Study On The Valuation Of Inventory Pledged Loans With Counterparty Risk

As a creative product of logistics finance and supply chain finance, inventory pledgedloans has become one of main financing ways. In recent years, some banks in China’scoastal areas have been cooperating with logistical companies to develop this kind ofproduct one after another. By virtue of characters of circulation and liquidity, inventoryof goods is the basic element in production chain, and is owned by many SMEs (smalland medium-size enterprises). So the inventory pledged loan has become the importantway of supply chain financing at home and aboard. From the borrower’s perspective,using inventory of goods as collateral could efectively alleviate the shortage of fundsand smooth the cash flow of supply chain. From the lender’s perspective, the quality ofinventory do much better in reducing financing risk than enterprises’ net assets and debts.Based on these advantages, inventory pledged loans has huge potential development spacein China. But the lack of pricing technology and loopholes in laws and regulations makeit difcult to control risks. In addition, key risk control factors of this product, such asLTV(loan-to-value) ratio, just rely on experiences, so it is important to study the valuationproblem of inventory pledged loans.Currently, there are many literatures on the valuation of inventory pledged loans.Most of them considered the risks of such a loan, and studied the valuation providedthat the borrower defaults at maturity, and the default risk is endogenous or exogenous.Other researches considered the influence of price on inventory management decision. All results are helpful for China’s inventory pledged loans, but all of them neglected thecounterparty risk in the loan contract. The counterparty risk is a risk that both partiesof the contract may default before or at maturity. The reason of focusing on this risk isbecause both parties of inventory pledged loans in China are small and medium finan-cial institutions (lender) and SMEs(borrower), and these firms are easily impacted by theexternal environment and policies. So it’s significant to take the counterparty risk intoconsideration in China. Based on previous researches, this paper focuses on the valuationof inventory pledged loans with counterparty risk and finite maturity. Clearly, our re-sult may support finance product development and risk management technically. At thesame time, we hope to provide potential technical supports for resolving SMEs’ financingdifculties.The thesis is structured as follows. Chapter one introduces the background and theimplication of the thesis, as well as research methods and framework. Chapter two re-views the relevant literatures. Chapter three and Chapter four are the core of the thesis.Theoretically, Chapter three derives the price of such a loan under diferent cases of thelender’s default, and establishes the relationship between the loan price and LTV ratio.Chapter four considers the unilateral default risk, that is, only borrower default risk, andshows the reasonable relationship between the loan price and LTV ratio. Besides, thispaper establishes the dynamic relationship among key parameters, means LTV ratio, loanrate, service fee, inventory price and so on. This relationship may technically support riskmanagement. Moreover, Chapter four uses Matlab to illustrate the theoretical results andcompare diferent results under diferent assumptions. Our results show that there is apositive correlation between LTV ration and service fee under unilateral default risk, asLTV ratio and loan rate the same. But once we take counterparty risk into consideration,these efects can’t hold and become complicated. Conclusion is given in the last part.We give a general valuation framework of inventory pledged loans with counterpar- ty risk in this paper. And our results, especially the relationship among LTV ratio, loanrate, service fee and inventory price, will provide both parties of such a loan valuablereferences for amending relevant policies and risk management. At the same time theseresults provide potential technical supports for easing SMEs’ financing difculties.