A Financial Institution (FI) has issued a one-year loan commitment of $2 million for an up-front fee of 25 basis points. The back-end fee on the unused portion of the commitment is 10 basis points. The FIs base rate on loans is 7.5 percent and the loan to this borrower carries a risk premium of 2.5 percent. The FI requires a compensating balance on loans of 5 percent. Reserve requirements on demand deposits are 8 percent.

Required:

a. If the borrower draws down 100 percent of the commitment at the beginning of the year, what is the expected return on the loan (without taking future values into consideration)? (4 marks)

b. If the borrower draws down 75 percent of the commitment at the beginning of the year, what is the expected return on the loan (without taking future values into consideration)? (4 marks) c. If the borrower draws down 75 percent of the commitment at the beginning of the fourth month, what is the expected return on the loan (without taking future values into consideration)? (4 marks)

d. Suppose that the expected return of loan commitments issued by this FI is 10.85% and the yield of Treasury bond is 7%, what are the probability of repayment and the probability of default of this loan commitments? (2 marks