a) A commercial bank is planning to give a loan of $3,000,000 to a firm. The bank expects to charge an up-front fee of 0.15% and a service fee of 0.04%. The loan has a maturity of 10 years. The cost of funds (and the RAROC benchmark) for the commercial bank is 12%. The commercial bank has estimated the risk premium on the loan to be approximately 0.20%, based on three years of historical data. The current market interest rate for loans in this sector is 12.15%. The 99th (extreme case) loss rate for borrowers of this type has historically run at 4%, and the dollar proportion of loans of this type that cannot be recaptured on default has historically been 85%. The 'bank's
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