As a senior loan officer at MC Bancorp, you have the following loan applications waiting for review. The bank uses Altmans Z score, default probabilities, mortality rates, and RAROC to assess loan acceptability. The banks cost of equity (the RAROC benchmark) is 8 percent. The banks loan policy states that the maximum probability of default for loans by type is as follows:

Loan Type and Maturity: A-rated, Maximum Allowable Default Probability: 0.50%

Loan Type and Maturity: AAA-rated, Maximum Allowable Default Probability: 1.25%

Which loans should be approved, and which rejected?

A.) An A-rated corporate loan with a maturity of three years. A-rated corporate loans are evaluated using the mortality rate approach. A schedule of historical defaults (annual and cumulative) experienced by the bank on its A-rated corporate loans is as follows:

	Years after Issuance
Loan type	1 year	2 years	3 years	4 years
A-rated corporate loans
Annual default	0.10%	0.25%	0.40%	0.65%
Cumulative default	0.10	0.325	0.595	1.858

B.) A $2 million, five-year loan to a BBB-rated corporation in the computer parts industry. MC Bancorp charges a servicing fee of 75 basis points. The duration on the loan is 4.5 years. The cost of funds for the bank (the RAROC benchmark) is 8 percent. Based on four years of historical data, the bank has estimated the maximum change in the risk premium on the computer parts industry to be approximately 5.5 percent. The current market rate for loans in this industry is 10 percent.