P9.5 Optimal Credit Policy. Kate Warner, a senior loan officer with Citybank in Cleveland, Ohio, has both corporate and personal lending customers. On average, the profit contribution margin or interest rate spread is 1.5 per cent on corporate loans and 2 per cent on personal loans.

This return difference reflects the fact that personal loans tend to be riskier than corporate loans.

Warner seeks to maximize the total dollar profit contribution earned, subject to a variety of restrictions on her lending practices. To limit default risk, Warner must restrict personal loans to no more than 50 per cent of the total loans outstanding. Similarly, to ensure adequate diversification against business-cycle risk, corporate lending cannot exceed 75 per cent of loaned funds. To maintain good customer relations by serving the basic needs of the local business community, Warner has decided to extend at least 25 per cent of her total credit authorization to corporate customers on an ongoing basis. Finally, Warner cannot exceed her current total credit authorization of $100 million.