QUESTION 3B. CREDIT RISK AND LOAN PRICING (4 MARKS)

Derby Bank offers consumer loans with a 5 per cent base rate, charges a 0.25 per cent loan origination fee, imposes a 15 per cent compensating balance requirement and must pay a 5.5 per cent reserve requirement to the central bank. The loans typically are repaid at maturity. Calculate the loans annual gross return, assuming the risk premium on consumer loans is 1.5 per cent.

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