A $40,000 One-Year Loan with a 1% Origination Fee and a 7.50

question 29

Essay

A $40,000 one-year loan with a 1% origination fee and a 7.50% interest rate is funded with money on which the bank owes 3%. What is the expected pretax dollar spread on the loan? If the bank needs to net at least 3.5% on the funds lent to make its ROE, how many dollars can the bank spend on credit investigation, loan servicing, etc.? Would the bank be able to spend more if the loan amount was greater? What does this example suggest about credit analysis?

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Definitions:

Pareto Optimal Allocation

An allocation of resources from which it is impossible to reallocate so as to make any one individual better off without making at least one individual worse off.

Utility Function

A mathematical model in economics that represents an individual's preference system, used to rank choices in order of preference.

Apples

In economic terms, apples can serve as an example of a consumer good, whose supply and demand can be analyzed to understand market dynamics.

Bromides

Compounds containing the bromide ion or compounds that act as a sedative; colloquially used to refer to common sayings or platitudes that lack originality.