BUS-F 446 Chapter Notes - Chapter 10: Risk Premium, Risk-Adjusted Return On Capital, Interest Rate Risk
Document Summary
Risk is based upon the likelihood of default, and credit risk is defined as deviations from the expected default. Correlation risk is another aspect of credit risk, which means that credit risk is correlated across whole segments of the economy. Credit risk is more understated than people realized. Banks are switching from fixed rate loans to floating rate loans. Two components of risk for fixed rate loans: credit risk, interest rate risk: interest rates fluctuate; in a floating rate loan there"s much less interest rate risk and the concentration of credit risk becomes much higher. Many financial institutions are involved with selling financial guarantees: letters of credit, credit default swaps (cds) Securitization: packaging loans together and selling off claims to the income from those loans: banks kept the riskiest piece (residual, toxic waste). Investors should be indifferent between risk free return versus risky return with a higher return.
