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

Quizplus · Accepted Answer

The expected return is calculated by considering the interest income, fees, and compensating balance requirements. The interest income from the drawn portion is $5 million * 50% * 12% = $300,000. The up-front fee is $5 million * 0.15% = $7,500. The back-end fee is $2.5 million * 0.05% = $1,250. The compensating balance is $5 million * 10% = $500,000, with a reserve requirement of 10%, leaving $450,000 usable. The total income is $300,000 + $7,500 + $1,250 = $308,750. The effective loan amount is $2.5 million + $450,000 = $2.95 million. The expected return is $308,750 / $2.95 million = 10.47%.

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