A bank is planning to make a loan of $25,000,000 to a firm in the steel industry. It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years and a duration of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 percent. Assume the bank has estimated the maximum change in the risk premium on the steel manufacturing sector to be approximately 4.2 percent, based on two years of historical data. The current market interest rate for loans in this sector is 12 percent. a. What should be the duration in order for this loan to be approved? b. Assuming that duration cannot be changed, how much additional interest and fee income would be necessary to make the loan acceptable? c. Given the proposed income stream and the negotiated duration, what adjustment in the risk premium would be necessary to make the loan acceptable?
A bank is planning to make a loan of $25,000,000 to a firm in the steel industry. It expects to charge a servicing fee of 50 basis points. The loan has a maturity of 8 years and a duration of 7.5 years. The cost of funds (the RAROC benchmark) for the bank is 10 percent. Assume the bank has estimated the maximum change in the risk premium on the steel manufacturing sector to be approximately 4.2 percent, based on two years of historical data. The current market interest rate for loans in this sector is 12 percent.
a. What should be the duration in order for this loan to be approved?
b. Assuming that duration cannot be changed, how much additional interest and fee income would be necessary to make the loan acceptable?
c. Given the proposed income stream and the negotiated duration, what adjustment in the risk premium would be necessary to make the loan acceptable?
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