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 to the bank if 50 percent of the loan is drawn using discounted cash flows? That is, the return has to be estimated at the beginning of the loan period using present values.Assume there are reserve requirements of 10 percent on demand deposits.

Question

Quizplus · Accepted Answer

The expected return is calculated by considering the fees, compensating balance, reserve requirements, and the portion of the loan drawn. The up-front fee is 15 basis points on $5 million, and the back-end fee is 5 basis points on the unused portion ($2.5 million). The compensating balance requirement reduces the effective loan amount, and reserve requirements further reduce the usable balance. The effective interest rate is calculated using these adjusted cash flows, resulting in an expected return of 12.59 percent.

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