Kansas Bank has a policy of limiting their loans to any single customer so that the maximum loss as a percent of capital will not exceed 20 percent for both secured and unsecured loans.The limit has been adopted under the assumption that if the unsecured loan is defaulted,there will be no recovery of interest or principal payments.For loans that are secured (collateralized),it is expected that 40 percent of interest and principal will be collected.

Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized)loan is 10 percent (as a percent of capital).If it wishes to keep a concentration limit at 40 percent for secured loans,what is the estimated amount lost per dollar of defaulted secured loan?

Question

Kansas Bank has a policy of limiting their loans to any single customer so that the maximum loss as a percent of capital will not exceed 20 percent for both secured and unsecured loans.The limit has been adopted under the assumption that if the unsecured loan is defaulted,there will be no recovery of interest or principal payments.For loans that are secured (collateralized),it is expected that 40 percent of interest and principal will be collected.

Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized)loan is 10 percent (as a percent of capital).If it wishes to keep a concentration limit at 40 percent for secured loans,what is the estimated amount lost per dollar of defaulted secured loan?

Quizplus · Accepted Answer

Concentration limit = Maximum loss as a percent of capital x (1 ÷ Loss rate)
Loss rate = Maximum loss as a percent of capital ÷ Concentration limit
Loss rate = 0.10 ÷ 0.40 = 0.25.

Kansas Bank Has a Policy of Limiting Their Loans to Any