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The instructions are given in the word doc that I have attached.
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EXTRA CREDIT (DUE March 6, 2024 at 11:59 pm)
(Worth 15 points) Union Trust Commercial Bank has issued a one-year $100 million loan
commitment to a customer for an up-front fee of 25 basis points. In the analysis to compute
its loan rate for this customer, the bank has determined that its base lending rate will be
10% and its margin to compensate the bank for default risk for this particular customer is
2%. The back-end fee for non-usage of the commitment is 10 basis points. The bank
requires a 5 percent compensating balance in demand deposits on the entire amount of the
commitment. The reserve requirement ratio on demand deposits at the central bank is 10
percent. What is the loan rate offered to this customer? What is effective return on the loan
to the bank if 50 percent of the loan is taken down? In computing this return, do not take
into consideration future values of fee or interest income received. The bank has concluded
that the probability of default on this type of credit is 5% and that when a default occurs
about 60% will be recovered. What is the expected gross return on the loan (in this part,
use the effective interest rate computed when the net fees and interest income are evaluated
at the end of the year when the loan is due)?
**Note: Assume that the bank’s cost of funds is 6 percent. That is, the bank can earn
6% on its funds.
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