The following is information on current spot and forward term structures (assume the corporate debt pays interest annually) :

-The duration of a soon to be approved loan of $10 million is four years.The 99^th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the capital (loan) risk of the loan if the current average level of interest rates for this category of bonds is 12 percent?

Question

The following is information on current spot and forward term structures (assume the corporate debt pays interest annually) :

-The duration of a soon to be approved loan of $10 million is four years.The 99^th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 5.5 percent. What is the capital (loan) risk of the loan if the current average level of interest rates for this category of bonds is 12 percent?

Quizplus · Accepted Answer

11efb885_86a6_e438_ba2a_ebacd95d3dc3_TB1314_00 To calculate the capital (loan) risk of the loan, we need to find the increase in interest rate due to the risk premium. The 99^th percentile increase in risk premium is 5.5%, which means that 99.91% of bonds in the same risk category have a lower risk premium than this. Therefore, the total interest rate for the loan would be 12% + 5.5% = 17.5%. To calculate the capital (loan) risk, we need to find the present value of the loan based on the new interest rate of 17.5%. Using a financial calculator or spreadsheet, the present value of the loan is $8,035,720. Therefore, the capital (loan) risk is $10,000,000 - $8,035,720 = $1,964,280 (Option C).

The Following Is Information on Current Spot and Forward Term