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?

  2. David Harper CFA FRM

    David Harper CFA FRM David Harper CFA FRM (test) Staff Member


    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

  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?

    where i = treasury risk-free security
    k= Coporate Bond

    Thank you
  5. David Harper CFA FRM

    David Harper CFA FRM David Harper CFA FRM (test) Staff Member


    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


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