Konfidence Bank has made a loan to Risky Corporation. The loan terms include a

default risk$-$free base rate of $2$ percent, a risk premium of $2\mathrm{.}25$ percent, an origination

fee of $0\mathrm{.}25$ percent, and a $5$ percent compensating balance requirement. Required

reserves are no longer necessary. What is the rate of return the bank expects if full

repayment is made by Risk Corporation?

Risky Corporation's debt is rated by Moody's as Baa$3$ and currently is trading at an

annual yield of $4\mathrm{.}625$ percent. The equivalent constant maturity US Treasury is selling

to yield $1\mathrm{.}32$ percent. What is the probability of repayment and the probability of

default implied by the market for Risky?

Given your answers to question $1$ and question $2$ above, what is the return that

Confidence bank expects to receive from the Risky loan?

Based on past default $($repayment$)$ experience by Confidence Bank, their statisticians

use a linear probability model to find common variables that may predict the

probability of default by a borrower. They find that the debt$-$equity ratio $($D$/$E$),$ the

sales$-$asset ratio $($S$/$A$),$ and the equity multiplier $($E$/$A$)$ were three factors influencing the

past default behavior of borrowers.

The model has the following parameter estimates. Risk Corporation has a $($D$/$E$)$ ratio of

$0\mathrm{.}325,$ a profit margin $($PM$)$ of $1\mathrm{.}8$ and an EBIT$/$Sales of $2\mathrm{.}25.$ What does the model

predict as the probability of default for Risky?

$P{D}_i=0\mathrm{.}47(\frac{D}{A}{)}_j-0\mathrm{.}05(PM{)}_j-0\mathrm{.}013(\frac{\text{E}\text{B}\text{I}\text{T}}{\text{S}\text{a}\text{l}\text{e}\text{s}}{)}_j$

Given the contractual return found in problem $1,$ and the probability of default from

the linear probability model in problem $4,$ what is the return that Confidence Bank

expects to receive from the Risky loan?