# Contractually promised gross rate of return on a loan

Discussion in 'P2.T6. Credit Risk (25%)' started by sridhar, Jul 22, 2008.

1. ### sridharNew Member

This is a technical nit...Using the terminology of the reading,

is the "Contractually promised gross rate of return on a loan"

is this 1 + k or just k.....

I know the difference -- but technically which is correct. Is it the case that k and 1 + k are used interchangeably to refer to the same thing, but the context disambiguates the nuance?

--sridhar

2. ### David Harper CFA FRMDavid Harper CFA FRM (test)

sridhar,

technically, Saunders seems to mean (k) rather than 1+k; e.g., 15% instead of 1.15

this came up last year..

b/c he doesn't appear to need the "1 +" so why not just solve for (k); the "1+ " is unnecessary mathematically

my theory on why he did this relates to convention in performance attribution: if you see 1 + k, you are less likely to make an error. If is is just (k), you may think that is 1.15 but 1+k leaves less room for a doubt (??). Viewed this way, it is like user-friendly code

David

3. ### gaurava625New Member

Thanks david,...

4. ### asomaningkwame@yahoo.comNew Member

David, when computing a marginal default probability using the term structure approach, we use
expected return on a corporate bond and a treasury (risk-free) security. If the company has no Bond but its debts are loans, how is this approach use? can one use the same fomular? Are there any adjustments to be made?

1-p=1-[(1+i)/(1+k)]
where i = treasury risk-free security
k= Coporate Bond

Thank you

5. ### David Harper CFA FRMDavid Harper CFA FRM (test)

Kwame,

While the bond/loan difference is meaningful (de Servigny), for this Anthony Saunders model, it is not: it applies to loan/bond. It makes simplifying assumptions, so he refers to improvements but they tend to relate to economic elements not bond/loan format. So, you can adjust for collateral but that applies for bond/loan

David