Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition

Solution to Stage Eight

1.

Capital for a loan of 100 = (LGD × safety – LGD × PD) × maturity The table, capital required for credit risk, reports the required capital and the components of the formula for a loan of $100. Required capital: $9.19 Safety: 19.03% Credit spread: $45 × 2% = $0.90 Maturity adjustment: 1.2 Required capital for $100 loan = (LGD × safety – LGD × PD) × maturity   = ($45 × 0.1903 – $45 × 0.02) × 1.2 = $9.19 Capital for $200 loan = 2 × $9.19 = $18.38 Risk-weighted assets = $18.38 × 12.5 = $229.75

2.

The safety factor, 19.03%, represents ...