Hawkes Bank has issued a one-year loan commitment of $100 million for an up-front fee of 40 basis… 1 answer below »

This is a problem similar to those found in Chapter 16. Hawkes Bank has issued a one-year loan commitment of $100 million for an up-front fee of 40 basis points. The back-end fee on the unused portion of the commitment is 15 basis points. The bank’s base rate on loans is 5.5 percent, and loans to this customer carry a risk premium of 1.5 percent. The bank requires a compensating balance on loans of 7 percent to be placed and maintained in demand deposits and Hawkes Bank must maintain reserve requirements on demand deposits of 10 percent. The customer is expected to draw down 70 percent of the commitment at the beginning of the year.

f1 = up front fee.

f2 = back end fee.

td = take down proportion.

BR = borrowing rate.

m = risk premium.

b = compensating balance.

RR = reserve requirement.

a. What is the expected return on this loan?

Using the formula:

1+k = 1+[(0.0040)+(0.0015)(1-0.70)+(0.055+0.015)(0.70)]/{0.70-[0.07(0.70)(1-0.10)]}

1+k = 1+

1 + k = ___________, or k = ___________ percent.

Alternatively, using dollar values:

Up-front fee = 0.0040 x $100,000,000 = $ 400,000

Interest income = 0.0700 x $100,000,000(0.7) = $4,900,000

Back-end fee = 0.0015 x $100,000,000(1-0.7) = $__45,000__

Total revenue $5,345,000__

Funds committed = $100,000,000(0.7) – $4,900,000 (compensating balance = $100,000,000(0.70)(0.07)) + $490,000 (reserve requirements on demand deposits = $100,000,000(0.70)(0.07)(0.1)) = $________________.

Expected rate of return = Total Revenue/Funds Committed= $______________/$______________ = _________ percent.

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