Place yourself in the role of the owner of a bank that is making loans to businesses. Suppose you always loan money in increments of $1000 (i.e. 1000,2000,…. 12,000… 1,200,000… etc..) and you charge interest every six months. Finally your client will pay all principal at the end of the loan (a date you will agree to).

Make up one fictitious loan given the conditions above.

When will your client want to prepay the loan? 

When will your client not want to prepay the loan? 

What is the impact on the value of the loan when market interest rates increase or decrease? 

What is the impact of the value of the loan if the firm becomes more or less risky? 

How might you design the loan so that it is less risky to you (i.e. more risky to the borrower).