Question

Suppose that Macao Development Bank offers Ding Ding short-term loan of $1,250, 000 to finance its operation. The bank has its prime rate of 3.875% and/or bank raises by selling NCD at interest rate of 2.625% to fund this loan. Non- funds operating costs are estimated at 0. 875% and additional 1.25% is to compensate for default risk. The lender requires 0. 875% as prof it margin. The borrower is offered by the bank two types of interest rates term. The first method is 1. 4 times-prime rate of price leadership method and the other one is cost-plus loan pricing method. Which is the best alternative for the borrower? Why ?

Answer 1

The solution of the question is as below :-

> Rate based on prime rate = 3.875 * 1.4 times

                                            = 5.425 %

> Rate based on Cost plus profit based

Particulars	Rate
NCD rate	2.625
Non-funds operating costs	0.875
Default risk	1.25
Profit margin	0.875
Cost plus profit Rate	5.625

> Conclusion

Since the cost plus rate is more than the rate based on prime rate, borrower should select the prime based rate. The saving on selecting prime based rate is 0.20 %.