A bank has a basket of three-year loans with a value of $ 5 million that pay annual interest of $200,000 per annum. Interest payments are conducted every month but the total principals of the loans are due at the end of the third year.

a. The bank is willing to sell these loans without recourse at an interest rate of 3.5 percent. What price should it receive for these loans? (2 marks)

b. Another bank is willing to purchase the loans with recourse at a yield of 3.4 percent per annum. According to the management information system of the selling bank there is a 1.0% probability of default on these loans and 70% of the loans could be recovered upon default due to the security (collateral) that the bank holds. Is it better to sell the loans with or without recourse? (3 marks)