Question
A lender proposes a 2- year fully amortizing loan of $100 million with annual payments. The 99th percentile increase in risk premium for bonds belonging
A lender proposes a 2- year fully amortizing loan of $100 million with annual payments. The 99th percentile increase in risk premium for bonds belonging to the same risk category of the loan has been estimated to be 6.5 percent. The current average level of interest rates for this category of bonds is 8 percent. The fee income on this loan is 25 basis points and the spread over the cost of funds to the bank is 75 basis points. What is the estimated risk- adjusted return on capital (RAROC) of this loan? If the minimum RAROC acceptable to the bank is 8.5 percent, will the bank approve the loan ?
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