A bank is planning to loan $5,000,000 to a firm in the steel industry. The current market interest rate for loans in this sector is 13%, and the expected loss rate is 1%. It would charge a servicing fee of 50 basis points (0.50%). The loan has a maturity of 8 years with a duration of 7.5 years. The banks cost of funds is 10%. Based on two years of historical data, the credit spread on the steel manufacturing sector has changed with the following frequency:

Percentile Change in the Risk Premium

Minimum -3.0%

Lowest 1% -2.0%

50% (Median) +0.1%

Highest 1% +4.2%

Maximum +5.0%

The bank requires a minimum RAROC of 12%.

a. Using the RAROC model, should the bank make the loan?

b. What maximum loan duration would cause this loan to be approved?

c. Assuming that duration cannot be changed, how much total interest and fee income will be necessary to make the loan acceptable?