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anbu.edu
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Postby anbu.edu » Tue Oct 08, 2013 11:46 am

A bank cr officer, who has reviewed a loan application, has made the following statement:“On a stand alone basis, I was not very keen on granting this loan however, I granted this loan after looking at the overall asset portfolio of the bank.” Based on the above statement, which of the following is true.
Choose one answer.
a. The correlation of the newly granted loan with the overall portfolio is high and therefore the credit officer was right in granting the loan. Incorrect
b. The correlation of the newly granted loan with the overall portfolio is low and therefore the credit officer was wrong in granting the loan. Incorrect
c. The correlation of the newly granted loan with the overall portfolio is low and therefore the credit officer was right in granting the loan. Correct
d. The correlation of the newly granted loan with the overall portfolio is high and therefore the credit officer was wrong in granting the loan. Incorrect


Ifthe banker says "On a stand alone basis, I was not very keen on granting this loan however, I granted this loan after looking at the overall asset portfolio of the bank"-means the portfolio is well diversified which means they are highly negatively correlated .. can anyone please explain this questions answer

edupristine
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Postby edupristine » Mon May 26, 2014 9:57 am

You must have heard the jargon " Never put all your eggs in one basket". This means that your investments should be highly diversified and not concentrated or inclined towards a particular sector/industry.
In the above scenario, answer choice (c) is correct:
If the correlation of the newly granted loan is low wrt the overall portfolio of the bank, this means that if the bank portfolio suffers a loss, then it would not have a major negative influence on the newly granted loan. Hence, the bank officer was right in granting the loan.


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