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 expected return on the loan to the bank if 50 percent of the loan is drawn? Do not take future values of fee or interest income received.

Question

What is expected return on the loan to the bank if 50 percent of the loan is drawn? Do not take future values of fee or interest income received.

Quizplus · Accepted Answer

The expected return is calculated by considering the fees, interest, and compensating balance. 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 is 10% of the drawn amount ($2.5 million), which is $250,000, and the reserve requirement is 10% of this balance. The interest income is 12% on the drawn amount. The expected return is calculated by dividing the total income by the effective loan amount (considering the compensating balance and reserve requirement).

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