Question

Question 1. Discuss the important of credit risk analysis to a financial institution.

Question 2. Discuss the difference between book value accounting and market value accounting

Question 3. Explain the role of financial instititutions in loan securitization issuance. Not less than 250 words.

Answer 1

(1).  Financial companies provide short to medium term funding to consumers and commercial businesses. Finance companies do not have access to cheap deposits like commercial banks do.Only a few finance companies in some states are allowed to raise a fixed deposit.Finance companies use loans from banks, commercial papers, bonds and capital as sourcesfor their funds. Finance companies deploy their funds to make consumer loans, businessloans, leasing and real estate loans. Finance companies offer personal loans and automobile loans. Finance companies also provide commercial loans to companies, factoring services,and funding for leverages buyouts and leasing.Consumer loans.Finance companies offer personal loans and automobile loans. Personalloans are offered to take care of a variety of expenses including home improvements, mobilehomes etc. Automobile loans are provided to purchase vehicles.Consumer loans aresensitive to economic conditions. Once economic conditions worsens, layoffs take place.Laid off workers default in their loan obligations.Business loans.Finance companies provide commercial loans to companies, factoring services, funding for leveraged buyouts and leasing. Commercial loans are short termworking capital loans used to finance purchase of inventor for production. Factoring servicesinvolve the purchase of accounts receivables at a discount. Finance companies also purchase equipment and lease them to commercial organizations.Many consumer of finance companies are not the consumers withthe consumers with the best credit capacity. Businesses are also small to mediumsized businesses. So, they carry significantly more risk to default. This is in sharp contrast tothe credit risk faced by other financial institutions. They have well diversified portfolios.Many of their clients have the best repayment capacity. As a result, other financial institutions feel the impact of deteriorating economics rather later. The impact itself ismitigated by the well diversified portfolio of credit. Finance companies face a greater degree of credit risk than others.

(2). Book value accounting reports assets and liabilities at the original issue values.Current market values may be different from book values because they reflect current market conditions, such as interest rates or prices. This is especially a problem if an asset or liability has to be liquidated immediately. If the asset or liability is held until maturity, then the reporting of bookvalues does not pose a problem

(3) . Securatization of debt or asset refers to the process of liquidating the illiquid and long termassets like loans and receivables of financial institutions like banks by issuing marketablesecurities against them.

Securitization gives financial institutions the opportunity to use their assets as sources of funds and, in particular, to remove lower-yielding assets from the balance sheet to be replaced with higher-yielding assets.The financial institution can create liquid assets out of illiquid, expensive-to-sell assets. Also, this helps diversify the lender’s credit risk exposure.It permits lenders to hold a more geographically diversified loan portfolio, perhaps counteringlocal losses with higher returns available from loans from different geographic areas with morebuoyant economies.Securitization is also a tool for managing interest rate risk and possibly credit risk, depending onthe quality of the packaged loans.Securitization opens avenues for lending institutions to earn added fee income from servicing thepackaged loans. Lenders can also benefit from the normal positive interest rate between the average yield on the packaged loans and the coupon (promised) rate on the securities issued against those loans, capturing residual income.