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Credit and Leverage
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Question 1 of 30
1. Question
Credit derivatives enable banks and other institutions to hedge credit risk or to guard against deterioration in the value of their credit portfolio. Which of the following is not an advantage that derivative instruments bring to the protection buyer?
Correct
Protection buyers are those who seek to protect the credit asset (e.g. loan or bond) they have or intend to acquire. The following are advantages that derivative instruments bring to the protection buyer:
– It enables credit risk transfer to a third party, significantly reducing the credit portfolio risk.
– As the overall credit risk reduces, the protection buyer may underwrite more, i.e. increase credit capacity.
– The asset remains on the balance sheet of the protection buyer earning income.
– In some cases, where the bank or financial institution reduces its overall credit risk through credit derivatives, it has a favourable impact on the regulatory capital, i.e. reduces the regulatory capital requirements.Incorrect
Protection buyers are those who seek to protect the credit asset (e.g. loan or bond) they have or intend to acquire. The following are advantages that derivative instruments bring to the protection buyer:
– It enables credit risk transfer to a third party, significantly reducing the credit portfolio risk.
– As the overall credit risk reduces, the protection buyer may underwrite more, i.e. increase credit capacity.
– The asset remains on the balance sheet of the protection buyer earning income.
– In some cases, where the bank or financial institution reduces its overall credit risk through credit derivatives, it has a favourable impact on the regulatory capital, i.e. reduces the regulatory capital requirements. -
Question 2 of 30
2. Question
A credit derivative is a bilateral contract that transfers the entire (or specific aspects of) credit risk on a specified debt obligation to another party. Which of the following is not an advantage that derivative instruments bring to the protection seller?
Correct
Protection sellers provide the protection or insurance on credit risk for a premium. Protection sellers are underwriting credit risk and hence must conduct a thorough credit risk analysis. The following are advantages that derivative instruments bring to the protection seller:
– It offers the opportunity to earn unfunded income.
– The investment remains off-balance sheet and actual cash needs to be deployed only if the ‘credit event’ is triggered.
– The overall return could exceed (i.e. be more than) that of the direct investment.
– Overall transaction cost tends to be relatively lower than the cash or direct investment.Incorrect
Protection sellers provide the protection or insurance on credit risk for a premium. Protection sellers are underwriting credit risk and hence must conduct a thorough credit risk analysis. The following are advantages that derivative instruments bring to the protection seller:
– It offers the opportunity to earn unfunded income.
– The investment remains off-balance sheet and actual cash needs to be deployed only if the ‘credit event’ is triggered.
– The overall return could exceed (i.e. be more than) that of the direct investment.
– Overall transaction cost tends to be relatively lower than the cash or direct investment. -
Question 3 of 30
3. Question
Credit derivatives enable the transfer of credit risks to other parties who would compensate, in the event of specific losses being incurred. Such events are termed credit events. Which of the following does a credit event usually include?
I. Payment preferences.
II. Restructuring of the debt.
III. Bankruptcy or moratorium.
IV. Cross default clause triggered credit event.Correct
The credit event can be mutually agreed upon by the protection buyer and seller. The credit event usually includes the following:
∙ Default.
∙ Restructuring of the debt.
∙ Cross default clause triggered credit event.
∙ Rating downgrades/migration of the rating to unacceptable levels.
∙ Bankruptcy or moratorium.
∙ Failure to pay.
∙ Any other mutually agreed upon event.Incorrect
The credit event can be mutually agreed upon by the protection buyer and seller. The credit event usually includes the following:
∙ Default.
∙ Restructuring of the debt.
∙ Cross default clause triggered credit event.
∙ Rating downgrades/migration of the rating to unacceptable levels.
∙ Bankruptcy or moratorium.
∙ Failure to pay.
∙ Any other mutually agreed upon event. -
Question 4 of 30
4. Question
Which of the following allows the creditor (or the protection buyer) to transfer credit risk to another party by paying a fixed amount (premium), either in one lump sum or at regular intervals?
Correct
Credit default swap (CDS) allows the creditor (or the protection buyer) to transfer credit risk to another party by paying a fixed amount (premium), either in one lump sum or at regular intervals. The Credit Default Swap (CDS) is the most common credit derivative.
Incorrect
Credit default swap (CDS) allows the creditor (or the protection buyer) to transfer credit risk to another party by paying a fixed amount (premium), either in one lump sum or at regular intervals. The Credit Default Swap (CDS) is the most common credit derivative.
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Question 5 of 30
5. Question
Which of the following is the estimated market price of the collateral (or of the financial instrument) when a credit event has been declared?
Correct
Recovery value is the estimated market price of the collateral (or of the financial instrument) when a credit event has been declared. In cash settlements, the protection buyer receives a cash payment proportional to the severity of the loss on the reference asset (i.e. initial value – recovery value).
Incorrect
Recovery value is the estimated market price of the collateral (or of the financial instrument) when a credit event has been declared. In cash settlements, the protection buyer receives a cash payment proportional to the severity of the loss on the reference asset (i.e. initial value – recovery value).
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Question 6 of 30
6. Question
A call/put option represents the right, but not the obligation, to buy/sell. Credit option is a credit derivative that applies the principle of option to reduce credit risks. Which of the following statements about credit options is true?
I. A credit option allows the protection buyer to be protected against any credit loss arising from any predefined credit events.
II. In exchange for these benefits and protection, the protection seller will pay a fee upfront known as a premium.
III. If the credit event does not occur during the contracted period, then the protection buyer would let the option lapse.
IV. If any of the credit events are triggered, the company/bank (the protection buyers) would seek compensation (termination payment) under the option.Correct
Like equity options, credit options may be either American or European style. A Credit option allows the protection buyer to be protected against any credit loss arising from any predefined credit events. If the credit event does not occur during the contracted period, then the protection buyer would let the option lapse. However, on the other hand, if any of the credit events are triggered, the company/bank (the protection buyers) would seek compensation (termination payment) under the option. In exchange for these benefits and protection, the protection buyer will pay a fee upfront known as a premium.
Incorrect
Like equity options, credit options may be either American or European style. A Credit option allows the protection buyer to be protected against any credit loss arising from any predefined credit events. If the credit event does not occur during the contracted period, then the protection buyer would let the option lapse. However, on the other hand, if any of the credit events are triggered, the company/bank (the protection buyers) would seek compensation (termination payment) under the option. In exchange for these benefits and protection, the protection buyer will pay a fee upfront known as a premium.
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Question 7 of 30
7. Question
Historically credit is good if used wisely. Under which of the following conditions could both lenders (and creditors) and borrowers (or debtors) and even global economies suffer because of credit?
I. Poor credit risk analysis.
II. Inadequate credit risk management.
III. Adequate credit risk management.
IV. Robust credit risk analysis.Correct
Historically credit is good if used wisely. Lenders (and creditors) and borrowers (or debtors) and even global economies could suffer because of credit in the event of poor credit risk analysis and inadequate credit risk management. Credit prudently used can create wealth and bring overall prosperity to the economy.
Incorrect
Historically credit is good if used wisely. Lenders (and creditors) and borrowers (or debtors) and even global economies could suffer because of credit in the event of poor credit risk analysis and inadequate credit risk management. Credit prudently used can create wealth and bring overall prosperity to the economy.
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Question 8 of 30
8. Question
Which of the following terms refers to a financial institution’s opposite number in a bilateral financial contract?
Correct
Counterparty refers to a financial institution’s opposite number in a bilateral financial contract. Counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation.
Incorrect
Counterparty refers to a financial institution’s opposite number in a bilateral financial contract. Counterparty risk is the likelihood or probability that one of those involved in a transaction might default on its contractual obligation.
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Question 9 of 30
9. Question
The credit risk that arises from a transaction involving a counterparty is often called counterparty (credit) risk. Which of the following terms best describes counterparty credit analysts?
Correct
Bank and financial institution analysts whose role is to evaluate the credit risk associated with the transaction are frequently called counterparty credit analysts. The focus of counterparty credit analysts is on the potential credit risks that result from financial transactions, including settlement risk.
Incorrect
Bank and financial institution analysts whose role is to evaluate the credit risk associated with the transaction are frequently called counterparty credit analysts. The focus of counterparty credit analysts is on the potential credit risks that result from financial transactions, including settlement risk.
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Question 10 of 30
10. Question
Which of the following refers to a transaction between two parties in which someone supplies money, goods, services, or securities in return for a promise of future payment by the other party?
Correct
Credit refers to a transaction between two parties in which someone (the creditor or lender) supplies money, goods, services, or securities in return for a promise of future payment by the other party (the debtor or borrower). Such transactions normally include the payment of interest to the lender.
Incorrect
Credit refers to a transaction between two parties in which someone (the creditor or lender) supplies money, goods, services, or securities in return for a promise of future payment by the other party (the debtor or borrower). Such transactions normally include the payment of interest to the lender.
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Question 11 of 30
11. Question
The number of risks impacting an entity that might derail the objectives and strategies is enormous. It is essential to understand all material risks. Which of the following are methods of risk identification?
I. Interviews and questioning.
II. Communal meetings and gatherings.
III. Studying market developments/peer comparison against benchmarks.
IV. Committee sessions.Correct
It is not practical to identify all such risks, however, it is essential to understand all material risks. Generally, risk identification is done through the following ways:
– Interviews and questioning.
– Studying market developments/peer comparison against benchmarks.Incorrect
It is not practical to identify all such risks, however, it is essential to understand all material risks. Generally, risk identification is done through the following ways:
– Interviews and questioning.
– Studying market developments/peer comparison against benchmarks. -
Question 12 of 30
12. Question
Meetings with senior corporate management and discussions are the most commonly applied method of risk identification. Analysts provide the company with time to prepare a thorough presentation and guide the meeting with intelligent questioning to gather information. The person conducting the credit risk analysis must call for background material on the industry and company beforehand. Which of the following are part of this background material?
I. Audited annual financial statements for five years.
II. Essential factors for failure.
III. Product brochures and other descriptive materials on the operations and products/services.
IV. Industry background and the customer’s position with the industry.Correct
The person conducting the credit risk analysis must call for background material on the industry and company beforehand, which includes the following:
– Audited annual financial statements for five years.
– Latest management accounts/interim financial statements subsequent to the previous audited.
– Memorandum/articles of association/partnership deed/other legal or government-related documents.
– Product brochures and other descriptive materials on the operations and products/services.
– Industry background and the customer’s position with the industry.
– Industry competition factors.
– Order book.
– Corporate governance.
– Succession plan.
– Nature of activity.
– Competitive advantages.
– Critical success factors.Incorrect
The person conducting the credit risk analysis must call for background material on the industry and company beforehand, which includes the following:
– Audited annual financial statements for five years.
– Latest management accounts/interim financial statements subsequent to the previous audited.
– Memorandum/articles of association/partnership deed/other legal or government-related documents.
– Product brochures and other descriptive materials on the operations and products/services.
– Industry background and the customer’s position with the industry.
– Industry competition factors.
– Order book.
– Corporate governance.
– Succession plan.
– Nature of activity.
– Competitive advantages.
– Critical success factors. -
Question 13 of 30
13. Question
Which of the following refers to the defects, inadequacies, and lack of skill and experience of the people in key positions?
Correct
Management risk refers to the defects, inadequacies, and lack of skill and experience of the people in key positions. The degree of incompetence and unsatisfactory track record of the management team ought to suggest the magnitude of this risk.
Incorrect
Management risk refers to the defects, inadequacies, and lack of skill and experience of the people in key positions. The degree of incompetence and unsatisfactory track record of the management team ought to suggest the magnitude of this risk.
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Question 14 of 30
14. Question
Management risk refers to the defects, inadequacies, and lack of skill and experience of the people in key positions. Which of the following are characteristics of good management?
I. Intensifies business failure.
II. Can rectify the business failure.
III. Overlooks a badly managed business.
IV. Can turn around a badly managed business.Correct
Characteristics of good management include that they can turn around a badly managed business or rectify business failures. On the other hand, bad management can break a good business in no time. Bad management is one of the biggest risks at entity level, which can cause a good business to fail, even with all favourable factors.
Incorrect
Characteristics of good management include that they can turn around a badly managed business or rectify business failures. On the other hand, bad management can break a good business in no time. Bad management is one of the biggest risks at entity level, which can cause a good business to fail, even with all favourable factors.
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Question 15 of 30
15. Question
Management risk refers to the defects, inadequacies, and lack of skill and experience of the people in key positions. Which of the following are common hints, which may point to an operating risk related to the management?
I. Lack of skilled managers
II. Poor corporate governance
III. Three-man rule
IV. Low staff moraleCorrect
The following are some common hints, which may point to an operating risk related to the management:
– One-man rule
– Imbalance in the top management team
– Weak finance function
– Lack of skilled managers (or inability to attract skilled managers in key positions)
– Disharmony in management
– Low staff morale
– Fraudulent management
– Inadequate response to change
– Poor corporate governanceIncorrect
The following are some common hints, which may point to an operating risk related to the management:
– One-man rule
– Imbalance in the top management team
– Weak finance function
– Lack of skilled managers (or inability to attract skilled managers in key positions)
– Disharmony in management
– Low staff morale
– Fraudulent management
– Inadequate response to change
– Poor corporate governance -
Question 16 of 30
16. Question
All organizations face risk, regardless of size or industry. Human resource risk is one of the many internal risks that exist in a company. Which of the following are examples of human resource risk?
I. Strikes
II. Very high staff turnover and poor motivation levels
III. Militant unionism
IV. Breakdown of key machineryCorrect
Human resources include more than regular full-time employees. They include all management and labor personnel, family and non-family members, full-time and part-time people, and seasonal and year-round employees. The following are among the risks in the category of human resource risks:
– Strikes
– Militant unionism
– Very high staff turnover and poor motivation levels, which will lead to poor productivity levels.Incorrect
Human resources include more than regular full-time employees. They include all management and labor personnel, family and non-family members, full-time and part-time people, and seasonal and year-round employees. The following are among the risks in the category of human resource risks:
– Strikes
– Militant unionism
– Very high staff turnover and poor motivation levels, which will lead to poor productivity levels. -
Question 17 of 30
17. Question
Under which of the following categories of risks that affect a company does risks that affect the entire company and its future direction fall?
Correct
Risks that affect the entire company and its future direction fall under Corporate risks. Huge losses in a subsidiary may carry the risk of cash down streaming while the hostile takeover threat may cause the top management to divert attention from normal operating activities.
Incorrect
Risks that affect the entire company and its future direction fall under Corporate risks. Huge losses in a subsidiary may carry the risk of cash down streaming while the hostile takeover threat may cause the top management to divert attention from normal operating activities.
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Question 18 of 30
18. Question
There are several instances where businesses fail not because of lack of business opportunities, but due to poor or improper management of financial affairs. Which of the following categories of risks refers to the chances of the collapse of business due to wrong financing decisions?
Correct
Financial risk refers to the chances of the collapse of business due to wrong financing decisions/strategies such as lopsided capital structure, asset-liability mismatch, etc. Financial risks can plunge a successful business into bankruptcy, if not managed properly.
Incorrect
Financial risk refers to the chances of the collapse of business due to wrong financing decisions/strategies such as lopsided capital structure, asset-liability mismatch, etc. Financial risks can plunge a successful business into bankruptcy, if not managed properly.
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Question 19 of 30
19. Question
Financial risks can plunge a successful business into bankruptcy, if not managed properly. Hence, it is vital for a credit decision to be preceded by an in-depth financial analysis of the customer. For which of the following purposes is financial analysis important?
I. Triggers questions that lead to a meaningful operating/business analysis.
II. To determine the extent of financial support needed by the prospective borrower.
III. To determine corrupt top management officials.
IV. Digs deep and brings out the financial risks.Correct
Financial analysis is done based on financial statements. Credit risk due diligence relies on financial statements for financial analysis which ought to have a cash flow-oriented approach. Financial analysis serves mainly three purposes:
1. It digs deep and brings out the financial risks.
2. It triggers questions that lead to a meaningful operating/business analysis.
3. To determine the extent of financial support needed by the prospective borrower.Incorrect
Financial analysis is done based on financial statements. Credit risk due diligence relies on financial statements for financial analysis which ought to have a cash flow-oriented approach. Financial analysis serves mainly three purposes:
1. It digs deep and brings out the financial risks.
2. It triggers questions that lead to a meaningful operating/business analysis.
3. To determine the extent of financial support needed by the prospective borrower. -
Question 20 of 30
20. Question
Which of the following shows the financial position of a business as at a particular date, usually the end of a period – say a year, a quarter, or a month?
Correct
The balance sheet shows the financial position of a business as at a particular date, usually the end of a period – say a year, a quarter, or a month. A balance sheet is a critical tool for effective credit evaluation. It answers a lot of questions that a financial analyst is likely to ask while ascertaining creditworthiness.
Incorrect
The balance sheet shows the financial position of a business as at a particular date, usually the end of a period – say a year, a quarter, or a month. A balance sheet is a critical tool for effective credit evaluation. It answers a lot of questions that a financial analyst is likely to ask while ascertaining creditworthiness.
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Question 21 of 30
21. Question
A balance sheet is a critical tool for effective credit evaluation. It answers a lot of questions that a financial analyst is likely to ask while ascertaining creditworthiness. Which of the following are part of such questions?
I. What is the quantum of fixed assets and are they put to optimum use?
II. What are the required working hours?
III. What is the level of trade debtors?
IV. What are the taxation and other statutory liabilities outstanding?Correct
A balance sheet is a critical tool for effective credit evaluation. It answers a lot of questions which a financial analyst is likely to ask while ascertaining creditworthiness, such as the following:
– What is the capital structure of the business? Is it appropriate? Have the owners of business put sufficient capital into the business?
– What are the short-term and long-term liabilities (i.e. debt) of the business? Are they properly structured? Is it possible to relate each source of finance to a particular asset item?
– What is the credit period provided by trade suppliers? Did the suppliers alter trade terms?
– What are the taxation and other statutory liabilities outstanding?
– What is the quantum of fixed assets and are they put to optimum use?
– What is the level of stocking required and what are the stock management policies, in broader terms?
– What is the level of trade debtors?Incorrect
A balance sheet is a critical tool for effective credit evaluation. It answers a lot of questions which a financial analyst is likely to ask while ascertaining creditworthiness, such as the following:
– What is the capital structure of the business? Is it appropriate? Have the owners of business put sufficient capital into the business?
– What are the short-term and long-term liabilities (i.e. debt) of the business? Are they properly structured? Is it possible to relate each source of finance to a particular asset item?
– What is the credit period provided by trade suppliers? Did the suppliers alter trade terms?
– What are the taxation and other statutory liabilities outstanding?
– What is the quantum of fixed assets and are they put to optimum use?
– What is the level of stocking required and what are the stock management policies, in broader terms?
– What is the level of trade debtors? -
Question 22 of 30
22. Question
Sometimes the financial analyst will require certain adjustments to the balances sheet variables as presented in audited accounts. Under which of the following instances would the financial analyst have to recast the balance sheet, sometimes through the profit and loss account?
I. Converting off-balance sheet items into on-sheet items.
II. Reviewing the compensation of employees.
III. Reassessing the values of balance sheet variables.
IV. Adjusting inventory valuation.Correct
Sometimes the financial analyst will require certain adjustments to the balances sheet variables as presented in audited accounts. This is because of the fact that the accountants and auditors prepare financial statements generally for the shareholders and many items are classified accordingly, based on IFRS or GAAP followed by each country. The following are certain instances where the financial analyst would have to recast the balance sheet, sometimes through the profit and loss account:
– Adjusting inventory valuation.
– Reassessing the values of balance sheet variables.
– Converting off-balance sheet items into on-sheet items.
– Dividends payable.
– Intangibles.
– Unsubordinated shareholders loan.
– Dues from/to related parties.
– Alternative accounting.Incorrect
Sometimes the financial analyst will require certain adjustments to the balances sheet variables as presented in audited accounts. This is because of the fact that the accountants and auditors prepare financial statements generally for the shareholders and many items are classified accordingly, based on IFRS or GAAP followed by each country. The following are certain instances where the financial analyst would have to recast the balance sheet, sometimes through the profit and loss account:
– Adjusting inventory valuation.
– Reassessing the values of balance sheet variables.
– Converting off-balance sheet items into on-sheet items.
– Dividends payable.
– Intangibles.
– Unsubordinated shareholders loan.
– Dues from/to related parties.
– Alternative accounting. -
Question 23 of 30
23. Question
Which of the following refers to certainties which ensure adequate financial resources or means to repay the credit despite the presence of risks?
Correct
Risk mitigants refer to certainties that ensure adequate financial resources or means to repay the credit despite the presence of risks. Risk mitigants are sought as a comfort to the credit risks identified.
Incorrect
Risk mitigants refer to certainties that ensure adequate financial resources or means to repay the credit despite the presence of risks. Risk mitigants are sought as a comfort to the credit risks identified.
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Question 24 of 30
24. Question
Mitigants refer to certainties that ensure adequate financial resources or means to repay the credit despite the presence of risks. Which of the following are the main categories of risk mitigants?
I. Qualitative mitigants
II. Quantitative mitigants
III. Strength mitigants
IV. Security mitigantsCorrect
Risk mitigants can be broadly categorized into two main categories: Qualitative mitigants and quantitative mitigants. Many mitigants can be traced to the income, assets, wealth or strengths of the obligor, some of which can be identified by financial analysis.
Incorrect
Risk mitigants can be broadly categorized into two main categories: Qualitative mitigants and quantitative mitigants. Many mitigants can be traced to the income, assets, wealth or strengths of the obligor, some of which can be identified by financial analysis.
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Question 25 of 30
25. Question
Which of the following categories of mitigants derive force from the factors that provide excellence or superiority to the obligor in certain areas?
Correct
Qualitative mitigants derive force from the factors that provide excellence or superiority to the obligor in certain areas, which ensure adequate repayment ability by ensuring a sufficient volume of business or profitability.
Incorrect
Qualitative mitigants derive force from the factors that provide excellence or superiority to the obligor in certain areas, which ensure adequate repayment ability by ensuring a sufficient volume of business or profitability.
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Question 26 of 30
26. Question
Qualitative mitigants derive force from the factors that provide excellence or superiority to the obligor in certain areas, which ensure adequate repayment ability by ensuring a sufficient volume of business or profitability. Which of the following is/are classes of qualitative mitigants?
I. Strengths
II. Risk factor
III. Strategies
IV. SecurityCorrect
Qualitative mitigants vary from case to case, however, they can be broadly classified into three: Strengths, strategies, and other factors. Most of the qualitative mitigants depend upon the strengths of the company or the management techniques adopted by the company.
Incorrect
Qualitative mitigants vary from case to case, however, they can be broadly classified into three: Strengths, strategies, and other factors. Most of the qualitative mitigants depend upon the strengths of the company or the management techniques adopted by the company.
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Question 27 of 30
27. Question
Which of the following categories of risk mitigants are quantifiable and often the creditor or lender can estimate the level of comfort quantitatively?
Correct
Quantitative mitigants are quantifiable and often the creditor or lender can estimate the level of comfort quantitatively. Letters of credit or guarantees provided to a manufacturer by buyers and mortgages of land and buildings by a borrower to secure a bank loan are some of the examples of quantitative mitigants.
Incorrect
Quantitative mitigants are quantifiable and often the creditor or lender can estimate the level of comfort quantitatively. Letters of credit or guarantees provided to a manufacturer by buyers and mortgages of land and buildings by a borrower to secure a bank loan are some of the examples of quantitative mitigants.
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Question 28 of 30
28. Question
Quantitative mitigants are quantifiable and often the creditor or lender can estimate the level of comfort quantitatively. Which of the following is a common type of quantitative mitigants?
I. Security
II. Strength
III. Strategies
IV. Transfer of risksCorrect
Two of the common quantitative type mitigants are transfer of risks and security. Transfer of risks is usually done by insurance, where the specifications of insurance are spelt out. Tangible and intangible securities are sought by the creditor/lender to mitigate the credit risks.
Incorrect
Two of the common quantitative type mitigants are transfer of risks and security. Transfer of risks is usually done by insurance, where the specifications of insurance are spelt out. Tangible and intangible securities are sought by the creditor/lender to mitigate the credit risks.
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Question 29 of 30
29. Question
Risk mitigants are sought as a comfort to the credit risks identified. Which of the following principles is to be borne in mind while selecting mitigants?
Correct
The following principles are to be borne in mind while selecting mitigants:
– Integrity and an excellent track record of the obligor are the best mitigants. Whilst ‘willingness’ and ‘capacity’ to repay are both important, willingness is more important.
– If the credit is not able to stand alone or be justified in itself, it is often too risky to extend it just on the basis of the mitigants.
– A source of repayment ought to be embedded in the purpose of the credit, as far as possible.
– Since the cash flows are the source of repayment, the mitigants should either protect the cash flows or open up another source (of cash flow) in the event of risk occurrence.
– Always seek as a minimum, two sources of repayment.
– Although tangible security is a mitigant, it is not the same as the source of repayment.
– In the case of term loans, Free Cash Flow (FCF) must be checked and if insufficient, it must be understood how the obligor will meet the repayment commitments.Incorrect
The following principles are to be borne in mind while selecting mitigants:
– Integrity and an excellent track record of the obligor are the best mitigants. Whilst ‘willingness’ and ‘capacity’ to repay are both important, willingness is more important.
– If the credit is not able to stand alone or be justified in itself, it is often too risky to extend it just on the basis of the mitigants.
– A source of repayment ought to be embedded in the purpose of the credit, as far as possible.
– Since the cash flows are the source of repayment, the mitigants should either protect the cash flows or open up another source (of cash flow) in the event of risk occurrence.
– Always seek as a minimum, two sources of repayment.
– Although tangible security is a mitigant, it is not the same as the source of repayment.
– In the case of term loans, Free Cash Flow (FCF) must be checked and if insufficient, it must be understood how the obligor will meet the repayment commitments. -
Question 30 of 30
30. Question
Which of the following is an essential difference between the two main categories of mitigants – qualitative and quantitative mitigants?
I. The creditor can be reasonably assured about the sum or amount in qualitative mitigants.
II. Quantitative mitigants rely on the repayment ability from within the organization while the qualitative mitigants are usually from a third party or source.
III. Qualitative mitigants rely on the repayment ability from within the organization while the quantitative mitigants are usually from a third party or source.
IV. The creditor can be reasonably assured about the sum or amount in quantitative mitigants.Correct
The essential differences between qualitative and quantitative mitigants are as follows:
– Qualitative mitigants rely on the repayment ability from within the organization while the quantitative mitigants are usually from a third party or source.
– The creditor can be reasonably assured about the sum or amount in quantitative mitigants, as the name implies, i.e. they are more quantifiable.Incorrect
The essential differences between qualitative and quantitative mitigants are as follows:
– Qualitative mitigants rely on the repayment ability from within the organization while the quantitative mitigants are usually from a third party or source.
– The creditor can be reasonably assured about the sum or amount in quantitative mitigants, as the name implies, i.e. they are more quantifiable.