Finance Department

 

Date of this Version

1998

Document Type

Article

Citation

Journal of Actuarial Practice 6 (1998), pp. 63-112

Comments

Copyright 1998 Absalom Press

Abstract

A cash flow model is developed to set the price for a loan to a borrower with known risks. Similarities are noted between this model and those used for profit testing in life insurance. We emphasize aspects that reasonably can be treated in several ways and also indicate where the cash flow model differs from the pricing methods usually employed in bank lending. The sensitivity of interest rates to various parameters of the model such as the length of loan and the expected default rate is examined. Also, we examine how features of loans, including cash back and early repayments, can be priced.

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