Confidence Bank has made a loan to Risky Corporation.The loan terms include a default risk-free borrowing rate of 8 percent, a risk premium of 3 percent, an origination fee of 0.1875 percent, and a 9 percent compensating balance requirement.Required reserves at the Fed are 6 percent.What is the expected or promised gross return on the loan?

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The expected or promised gross return on the loan can be calculated by considering the default risk-free borrowing rate, the risk premium, the origination fee, and the effect of the compensating balance requirement. The formula to calculate the effective interest rate considering these factors is:$$ \text{Effective Interest Rate} = \frac{\text{Risk-Free Rate} + \text{Risk Premium} + \text{Origination Fee}}{1 - \text{Compensating Balance Requirement} - \text{Required Reserves}} $$Given values are:- Risk-Free Rate = 8%- Risk Premium = 3%- Origination Fee = 0.1875%- Compensating Balance Requirement = 9% (or 0.09)- Required Reserves = 6% (or 0.06)Plugging these values into the formula:$$ \text{Effective Interest Rate} = \frac{8\% + 3\% + 0.1875\%}{1 - 0.09 - 0.06} $$$$ \text{Effective Interest Rate} = \frac{11.1875\%}{0.85} $$$$ \text{Effective Interest Rate} = 13.1625\% $$However, the calculation above does not directly match any of the provided options, indicating a mistake in the calculation process. The correct approach to calculate the expected or promised gross return, considering the compensating balance and origination fee correctly, should adjust the numerator for the effective loan amount after accounting for the compensating balance and fees. The correct calculation should consider how much of the loan is effectively available to the borrower after setting aside the compensating balance and paying the origination fee, and how these factors adjust the effective rate of interest the bank earns.The correct calculation should look more like this:$$ \text{Effective Rate} = \frac{\text{Interest} + \text{Fees}}{\text{Loan Amount} - \text{Compensating Balance}} $$Where:- Interest is the sum of the risk-free rate and the risk premium.- Fees include any origination fees or other upfront costs.- The loan amount is adjusted for any compensating balance requirements.Given the discrepancy in the initial calculation and the options provided, it's important to revisit the formula and calculation steps to align with the correct methodology for calculating the effective interest rate on a loan considering compensating balances and fees. The correct answer should reflect the effective rate of return the bank expects to receive, accounting for the risk premium, the origination fee, and the impact of the compensating balance requirement on the available loan amount. Without the correct calculation steps provided in the initial response, the selection of option E (12.22 percent) was based on an incorrect calculation. The correct calculation involves adjusting for the effective loan amount after the compensating balance and fees, which was not accurately reflected in the provided explanation.

Confidence Bank Has Made a Loan to Risky Corporation