1. Loan structuring: Petersons Fittings (PF), a manufacturer of pipe and plumbing supplies wishes to purchase a high-stress stamping machine to produce tempered pipe fittings. Because of the extreme forces involved in the manufacturing process, such machines have a useful economic life of only two years and their market value declines in proportion to the time they have been in use. (That is a one-year old machine is worth half as much as a new one, a two-year old machine has zero salvage value.) PF wishes to borrow the $100,000 purchase price, using the stamping machine as collateral.

As a lending officer at Friendly Bank you are considering two possible repayment schedules for the loan. Under an amortized structure, PF would make two equal annual payments. Under a coupon structure, PF would pay interest only at the end of the first year, and interest and principal at the end of the second.

Will the choice of loan structure affect Friendlys expected default losses on the loan? If you answer yes, indicate which structure would have lower loan losses and explain why this is so. If you answer no, explain why the repayment structure does not affect expected loan losses.