Suburb Bank has issued a one-year loan commitment of $10 million for an up-front fee of 50 basis points. The back-end fee on the unused portion of the commitment is 20 basis points. The bank’s base rate on loans is 7 percent, and loans to this customer carry a risk premium of 2 percent. The bank requires a compensating balance of 10 percent to be placed in demand deposits and must maintain reserve requirements on demand deposits of 10 percent. The customer is expected to draw down 60 percent of the commitment at the beginning of the year.
a. What is the expected return on this loan?
b. What is the expected annual return on the loan if the draw-down on the commitment does not occur until the end of six months?
