What shortcomings are introduced by using traditional cra

Reference no: EM13502518

1.A bank was expecting to receive $100,000 from its customer based in Great Britain. Since the customer has problems repaying the loan immediately, the bank extends the loan for another year at the same interest rate of 10 percent. However, in the rescheduling agreement, the bank reserves the right to exercise an option for receiving the payment in British pounds, equal to £181,500, converted at the current exchange rate of £1.65/$.

a. If the cost of funds to the bank is also assumed to be 10 percent, what is the value of this option built into the agreement if only two possible exchange rates are expected at the end of the year, £1.75/$ or £1.55/$, with equal probability?

b. How would your answer differ, if the probability of the exchange rate being £1.75/$ is 70 percent and that of £1.55/$ is 30 percent?

c.Does the currency option have more or less value as the volatility of the exchange rate increases?

2.A $20 million loan outstanding to the Nigerian government is currently in arrears with City Bank. After extensive negotiations, City Bank agrees to reduce the interest rates from 10 percent to 6 percent and to lengthen the maturity of the loan to 10 years from the present 5 years remaining to maturity. The principal of the loan is to be paid at maturity. There will no grace period and the first interest payment is expected at the end of the year.

a. If the cost of funds is 5 percent for the bank, what is the present value of the loan prior to the rescheduling?

b. What is the present value of the rescheduled loan to the bank?

c.What is the concessionality of the rescheduled loan if the cost of funds remains at 5 percent and an up-front fee of 5 percent is charged?

d. What up-front fee should the bank charge to make the concessionality equal zero?

3.A bank is in the process of renegotiating a loan. The principal outstanding is $50 million and is to be paid back in two installments of $25 million each, plus interest of 8 percent. The new terms will stretch the loan out to five years with only interest payments of 6 percent, no principal payments, for the first three years. The principal will be paid in the last two years in payments of $25 million along with the interest. The cost of funds for the bank is 6 percent for both the old loan and the renegotiated loan. An up-front fee of 1 percent is to be included for the renegotiated loan.

a.What is the present value of the existing loan for the bank?

b.What is the present value of the rescheduled loan for the bank?

c.Is the concessionality positive or negative for the bank?

4.Which variables typically are negotiation points in an LDC multiyear restructuring agreement (MYRA)? How do changes in these variables provide benefits to the borrower and to the lender?

5.Who are the primary sellers of LDC debt? Who are the buyers? Why are FIs often both sellers and buyers of LDC debt in the secondary markets?

6.What are the benefits and costs of rescheduling to the following?

a. A borrower.

b. A lender.

7.What is systematic risk in terms of sovereign risk? Which of the variables often used in statistical models tend to have high systematic risk? Which variables tend to have low systematic risk?

8.Explain the following relation:

p = f (IR, INVR)

+, + or -

p = Probability of rescheduling

IR = Total imports/Total foreign exchange reserves

INVR = Real investment/GNP

9.What shortcomings are introduced by using traditional CRA models and techniques? In each case, what adjustments are made in the estimation techniques to compensate for the problems?

10.Countries A and B have exports of $2 billion and $6 billion, respectively. The total interest and amortization on foreign loans for both countries are $1 billion and $2 billion, respectively.

a.What is the debt service ratio (DSR) for each country?

b.Based only on this ratio, to which country should lenders charge a higher risk premium?

c.What are the shortcomings of using only these ratios to determine your answer in (b)?

Reference no: EM13502518

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