Problem:
Kansas Bank has a policy of limiting their loans to any single customer so that the maximum loss as a percent of capital will not exceed 20 percent for both secured and unsecured loans. The limit has been adopted under the assumption that if the unsecured loan is defaulted, there will be no recovery of interest or principal payments. For loans that are secured (collateralized), it is expected that 40 percent of interest and principal will be collected.
1. What is the concentration limit (as a percent of capital) for unsecured loans made by Kansas Bank?
a. 5 percent.
b. 10 percent.
c. 15 percent.
d. 20 percent.
e. 25 percent.
2. What is the concentration limit (as a % of capital) for secured loans made by this bank?
a. 10 percent.
b. 20 percent.
c. 33 percent.
d. 40 percent.
e. 50 percent.
3. Suppose Kansas Bank wants to ensure that its maximum loss on a secured (collateralized) loan is 10 percent (as a percent of capital). If it wishes to keep a concentration limit at 40 percent for secured loans, what is the estimated amount lost per dollar of defaulted secured loan?
a. 40 cents.
b. 35 cents.
c. 30 cents.
d. 25 cents.
e. 20 cents.
Additional Information:
This question is from Finance and it is about a scenario where Kansas Bank has put a limit upon individual unsecured loans so that loss resulting in such loans will not affect the capital of the bank. Questions about this practice have been answered in the solution comprehensively.