Q1: Examine the decision tree in Exhibit 8 and come up with a strategy which Ajay and his team

should adopt to identify credit worthy customers early in the assessment phase.

Answer: CHAID (Chi-square Automatic Interaction Detector) analysis is an algorithm used for

discovering relationships between a categorical response variable and other categorical predictor
variables. It is useful when looking for patterns in datasets with lots of categorical variables and is a
convenient way of summarising the data as the relationships can be easily visualised. CHAID is often
used in direct marketing to understand how different groups of customers might respond to a
campaign based on their characteristics. So, suppose, for example, that we run a marketing campaign
and are interested in understanding what customer characteristics (e.g., gender, socio-economic
status, geographic location, etc.) are associated with the response rate achieved.

LTV (Loan to Value Ratio) = Total loan requested/Market Value

FOIR (Fixed Obligation to Income Ratio) = (EMI + Ongoing Loan EMI)/Total House hold Income

In exhibit 8 decision tree analysis - Ajay and his team should adopt to identify credit worthy customers
who has LTV & FOIR value lowest among all customers may credit worthy customers early in the
assessment phase. FOIR value lowest in case of Tier 1 cities of India.

Q2) Using the classification table in Exhibit 10, answer the below questions:

a) Given 100 loan applicants who have been approved a loan, how many of them would the model
be able to correctly predict as sanctions?

b) Calculate the proportion of actual rejects which have been incorrectly classified as sanctions

Q3) Apply the CHAID decision tree on the 100 data points provided Exhibit 11 and construct the
classification table. (Assume the cut-off - 0.8). Is it similar to the one provided in Exhibit 10? What
are your conclusions regarding the CHAID decision tree results?

Q4) Examine the decision tree in Exhibit 8 and explain why derived variables such as LTV and FOIR
have better explanatory power than the individual variables used to derive them?

Answer: [Loan-to-value (LTV) ratio is a number lenders use to determine how much risk they're taking
on with a secured loan. It measures the relationship between the loan amount and the market value of
the asset securing the loan, such as a house or car.
If a lender provides a loan worth half the value of the asset, for example, the LTV is 50%. As LTV
increases, the potential loss the lender will face if the borrower fails to repay the loan also rises,
creating more risk.
Loan-to-value ratio can apply to any secured loan but is most commonly used with mortgages. In fact,
several bank mortgage programs specify LTV limits as part of their qualifying criteria.
FOIR (Fixed Obligations to Income Ratio) is a popular parameter which banks use to determine loan
eligibility. FOIR takes into account all the fixed obligations that a borrower is supposed to meet
regularly on a monthly basis. The fixed obligations do not include statutory deductions from the salary
such as Provident Fund, professional tax and deductions for investments such as insurance or a
recurring deposit. Banks have different FOIR for different loans. It can be 50% for a Personal Loan
whereas the requirement can be 35% to 40% for a Home Loan. Usually, the banks fix up the FOIR as
50%.]
 CHAID method is more computationally efficient in identifying potential interactions when
compared with adding all possible interactions in either of the stepwise, backward, or forward
feature selection procedures in logistic regression. Also, the customer profile created based
on the CHAID tree could provide a better understanding about the variable interactions.
 CHAID decision tree in Exhibit 8 - decision tree based CHAID analysis is applied to identify
potential variable interactions, it has been observed that LTV and FOIR are the interaction
terms identified by CHAID analysis and they are all statistically significant.