Question

Fernandez has applied for a revolving credit line of $ 9 million to assist in marketing a new product line. The terms of the loan will be as follows:

(a) All the loans will be discount loans.

(b) A commitment fee of 0.1 percent on the unused portion of the loan will be charged.

(c) The compensatory balance requirements will be 3 percent on the total credit line and 2 percent on the outstanding loans.

(d) The bank will pay 1 percent interest on demand deposits.

(e) The rate of interest to be charged will be the prime rate plus 3 percent.

(f) The bank will use the "actual/360" accrual method to compute interest payments.

(g) The credit line will be extended for a period of three years.

The loan officer estimates that Mr. Fernandez will use about 68 percent of the credit line on average. If the prime rate is 10 percent and the required reserve rate on demand deposits is 15 percent.

Compute the effective yield for the bank.

Enter your answer in decimals, keep 4 decimal places (e.g., enter 15.12% as .1512).

Answer 1

Interest Rate for 365 days = (Prime Rate + 3%) * 365 / 360 = 0.13 * 365 / 360 = 13.18%

Effective Yield = (Used Portion * Interest Rate + Unused Portion * Commitment fee - (Compensatory Charge + 2% * Used Portion)*Interest on demand Deposits) / Used Portion - Used Portion * Interest Rate - (Compensatory Charge + 2% * Used Portion)* (1 - Reserve Rate))

Effective Yield = (0.68 * 0.1318 + 0.32 * 0.001 - (0.03 + 0.02 * 0.06)*0.01) / (0.68 - 0.068 * 0.1318 - (0.03 + 2% * 0.068)* (1 - 0.15))

Effective Yield = (0.089624 + 0.00032 - 0.000312 / (0.68 - 0.089624 - 0.03706

Effective Yield = (0.089632 / 0.5533

Effective Yield = 16.20%