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Star 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

Star 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.

(i) Calculate the loans annual gross return, assuming the risk premium on consumer loans is 1.5 per cent (show all workings). (4 marks)

(ii) If the bank increases its compensating balance requirement, how will this affect the loan return? Explain your answer. (4 marks)

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