Investment Strategy and Loan Approvement

Abstract

Investment decisions are the most common decisions

that are normally made by organizations. Getting funds

approved is the second most important activity for a

company wishing to raise credit facilities to assist them

make investment. Investments may be international

expansion or acquisition of assets for diversification

purposes which will assist the company in growth. This

involves setting of strategies and always choosing or

setting a strategy of investment that is acceptable to the

loan provider. Investments are made under conditions

of uncertainty where the future is not known and is

uncertain but companies follow those uncertain routes.

This calls for proper decision making in the provision

of credit facilities.

The study was set in a commonwealth bank of

Australia and bank of America ; An American bank

one a multinational bank while the earlier is an

Australian bank that has successfully entered the

international market with her presence felt in Australia.

Both offer business loans for expansion in various

countries. In my study have to identify and strategies

implemented by each bank, their risk analysis process

and how the risk is calculated before a loan is given

and the effect of the strategy to its market

competitiveness.

Every Bank executive and managers wants to move

forward should take this study serious. The main

purpose of businesses is the maximization of goals. In

order for banks to achieve these goals in this era of

corporate sustainability, fraudsters and corrupt loan

there is need to move towards best methods of

assessing the credit facility and come up with criteria

to use issue of loans. Banks need to develop strategies

that will lead them to grater heights in the world stage

market.

Therefore, to accommodate the rapid changes

occurring in the business and banking world, quick

decisions about loan approving strategies are made and

well communicated.. This study is paramount to the

banks understudy because the research will assist in

decision-making.

Introduction

The speedy processing of credit facilities in banks are

very vital especially when banks need to keep

customers satisfied to bank with them and increase

market share but reduce risk of losing funds. In the

recent past banks have embarked on quick credit

facility processing so as to get and maintain more

customers into their banks. This is because they want

to win market share (to have a large market share). The

key to improving on profits is to get more clients, win

the market share, keep the existing customers by

making them to be loyal and then benefits will

definitely increase by day. However, customer’s

loyalty and large market shares do not bring in profits

to the banks always and this need to be checked

thoroughly.

For example, we have prestigious customers who are

on their segments. Banks have divided customers into

segments, which have customers who have similar

needs and are worth broadly in the same economic

value. Under these propositions, we have the prestige

proposition. Non prestige customers have large

amounts of money invested in banks but they do not

always bring in profits because they have large costs

which are associated with them because they need

personalized banking, they also need special attention

and on the other hand they might demand special

services which are additional costs to the bank. So for

the past years, companies have decided to embark on

quick loan credit facility processing because they have

realized that this service and value are intrinsically

linked and the way you handle a customer means a lot

and this is how the bank will get more and more

clients.

Banks have tried to differentiate themselves for

competitors through providing better customer service.

Consistent delivery of superior loan service requires

the careful design and execution of a whole system of

activities that include people, technology and good

processes. This will lead to more revenue from

customers who will be impressed with services

provided. To do this, banks embarked on creating loans

and financial strength of their customers can be sought

through monthly statements. After this, they enhanced

the customer’s profitability before advancing any

credit facilities. This is the analysis of the value bought

in by the customer against the cost of loans facility

issued to the customer owns.

So each customers cost and revenue is known to

measure whether the customer is a loyal customer who

has no profits to the bank or whether he is a long-term

profitable customer who needs nurturing so that the

bank can give the customer the nurturing he deserves

that issue quick loan facility. They should also need to

know about short-term customers who need to be

exploited before they pull out. This will all lead to the

quick credit facility issuance that will keep the

customer in the business.

Background of study

Banks have also embarked on segmentation of their

customers into different value propositions according

to the profitability of customers, which influences

credit facilities. This is when the 80-20% profit

generation against customers arises from. Banks

customer segments have people with similar needs and

worth broadly in the same economic value, earn almost

similar income etc. They are given a combination of

services, products, prices and branding which fit them.

This is called managing customers according to

segments. Banks also compute the lifetime value or

profitability of customers through forecasting and use

of strategies like introducing new products that will fit

the customers in future. Banks can also modify existing

products to fit customers in a particular way hence

making them satisfied and this will lead to increased

revenue.

Banks should also try to come up with strategies that

are directly related to how they know the credit

worthiness to increase the rate at which credit is

processed so as to solve their needs. Customer

understanding is vital because a good strategy is that

which is related to the improvement of bank products,

whether asset products like loans or liability products

where bank entrust their money to the customer. This

means banks should come up with strategies aimed at

particular target customers to understand their

investment strategies. This type of strategy is

persuasive in that it explains to customers why they

should take credit facilities. it also shows that the credit

facilitates depends on other factors not only the

investment strategy

Banks can also pick on the behavior based

segmentation strategy and this involves looking at past

and present relationship of the customer and the bank

before giving loans or any other credit facilitates.

Banks should look at how long a client has been in the

bank.

Has the client been on and off-has he ever left the bank

for another bank and back? They should also look at

the value of customers in terms of how much money

the customer has in the bank or how much he has

borrowed or he is willing to borrow. Segmentation of

clients is important in banks because customers are

given a bundle of benefits that have been used.

Geographic- should be also be used and is where the

banks take into account the geographical boundaries

and this majorly assists the bank in staffing and

opening of new branches and also to assess market

potential. They have also been using psychographic

segmentation that deals with customer lifestyle, tastes

and preferences, why customer want a particular

product instead of the other.

The demographic segmentation deals with dividing

customers according to age, stage in life cycle etc. and

it helps banks to design production for all types of

people depending on their age, income, etc. this also is

another factor that is considered in according credit

facilitates.

Apart from the behavior based segments, the bank can

also adopt segmentation, depending on what the bank

wants and not what customers want, banks have

different value propositions that it wishes to give

customers hence it will segment its products according

to its value propositions and as customers take them

they automatically fall to segments. The banks have

three major objectives and these are get deposits and

minimize the cost of funds producing quality credit

balances at maximum spread income and to generate

free income and reduce services expenses. This leads

to the following four segments. There are those people

who want to invest others want to borrow, others want

convenience and on others are fast limited customers.

These segments can be used as a basis for the bank to

develop long-term strategies, to attract customers to the

different segments.

As much as strategies are good, bank should avoid

using one strategy for all products or marketing

applications effective segments or marketing

applications effective segments. A strategy will vary

according to what are the marketing objectives. In the

case of attracting new customers who have no history

with the bank. The bank will come up with a wedge

product strategy where they give customers of other

banks a chance to sample some of its products or

services for the time being and this will enable them to

cross-sell more profitable products to them and create a

long lasting relationship with them. This is done by

direct marketing for example they can send letters to

customers requesting them to try products or phone

calls.

In making existing customers to be more profitable, the

bank should study their behavior carefully and give

them the most appropriate product or service that can

turn a marginally customers, their lifestyle and the

amounts of cash they handle and the needs comes from

good data management. When the bank can use the

data it has to identify best ways in available banks,

database can enable them to know which customers are

profitable, marginally profitable and unprofitable.

Apart from keeping existing customers, banks also

need get more and more customers by prospecting well

and turning these prospects to potential customers. The

methods we have seen that are employed here is the

direct mail methods and telephone calls. Geographical

prospects can also be employed by use of strategic

positioning of new branches at areas where trade is

high and directing advertisements to such areas to lure

more customers into the banks customer base,

whichever the method, banks have realized that CRM

is very important because it concerns more on

customer satisfaction rather than products.

Most banks then have realized that in order to

understand customers well and this information is in

the banks database. There should be therefore good

management of data that gives information about the

customers and whether they are profitable or not. For

good data management, banks should ensure that:

1. They have relevant and accurate

data(information) about the customers,

2. Develop daily, weekly, yearly etc analysis of

customers’ profitability and

3. Develop tactics on these segments that modify

behaviors of both customers and employees to

increase sales and revenue while lowering costs.

Banks should ensure good data management by careful

collection of customer data, turning this data into

knowledge and then using this knowledge to develop

strategies and tactics to modify behavior of both

employees and customers and prospects to improve

long-term profits.

Banks should realize that just aiming at having a large

market share is not enough to generate profits. They

should also ensure that they do good customer relations

management in order to achieve good results. This is

by understanding their customer needs well and then

the bank will match the customers with available

products to ensure maximum customer satisfaction.

They should also manage customers well by

segmenting them into useful segments based on

profitability so as to give them beneficial value

prepositions that will make them have good long-term

relationship with the bank and hence increase the

profitability.

Using the information kept will determine the approve

of the loan facilities although there are other factors

which are related with the strategies of the loan seeker

but they are less influential as compared to banks own

information.

Statement of the Problem

Making a decision, how to give loans to customers and

how it should be done with the support of the

management is difficult and had to believe. The

conventional analysis of customers investment strategy

has looked simply at efficiency of customer awarding

of a loan as compared to the efficiency of banks to

detect the losses that will be incurred using risk

analysis : if the cost of risk analysis is greater than the

cost of administering within the bank, then banks needs

to change the method of assessing the customer credit

worthiness.

Transaction cost analysis does not, however, provide

the complete answer. In the first place, customer credit

facilities strategies are not simply accept or reject

choices—there are wide varieties of ways in which a

bank can structure credit facilities to attract customers

to product. Secondly, the most critical long-run

consideration is the development of banks capability to

award credit quickly. If a bank is to sustain competitive

advantage, it must restrict itself to those activities

where it possesses the capabilities that are superior to

those of the other banks that perform those activities.

The most difficult issues arise where there are linkages

between customers’ investment strategy and banks risk

analysis strategies.

Ultimately, investment decisions revolve around two

key questions. First, which activities will we undertake

for profitability and attract sponsorship? Second, how

do convince the bank to attract their credit facilities

and increase our profitability?

Purpose of the Study

The objectives of this study is

To identify the strategies implemented by banks

to attract credit facilities and how they are

developed.

How customer investment strategy and banks

risks assessment affects the rate of loan issuance.

Assess the relative merits of the strategies and

loan transactions in organizing customer loan

processing and related activities and understand

the circumstances that influence their

comparative advantages.

Identify a range of possible factors that influence

among banks and related firms loan processing.

Identify scenarios of various strategies affecting

loan issuance.

Explain why some types of strategies and related

activities are integrated within a single bank,

whereas others are performed by separate banks.

Identify the critical considerations pertinent to

make-or-buy decisions and the extent to which a

bank should adopt.

To achieve the objectives I will go through case studies

of two banks whereby the concept of customer

relationship and product development strategies are in

use.

The scope of the study

To understand investment strategies and strategies that

relate loan issuing of to their customers, services and

diversification for banks, a comprehensive analysis is

carried out to ascertain the various needs of customers

in the banking sector in relation loans approval. This

research project is on two banks. In carrying out this

project, certain constraints will inhibit effective study,

firstly due to short deadline period to finish this write,

time factor will render certain aspects not to be

examined in details. Secondly, the study assumes that

effective and efficient management and application of

loan approval strategies are the determinant of

performance and greater market position of banks.

This due to the fact that if customers don not have

money the banks will be doing badly.On the other

hand, in economic reality, there are features that affect

performance and market position of banks and

companies such as Capital deployment, employee’s

motivation, organizational structure, organization

capacity, supply chain management and technology.

However, this study does not consider these factors.

This study also assumes that all strategies applied by

two banks are geared towards increasing speed of loans

approval in terms of increasing the market share. It

also assumes that they are ready to implement are

customer friendly strategies that increase the market

share. Nevertheless, this is not the case in the real

strategic management situation in as these strategies

are often separated and could be use for survival.

Significance/Importance of the Study

My research study will be of great value to future

researchers, management of banks, investors, educators

and others because:

To highlight the important role that investment

strategies play on the bank’s market share and

customers satisfaction.

It highlights how customer investment strategies

are made and how they strategies affect the bank

market share.

It helps the management in making strategic

decision-making.

Determine the risk preference function for the

centre of the bank

Determine which risk measure(s) are compatible

with this risk preference function

Assess the relevance of coherency for the

internal risk measure(s)

Assess the impact of the structure of the

compensation payment function on portfolio

selection and incentive-compatibility

Identify how agency problems impact on the

performance measurement framework

Design a solution to deal with agency problems

Evaluate how bank-wide factors impact on the

decisions of managers and the assessment of

their performance.

Research Questions

The key questions for the research were set as follows:

how does the target credit rating of the bank

influence portfolio selection and pricing?

When might a higher solvency standard

beneficial to a banking firm?

should hurdle rates adjust in line with changes in

the target credit rating of a bank?

Which credit rating implemented by the two

banks and they how have they developed them?

What are the advantages of each form of form

strategies?

What are possible relationships among vertically

related banks and, including spot market

transactions and strategic alliances?

What is the relationship between the investment

strategies?

What loans approval strategy is favorable to

bank board members?

What is in house policy and what is it used for?

Are the policies of the two banks different from

those of competitors?

Assumptions regarding the hurdle rate, and in

particular, whether it should adjust to reflect changes in

leverage, are critical to determining the optimal credit

rating for a bank. This in turn impacts on pricing

decisions and the market value of credit portfolios, and

consequently, the risk-adjusted performance measures

of portfolios under the control of managers. A loan

pricing model was constructed to test the impact of

changes in the target credit rating of a bank on the

pricing of its loans.

The decision of a bank to increase its solvency

standard increases the minimum interest rate on its

loans in order to achieve the required hurdle rate on

capital assigned to the loans. Offsetting this upward

pressure is the impact of the reduced funding costs

arising from the higher credit rating. If retail deposit

rates are insensitive to an upgrade in the credit rating

of bank debt securities, we find that the benefits to a

bank from increasing its target credit rating rest with

the extent to which the cost of wholesale funds falls

relative to the increase in the price of bank loans.

Research Hypothesis

The following hypothesis will guide the research:

H1. On average, behavior segmentation in loan

approval will be similar all the banks and the

sample will be a true representative.

H2. The investment strategy of the loan seekers

will be positive or negative depending on the

motive and the customer management embraced.

H3. On average, risk of the investment of the

bank customers will be more powerful predictors

of customer relationship management.

H4. All banks makes choices of the credit facility

management without the banking sector

regulator interfering.

H5. Bank customers of banks are aware of the

loan application rules and willing to served by

them.

H6. Risk assessment depends on the policies of

the banks.

H7AThe ideas underlying the problem-solving

task to be solved is understood by key players in

the industry.

Loan approval is very powerful in shaping the banks

profitability and the investor’s success. The result

obtained can not be ignored it should be used to make

some few changes in the banking sector and investors

strategies. Banks are an important sector in the circular

flow of money in any economy and thus the beginning

of economic development of a country. Therefore it is

an important sector that should be managed with care.

Limitation of the Study

This research project is on a session of the project. In

carrying out this project, certain constraints will inhibit

effective study:

1. Time factor will render certain aspects not to be

investigated in details because of the deadline

period to finish this thesis,

2. The study assumes that effective and efficient

management and application of investment

strategies are the sole determinant of loan

approval. However, in economic reality, there

are features that affect loan approval such as

Capital deployment, employee’s motivation,

organizational structure, organization capacity,

supply chain management and technology.

3. My study also assumes that the all loan approval

strategies will be applied by banks and they are

geared towards increasing market share banks.

Delimitation of the Study

The researcher is a student, he will be carrying out the

research with the trust that managements will co-

operate.

The research will be carried out by a full time student

thus having enough time for coverage of the topic.

The researcher will access the banks with easy because

of he is an insider that is he works in the baking sector.

Definition of Terms

The terms that are in use in this thesis are defined in

the context in which they are being used in this

research and they are as follows:

Strategy:Strategy is the direction and scope of

an organization over the long term, which

achieves advantage in a changing environment

through the configuration of resources and

competencies with the aim of fulfilling

stakeholders’ expectations.

Market share:This refers to the total sales of a

bank divided by the total sales of other firms for

a specified product –market. It may be

calculated on the basis of actual sales or forecast

sales.

Intended strategy:This is an expression of

desired strategic direction deliberately

formulated or planned by managers.

Overview Summary

This section gives a general outline of the main parts of

this Thesis. It will have an abstract and five chapters

written and each chapter will contain the following.

Abstract

The final report will begin with an abstract that will

summarize the topic, the findings and the importance.

Executive Summaries

This will summarize all the chapters and the

conclusion reached.

Chapter I

The chapter will have introduction, which will explain

issues surrounding the topic and the importance of the

study. Then there will be background information that

will cover topic and the banks under study , it will also

provide with an overview of the study, purpose of the

study, research question, research hypothesis,

limitation and delimitation, Significant of the study and

definition of the terms used.

Chapters 2

This chapter covers literature relating to the topic

under study and in my case this will cover an

introduction, literature review, Collection of theories

and secondary sources and Criticism of secondary

sources

Chapter Three

In this chapter the researcher will explain the

methodology used that is the Research Approach, the

Research Design and discussion of its quality, validity

and reliability, , The Target company, Procedure,

Instruments for data and continuous prose collection

and data analysis technique.

Chapter 4

This chapter contains empirical data presentation,

which is made up of the strategies implemented by

banks and their market situation.

Chapter 5

This will be the last chapter. It will contain summary of

the findings recommendations and conclusion.

Literature Review

Introduction

This is a literature review of investment strategy, risks

associated with investments and standards set out for

loan issuance. The literature consolidates information

from various literatures written by various groups,

scholars and central bank. The thesis will differentiate

between the capital budgeting decisions of companies,

cost of capital, risks associated with loans and other

related issues. Analysis on credit facilities will be

carried out and this will be in form of scholarly written

documents,.

Collection of theories and secondary sources

The researcher will use books available in the

University for the Collection of literature. The

computer laboratory in the university and personal

computer in the house has contributed greatly in the

success of my project through the access of scholarly

written documents available in the internet. Therefore,

the process of gathering data from articles, journals and

books is done primarily by the use of university

material. The research on internet was done through

funnel manner by using key worse such as cost of

capital, credit worthiness and issuance of loans. The

World Bank and reserve bank facilities that have been

used will also be acknowledged.

In addition, the government and other state documents

have been used intensively as supplementary sources

during the search of information for this project.

Factors influencing capital decision

In any manufacturing organization, the largest dollar

investment maintained is in fixed assets. Fixed assets

are necessary for production and without them their

will be no production. Each firm maintains fixed assets

depending on their nature of production processes.

Because of change in techno lodge and competition,

organization make capital expenditure specifically to

acquire, replace, or modernize fixed assets or gain a

less tangible benefit over along period of time.

Capital Budgeting

This is the overall process of generating, evaluating,

selecting and following up on capital expenditure

alternatives. In most cases, firms are affected by the

amounts available for this process and the type of the

proposal they are undertaking into consideration.

Because of this constraint, firms opt to undertake those

projects which maximize their benefits in the long run.

They can also rank the proposals according to the

predetermined criterion and choose the best depending

on their returns to the company. Further a company can

limit its funds such that only those proposals that yield

high return in the long run will be accepted whereas it

can accept all the projects considered if its funds are

unlimited.

Availability of funds

This affects capital budgeting because if a firm has to

incur any capital expenditure it must have some funds

to use. Therefore it affects the decision process making

environment of the management as to how much to

spend. Some firms have unlimited funds for investment

hence making the process even cheaper but others have

limited funds meaning that the amounts for capital

expenditure is fixed normally specified in the company

annual budget. Where there are unlimited funds the

company accepts all projects that yield gains higher

than the predetermined level. If it is limited, the

organization ranks the proposals and chooses the best.

Firms use cash flows to measure their ability to acquire

the proposed assets or pay bills

Type of the Project

The firm has to establish the best project from a

number of different proposals available. This is

difficult because any project undertaken must be

capable of bringing high returns to the organization in

the long run. Some projects are independent such that

acceptance of one project does not eliminate the

consideration of the others. Whereas others are

mutually exclusive meaning that in allocating funds to

these projects, the firm has to rank them according to

the long term gains.

The cost of the new projects

This is the outlay of the intended fixed asset and

normally the purchase price is definite. The firm must

consider its available funds for purchasing this new

asset. This is done by measuring its net cash flows

which is called net investment. If the company is not

replacing an existing asset and does not incur any

installation cost, then the purchase price is equal to the

net investment.

Installation costs

These are extra costs incurred to make the machine

into operation and all this must be recognized by the

firm and capitalized. This is because they are part of

the initial cost and they should be capitalized.this will

enhance accuracy of determining depreciation.

Loans

A loan is an arrangement whereby the lender, which

may be a commercial bank or commercial finance

company, receives control of the pledged collateral.

This arrangement provides the lender with the ultimate

degree of security.

Lending procedures

In the case of a loan, the lender selects the collateral

that is acceptable as collateral for the loan. Once the

collateral has been selected, the lender takes or hires to

physically take possession of the collateral.

Terminal warehouses (inventory loan)

A terminal warehouse is one located in the

geographical vicinity of the borrower. It is a central

warehouse that is used to store the merchandise of

various customers. A terminal warehouse is normally

used by the lender when the inventory used as security

is easily transported and can be delivered to the

warehouse relatively inexpensively. When the goods

arrive at the warehouse designated by the lender the

warehousemen checks the merchandise in. he lists each

item received on a warehouse receipt, noting the

quantity, serial or lot numbers, and the estimated value.

Once the warehouseman has checked in all the

merchandise, he forwards the warehouse receipt to the

lender, who then files a lien on all the items listed on

the receipt.

Field warehouses

Under a field warehouse arrangement, the lender hires

a field warehousing company to actually set up a

warehouse on the borrower’s premises or lease part of

the borrower’s warehouse. There are a number of

companies in the united states that specialize in

establishing field warehouses for a fee. The procedures

followed by the field warehousemen are quite similar

to those followed by the terminal warehousemen. Once

they have isolated the inventory to be used as

collateral, they check it in, listing the items and their

characteristics on the warehouse receipt, files a lien on

the pledged collateral. A field warehouse may take the

form of a fence around a stock of raw materials located

outdoors, it may consist of a rope-off section of the

lender’s warehouse, or it may actually be a warehouse

constructed by the warehousing company on the

lender’s premises, which have been leased by the

warehousing company.

Regardless of whether a terminal or field warehouse is

established, the ware housing company places a guard

over the inventory. Public warehouses always have a

guard; under a field warehousing arrangement, a guard

is stationed by the warehoused collateral. The guard or

warehouseman is not permitted to release the collateral

without authorization from the lender. In other words,

the lender has complete control over the inventory used

to collateralize the loan. Only upon written approval of

the lender can any portion of the secured inventory be

released.

The loan agreement

The actual lending agreement will specifically state the

requirements for the release of inventory. As in the

case of other secured loans, the lender accepts only

collateral believed to be readily marketable and

advances only a portion of the collateral’s book value.

The types of collateral normally found most acceptable

for warehouse receipt loans are canned foods, lumber,

refined products, and basic metal stocks. The loan

agreement typically provides for the release of certain

pledged items upon receipt of partial repayments of the

loan. The lien on the released merchandise is, of

course, removed.

Although most warehouse receipts are nonnegotiable,

some are negotiable, which means that they may be

transferred by the lender to other parties. If the lender

wants to remove a warehouse receipt loan from his

books, he can sell a negotiable warehouse receipt to

another party, who then replaces the original lender in

the agreement. In some instances the ability to transfer

a warehouse receipt to another party may be desirable.

The cost of warehouse receipt loans

The specific costs of warehouse receipt loans are

generally higher than those of nay other secured

lending arrangements due to the need to hire and pay a

third party (the warehousing company) to guard and

attend to the collateral. The basic interest charged on

warehouse receipt loans is higher than that charged on

unsecured loans. It generally ranges from 3 to 5 percent

above the prime rate. In addition to the interest charge,

the borrower must absorb the costs of warehousing by

paying the warehouse fee, which is generally between

1 and 3 percent of the amount of the loan. These

charges vary depending upon the size of the loan and

other factors. In some instances the firm’s marginal

warehousing costs are small since they have to

warehouse the inventory anyway. The borrower is

normally required to pay the insurance costs on

warehoused merchandise.

Whenever warehouse receipt loans are arranged, it is

important for the lender to select a reputable

warehousing company. The warehousing company as

his agent is responsible for seeing that the collateral

pledged is actually in the warehouse. There have been

instances in the past where receipts against nonexistent

collateral. If this happens, and the borrower defaults on

the loan, the lender is in the same position as an

unsecured creditor.

The main features and complexities of capital

budgeting

Capital budgeting involves the decision making for

long-term projects or investments for company. It

involves the for following decision making model:

1. identification of objectives;

2. search for investment opportunities;

3. identify states of nature;

4. list possible outcomes;

5. Measure payoffs;

6. select investment projects;

7. obtain authorization and implement projects;

8. review capital investment decisions.

The effects of inflation on future cash flows and the

required rate of return

Always the discount rate of return has required rate of

return on a risk less investment plus the risk premium

that is associated with the project risk. Inflation affects

both the risk free rate and the risk premium. In order

for one to incorporate inflation in the future, cash

flows, the interest rate has to be adjusted for inflation.

Fisher proposed the following formula for adjusting the

required rate of return.

(1+nominal rate of return)= (1 + real rate of interest) x

(1 +expected rate of inflation)

Using the above rate of return as an example and the

inflation rate of is 8%. then applying the fisher

equation it would be

(1+0.0925)(1+0.08)= 1.1799

The nominal rate of return then it would be 17.99%.

This means the shareholders who were earning at 9.25

for every 100 before inflation for the time value of

money will now earn 17.99 for every 100. if the return

is less than that then they will be loosing.

Inflation also affects the future cash flows. Take for

instance; assume that you expect a cash flow of 1000

in one year’s time the rate of inflation remains at 8% as

used above. The expected cash flow will be 1080

instead of the expected. However, the investors will

not better off than when receiving 1000 without

inflation

Capital budgeting under uncertainty of cash flows

Uncertainty exists where there are several possible

outcomes, but there is little previous information or

statistical evidence to enable the possible outcomes to

be predicted. There many methods of handling

uncertainty this includes (1) probabilities; this is the

likelihood that an event is will occur for example using

the above data given and assuming that the

probabilities of having 440,000 per year is 70% and

probability of having 500,000 is 30%.

Then the cash flows will be as follows

The cash flows that will be subjected to measure NPV

analysis will be 452,000.

From the probabilities that some cash is likely to be

earned then standard deviations is used to measure

dispersion of the probabilities.

Investment risk

Assessing the risk attitude of bank owners is more

contentious. When limited liability and the regulatory

safety net are taken into consideration, bank

shareholders may be risk-seeking and have a convex

risk preference function. If a bank carries significant

franchise value, however, owners may prefer that the

bank acts in a risk-averse manner in order to preserve

the associated benefits. In this case the objective

function for the bank would be concave. This also

assumes that the owners are concerned with total bank

risk, and not just systemic risk.245 On the assumption

that the value of the franchise to bank owners exceeds

the value of the option associated with limited liability,

we make the assumption that bank owners will also be

risk-averse.

Consequently it was concluded that the bank risk

preference function should possess the characteristics

of non-satiety, risk-aversion and a preference for

positive skewness in the distribution of returns.

Stochastic dominance is used as the methodology to

rank portfolios in accordance with the risk preferences

of the centre. The key to using stochastic dominance

criteria is that the methodology allows portfolios to be

ranked without having to specify the exact form of the

investor utility function – different orders of stochastic

dominance correspond to different classes of utility

function. Third-order stochastic dominance (TSD)

criteria embody non-satiety, risk aversion and a

preference for positive skewness in the distribution of

returns. This makes it the most applicable criteria for

risk-ordering portfolios given our conclusions

regarding the characteristics of the risk preference

function of the centre.

It was found that the lower partial moment of orderAn=

2 (LPM2) provides a measure of risk that is consistent

with the risk preference function of the centre. More

specifically, portfolios that dominate by TSD criteria

are decreasing in risk according to the LPM2 risk

measure. The quadratic power function in this measure

means large deviations from the loss threshold receive

a greater penalty than smaller deviations in the risk

measure – consistent with a risk-averse attitude to

losses and a preference for positive skewness in the

distribution of returns.

Methodology

Introduction

The intention of research is to identify factors that

influence issuance of loans to individuals and how

individuals get past against them. The research looks at

strategies that are implemented by banks. The research

is based on two companies, the bank of America and

the common wealth bank of Australia.

Research Methodology

The main objective of this dissertation is to identify

how the chosen research methodology will match the

main objective of the dissertation question and how it

will be achieved. Essentially, there are two types of

research methodology; they are qualitative and

quantitative research. While the quantitative research is

carried out through obtaining primary data such as

questionnaire, qualitative research is a research that is

conducted through interviews and observations.

Therefore, the method enables a researcher to explore

the details of individual perceptions over phenomena.

Research Approach

The research approach that develops the methodology

explained below is based on descriptive research

theory and inductive reasoning. This is important to

develop the foundation by which the research will be

designed, conducted and consequently analyzed.

Firstly, it is important to establish the research

approach in order to create a significant qualitative

methodology. The research approach undertakes a

specific design that is “the overall strategy chosen to

obtain the information required answering the research

question” (Ghauri and Gronhaug p 47, 2002). The

research approach will review the types of research

design and data collection methods. The research

approach is built on logical relations and not just

beliefs.

Descriptive research is used when the research

question is understood (Ghauri and Gronhaug 2002). In

the research approach, the data measurements are

dependent on the obtainment of required information

and the quality of the information. The outcome of the

research, therefore, is dependent on the measurement

procedures used in the collection of the data, and this

in turn is dependent on the types of data collection

(Ghauri and Gronhaug p 47 2002).

This is an important concept of qualitative research,

where the description is either inductive or deductive.

Inductive research begins with a question and seeks to

describe it, and deductive research begins with the

problem by working backwards to the answers.

Therefore, this research uses the inductive approach to

build the theory from the data gathered to explore

possible conclusions towards credit facilities factors.

Collection of Theories and Secondary Sources

The researcher has collected information from various

literature reviews, which are available at internet

scholarly books, journals and newspapers. Theses

materials used are not sufficient to add something new

to the subject, which has been extensively researched.

Research Method

There are many approaches to this research being a

case study. Case studies are always investigated using

two-research method, Qualitative and Quantitative.

Quantitative approach involves the collection of

figures and facts in a form of tables and graphs.

Qualitative involves measuring people’s attitude,

behaviors and opinions. One can note that a person’s

perceptions opinions and attitudes cannot be measured

using quantitative technique. I.e. you cannot assign a

figure to somebody’s attitude of something.

Researchers have written that qualitative method of

collecting data or information is through observation,

interviews and analysis in a narrative manner. In this

case, quantitative analysis will not benefit us much as

compared to qualitative analysis.

The researcher is going to use qualitative method of

research in analyzing the strategies or factors adopted

by group common wealth bank of Australia and bank

of America. We shall also look using the same method

affect the issuance of loans. Therefore, in my final

report, I am producing an analysis for the two.

Data Collection

Data collection was carried out through internet search

engines and interviews. The researcher is a student

with authority in the university to target the two banks

to get insight of credit facilities given out by banks,

although the interview will be very difficult. Other

considerations have been made for this quantitative

method but the result is to interpret the information as

it was seen visible through interviews. I shall use

questioners I carrying out this important research.

For, me to carry out the test interviews possible and

bring an employee of one of the company; I have

selected the best option possible for my colleagues. I

have also use conventional interviews, which are

interview through internet for common wealth bank of

Australia and Australian bank. Although I gathered

information sufficient for me to make decisions, I

realized that face-to-face interview is more appropriate

as compared to telephone and internet. This is because

face-to-face interviews are easier since the questions

can be rephrased if the respondent does not understand

the question. However, in the internet and telephone

the respondent can choose to ignore the questions.

Quality Criteria

I shall explore whether there is a quality criteria for the

qualitative method used. This will be possible if we

give in depth analysis to give the findings a degree of

truth and validate them.

Validity

The validity of this investigation is achieved if it

measures what was intended for. The valuables should

be able to measure what the research intended to do.

Validity can be characterized by internal and external

validities. In this case, we are not going to use

laboratory measures.

Quality criteria

The purpose of this section is to establish the stance

used in the qualitative approach to this Study. In doing

so, the reader will better comprehend the degree of

truth that this dissertation has In addition, validate the

findings.

Validity

The validity of a study is achieved if it measures what

it was intended for, that is variables measure what the

research was intended to measure with little or no

error. This is characterized by internal and external

validity, which varies between types of research; field

experiments (research done in natural environment)

and lab experiment (done in contrived or artificial

environment). In lab experiments, the researcher

controls the setting, in which the research is been

conducted, may influence the variables, while

observing the changes or no changes in variables. Due

to the ability to control and eliminate certain variables

or conditions that may have a profound effect on the

outcomes of the research, would likely improve the

validity of the research. On the other hand, in field

experiments, the researcher retains control over the

independent variables but conducts the research in a

natural setting, without control over environmental

influences.

Internal validity describes or accounts for all factors,

including those that are not directly specified in the

theory being tested, but might affect the outcome of the

study. That is, it usually concerns the soundness of the

research being carried out. External validity on the

other hand refers to the generalization of the research,

which is the ability of the conclusions

To be validly extended from the specific environment

in which the research study is conducted to similar real

world situations.

The research for this thesis could be considered as a

field research (survey) as it is carried out in a particular

company in the real world. The literature on this

survey was got from an interview on human beings of

the company thus; we cannot influence their responses

in any significant way. To ensure for both internal and

external validity, we believe to have used the most

accurate and up-to-date literature, the right and relevant

questions asked during the interview (face-to-face

interview), the most feasible data collection method

utilized and the tools used to analyze the data are also

considered to be the most appropriate in this situation.

Therefore, this thesis is considered accurate and hence

produces valid results. Thus, we assume that the

overall validity of the results is considered high.

However, we would argue that the internal validity of

this thesis is relatively high but the same cannot e said

for its external validity. The reason for this position is

discussed under the degree of generalization.

Reliability

The aim of any researcher we believe is to use a given

procedure and reach a conclusion that will be

applicable in any given environment. The primary

objective should be that if a later investigation

followed exactly the same procedure as described by

an earlier investigator and conducted the same study all

over again; this later investigator should be able to

arrive at the same findings and conclusions.

Thus, the study could be considered highly reliable.

However, due to the very nature of human beings, a

100% reliability (especially regarding External

validity) cannot be guaranteed for this thesis, as errors

might occur in the course of writing down answers

during the interview or in coding answers due to

human nature. In this study, the errors were minimized

as one interviewer poses the questions and the other

concentrates in writing down responses. Immediately

after each interview, the two interviewers sat together

to discuss and document the final responses. With all

these measures put in place to minimize error, we

believe that the results of this study could be regard as

reliable.

Degree of generalization

Generalization is the applicability of results of a

research study to other settings. Probability sample is

only what justifies that inference can be made about

the population but this is not a guarantee as the results

from the sample cant be generalized because of the risk

of random and

Systematic errors in the sample. In case studies, it is

not important to make generalization of the study but

to explain what is the situation of that company in that

particular situation and there is no problem if the

results cannot be generalized. This is so because no

two companies can be the same, thereby case studies in

general do not return appropriate information for

generalization but in optimal case, can produce a rough

guideline/understanding of how theories are practically

applicable. Thus, our findings from the study can be

considered as Guidelines for companies implementing

certain strategies to gain growth in their market

Choice of Case Study

The research problem is that the investment strategies

adopted by bank of America influence decisions to

receive credit facilities as compared to strategies

required by common wealth bank of Australia. I shall

have to explore the complex and different perspectives

on how investment strategies are developed and

implemented by common wealth bank of Australia.

Therefore, I have used scientific study methods to

understand how these strategies have been

implemented and how to assist the bank. It is because

of this perspective that I decided to choose bank of

America and common wealth bank of Australia with

different approaches to expansion from different parts

of the world i.e. developed and developing.

Background of bank of America

Bank of America is the largest bank in the world which

resulted from the merger of two major banks in the US.

They have expanded into various economies of the

world and have created themselves a name in the

banking sector with few issues remaining unsolved.

Being one of the largest banks in the world, it was

incorporated in the United States of America for the

purpose of providing banking services to the American

society. The company has expanded to almost all

countries of the world through strategic alliances,

takeovers, and mergers as methods of diversification.

Bank is a public traded company and for years, this

company has moved to many countries geographically

and they have had products and services improved to

the level of online banking for the world. The owners

and their families run the management of the bank and

its activities influence decisions of many economies of

the world. They provide highly valuable services to the

world. At the present the company issues credit

facilities after assessing the riskiness of the client’s

information. This has strengthened their market share

through providing loan facilities to companies or

individuals who have stable financial records..

Background of Commonwealth bank of Australia

The common wealth bank of Australia was

incorporated in Australia as moved to various parts of

the world and they represent interests of Australia to

many places. The bank has a good credit facility policy

which ought to be emulated by many banking

institutions while issuing credit facilities.

Results

Assume the is approached by a customer to finance a

project it risk will be analyzed as followed

COST OF CAPITAL : Cost of capital for retaining

KeA= D1A/POA+ g

PoA= 35 D1A= 3.25 g = 5%

KeA= 3.25/ 35 +5% = 14.3%

= 14.3%

Cost of capital for common stock

KeA= D1A/POA– f + g

PoA= 35 D1A= 3.25 g = 5% f= 2

KeA= 3.25 +5% = 14.8%

35-2 = 14.8%

Cost of capital for preferred stock

KpA= D1/ PO – f

PoA= 102 D1A= 6% of 100 f= 4

KpA= 6 = 6.1%

102-4 = 6.1%

Cost of capital for debt

PdA=CF+ interest/(1- Kd)n

PdA– CF = interest PdA– 1000

(1- Kd)nACF —( 1000-20- 20)= 960

1000 – 960 = 6.5% X1000

(1- Kd)10

40 (1- KD)A10A= 65

(1- KD)A10A= 65/40

10 log (1- KD) =log 1.625

log (1- KD) =log 1.625/10

log (1- KD) =0.21085/10

log (1- KD) = log 1.0497

1- KDA= 1.0497

KdA=5%

WACC = wdrd(1-T)A+ wprpA+ wkerkeAWACC= 0X 5%( 1-

0.4) + 0 X 6.1% + 599,300/699,300 X 14.8% +

100,000/ 699,300 X 14.3%= 14.7%

The project Initial Investment

Cost of purchase of a new machine = 14 million

Cost of installation = 1 million

Increase in account receivable = 1.5 million

Inventory increase = 2 million

Account payable = (1 million )

Disposable value of old machine = (3.5 million)

Initial Investment 14 million

Therefore NPV = (1,000,000)+ 440,000 + 440,000

+440,000 +440,000 + 440,000

(1.0925)1A(1.0925)A2A(1.0925)3A(1.0925)4A(1.0925)5

(1,000,000) + 402,746 + 368,646+ 337,433+ 308,863+

282,712

= 700,400

Analysis

Assumptions regarding the hurdle rate, and in

particular, whether it should adjust to reflect changes in

leverage, are critical to determining the optimal credit

rating for a bank. This in turn impacts on pricing

decisions and the market value of credit portfolios, and

consequently, the risk-adjusted performance measures

of portfolios under the control of managers. A loan

pricing model was constructed to test the impact of

changes in the target credit rating of a bank on the

pricing of its loans.

The decision of a bank to increase its solvency

standard increases the minimum interest rate on its

loans in order to achieve the required hurdle rate on

capital assigned to the loans. Offsetting this upward

pressure is the impact of the reduced funding costs

arising from the higher credit rating. If retail deposit

rates are insensitive to an upgrade in the credit rating

of bank debt securities, we find that the benefits to a

bank from increasing its target credit rating rest with

the extent to which the cost of wholesale funds falls

relative to the increase in the price of bank loans.

A number of scenarios are employed to measure the

impact of bank-wide decisions on target credit rating

and funding mix on the pricing of bank loans. As the

bank increases its target credit rating, there is a

significant divergence between the change required in

the cost of wholesale funds to maintain unchanged loan

rates and empirical data on bank credit spreads. This

divergence narrows, however, as the credit quality of

the bank loan book increases and the proportion of

retail deposits falls. The divergence also narrows

considerably when the hurdle rate on capital is allowed

to adjust to reflect changes in bank leverage.

Further, our model shows that a bank can gain from

increasing its solvency standard, in the sense that the

cost of funds falls more than the increase in loan

prices, when the regulatory capital requirement for the

loan exceeds the economic capital requirement.

This occurs when banks make loans to high credit-

quality borrowers, because capital ‘capacity’ enables

the bank to realize a reduction in funding costs without

an offsetting increase in economic capital, and hence

an increase in loan interest rates. Our analysis shows

that the benefits of changes in credit rating are

contingent upon assumptions regarding changes in the

hurdle rate in response to changes in leverage.

This is also relevant at the level of managers, where

performance on portfolios is measured by the RORAC

against the bank hurdle rate. In chapter four we found

that a fixed hurdle rate for pricing bank assets is not

consistent with a constant probability of default when

bank returns are less than perfectly correlated with the

return on the market portfolio. We argued that the

internal hurdle rate should capture the additional costs

to investors associated with bank-specific risks. If the

contributors of economic capital to the bank perceive

that bank leverage is governed by minimum regulatory

requirements, then a case might be established for a

constant hurdle rate. However as banks target higher

solvency standards, and the gap between economic

capital and regulatory capital widens, the contributors

of capital should be willing to accept a lower required

return in response to lower bank leverage.

Recommendations and Conclusion

Most organizations and individuals seek loan facilities

for investment. However, all these organizations that

seek loan facilities face risks of various magnitudes.

From the perspective of a bank, each individual or

entity seeking a loan has a risk and it differs from one

entity to another because of differences in

fundamentals. For a bank to give an individual the

loan, they must be ready to transform the risk, price it

and monitor the risk to ensure that their money is given

to the right person. Investment policy or investment

strategy of an organization will assist them get loan

facilities depending on the loan facility they intend to

give.

Therefore before the bank advances credit facilities,

they have a responsibility of managing their credit

facility, market the company’s products and manage

the operational risk associated with the loan. The

company is charged with the responsibility of ensuring

that the risk associated with giving loans is properly

managed. It may be simple but accompanying risk

must be captured in order to ensure that loans are

issued to people who have provided all information

needed to estimate the amount of risk involved in issue

of loans.

The information about investment strategy is important

as it will assist the bank or the credit facility provider

to estimate the risk associated with the loan. You

cannot dismiss the investment strategy as a way of

assisting an organization or individual in receiving a

loan facility or facilitating the quick process of the loan

facility. Then much in the same way as the business

operates, the bank will have a reduced risk. Businesses

operated by individual owners have high risks

compared to business operated by a group of partners.

The information provided by each person will be the

reasons for the money and of course the bank or a

lending institution cannot issue money to a business

with a poor investment strategy. For example, a

company wanting to investment in a factory to produce

new products in the market will stand a better chance

of getting credit facilities as compared to a company

with a strategy to invest in a company which is

producing products saturated in the market.

The bank will have to calculate the expected risk of the

investment opportunity available and estimate the

profit of the investment proposed by the loan seeker.

The risk will be allocated the available capital and

other resources within the organization. This will

provide the bank with the required rate for lending

money. If the rate is lower than the proposed, then the

project will not be risky and the bank will not provide

the loan. First, the loan interest rate must be higher.

Therefore, provides best opportunities of the

investment. If the investment strategy is not sound and

bearing in mind the supply of capital is limited, the

task is reduced, that is investing in those opportunities

that have high returns.

There are many factors that determine the getting of a

loan from a banking facility. As identified, these

factors are crucial and necessary for the loan facilities.

Unfortunately, most banks do not use these facilities in

issuing of loans. The center of the bank charged with

responsibilities of issuing loans at item find themselves

looking at other issues which are irrelevant in issuance

of loans. However, almost all apart from the few cases,

bank loans are issued based on the facts. There is no

universally accepted means of measuring risks of the

loan seeker from the perspective of the bank. The

literature reviewed show that the amount of

information provided by the clients influences issuance

of loans. The literature further shows ha banks view

risk based on the information provided.

Although market prices determine the loan to be

issued, risk is also considered. According to Domar

and Musgrave, the banks view risks as the probability

of losing their money while Savage (1951) argued that

risk is making wrong investment choice and Roy

(1952) describes risk as the perception about the future

cash inflows. There are many writers and scholars who

have viewed risks from the perspective of the bank as

terms of variability of the expected amount from the

loan seeker. The unavailability of a standard way of

understanding risk based on the information provided

from the client and no proper objectives stating how

risk is measured then banks will rely on the

information provided. This information provided will

revolve around your investment strategy. Therefore, it

is necessary for the person seeking credit facilities to

draw up proper information relating to risk investment

strategy to assist him get credit facilities.

Companies who are faced with lack of information on

how to measure risk describe it or spread it will find

themselves making wrong investment decisions in not

getting credit facilities. Therefore, they should be able

to come up with strategies that will assist them get

credit facilities and other institutions. Therefore, the

credit facility provider requirements implicitly involve

a notion of risks as determined by bank regulators that

is the free interest arte security setters who are the

government arm sets the minimum risk before issuing

loan facilities. There are credit risks which are set out

by bank regulators and these determine whether the

loan seeker will get credit facility.

Therefore it is common knowledge that the cost of

capital of the firm in question will determine the

amount of loan that will be provided. If the company

has a high cost of capital, the probability of getting a

loan becomes low because this company will not be

bale to raise money that will sustain the interest that

accrue on the loan. To avoid technical defaults, banks

will avoid such a client.

Banks will use the perspective which identifies risks as

a probability that the client will not be bale to pay and

there is a risk of this client getting out of business thus

determines the economic capital requirement of that

firm before raising funds. Investment strategy is

affected by great rating by the bank and credit

worthiness.

There is a problem with the above mentioned method

since solvency follows a company after they have

failed to deliver the part of the agreement. This is why

the companies or an individual seeking credit facilities

need to disclose the loan provider the purpose of the

loan, proposed method on how it will be paid back and

the thresh hold. There fore there is another standard of

measure that assists the company to get credit facilities.

This measure is the measure of solvency. This implies

that the risk measured using the ability of the firm to

pay the loan does not capture the potential losses which

will be incurred upon failure by the company to honor

their agreements.

Viewed from one perspective, that is from the bank’s

point of view, the risk is greater if the financial

statements of the company reflects poor profitability

and performance. The challenge is in the hands of the

bank to ensure that there is relevant measure for risk of

the client’s information provided. The methods used

should be recognized method for risk measurement.

This requires the ability of the bank to decentralize her

activities in issuance of loans. If the bank’s credit

facility is not decentralized, then the loan will not be

forthcoming as quick as industrialized areas.

Take for example Commercial bank of Australia

discussed in this case and Bank of America who have

decentralized their facilities and another bank in the

third world which has failed to decentralize. The third

world bank will take long to issue credit facility and it

will be riskier for that bank since the credit facility

offered is not properly decentralized.

The question that arises from the above two examples

is whether the creditor or the person seeking the credit

facility is risk averse or risk taker. This is another that

well determines the issuance of loan.

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Investment Strategy and Loan Approvement

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