Question 7 Suburb Bank has issued a one-year loan commitment of $10,000,000 for an up-front fee of 50 basis points. The back-end fee on the unused portion of the commitment is 20 basis points. The bank requires a compensating balance of 10 percent on demand deposits, has a cost of funds of 7 percent, will charge an interest rate on the loan of 9 percent, and must maintain reserve requirements on demand deposits of 10 percent. The customer is expected to draw down 60 percent of the commitment. (a)What is the expected return on this loan? [4 Marks] (b)What is the expected annual return on the loan if the draw-down on the commitment does not occur until at the end of six months? [5 Marks]

Question 8 Suppose the estimated linear probability model used by an FI to predict business loan applicant default probabilities is PD = 0.03X1+ 0.02X2-0.05X3+ error, where X1is the borrower's debt/equity ratio, X2is the volatility of borrower earnings, and X3is the borrower's profit ratio. For a particular loan applicant, X1= 0.75, X2= 0.24, and X3= 0.17. (a)What is the projected probability of default for the borrower? [3 Marks] (b)What is the projected probability of repayment if the debt/equity ratio is 2.5 and the borrower's profit ratio increases to 0.29? [5 Marks] (c)What inputs are used in the Linear Probability Model and what do they help to explain? [2