure of liquidity that excludes inventory from current assets

A

Quick Ratio

41
Q

Formula of Current Ratio

A

Current Assets / Current Liabilities

42
Q

Formula of Quick Ratio

A

(Current Assets - Inventory) / Current Liabilities

43
Q

also known as Asset management ratios , are financial metrics used to assess a company’s ability to generate revenue from its assets

a. Liquidity Ratio
b. Profitability Ratio
c. Efficiency Ratio

A

c. Efficiency Ratio

44
Q

Measures the average time it takes a company to collect payment from customers after a sale is made on credit

A

Number of Days Sales in Receivables (DSO)

45
Q

Measures the average time it takes a company to sell and replace its inventory.

A

Number of Days in Inventory (DOH)

46
Q

Formula of Days in Inventory (DOH)

A

( Inventory / Cost of Goods Sold) x 365 days

47
Q

Formula of Number of Days Sales in Receivables (DSO)

A

Accounts Receivable / Net Credit Sales) x 365 days

48
Q

Measures the efficiency of a company’s use of working capital (funds used for day-to-day operations) to generate sales

A

Sales to Working Capital

49
Q

Formula of Sales to Working Capital

A

Formula: Net Sales / Working Capital

50
Q

Measures the amount of sales generated per dollar invested in fixed assets (long-term assets like property, plant, and equipment).

A

Sales to Fixed Assets (Fixed Asset Turnover)

51
Q

Formula of Sales to Fixed Assets (Fixed Asset Turnover)

A

Formula: Net Sales / Fixed Assets

52
Q

Measures the overall efficiency of a company’s use of all its assets to generate sales.

A

Sales to Total Assets (Asset Turnover)

53
Q

Formula of Sales to Total Assets (Asset Turnover)

A

Formula: Net Sales / Total Assets

54
Q

also known as leverage ratio are the basis of analyzing credit risk on a company’s balance sheet. They provide insight into a borrower’s ability to meet both short-term and long-term financial obligations.

A

Debt & Solvency Ratio

55
Q

These ratios measure the amount of debt a company has compared to its equity or assets. It is the ratio of total debt and total assets.

A

Debt Ratios

56
Q

These ratios take a broader view, assessing a company’s ability to survive in the long term and meet all its financial commitments.

A

Solvency Ratios

57
Q

Measures the proportion of a company’s assets that are financed by debt (loans and other liabilities).

A

Debt-to-Asset Ratio

58
Q

Formula of Debt-to-Asset Ratio

A

Formula: Total Liabilities / Total Assets

59
Q

Measures a company’s ability to cover its interest expenses on outstanding debt

A

Times Interest Earned Ratio (TIE Ratio)

60
Q

Formula of Times Interest Earned Ratio (TIE Ratio)

A

Formula: Earnings Before Interest and Taxes (EBIT) / Interest Expense

61
Q

Measures a company’s ability to service its debt obligations using its operating cash flow (the cash generated from its core business activities)

A

Cash Flow to Debt Ratio

62
Q

Formula of Cash Flow to Debt Ratio

A

Formula: Cash Flow from Operations + Depreciation / Total Debt

63
Q

Evaluate how effectively a company generates profits. A consistently strong ________________ suggests a borrower’s potential to make loan payments, reducing credit risk

A

profitability ratio

64
Q

Measures the percentage of each sales dollar remaining after accounting for the cost of goods sold (COGS).

A

Gross Profit Margin Ratio

65
Q

Formula of Gross Profit Margin Ratio

A

Formula: Gross Profit / Net Sales x 100%

66
Q

Measures the percentage of each sales dollar remaining after accounting for COGS, selling, general & administrative expenses (SG&A).

A

Operating Profit Margin Ratio

67
Q

Formula of Operating Profit Margin Ratio

A

Formula: Operating Income / Net Sales x 100%

68
Q

Measures how effectively a company uses its assets to generate profit

A

Return on Assets (ROA) Ratio

69
Q

Formula of Return on Assets (ROA) Ratio

A

Formula: Net Income / Total Assets x 100%

70
Q

Measures how much profit a company generates relative to the shareholders’ investment in the company

A

Return on Equity (ROE) Ratio

71
Q

Formula of Return on Equity (ROE) Ratio

A

Formula: Net Income / Shareholders’ Equity x 100%

72
Q

Measures the percentage of a company’s net income that is paid out to shareholders as dividends

A

Dividend Payout Ratio

73
Q

Formula of Dividend Payout Ratio

A

Formula: Dividends Paid / Net Income x 100%

74
Q

Cautions with ratio analysis

A
  • Different Accounting Practices
  • Inflationary Effects
  • Historical Information
  • Ignores Qualitative Factor
  • Operating in Multiple Industries
75
Q

is a tool that financial managers use to assess the relative proportions of different financial statement items.

A

Vertical analysis

76
Q

It evaluates financial statements by expressing each line item as a percentage of a base amount for that period.

A

Vertical Analysis

77
Q

is given to a business for commercial or industrial purposes. These loans provide funding for qualified business expenses, including working capital.

A

commercial and industrial (C&I) loan

78
Q

are an important form of external financing, as they allow large companies to obtain funds for various projects.

A

Commercial and industrial loans

79
Q

The indicator variable Z is an overall measure of the borrower’s default risk classification.

A

Altman’s z score

80
Q

This classification, in turn, depends on the values of various financial ratios of the borrower (Xj) and the weighted importance of these ratios based on the observed experience of defaulting versus non defaulting borrowers derived from a discriminant analysis model.

A

Altman’s z score

81
Q

Formula of Altman’s z score

A

Z = 1.2X1 + 1.4X2 + 3.3X3 + 0.6X4 + 1.0X5

82
Q

Formula of Altman’s z score (X1)

A

X1 = Working Capital / Total Assets

83
Q

Formula of Altman’s z score (X2)

A

X2 = Retained Earnings / total assets

84
Q

Formula of Altman’s z score (X3)

A

X3 = earnings before interest and taxes / total assets

85
Q

Formula of Altman’s z score (X4)

A

X4 = market value of equity / book value of total liabilities

86
Q

Formula of Altman’s z score (X5)

A

X5 = sales / total assets

87
Q

In Altman’s z score

Less than 1.81 – ?
Between 1.81 and 2.99 – ?
Greater than 2.99 – ?

A

Less than 1.81 – high default risk firm
Between 1.81 and 2.99 – intermediate default risk firm
Greater than 2.99 – low default risk firm

88
Q

is a tool used to assess and track the credit risk of borrowers over time. It employs various quantitative techniques and data analysis methods to evaluate the financial health and repayment capacity of borrowers.

A

Moody’s Analytics credit monitoring model

89
Q

The model continuously monitors changes in key financial metrics, market conditions, and other relevant factors to provide timely insights into credit risk dynamics. helps financial institutions and investors make informed decisions about lending, investment, and risk management.

A

Moody’s Analytics credit monitoring model

90
Q

Formula of RAROC

A

RAROC= one year income on loan /Loan risk or value at risk

or

RAROC= one year income on loan / Value of a loan x unexpected default rate x loss given by default

or

RAROC= Revenue - costs - expected losses / Economic capital

91
Q
A

2. BA-FM 24P(2018)-A (LEC) Banking and Financial Institution (9 decks)

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