CBP Financial Analysis and Credit Management 3 — Questions and Answers
Question 1: What is the purpose of a loan-to-value (LTV) ratio in real estate lending?
- To measure the borrower's debt service capacity
- To assess collateral coverage relative to loan amount (Correct answer)
- To calculate the interest rate spread
- To determine the borrower's net worth
Correct answer: To assess collateral coverage relative to loan amount
LTV measures the loan amount as a percentage of the property's appraised value, indicating how much equity cushion exists to protect the lender in case of default.
Question 2: In credit scoring, which factor typically carries the MOST weight in a FICO score calculation?
- Length of credit history
- Credit utilization ratio
- Payment history (Correct answer)
- Types of credit used
Correct answer: Payment history
Payment history accounts for approximately 35% of a FICO score, making it the single most influential factor in the calculation.
Question 3: A bank is reviewing a commercial loan where the borrower's interest coverage ratio is 1.1x. How should the credit analyst interpret this?
- The borrower comfortably covers interest expense with room to spare
- The borrower barely covers interest expense, indicating elevated risk (Correct answer)
- The borrower's interest expense exceeds earnings, requiring immediate default action
- The ratio indicates exceptional creditworthiness
Correct answer: The borrower barely covers interest expense, indicating elevated risk
An interest coverage ratio of 1.1x means the borrower earns only 10% more than its interest obligations, leaving very little buffer for earnings deterioration.
Question 4: Which type of credit facility provides a borrower with the ability to draw, repay, and redraw funds up to a specified limit?
- Term loan
- Revolving credit facility (Correct answer)
- Bullet loan
- Amortizing loan
Correct answer: Revolving credit facility
A revolving credit facility allows flexible drawdowns and repayments within the credit limit, making it suitable for working capital needs.
Question 5: When a bank assigns an internal credit rating to a borrower, what is the primary purpose?
- To determine the borrower's tax obligations
- To estimate the probability of default and set loan pricing and reserves (Correct answer)
- To calculate the borrower's market capitalization
- To assess the bank's own equity capital adequacy
Correct answer: To estimate the probability of default and set loan pricing and reserves
Internal credit ratings estimate the likelihood of default, which drives loan pricing (spread), loss provisioning, and regulatory capital allocation under Basel frameworks.
Question 6: What does 'working capital' represent on a company's balance sheet?
- Total assets minus total liabilities
- Current assets minus current liabilities (Correct answer)
- Fixed assets minus long-term debt
- Cash and equivalents minus short-term borrowings
Correct answer: Current assets minus current liabilities
Working capital (current assets minus current liabilities) measures the short-term operational liquidity available to a business for day-to-day operations.
Question 7: A 'stressed' or 'sensitivity' analysis in credit underwriting is conducted primarily to:
- Maximize the interest income on the loan
- Test how the borrower's financials perform under adverse economic scenarios (Correct answer)
- Determine the optimal loan maturity structure
- Verify the accuracy of the borrower's historical tax returns
Correct answer: Test how the borrower's financials perform under adverse economic scenarios
Sensitivity analysis stress-tests key assumptions (revenue decline, margin compression) to assess whether the borrower can still service debt under adverse conditions.
CBP Financial Analysis and Credit Management 3
What is the purpose of a loan-to-value (LTV) ratio in real estate lending?