Question

4. What is the gross return on a loan if the bank requires the firm to hold 1.6 percent in compensating balances, charges an origination fee of 0.0175 percent, the relevant firm’s risk premium is 3.8%, the LIBOR is 3.1%, and the reserve requirement is 10%?

The Gross Return on the loan = ___________________

Answer 1

Gross return = [f+ br+rp]/[1- {b(1-RR)}]

              =[.000175+.031+.038]/[1-{.016(1-.1)} ]

              =[.069175]/[1-{.016*.90}]

              = .069175 /[1-.0144]

             = .069175/.9856

            = .0701857 or 7.01857 %   (rounded to 7.02%)

WHERE,

f=origination fees

br=base rate

rp=risk premium

b=compensating balance

RR=Reseve requirement