Explanation:
To find the bank most likely to default, we calculate the Distance to Default (DD) for each bank. A smaller DD indicates a higher likelihood of default. Using the simplified DD formula: with :
Bank C has the lowest distance to default ($5.11$), therefore it is the most likely to default.
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Q.64 Jane Thomas is a credit manager at ABC Bank. She is assessing the risk of default for four banks that her bank regularly lends to. She has obtained the following information on the two banks.
| Bank A | Bank B | Bank C | Bank D | |
|---|---|---|---|---|
| Annual volatility of assets value | 9% | 11% | 10% | 7% |
| Face value of debt | $80 million | $120 million | $90 million | $60 million |
| Market value of assets | $150 million | $230 million | $150 million | $100 million |
Which of the four banks is most likely to default, assuming that a zero-coupon bond maturing in 1 year is the only liability for each company and has a 1-year horizon?
A
Bank A
B
Bank B
C
Bank C
D
Bank D