This workout asks us to assess the risk from six different scenarios and decide whether the risk to a bank underwriting the loan products is high, medium or low, and also discuss the rationale for that assessment.

The first scenario is an overdraft provided to a company to enable it to purchase inventory which is to be processed and sold.

The risk here is low to medium.

The rationale for this is that an overdraft is repayable on demand so the bank can demand its money back at any time. The bank could also force the reduction of the overdraft using proceeds from the sale of the processed inventory. The next scenario is a 15 year term facility to finance purchase of a container ship. The loan is repayable in full at the end of the 15 year period.

The risk here is high for a number of reasons. A lot can go wrong over that 15 year period. It's a long period of time and it's uncertain where the repayment of the loan is going to come from. If it was from the value of the ship at the end of the 15 years the valuation of that ship is highly uncertain.

The third scenario is a 15 year loan for general purposes with repayment being made in equal annual installments over the 15 year period. The risk for this scenario is medium.

Although 15 years is a long period of time and general purposes is a rather unspecific description. The loan value or the exposure to the bank will fall steadily over that 15 years therefore reducing the bank's exposure.

The fourth scenario is a five year revolving credit facility to fund trade receivables as part of a sales and general working capital expansion program. The risk here is medium.

The rationale for this is that forecasting cash flows over a period of five years should be feasible and should be fairly accurate. In addition, the expansion of the working capital will result in higher receivables which will in turn turn into cash which will enable the facility to be repaid.

The fifth scenario is a bridging loan to a company to acquire a target. It will repay the bridging loan using an equity issuance at some point in the future. The risk for this scenario is high.

The rationale is that the equity issue could raise less than expected or fail altogether. In this high risk circumstance syndication of the loan is often used to spread the risk across a number of banks.

The final scenario is a subsidiary of a large company is building a power plant and requires a 15 year loan. The completed power plant will be collateral for the loan. The risk here is low to medium.

The rationale is that the two distinct project financing stages are the construction phase which is more risky, but is shorter term and the post-construction phase, which has less risk as the project by then, should be generating cash flows.