英语论文网

According to the concept VAR can be applied to a portfolio in which trading of stocks and bonds take place and historical data is available for it. Because the current market value of the stocks and bonds are directly observable and can be calculated easily. But daily price or Market Value of the loans is not directly observable because loans are not the tradable instruments in the financial market. We cannot calculate the mean value for loans as they are not traded in stocks and bonds market.

As Current Market Value is not available so volatility measure is difficult.

Normal Distribution is the approximation even in the case of Market Securities. In case of Loans the assumptions tends to be even more wild approximation.

So we can conclude that, as the Bank under discussion is not involved in such sort of trading and issue loan in Agriculture sector only. This means the model of VAR is not the best option for the bank.

6.1.C) Credit Default Swap (CDS):

It can be used as a tool to transfer credit risk to the other party. Banks usually indulge in such sort of transactions to maintain their working capital if any credit instrument is in the status of Nonperforming Loan. CDS is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) goes into default. Following figure shows the concept of transaction;

As we know that Global Financial Crisis were triggered by these swaps. These swaps were became the weapon of mass destruction for the financial market when mortgaged backed securities defaulted. The chain was made when Large Size Banks issued Credit Default Swaps to the investors through Broad Index Securitized Trust Offering, Bristo in short. Here every financial institution was involved in trading such swaps as market was on boom for CDS. So they were linked in a manner that if one of them defaults the chain reaction will start. Same happened here Lehman Brothers the biggest CDS player got a hit in this chain first and then led to the failure of many other institutions linked with it like American Insurance Group (AIG). Out of $700 Billion most of the CDSs of Lehman Brothers were insured by AIG. On the basis of the said concept we are of the view that credit default swaps is not the best option. Because every bank is now avoiding investment in CDS, as they are aware of its consequences in the Global Financial System.

6.1.D) 5Cs of Credit Financings

This model contains five C's of Business and Commercial Financing. This is a very simple method used by financial institutions, investors and lenders around the world to determine and see the credit worthiness of the potential borrower.

This model uses five Characteristics to assess the riskiness of the prospective borrower. They are discussed one by one in the coming paragraphs,

Character

Capacity

Capital

Collateral

Conditions