[ACTFMKT] Comprehensive Exam

1. Character

2. Capacity

3. Capital

4. Conditions

5. Collateral

5 C’s of Credit

1. working capital / total assets

2. retained earnings / total assets

3. earnings before interest and tax / total assets

4. market value of equity / total liabilities

5. sales / total assets

Components of Altman Z-score

Credit risk

risk that financial obligations are not paid when they fall due because the borrower or counterparty (“obligor”) is either unable, or unwilling, to pay

Financial institutions

transforms financial claims of household savers efficiently into claims issued to corporations, individuals, and governments

Financial institutions

has the ability to process and evaluate information and control and monitor borrowers

Credit allocation

an important type of financial claim transformation for commercial banks

Credit allocation

FIs accept the risks of loans in return for interest that (hopefully) covers the costs of funding net of defaults and, as a result, are exposed to credit risk

Credit quality

a measurement of an individual's or company's creditworthiness

Creditworthiness

the ability to repay debt

Credit analysis

the process of determining the ability of a company or a person to repay their debt obligations.

Credit analysis

contains both qualitative and quantitative factors such as amounts owed, character, and capacity to make payments

Credit analysis

used to determine whether a company or individual qualifies for a loan or mortgage

Credit analysis

used to determine the quality of a bond

Gross debt service ratio

total accommodation expenses (mortgage, lease, condominium, management fees, real estate taxes, etc.) / gross income

Total debt service ratio

(total accommodation expenses + all other debt service payments) / gross income

Credit scoring systems

mathematical models that use observed loan applicant’s characteristics to calculate a score that represents the applicant’s probability of default

Liquidity risk

risk of incurring losses resulting from the inability to meet payment obligations in a timely manner when they become due or from being unable to do so at a sustainable cost

Liquidity risk

a normal aspect of the everyday management of financial institutions (Fis); the fundamental role of banks in the maturity transformation of short-term deposits into long-term loans makes banks inherently vulnerable to liquidity risk, both of an institution-specific nature and that which affects markets as a whole

Net deposit drains

the amount by which cash withdrawals exceed additions

Stored liquidity

maintaining liquid assets to meet cash needs

Purchased liquidity

rely on the ability to acquire funds from brokered deposits and borrowings

Purchased liquidity

used primarily by the largest banks with access to the money market and other non-deposit sources of funds

Purchased liquidity

can be expensive for the FI, however, since it must pay market rates for funds to offset net drains on low interest rate deposits

Net liquidity statement

lists sources and uses of liquidity

Peer group ratio comparisons

used to compare a bank’s liquidity position against its competitors

Financing gap

difference between a bank’s average loans and average (core) deposits

Financing requirement

financing gap + a bank’s liquid assets

Liquidity Coverage Ratio

ratio of the stock of high-quality assets that can be liquidated at short notice to the total net cash outflow over the next 30 days

Net Stable Fund Ratio

amount of available stable funding over 1 year divided by the required amount of stable funding over the year

100%

net stable fund ratio should be above ___ at all times

Interest rate risk

the potential for investment losses that result from a change in interest rates

Repricing model

funding gap model; examines the impact of interest rate changes on net interest income

Repricing gap

difference between those assets whose interest rates will be repriced or changed over some future period and liabilities whose interest rates will be repriced or changed over some future period

Duration model

examines the impact of interest rate changes on the overall market value of an FI and thus on net worth

Insolvency risk

bankruptcy risk; the real possibility that a company may be unable to meet its payment obligations in a defined period of time

Capital

primary protection against the risk of insolvency

Capital

a source of funds for FIs

Capital

a necessary requirement for growth under existing minimum capital-to-asset ratios set by regulators

Net worth

the economic meaning of capital

Net worth

market value (MV) of

an FI’s assets - market value of its liabilities

Market value basis

uses balance sheet values that reflect current rather than historical prices

Regulatory and accounting-defined capital

based in whole or in part on historical or book values