Please use the following information for the next two questions: A bank develops the following linear discriminant model of the credit quality (i.e., a higher Z means a better credit quality) based on their own loan database: Z = β1X1 + β2X2 + 2.0X3
where X1 is debt to asset ratio (long-term debts/total assets), X2 is return on asset (net income/total assets), and X3 is earnings retention ratio (retained earnings/total assets). Based on the estimates of coefficients provided the bank's risk management team, the coefficients of X1
and X2 are either 2 or -1.5. For one of its potential borrower, X1 = 30%, X2 = 20%, and X3 = 90%.
1) What should be the value of coefficients of X1 and X2, β1 and β2 respectively?
β1 β2
A. 2 -1.5
B. -1.5 2
C. -1.5 -1.5
D. 2 2
E. None of the above
2) Assuming the two critical values of Zs for loan decisions (approval or rejection) are 1.85 and 2.99, should the bank approve the loan for this client?
A. Yes, because the Z-score for this client is higher than the cut-off value 2.99.
B. Yes, because the Z-score for this client is lower than the cut-off value 2.99.
C. No, because the Z-score for this client is higher than the cut-off value 1.85.
D. No, because the Z-score for this client is lower than the cut-off value 1.85.
E. This client's case is indecisive
Quick Reply
