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 8.5 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 75 percent of the commitment at the beginning of the year, Calculate total (up-front and back-end) fee income, interest income, compensating balance, reserve requirement on deposits and the expected return on the loan (without taking future values into consideration). (6 marks)

b. If the borrower draws down 80 percent of the commitment at the beginning of the fifth month, calculate the expected return on the loan (without taking future values into consideration). (5 marks)

c. Suppose that the expected return of loan commitments issued by this FI is 12.00% and the yield of Treasury bond is 7%, calculate the probability of repayment, the probability of default and the risk premium of this loan commitments. (3 marks)