Please show work and how you arrived at your conclusion.
The assignment may be submitted as an Excel spreadsheet or an electronic (Word or PDF) document.
A financial institution is planning to give a loan of $5 million to a firm. It expects to charge an up-front fee of 0.20% and a service fee of 5 basis points. The loan has a maturity of 8 years. The cost of funds for the financial institution is 10%.
The FI has estimated a risk premium of 0.15%. The current market interest rates for this type of loan is 10.1%.
The 99th (extreme case) loss rate for borrowers of this type has historically run at 4%.
The dollar proportion of loans of this type that cannot be recaptured on default has historically been 85%.
Using the RAROC model, would you recommend that the FI make this loan? Why?