If the amount lost per dollar on a defaulted loan is 40 percent, then a bank that does not permit the loss of a loan to exceed 10 percent of its bank capital should set its concentration limit (as a percentage of capital) to

Question

Quizplus · Accepted Answer

If the bank does not permit the loss of a loan to exceed 10 percent of its capital, then the maximum concentration limit is the amount of capital that would be lost if all loans in a given sector defaulted, set at 10 percent of the bank's capital. 
Let x be the concentration limit as a percentage of capital. 
Then, the amount lost per dollar on a defaulted loan is 40 cents. 
Thus, the maximum loss the bank can sustain on the concentration limit is 10 percent of its capital. 
So, we have: 
0.4(amount of loans lost) = 0.1(total capital) 
Amount of loans lost/total capital = 0.1/0.4 = 0.25 = 25% 
Therefore, the concentration limit should be set at 25% of the bank's capital, which is choice C.

If the Amount Lost Per Dollar on a Defaulted Loan