3. The cost of financial intermediation (intermediate). Weyerhaeuser, the lumber multinational company, is comparing the cost of alternative methods for financing its exports trade. US$500 million is needed for 180 days and can be sourced from Chicago Trust in the form of a bridge loan at a cost of 5.75 percent. Alternatively, Weyerhaeuser could tap the commercial paper market at the cost of 5.00 percent with an additional 35 basis points for a backup line of credit from Bank of America.

a. Compare the cost of either financing option proposed to Weyerhaeuser.

b. What is Chicago Trust’s cost of capital? What is the minimum interest rate it should charge on a six-month loan to Weyerhaeuser? What is the net income generated by a loan toWeyerhaeuser? Does it account for the 10 percent capital adequacy ratio imposed by Basel II? Weyerhaeuser’s CFO is perplexed by the gap in financing cost, as he has just learned about Chicago Trust’s ongoing commercial program at the rate of 5.25 percent with a letter of credit from Bank of America at the cost of 25 basis points. How could he reconcile the cost of financing difference given that Chicago Trust is required to keep a minimum equity capital at 10 percent of its book value (as per Basel 2.5 agreement), that the cost of its equity capital is 12 percent, and that to break even Chicago Trust has to charge a spread of 50 basis points over its cost of funds? Assume that Chicago Trust’s debt financing (as a percentage of debt + equity) is comprised of 40 percent of customers’ deposits in checking accounts (which do not pay interest) and 50 percent of commercial paper.