Contractually promised gross rate of return on a loan

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

  1. sridhar

    sridhar New 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. sridhar,

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

    this came up last year..
    http://www.bionicturtle.com/forum/viewreply/105/

    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. gaurava625

    gaurava625 New Member

    Thanks david,...
  4. 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. 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

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