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NZ Sheep Ltd (NZS) is in the business of exporting of live sheep to the...

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Accounting

NZ Sheep Ltd (NZS) is in the business of exporting of live sheep to the Middle East. To increase its export capacity, the company has recently begun negotiating a 2-year interest-only loan in the amount of $25 million from Foreign Commerce Bank (FCB).

As FCB has not previously had any dealings with NZS, FCB undertakes a risk analysis of NZS. It determines a key risk exposure: if there is a change in Government Policy in relation to live exporting of sheep, this would cause liquidity problems for NZS which at the extreme could result in the default of the company one year from today.

If NZS was to default one year from today, FCB expects to recover 65% of the exposure at the time of the default but in doing so will incur costs of 2.25% of the exposure at the time of the default due to the recovery process. Assume the risk-free rate is currently 4.5%.

a)Calculate the present value of both the recovered amount and the costs incurred in the recovery process.

b)In percentage terms, what is the loss given default (LGD) of the loan?

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