Sun Bank has issued a one-year $5 million loan commitment to a customer for an up-front fee of 15 basis points and at a fixed rate of 12 percent.The back-end fee for the unused portion of the commitment is 5 basis points.The bank requires a 10 percent compensating balance in demand deposits.Reserve requirements on demand deposits are 10 percent. What is the expected return on the loan at the end of the year if 50 percent of the loan is drawn? Estimate using future values of fee and interest income received, that is, return is defined as all fee and interest income earned at year-end as a percentage of funds used.Assume the cost of funds to the bank is 8 percent.

Question

Quizplus · Accepted Answer

The expected return is calculated by considering the interest income, fees, and compensating balance requirements. With 50% of the loan drawn, the bank earns interest on $2.5 million at 12%, an up-front fee on the full $5 million, and a back-end fee on the unused $2.5 million. The compensating balance requirement reduces the effective funds used. The cost of funds is 8%, and the return is calculated as the total income minus the cost of funds, divided by the effective funds used.

Sun Bank Has Issued a One-Year $5 Million Loan Commitment