Question

Metrobank offers one-year loans with a 14 percent stated rate, charges a 1/4 percent loan origination fee, imposes a 6 percent compensating balance requirement, and must pay a 4 percent reserve requirement to the Federal Reserve. What is the return to the bank on these loans? (Do not round intermediate calculations. Round your answer to 1 decimal place. (e.g., 32.1))

Answer 1

Here, we’ve Origination fee (Of) = 0.25%

Stated rate (Sr) = 14.00%

Risk premium (Rp) = 0%

Compensating balance (b) = 6.00%

Reserve requirement (RR) = 4.00%

Therefore, the Rate of return to the Bank = [Of + (Sr + m)] / [1 – {b x (1 – RR)}]

= [0.0025 + 0.14 + 0.00] / [1 – {0.06 x (1 – 0.04)}]

= 0.1425 / [1 – {0.06 x 0.96}]

= 0.1425 / [1 - 0.0576]

= 0.1425 / 0.9424

= 0.1512096 or

= 15.1% (Rounded to 1 decimal place)

Hence, the Rate of return to the Bank will be 15.1%