Corporate finance: value sustainability and analysis
Prof. Dr. Mariana Oreng
Exercise list - Final exam (2025/1)
1. True or false?
a. A bank acquires funds by issuing (selling) liabilities, which are the sources of
funds the bank uses.
b. A bank is insolvent when it has liabilities in excess of assets, meaning that the
bank can be forced into liquidation.
c. Reserve requirements refer to the choice of a bank to offer a fraction of its
deposits as loans.
d. In the context of banking, interest rate risk refers to the riskiness of earnings
and returns on bank assets caused by interest-rate changes.
e. Diversification can effectively eliminate systemic risk but cannot reduce
idiosyncratic risk.
f. “Junk” bonds often experience much lower default rates.
2. Which of the following best describes "credit risk" in the context of investing in
government bonds?
a. The risk that inflation will erode the purchasing power of bond interest
payments.
b. The risk that the government will fail to pay interest and principal on the
agreed dates.
c. The risk that the bond's price will fluctuate due to changes in market interest
rates.
d. The risk that the bond will be difficult to sell in the secondary market.
e. The risk that currency exchange rates will affect the bond's value.
3. Given the following nominal interest rates for long-term securities and a Treasury yield to
maturity (YTM) of 4.51%, calculate the risk premium for each rating class.
Rating class Nominal interest rate (%)
AAA 5.5
BBB 6.01
B 7.9
4. A corporate debt instrument offers an annual interest rate of 18%, while the risk-free
government bond rate is 5% per annum.
a. Calculate the probability of default (PD) embedded in this corporate debt
instrument.
b. Given that this corporate debt instrument has a credit rating of A, which
implies a cumulative default rate of 0.23% over 3 years, compare the
calculated probability of default (PD) with the default rate implied by the
credit rating.
5. NewBank started its first day of operations with $155 million in capital. A total of $92 million
in checkable deposits is received. The bank makes a $28 million commercial loan and lends
another $23 million in mortgage loans. If required reserves are 5.4%, what does the bank
balance sheet look like? Please include both required reserves and excess reserves in your
answer.
ANSWERS
1) T; T; F; T; F; F
2) B
3) AAA = 0,99%; BBB = 1,5%; B = 3,39%
4) PD = 1- (1.05/1.18) = 11.1%; b) The cumulative default rate over 3 years for
credit rating A is 0.23%, which translates to an annual default rate of
approximately 0.23%/3 =0.077% per annum. Comparing this with the
calculated PD of 11.1%, the calculated PD is significantly higher than the
default rate implied by the credit rating. This suggests that the calculated PD
indicates a higher perceived risk of default compared to what is implied by
the credit rating of A.
5)
ASSETS LIABILITIES
Excess reserves – 191,04 Deposits – 92
Required reserves – 4,96 Bank capital - 155
Commercial loans – 28
Mortages - 23
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