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Asset and Liability Management: The Banker’s Guide to Value Creation and Risk Control, Second Edition by Youssef F. Bissada, Jean Dermine

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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 ...

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