insuranee arrangements A large bank evaluates commerciallending officers in terms of the profitability and quality of their loa n portfolios. When a loan is consummated, the loan officer

"borrows" the principal from center at an intemally posted rate. The intemal rate depends on the maturity of loan. If the loan is a fixed rate loan, the loan officer is charged the posted rate on the outstanding balance each period. The rate used is fixed at the internaI rate at the time the loan was booked. In this way the lending officer is insured against interest rate movements, but not against default risk (to the extent default is not related to interest rate movements). Carefully analyze this transfer pricing arrangement.

How would a variable rate loan be treated?

AppendixLO1