Chap 017

CHAPTER 17 CHAPTER 17

LENDING TO BUSINESS FIRMS AND PRICING BUSINESS LOANS LENDING TO BUSINESS FIRMS AND PRICING BUSINESS LOANS

Goal of This Chapter: The purpose of this chapter is to explore h

Goal of This Chapter: The purpose of this chapter is to explore how an!ers can respond to ow an!ers can respond to aa  usiness customer see!ing a loan and to re"eal the factors the# must consider in e"aluating a  usiness customer see!ing a loan and to re"eal the factors the# must consider in e"aluating a  usiness loan re$uest% &n addition' we explore the different met

 usiness loan re$uest% &n addition' we explore the different methods used toda# to price usinesshods used toda# to price usiness loans and to e"aluate the strengths and wea!nesses of these pricing methods for achie"ing a loans and to e"aluate the strengths and wea!nesses of these pricing methods for achie"ing a financial institution(s goals%

financial institution(s goals%

)e# Topics in This Chapter  )e# Topics in This Chapter 

•

• T#pes of Business Loans: *hort Term and Long TermT#pes of Business Loans: *hort Term and Long Term •

• +nal#,ing Business Loan e$uests+nal#,ing Business Loan e$uests •

• Collateral and Contingent Collateral and Contingent LiailitiesLiailities •

• *ources and .ses of Business Funds*ources and .ses of Business Funds •

• Pricing Business LoansPricing Business Loans •

• Customer Profitailit# Customer Profitailit# +nal#sis+nal#sis

Chapter /utline Chapter /utline &&%% &&nnttrroodduuccttiioonn

&&&&%% BBrriieef 0f 0iissttoror# o# of Bf Buussiinneesss Ls Leennddiinngg &&&&&&%% TT##pepes s oof f BBuussiinneesss s LLooaansns

+

+%% **hhoorrtt--TTeerrm m BBuussiinneesss s LLooaannss B

B%% LLoonngg--TTeerrm Bm Buussiinneesss Ls Looaannss &

&%% *h*horort-t-TTeerm rm LoLoanans s to to BuBusisineness ss FiFirmrmss +

+%% *e*ellff--LLii$$uuiiddaattiing ng &&nn""eentntoorr# L# Looaannss B

B%% 22oorr!!iinng g CCaappiittaal l LLooaannss C

C%% &&nntteerriim m CCoonnssttrruuccttiioon n FFiinnaanncciinngg 3

3%% **eeccuurriitt# # 33eeaalleer r FFiinnaanncciinngg 4

4%% eettaaiilleer r aand nd 44$$uuiippmmeent nt FiFinnaanncicinngg F

F%% ++sssseett--BBaasseed Fd Fiinnaanncciinngg G

G%% **##nnddiiccaatteed d LLooaanns s 55**66CCss 

%% LLoonng-g-TTeerrm Lm Loaoanns ts to Bo Buussiinnesess Fs Fiirrmmss +

+%% TTeerrm Bm Buussiinneesss Ls Looaannss B

B%% ee""ooll""iinng g CCrreeddiit t FFiinnaanncciinngg C

C%% LLoonngg--TTeerrm m PPrroo88eecct t LLooaannss 3%

3% LoLoans tans to *upo *upporport tht the +e +c$uc$uisisititioion of /tn of /theher Busr Busininesess Fis Firmrms9s9LeLe"e"eraraged Bged Bu#u#outoutss &

&%% +n+nalal##,i,ing ng BuBusisineness ss LoLoan an ++pppplilicacatitiononss +%

+% oost st CoCommmomon *n *ouourrceces s of of LLoaoan n eepapa##mmenentt B%

B% +n+nalal##sisis of s of a Bua Busisineness ss BoBorrrrowowerer;s ;s FiFinanancnciaial *tl *tatatememenentsts 1%

1% &&mmpoportrtanant Bt Balalanance ce *h*heeeet Ct Comompopossititiion on aattioioss aa%% PPeerrcceennttaagge Ce Coommppoossiittiioon on of +f +sssseettss  %

 % Percentage Composition of ToPercentage Composition of Totaltal Liailities and 6et 2orth

Liailities and 6et 2orth

17-1 17-1

<%

<% &&mmpoportrtanant &t &ncncomome *te *tatatememenent Ct Comompoposisitition on atatiiosos aa%% PPeerrcceennttagage Ce Coommppososiittiioon on of Tf Toottaal &l &nnccoommee &&

&& FinFinancancial ial atatio io +n+nal#al#sis sis of of a Ca Custustomeomer;s r;s FinFinanciancial *al *tattatemeementsnts +%

+% ThThe Be Bususininesess s CuCuststomomerer;s ;s CoContntrorol l o"o"er er 4x4xpepensnseses B%

B% /per/peratiating ng 4ff4fficiicienc#enc#: : easeasure ure of of a Ba Busiusinesness s FirFirm;s m;s PerPerforformanmance ce 4ff4ffectecti"ei"enesnesss C%

C% aar!r!etetaaililitit# o# of tf the he CuCuststomomerer;s ;s PrPrododucuct ot or *r *erer"i"icece 3%

3% CoCo"e"erarage ge atatioios: s: eeasasururining tg the he ++dede$u$uacac# of # of 4a4arnrniningsgs 4%

4% LiLi$u$uiididit# &t# &ndndiicacattorors fos for Bur Busisineness ss CuCussttomomererss F

F%% PPrrooffiittaaiilliitt# &# &nnddiiccaattoorrss G%

G% ThThe Fie Finanancnciaial Lel Le"e"erarage Fage Factctor aor as a Bas a Baroromemeteter of a Br of a Bususininesess Fis Firmrm;s C;s Capiapitatall *tructure

*tructure &&&

&&& CompaComparing ring a Bua Businessiness Cus Customstomer(s er(s PerfoPerformance rmance to tto the Perhe Performformance oance of &f &ts ts &ndust&ndustr#r# +%

+% ContiContingent ngent LiaiLiailitilitieses 1

1%% TT##ppees os of Cf Coonnttiinnggeennt Lt Liiaaiilliittiieess <

<%% 44nn""iirroonnmmeennttaal Ll Liiaaiilliittiieess =

=%% ..nnddeerrffuunnddeed Pd Peennssiioon Ln Liiaaiilliittiieess &>%

&>% PrePreparparing ing *ta*tatemtementents of s of CasCash Flh Flows ows frofrom Bm Busiusinesness Fs Finainancincial al *ta*tatemtemententss +

+%% **ttaatteemmeennt t oof f CCaassh h FFlloowwss B%

B% PrPro Fo Fororma ma *t*tatatememenents ts of of CaCash sh FlFlowows as and nd BaBalalancnce *he *heeeetsts C%

C% ThThe Loae Loan /fn /ffificercer;s ;s esesponponsisiiililit# tt# to tho the Lee Lendinding &nng &nststititututioion and tn and the Che Cusustotomemer r  >

>%% PPrriicciinng g BBuussiinneesss s LLooaannss +%

+% The Cost-Plus The Cost-Plus Loan Pricing Loan Pricing ethodethod B

B%% TThhe e PPrriicce e LLeeaaddeerrsshhiip p ooddeell C

C%% BBeellooww--PPrriimme e aarr!!eet Pt Prriicciinngg 3%

3% CuCuststomomer er PrProfofititaaililitit# # ++nanal#l#sisis s 5C5CPP++ 1%

1% +n +n 4x4xamamplple oe of f ++nnnnualuali,i,ed ed CusCustotomemer Pr Prorofifitataiililit# t# +n+nalal#s#sisis aa%% PPrroolleemm

 %

 % &nterpretation&nterpretation <%

<% 4a4arrniningngs s CrCredediit t ffor or CuCuststomomer er 3e3epoposisittss =%

=% TThe Fhe Fututurure oe of Cf Cususttomomer Per Prrofofiittaaililiit# t# ++nanal#l#sisiss >

>&&%% **uummmmaarr# # oof f tthhe e CChhaapptteer r 

Concept Chec!s Concept Chec!s 17-1%

17-1% 2hat s2hat special pecial proleprolems does ms does usiusiness lness lending pending present resent to the mto the managemanagement of a uent of a usinessinesss lending institution?

lending institution?

2hile usiness loans are usuall# considered among the

2hile usiness loans are usuall# considered among the safest t#pes of lending 5their default rate'safest t#pes of lending 5their default rate' for example' is usuall# well elow default rates on

for example' is usuall# well elow default rates on most other t#pes of loans' these loansmost other t#pes of loans' these loans a"erage much larger in dollar "olume than

a"erage much larger in dollar "olume than other loans and' therefore' can other loans and' therefore' can su8ect an institution tosu8ect an institution to excessi"e ris! of loss and' if a sustantial numer of loans fail' can lead to failure% oreo"er' excessi"e ris! of loss and' if a sustantial numer of loans fail' can lead to failure% oreo"er'  usiness loans are usuall# much more complex financial deals than most other !inds of loans'  usiness loans are usuall# much more complex financial deals than most other !inds of loans'

re$uiring larger numers of personnel with special s!ills and !nowledge% These additional re$uiring larger numers of personnel with special s!ills and !nowledge% These additional resources re$uired an increase in the magnitude

resources re$uired an increase in the magnitude of potential losses unless the usiness loanof potential losses unless the usiness loan  portfolio is managed with great care and s!ill%

 portfolio is managed with great care and s!ill%

17-< 17-<

17-<% 2hat are the essential differences among wor!ing capital loans' open credit lines' asset- ased loans' term loans' re"ol"ing credit lines' interim financing' pro8ect loans' and ac$uisition

loans?

a% 2or!ing capital loans are short-run credits to fund the current assets of a usiness' such as accounts recei"ale' in"entories' or to replenish cash% .suall# a wor!ing capital loan is designed to co"er seasonal pea!s in a usiness customer(s production le"els%

 6ormall#' wor!ing capital loans are secured # accounts recei"ale or # pledges of in"entor# and carr# a floating interest rate on the amounts actuall# orrowed against the appro"ed credit line%

 % /pen credit lines include a credit agreement allowing a usiness to orrow up to a specified maximum amount of credit at an# time until the point in time when the credit line expires%

c% +sset-ased loans are secured on the asis of the shorter-term assets of a firm that are expected to roll o"er into cash in the future% Generall#' the amount and timing of the credit is  ased directl# upon the "alue' condition' and maturit# of certain assets held # a usiness firm

5such as accounts recei"ale or in"entor# and those assets are usuall# pledged as collateral  ehind the loan%

d% Term loans are usiness credit that ha"e an original maturit# of more than one #ear and are normall# used to fund the purchase of new plant and e$uipment or to pro"ide for a permanent increase in wor!ing capital% Term loans usuall# loo! to the flow of future earnings of a usiness firm to amorti,e and retire the credit% Term loans normall# are secured # fixed assets 5e%g%' plant or e$uipment owned # the orrower and ma# carr# either a fixed or a floating interest rate% e% e"ol"ing credit lines are lines of credit that promise the usiness orrower access to an# amount of orrowed funds up to a specified maximum amount@ moreo"er' the customer ma#  orrow' repa#' and orrow again an# numer of times until the credit line reaches its maturit#

date% &t is one of the most flexile of all usiness loans' and is often granted without specific collateral and ma# e short-term or co"er a period as long as fi"e #ears

f% &nterim construction financing in"ol"es an! funding to start construction or to complete construction of a usiness pro8ect in the form of a short-term loan@ once the pro8ect is completed' long-term funding will normall# pa# off and replace the interim financing%

g% Pro8ect loans are asicall# gi"en to support the startup of a new usiness pro8ect' such as the construction of an offshore drilling platform or the installation of a new warehouse or

asseml# line@ often such loans are secured # the propert# or e$uipment that are part of the new  pro8ect%

h% +c$uisition loans are made to finance mergers and ac$uisitions of usinesses% +mong the most noteworth# of these ac$uisition credits are le"eraged u#outs of firms # small groups of in"estors%

17-=% 2hat aspects of a usiness firm;s financial statements do loan officers and credit anal#sts examine carefull#?

+nal#sis of the financial statements of a usiness orrower t#picall# egins when the lender(s credit anal#sis department anal#ses how !e# figures on the orrower(s financial statement ha"e changed 5usuall# during the last three' four' or fi"e #ears% The percentage-composition ratios reflected in such financial statements' control for differences in si,e of firm' permitting the loan officer to compare a particular usiness customer with other firms and with the industr# as a whole% 2ith the help of these ratios' the loan officers and credit anal#sts examine the following aspects of a usiness firm;s financial statements:

a% Control o"er expenses: + usiness firm(s management !eeps a chec! on its $ualit# # anal#,ing how carefull# it controls its expenses and how well its earnings are li!el# to e  protected and grow%

)e# financial ratios to monitor a firm(s expense control program include' cost of goods soldAnet sales@ selling' administrati"e and other expensesAnet sales@ wages and salariesAnet sales@ interest expenses on orrowed fundsAnet sales@ o"erhead expensesAnet sales@ depreciation expensesAnet sales' and taxesAnet sales%

 % /perating efficienc#: &t is also important to loo! at how effecti"el# are assets eing utili,ed to generate sales and how efficientl# are sales con"erted into cash%

The important ratios here are' net salesAtotal assets' annual cost of goods soldAa"erage in"entor# le"els' net salesAnet fixed assets' and net salesAaccounts and notes recei"ale%

c% ar!etailit# of a product or ser"ice: + financial lender can often assess pulic

acceptance of what the usiness customer has to sell # anal#,ing such factors as the growth rate of sales re"enues' changes in the usiness customer(s share of the a"ailale mar!et' and the gross  profit margin 5GP These !e# factors can e found # computing the following ratios:

To measure the gross profit margin the manager has to di"ide the difference of net sales and cost of goods sold with the net sales% +lso' the net profit margin can e found # di"iding net income after taxes to net sales%

d% Co"erage atio: The co"erage ratio measures the ade$uac# of earnings to !now whether the orrower will e ale to pa# ac! the loan%

&mportant measures here include interest co"erage which can e computed # di"iding the income efore interest and taxes # total interest pa#ments' co"erage of interest and principal  pa#ments can e found # di"iding earnings efore interest and taxes # the sum of annual

interest pa#ments and principal repa#ments ad8usted for the tax effect% +lso' the co"erage of all

fixed pa#ments can e found # di"iding income efore interest' taxes and lease pa#ments # the sum of interest pa#ments and lease pa#ments%

e% Profitailit# indicators: The ideal standard of performance in a mar!et-oriented econom# is how much net income remains for the owners of a usiness firm after all expenses are charged against re"enue%

)e# arometers of such financial success include the following ratios Before-tax net incomeAtotal assets' net worth' or total sales' +fter-tax net incomeAtotal assets 5or /+

+fter-tax net incomeAnet worth 5or /4 +fter-tax net incomeAtotal sales 5or /*

f% Li$uidit# indicators: &t reflects the orrower(s li$uidit# position so as to raise cash regularl# and at a reasonale cost% The lender mainl# loo!s at the orrower(s ailit# to meet the loan pa#ments when the# come due%

&mportant ratio measures here usuall# include the current ratio 5current assetsAdi"ided # current liailities' acid-test ratio 5current assets D in"entor#A di"ided # current liailitiesE' net li$uid assets 5current assets D in"entor#  current liailities' and net wor!ing capital 5current assets  current liailities%

g% Le"erage indicators: The term financial le"erage refers to use of det expecting that the  orrower can generate earnings that exceed the cost of det' there# increasing potential returns

to a usiness firm(s owners%

atios indicating trends in this dimension of usiness performance usuall# include the le"erage ratio 5total liailitiesAtotal assets' capitali,ation ratio 5long-term detAtotal long-term liailities and net worth' and the det-to-sales ratio 5total liailitiesAnet sales%

/ne prolem with emplo#ing ratio measures of usiness performance is that the# onl# reflect s#mptoms of a possile prolem ut usuall# don;t tell us the nature of the prolem or its causes% anagement must loo! much more deepl# into the reasons ehind an# apparent trend in a ratio% oreo"er' an# time the "alue of a ratio changes that change could e due to a shift in the

numerator of the ratio' in the denominator' or oth%

17-% 2hat aspect of a usiness firm;s operations is reflected in its ratio of cost of goods sold to net sales? &n its ratio of net sales to total assets? &n its GP ratio? &n its ratio o f income efore interest and taxes to total interest pa#ments? &n its acid-test ratio? &n its ratio of efore-tax net income to net worth? &n its ratio of total liailities to net sales? 2hat are the principal limitations of these ratios?

The ratio of cost of goods sold to net sales is a widel# used indicator of a usiness firm;s expense controls% The ratio of net sales to total assets reflects the operating efficienc# indicating the

efficienc# with which the assets are eing utili,ed to generate sales% The gross profit margin 5GP measure reflects the mar!etailit# of the customer;s products or ser"ices% + firm;s ratio of 

income efore interest expense and taxes to total interest pa#ments indicates how effecti"el# a  usiness is co"ering its interest expenses through the generation of efore-tax income% The

acid-test ratio pro"ides a rough measure of a firm;s li$uidit# position The ratio of efore-tax income to net worth represents a measure of profitailit# of the usiness% Finall#' the ratio of liailities to net sales is an indicator of management;s use of financial le"erage%

These ratios are affected # changes in the numerator or the denominator or oth@ a financial or credit anal#st would want to !now the source of an# change in a ratio;s "alue% These ratios onl# measure prolem s#mptoms@ #ou must dig deeper to find the cause%

17-% 2hat are contingent liailities' and wh# might the# e important in deciding whether to appro"e or disappro"e a usiness loan re$uest?

Contingent liailities are usuall# not shown on customer alance sheets% These liailities can e in "arious forms such as pending or possile future oligations li!e lawsuits against a usiness firm' and warranties or guarantees the firm has gi"en to others regarding the $ualit#' safet#' or  performance of its product or ser"ice% /ther forms of contingent liailities that usiness firms are

li!el# to incur are unfunded pension liailities the firm will owe toward its emplo#ees in the future' taxes owed ut unpaid' or limiting regulations% +nother example is a credit guarantee in which the firm ma# ha"e pledged its assets or credit to ac! up the orrowings of another  usiness' such as a susidiar#% 4n"ironmental damage caused # a usiness orrower has also

recentl# ecome a great cause of concern of contingent liailit# for man# an!s% This is ecause a an! foreclosing on usiness propert# for nonpa#ment of a loan could ecome liale for

cleanup costs' especiall# if the an! ecomes significantl# in"ol"ed with a customer;s usiness or treats foreclosed propert# as an in"estment rather than a repossessed asset that is $uic!l# li$uidated to reco"er the unpaid alance on a loan%

Loan officers must e aware of all contingent liailities ecause an# or all of them could ecome due and pa#ale claims against the usiness orrower' wea!ening the firm;s ailit# to repa# its loan to the an!% 0ence' it ecomes important for the loan officer to as! the customer aout  pending or potential claims against the firm and then follow up with his or her own in"estigation'

chec!ing go"ernment records' pulic notices' and newspapers%

17-H% 2hat is cash-flow anal#sis' and what can it tell us aout a usiness orrower(s financial condition and prospects?

The statement of cash flows shows how cash receipts and disursements are generated # operating' in"esting' and financing acti"ities of a usiness firm% *uch a cash flow statement indicates the changes in a usiness firm;s assets and liailities as well as its flow of net profit and noncash expenses 5such as depreciation o"er a specific time period% &t shows where the firm raised its operating capital during the time period under examination and how it spent or used those funds in ac$uiring assets or pa#ing down liailities% &t also examines all purchases and sales of securities and long-term assets' such as plant and e$uipment in the form of in"esting acti"it#% The financing acti"ities section of the firm will include cash flows from short- and long-term funds pro"ided # lenders and owners' while cash outflows will include the repa#ment of  orrowed funds' di"idends to owners' and the repurchasing of outstanding stoc!%

From the perspecti"e of a loan officer' the cash flow statement indicates whether the firm is rel#ing hea"il# upon orrowed funds or on sales of assets% These are two less desirale funding sources from the point of "iew of lending mone# to a usiness firm as these sources of cash inflow suggest the compan# ma# e exhausting its li$uidit# and capacit# to orrow' casting douts regarding its ailit# to repa# future orrowings% Loan officers usuall# prefer to focus upon the generation of sufficient cash flows to repa# most of its det and remain "iale in the long run%

17-7% 2hat is a pro forma statement of cash flows' and what is its purpose?

+ pro forma statement of cash flows is useful not onl# to loo! at historical data in a statement of cash flows' ut also to estimate the usiness orrower(s future cash flows and financial condition and its ailit# to repa# the loan%

17-I% *hould a loan officer e"er sa# JnoK to a usiness firm re$uesting a loan? Please explain when and where%

+ loan re$uest ma# not appear of ha"ing reasonale prospects for eing repaid in the future% The loan officer can come to this conclusion after noticing the orrowing compan#(s recent record of sales re"enue' expenses' cash flow' and net earnings% Loan officers will ine"ital# e confronted with such loan re$uests that will ha"e to e flatl# re8ected' particularl# in those cases where the  orrower has falsified information or has a credit histor# of continuall# wal!ing awa# from

det oligations%

&n such cases' the loan officer should e as polite as possile' suggesting to the customer what needs to e changed or impro"ed for the future to permit the customer to e seriousl# considered for a loan% The officer can offer to pro"ide noncredit ser"ices' such as cash management ser"ices' ad"ice on a proposed merger' or assistance with a new securit# offering the customer ma# e  planning% +nother possile option is a counteroffer on the proposed loan that is small enough and

secured well enough to ade$uatel# protect the lender% +lso' the loan rate can e shaped in such a wa# that it further protects and compensates the lender for an# ris!s incurred%

17-M% 2hat methods are used to price usiness loans?

The following methods are in use toda# to price usiness loans: a% Cost-plus loan pricing

 % Price leadership pricing model c% Below-prime mar!et pricing

d% Customer profitailit# anal#sis 5CP+

Cost-plus-profit pricing re$uires the an! to add the cost of raising ade$uate funds to lend' the lender(s nonfunds operating costs' compensation for the degree of default ris! inherent in a loan re$uest' and the desired profit margin%

The price-leadership model' on the other hand' ases the loan rate upon a uniform national or international rate 5such as prime or L&B/ posted # ma8or commercial an!s% The prime rate is usuall# considered to e the lowest rate charged to the most creditworth# customers on short-term loans% The actual loan rate charged to an# particular customer is deshort-termined # adding the default-ris! premium and the term-ris! premium as a mar!up o"er the prime rate% Lending

institutions can expand or contract their loan portfolios simpl# # contracting or expanding their loan-rate mar!ups%

The elow-prime mar!et pricing prices a loan on the asis of cost of orrowing in the mone# mar!et plus a small profit margin% Customer profitailit# anal#sis loo!s at all the re"enues and costs in"ol"ed in ser"ing a customer and then the an! is re$uired to calculate the net rate of return from some large corporates co"ering a loan for onl# a few da#s or wee!s%

17-1N% *uppose a an! estimates that the marginal cost of raising loanale funds to ma!e a O1N million loan to one of its corporate customers is  percent' its nonfunds operating costs to

e"aluate and offer this loan are N% percent' the default-ris! premium on the loan is N%=7  percent' a term-ris! premium of N%H< percent is to e added' and the desired profit margin is

N%< percent% 2hat loan rate should e $uoted to this orrower? 0ow much interest will the  orrower pa# in a #ear?

+ccording to the cost-plus loan pricing model: Loan interest rate 

arginal cost of raising loanale funds to lend to the orrower Q

 6onfunds operating costs Q 4stimated margin to compensate for default ris! Q 3esired profit margin

Loan interest rate   percent Q N%N percent Q N%=7 percent Q N%< percent  %1< percent Based on a O1N million loan to e raised' the customer will pa# interest of: O1N'NNN'NNN R %1<  percent  O1<'NN%

17-11% 2hat are the principal strengths and wea!nesses of the different loan-pricing methods in use toda#?

Cost plus pricing is the simplest loan pricing model as it considers the co st of raising loanale funds and the operating costs of running the lending institution% 0owe"er' the model assumes that a lending institution can accuratel# 8udge the costs which often don(t turn out to e accurate% Price leadership o"ercomes the prolems of accuratel# predicting what the costs of a loan will e for a lending institution as ma8or commercial an!s estalish a uniform ase lending fee' the  prime rate' oreo"er' L&B/' which is eing switched o"er from prime rates' offer a common  pricing standard for all an!s' oth foreign and domestic' and gi"e customers a common asis

for comparing the terms on loans offered # different lenders% 0owe"er' it is still difficult to

assign ris! premiums to loans as it would differ among orrowers ased on the ris! that the# carr#%

Below prime mar!et pricing uses L&B/ as the ase rate and includes onl# a small profit margin as part of the loan price% This has een proposed onl# for short term loans for large' well !nown corporations ut is not generall# used for small and medium si,ed companies or longer term loans%

Customer profitailit# anal#sis is similar to cost plus pricing% &t howe"er differs from the same techni$ue as in that it considers the whole customer relationship into account when pricing a loan Customer profitailit# anal#sis has ecome increasingl# sophisticated as computer models ha"e  een designed to help with the anal#sis% /ften the orrowing compan# itself' its susidiar# firms'

ma8or stoc!holders' and top management are all consolidated into one profitailit# anal#sis statement so that the lender recei"es a comprehensi"e picture of the total customer relationship% +utomated CP+ s#stems permit lenders to plug in alternati"e loan and deposit pricing schedules to see which pricing schedule wor!s est for oth customer and lending institution% CP+ can also  e used to identif# the most profitale t#pes of customers and loans and the most successful loan

officers%

17-1<% 2hat is customer profitability analysis? 2hat are its ad"antages for the orrowing customer and the lender?

Customer profitailit# anal#sis is a loan pricing method that ta!es into account the lender(s entire relationship 5all re"enues and expenses associated with a particular customer with the customer when pricing the loan% &t is ased on the difference etween re"enues from loans and other ser"ices pro"ided and expenses from pro"iding loans and other ser"ices to the customer is ta!en o"er net loanale funds% 6et loanale funds are those funds used in excess of the customer(s deposits% &f the calculated net rate of return from a customer(s relationship is positi"e the loan is made and if it is not' the rate is raised or the loan is not made%

+s CP+ ta!es the entire relationship of the orrowing compan# itself' its susidiar# firms' ma8or stoc!holders' and top management into account' it gi"es a etter picture of which customer relationships are profitale to the lender%

Prolems and Pro8ects

17-1% From the descriptions elow please identif# what type of usiness loan is in"ol"ed% a% + temporar# credit supports construction of homes' apartments' office uildings' and

other permanent structures%

 % + loan is made to an automoile dealer to support the shipment of new cars% c% Credit extended on the asis of a usiness(s accounts recei"ale%

d% The term of an in"entor# loan is eing set to match the length of time needed to generate cash to repa# the loan%

e% Credit extended up to one #ear to purchase raw materials and co"er a seasonal need for cash%

f% + securities dealer re$uires credit to add new go"ernment onds to his securities  portfolio%

g% Credit granted for more than a #ear to support purchases of plant and e$uipment% h% + group of in"estors wishes to ta!e o"er a firm using mainl# det financing%

i% + usiness firm recei"es a three-#ear line of credit against which it can orrow' repa#' and orrow again if necessar# during the loan(s term%

 8% Credit extended to support the construction of a toll road%

Based upon the descriptions gi"en in the text the t#pe of usiness loan eing discussed is: a% &nterim construction financing

 % etailer and e$uipment financing c% +sset-ased financing

d% *elf-li$uidating in"entor# loan e% 2or!ing capital loan

f% *ecurit# dealer financing g% Term usiness loan

h% +c$uisition loan or le"eraged u#out i% e"ol"ing credit financing

 8% Long-term pro8ect loan

17-<% +s a new credit trainee for 4"ergreen 6ational Ban!' #ou ha"e een as!ed to e"aluate the financial position of 0amilton *teel Castings' which has as!ed for renewal of and an increase in its six-month credit line% 0amilton now re$uests a O7 million credit line' and #ou must draft #our  first credit opinion for a senior credit anal#st% .nfortunatel#' 0amilton 8ust changed

management' and its financial report for the last six months was not onl# late ut also garled% +s est as #ou can tell' its sales' assets' operating expenses' and liailities for the six-month  period 8ust concluded displa# the following patterns:

Millions of Dollars Januar F!"ruar Mar#$ A%ril Ma Jun!

 6et sales OI%1 O7%= O%< O=%N O=%M O=M%7

Cost of goods sold <7%I <I%1 <7% <H%M <7%= <H%H *elling' administrati"e'

and other expenses 1M%< 1I%M 17%H 1H% 1H%7 1%=

3epreciation =%1 =%N =%N <%M =%N <%I

&nterest cost on

 orrowed funds <%N <%< <%= <%= <% <%7

4xpected tax oligation 1%= 1%N N%7 N%M N%7 N%

Total assets <% <%= <=%I <=%7 <=%< <<%M

Current assets H% H%1 % % %N %I

 6et fixed assets 17%< 17% 17% 17%H 1I%N 1I%N

Current liailities %7 %< %H %M %I H%

Total liailities 1%M 1H%1 1H% 1H% 17%1 17%<

0amilton has a 1H-#ear relationship with the an! and has routinel# recei"ed and paid off a credit line of O million to O million% The department(s senior anal#st tells #ou to prepare

 ecause #ou will e as!ed for #our opinion of this loan re$uest 5though #ou ha"e een led to  elie"e the loan will e appro"ed an#wa#' ecause 0amilton(s president ser"es on 4"ergreen(s  oard of directors%

2hat will #ou recommend if as!ed? &s there an# reason to $uestion the latest data

supplied # this customer? &f this loan re$uest is granted' what do #ou thin! the customer will do with the funds?

The figures gi"en in the case as well as the supporting ac!ground information suggest se"eral de"eloping prolems% 0amilton has had a recent sha!eup in its senior management' which

usuall# leads to loss in control of the firm until the new management gains sufficient experience% +mong the o"ious prolems are decline in sales 5from OI%1 million to O=M%7 million in the  past six months% 0amilton;s cost of goods sold dropped ut # less than the decline in sales'

there# s$uee,ing the firm;s margin and net income% 2e can also note that the firm' proal# faced with declining cash flows' has een forced to rel# more hea"il# on orrowings which will mean that the an!;s position will e less secure% Current assets ha"e also declined while current liailities are on the rise' thus reducing the firm;s net li$uidit# position% The an!;s relationship with 0amilton needs to e re"iewed carefull# with an e#e to gaining additional collateral or reducing the an!;s total credit commitment to the firm%

+dditional information that would e desirale and helpful' if not essential' should include: 1 Past financial statements for the last two or three #ears' preferal# on a monthl# asis% This could help us "erif# seasonalit# and impro"ement%

< &ndustr# outloo! for the next six to eighteen months would also help in reinforcing 0amilton;s ailit# to ser"ice the det from the summer and fall cash flows%

= +dditionall#' information aout the compan#;s suppliers' other creditors' customers' and competitors would e helpful%

 +lso' more information aout other relationships that 0amilton has with 4"ergreen would certainl# e helpful%

&n summar#' the more information we ha"e' the etter our anal#sis and suse$uent decisions will  e%

17-=% From the data gi"en in the following tale' please construct as man# of the financial ratios discussed in this chapter as #ou can and then indicate what dimension of a usiness firm(s

 performance each ratio represents%

Busin!ss Ass!&s Annual R!'!nu! an( E)%!ns! I&!*s

Cash account OHN 6et sales OHNN

+ccounts recei"ale 1 Cost of goods sold 

&n"entories 1<I 2ages and salaries <

Fixed assets <IH &nterest expense <I

iscellaneous assets MH /"erhead expenses <M

7< 3epreciation expenses 1< Lia"ili&i!s an( E+ui& *elling' administrati"e'

and other expenses

<I

*hort-term det: 1NI Before-tax net income H

+ccounts pa#ale 117S Taxes owed 1

 6otes pa#ale =<S +fter-tax net income 

Long-term det 5onds 1

4$uit# capital 1HN

7<

S+nnual principal pa#ments on onds and notes pa#ale total O% The firm(s marginal tax rate is = percent% The financial ratios that could e computed gi"en the data in this prolem are the following: +% 4xpense Control atios:

Cost of goods sold O

  7%17 percent  6et sales OHNN

2ages and salaries OG<

  I%H7 percent  6et sales OHNN

&nterest expense O<I

  %H7 percent  6et sales OHNN

/"erhead expenses O<M

  B%I=percent  6et sales OHNN

3epreciation expenses O1<

  <%NN percent

 6et sales OHNN

*elling' administrati"e' and other expenses expenses O<I

  B%H7 percent

 6et sales OHNN

Taxes owed O1

  N%17 percent  6et sales OHNN

B% /perating 4fficienc#: easure of a Business Firm(s Performance 4ffecti"eness +nnual cost of goods sold O

  =%Ix

+"erage in"entor# O1<I  6et sales OHNN

  <%1Nx  6et fixed assets O<IH

 6et sales OHNN

  N%I=x

Total assets O7<

 6et sales OHNN

  =%I7x

+ccounts and notes recei"ale O1GG

(

)

(

)

+ccounts recei"ale O1

+"erage collection period    M= da#s

OHNN +nnual credit sales

=HN =HN

C% ar!etailit# of the Customer(s Product or *er"ice:  6et sales- Cost of goods sold OHNN -O

GP   <%I=percent

 6et sales OHNN

=

 6et income after taxes OG

 6P:    N%I= percent

 6et sales OHNN

3% Co"erage atios: easuring the +de$uac# of 4arnings &ncome efore interest and taxes O=

&nterest co"erage  1%<1x

&nterest pa#ments O<I

=

Co"erage of interest and principal pa#ments 

&ncome efore interest and taxes O=

   N%11x

Principal repa#ments O

&nterest pa#mentsQ O<I Q

1- Firm;s marginal tax rate 51- = percent 4% Li$uidit# indicators for usiness customers:

Current assets O==

Current ratio   1%<x

Current liailities O<<

Current assets- &n"entor# O=B=-O1<I

+cid-test ratio    N%MH x

Current liailities O<<G

 6et li$uid assets  Current assets - &n"entor#- Current liailities  O==-O1<I -O<<  -O1N million  6et wor!ing capital  Current assets - Current liailities O== -O<<  O11I million

F% Profitailit# indicators for usiness customers:

Before-tax net income OH

  N%I= percent Total assets O7<

+fter-tax net income OG

  N%HM percent Total assets O7<G

Before-tax net income OH

  =%7 percent

 6et worth O1HN

+fter-tax net income OG

  =%1=percent

 6et worth O1HN

G% The Financial le"erage factor: Total liailities OH

Le"erage ratio    77%M percent Total assets O7<

Long-term det O=<

Capitali,ation ratio    H percent

Total long-term liailities and net worth ONN Total liailities OGHG

3et-to-sales ratio    MB%17 percent  6et sales OHNN

17-% Grape Corporation has placed a term loan re$uest with its lender and sumitted the following alance sheet entries for the #ear 8ust concluded and the pro forma alance sheet expected # the end of the current #ear% Construct a pro forma *tatement of Cash Flows for the current #ear using the consecuti"e alance sheets and some additional needed information% The forecast net income for the current #ear is O<1N million with ON million eing paid out in di"idends% The depreciation expense for the #ear will e O1NN million and planned expansions will re$uire the ac$uisition of O=NN million in fixed assets at the end of the current #ear% +s #ou examine the pro forma *tatement of Cash Flows' do #ou detect an# changes that might e of concern either to the lender(s credit anal#st' loan officer' or oth?

Grape Corporation

5all amounts in millions of dollars +ssets at the 4nd of  the ost ecent ear  +ssets Pro8ected for the 4nd of the Current ear  Liailities and 4$uit# at the 4nd of the ost ecent ear  Liailities and 4$uit# Pro8ected for  the 4nd of the Current ear 

Cash O =< O HNN +ccounts pa#ale O M7N O1'NHM

+ccounts recei"ale

1'N1I 1'<1N 6otes pa#ale <'7== <'M=N

&n"entories IM M7= Taxes pa#ale =<7 <1H  6et fixed assets <'7N <'MN Long-term det oligations I7< 1'N7<

/ther assets HH I7 Common stoc! I I

.ndi"ided profits <H= 7=

Total assets O'<N O'I1N Total liailities and e$uit# capital

O'<N O'I1N

The *ources and .ses of Funds *tatement for Grape Corporation would appear as follows: Cas$ Flo,s fro* O%!ra&ions

 6et income O<1N

+dd: depreciation O1NN

Less:

increase in accounts recei"ale 5O1M<

increase in in"entories 5O7M

increase in other assets 5O<1

+dd: increase in accounts pa#ale OMM Less: decrease in tax pa#ale 5O111

 Net cash flow from operations -.

Cas$ Flo,s fro* In'!s&*!n& A#&i'i&i!s

+c$uisition of fixed assets 5O=NN

 Net cash flow from investment activities /-02 Cas$ Flo,s fro* Finan#in3 A#&i'i&i!s

&ncrease in notes pa#ale O1M7

&ncrease in long-term det O<NN

Less: di"idends paid 5ON

 Net Cash Flows from Financing Activities O=7

In#r!as! /D!#r!as!2 in Cas$ -40

There are se"eral areas of possile concern for a an! loan officer "iewing Grape;s pro8ected figures% First' the firm is rel#ing hea"il# upon increasing det of a ll !inds to finance its growth in assets% The increase in notes pa#ale of O1M7 million indicates a growing reliance on an! det supplemented # si,ale increases in supplier-pro"ided credit 5accounts pa#ale and long-term det oligations 5most li!el#' onds with no change in funds pro"ided # issuing stoc!% The  an! could experience a serious wea!ening in the strength of its claim against the firm as other

creditors post a more sustantial claim against assets%

Grape is pro8ecting a si,ale increase in its retained earnings 5undi"ided profits which suggests that management is counting on a #ear of strong earnings% 0owe"er' oth accounts recei"ale

and in"entories 5as well as net fixed assets are growing rapidl#' perhaps reflecting troules in collecting from the firm;s customers and in mar!eting products and ser"ices% The an !;s loan officer would want to explore with the compan# the ases for its pro8ected 8ump in net income and wh# accounts recei"ale and in"entories are expected to rise in such large amounts%

17- Blue Ua# Corporation is a new usiness client for First Commerce 6ational Ban! and has as!ed for a one-#ear' O1N million loan at an annual interest rate of H percent% The compan# plans to !eep a <%7 percent' O= million C3 with the an! for the loan(s duration% The loan officer in charge of the case recommends at least a  percent annual efore-tax rate of return o"er all costs% .sing customer profitailit# anal#sis 5CP+' the loan committee hopes to estimate the following re"enues and expenses which it will pro8ect using the amount of the loan re$uested as a ase for the calculations:

Es&i*a&!( R!'!nu!s Es&i*a&!( E)%!ns!s

&nterest income from loan? &nterest to e paid on customer(s O= million deposit? Loan commitment fee 5N%7V? 4xpected cost of additional funds needed to support

the loan 5V? Cash management fees 5=V? 5on an

annual a"erage of O1 million

Laor costs and other operating expenses associated with monitoring the customer(s loan 5<V?

Cost of processing the loan 51%V? a% *hould this loan e appro"ed on the asis of the suggested terms?

 % 2hat ad8ustments could e made to impro"e this loan(s pro8ected return?

c% 0ow might competition from other prospecti"e lenders impact the ad8ustments #ou ha"e recommended?

Es&i*a&!( r!'!nu!s5

&nterest income from loan O1N'NNN'NNN R H%NNV  OHNN'NNN

Loan commitment fee O1N'NNN'NNN R N%7V  O7'NNN

Cash management fee O1'NNN'NNN R =%NNV  ON'NNN

Total re"enues O1'1<'NNN

Es&i*a&!( !)%!ns!s5

&nterest on deposit O='NNN'NNN R <%7V  OI<'NN

4xpected cost of additional funds O1N'NNN'NNN R %NNV  ONN'NNN Laor costs and other operating costs O1N'NNN'NNN R <%NNV  O<NN'NNN Costs of processing the loan O1N'NNN'NNN R 1%NV  O1N'NNN

Total expenses OI=<'NN

N!& a*oun& of &$! "an6s r!s!r'!s !)%!#&!( &o "! (ra,n

+"erage amount of credit committed to customer O1N'NNN'NNN

Less: +"erage customer deposit alances O='NNN'NNN

 6et amount of loanale reser"es supplied to customer O7'NNN'NNN

Before-tax rate of return o"er costs from the entire lender-customer relationship e"enues expected -Costs expected

 6et amount of all loanale funds supplied customer 

=

O1'1<'NNN-OI=<'NN

  %1I percent%

O7'NNN'NNN

a% es' it should e appro"ed ecause the an! is earning more than its expenses and the net rate of return from the entire lenderDcustomer relationship is positi"e%

 % The fees that are charged could e made higher and the lender could tr# and find a wa# to reduce the expenses on the loan% Both of these would ha"e the effect of increasing the rate of return on the loan%

c% &n particular' it would e difficult to raise fees for this customer if the# can get these same ser"ices from other lenders more cheapl#% &t would not necessaril# cause a direct impact on expenses ut other lenders might alread# e more efficient in pro"iding these ser"ices and the# ma# alread# e charging a lower interest rate on this loan ased on the customer profitailit# anal#sis%

17-H% +s a loan officer for +llium 6ational Ban!' #ou ha"e een responsile for the an!(s relationship with .*F Corporation' a ma8or producer of remote-control de"ices for acti"ating tele"ision sets' 33s' and other audio-"ideo e$uipment% .*F has 8ust filed a re$uest for renewal of its O1N million line of credit' which will co"er approximatel# six months% .*F also regularl# uses se"eral other ser"ices sold # the an!% +ppl#ing customer profitailit# anal#sis 5CP+ and using the most recent #ear as a guide' #ou estimate that the expected re"enues from this

commercial loan customer and the expected costs of ser"ing this customer will consist of the following:

E)%!#&!( R!'!nu!s E)%!#&!( Cos&s

&nterest income from the re$uested loan 5assuming annuali,ed loan rate of V

 9? &nterest paid on customer deposits 5<%NV

 9? Loan commitment fee 51V 1NN'NNN Cost of other funds raised 1IN'NNN 3eposit management fees 'NN +ccount acti"it# costs 'NNN

2ire transfer fees ='NN 2ire transfer costs 1'=NN

Fees for agenc# ser"ices 'NN Loan processing costs 1<'NN

ecord!eeping costs 'NN

The an!(s credit anal#sts ha"e estimated the customer proal# will !eep an a"erage deposit  alance of O<'1<'NNN for the period the line is acti"e% 2hat is the expected net rate of return

from this proposed loan renewal if the customer actuall# draws down the full amount of the re$uested line for six months? 2hat decision should the an! ma!e under the foregoing assumptions? &f #ou decide to turn down this re$uest' under what assumptions regarding re"enues' expenses' and customer deposit alances would #ou e willing to ma!e this loan?

The expected re"enues and costs from continuing the present relationship etween +llium  6ational Ban! and .*F Corporation were gi"en in this prolem and the reader is as!ed to

estimate the expected net rate of return if the an! renews its loan to .*F% The total of expected re"enues and expected costs is:

E)%!#&!( r!'!nu!s E)%!#&!( Cos&s

&nterest re"enue O<NN'NNN 3eposit interest O<H'H= Loan commitment fees 1NN'NNN Cost of other funds raised 1IN'NNN

3eposit ser"ice 'NN 2ire transfer costs 1'=NN

5maintenance fees Loan processing costs 1<'NN

2ire transfer fees ='NN ecord !eeping expenses 'NN

+genc# fees 'NN +ccount acti"it# cost 'NNN

Total expected re"enues O=1<'NN Total expected costs O<<M'7H= N!& a*oun& of &$! "an6s r!s!r'!s !)%!#&!( &o "! (ra,n

+"erage amount of credit committed to customer O1N'NNN'NNN Less: +"erage customer deposit alances O<'1<'NNN  6et amount of loanale reser"es supplied to customer O7'I7'NNN Before-tax rate of return o"er costs from the entire lender-customer relationship

e"enues expected -Costs expected

 6et amount of all loanale funds supplied customer 

=

O=1<'NN-O<<M'7H=

 1%N percent

O7'I7'NNN

The estimated net rate of return is positi"e ut "er# negligile' hence the loan can e accepted  ut after much consideration%

&f we decide to turn down the loan' an initial reaction might e to increase loan re"enues # raising the interest rate on the loan or increasing the loan commitment fee% 3epending on the customer;s relationship with the an! and with other an!s' this ma# pro"e to e extremel# difficult% &nitiall#' it was assumed that the customer would draw down the entire line of credit' that is' orrow the full O1N'NNN'NNN% &f the customer were to orrow less than the full amount' the cost of funds raised to support this loan could e reduced' increasing the net re"enue from the loan% elati"e to expenses' it would e more li!el# that some ad8ustment in the expenses

associated with the relationship would e more appropriate% For example' a careful examination of the relationship acti"ities could allow for a re"ision of estimated costs incurred # the an! to manage the "arious aspects of the relationship%

17-7% &n order to help fund a loan re$uest of O1N million for one #ear from one of its est customers' Lone *tar Ban! sold negotiale C3s to its usiness customers in the amount of OH million at a promised annual #ield of <%7 percent and orrowed O million in the Federal funds mar!et from other an!s at toda#(s pre"ailing interest rate of <%IN percent%

Credit in"estigation and record!eeping costs to process this loan application were an estimated O<'NNN% The Credit +nal#sis 3i"ision recommends a minimal 1 percent ris! premium on this loan and a minimal profit margin of one-fourth of a percentage point% The an! prefers using cost-plus loan pricing in these cases% 2hat loan rate should it charge?

Lone *tar Ban! has sold negotiale C3s in the amount of OH million at a #ield of <%7 percent and purchased O million in Federal funds at a rate of <%IN percent% The weighted a"erage cost of   an! funds in this case would e:

2e can find the interest cost of funding a O1N million loan as follows:

*ale of negotiale C3s cost O1H'NNN 5OH'NNN'NNN R <%7 percent to the an!% 2hereas' the funds orrowed from Federal funds cost O11<'NNN 5O'NNN'NNN R <%IN percent%

0ence' the total interest cost of O<77'NNN is to e orne # the an!% /n a O1N million loan' t a"erage annual interest cost is <%77 percent 5O<77'NNN W O1N'NNN'NNN%

The an! incurs a noninterest cost N%< percent 5O<'NNN W O1N'NNN'NNN to process this loan application% The an! considers a ris! premium one percent and a N%< percent minimal profit margin%

Based on the cost-plus loan pricing model: Loan interest rate 

arginal cost of raising loanale funds to lend to the orrower Q

 6onfunds operating costs Q 4stimated margin to compensate for default ris! Q 3esired profit margin

Loan interest rate  <%77 percent Q N%< percent Q 1 percent Q N%< percent  %<7 percent 17-I% an# loans to corporations are $uoted toda# at small ris! premiums and profit margins o"er the London &nteran! /ffered rate 5L&B/% 4nglewood Ban! has a O< million loan re$uest for wor!ing capital to fund accounts recei"ale and in"entor# from one of its largest customers' +P4> 4xports% The an! offers its customer a floating-rate loan for MN da#s with an interest rate e$ual to L&B/ on =N-da# 4urodeposits 5currentl# trading at a rate of  percent  plus a one-$uarter percentage point mar!up o"er L&B/% +P4>' howe"er' wants the loan at a

rate of 1%N1 times L&B/% &f the an! agrees to this loan re$uest' what interest rate will attach to the loan if it is made toda#? 0ow does this compare with the loan rate the an! wanted to charge? 2hat does this customer(s re$uest re"eal aout the orrowing firm(s interest rate forecast for the next MN da#s?

+t toda#(s pre"ailing L&B/ rate the customer;s re$uested loan-rate formula would generate a loan interest rate of 1%N1 R %N percent  %NH percent% 0owe"er' the an! wanted to charge a rate of %N percent Q N%< percent  %< percent%

Loan rates tend to mo"e up and down faster with the customer;s loan-rate formula than with the  an!;s formula% This customer appears to elie"e interest rates will decline in a period of MN da#s

and hence pulls the loan rate lower%

17-M% Fi"e wee!s ago' oin Corporation orrowed from the commercial finance compan# that emplo#s #ou as a loan officer% +t that time' the decision was made 5at #our personal urging to  ase the loan rate on elow-prime mar!et pricing' using the a"erage wee!l# Federal funds

interest rate as the mone# mar!et orrowing cost% The loan was $uoted to oin at the Federal funds rate plus a three-eighths percentage point mar!up for ris! and profit%

Toda#' this fi"e-wee! loan is due' and oin is as!ing for renewal at mone# mar!et  orrowing cost plus one-fourth of a point% ou must assess whether the finance compan# did as

well on this account using the Federal funds rate as the index of orrowing cost as it would ha"e done # $uoting oin the pre"ailing C3 rate' the commercial paper rate' the 4urodollar deposit rate' or possil# the pre"ailing rate on .%*% Treasur# ills plus a small margin for ris! and

 proailit#% To assess what would ha"e happened 5and might happen o"er the next fi"e wee!s if the loan is renewed at a small margin o"er an# of the mone# mar!et rates listed elow' #ou ha"e assemled these data from the Federal eser"e *tatistical elease 01%

2hat conclusion do #ou draw from stud#ing the eha"ior of these common mone# mar!et ase rates for usiness loans? *hould the oin loan e renewed as

8!!6l A'!ra3!s of Mon! Mar6!& Ra&!s o'!r &$! Mos& R!#!n& 4 8!!6s Mon! Mar6!& In&!r!s& Ra&!s 8!!6 1

/1 ,!!6 a3o2

8!!6 9 8!!6 0 8!!6 : 8!!6 4

/4 ,!!6s a3o2

Federal funds 1%MMV <%NV 1%MIV <%NHV <%N<V

Commercial paper  5one-month maturit#

<%1= <%17 <%17 <%<N <%N C3s 5one-month maturit# <%7 <%I <%< <%= <%= 4urodollar deposits 5three-month

maturit#

=%NN =%NN =%NN =%1N <%I

.%*% Treasur# ills

5three-month' secondar# mar!et

1%I 1%I7 1%I <%N 1%IH

re$uested' or should the lender press for a different loan pricing arrangement? Please explain #our reasoning% &f #ou conclude that a change is needed' how would #ou explain the necessit# for  this change to the customer?

oin Corporation was $uoted a loan rate e$ual to the pre"ailing federal funds interest rate plus =AI of a percentage point 5or N%=7 percent% /n comparing the Federal funds rate with the  orrowing cost of $uoting oin the pre"ailing C3 rate' the commercial paper rate' the

4urodollar deposit rate' or possil# the pre"ailing rate on .%*% Treasur# ills plus the margin of N%=7 percent charged for ris! and profitailit#' we find the following trend:

8!!6 1 8!!6 9 8!!6 0 8!!6 : 8!!6 4 Loan granted at Fed rate <%=HNV <%1V <%=V <%=V <%=MV Commercial paper <%NV <%V <%V <%7V <%<V C3s 5one-month maturit# <%IV <%MV <%IMV <%MNV <%INV 4urodollar deposits =%=7V =%=7V =%=7V =%7V =%<<V .* Treasur# <%<1V <%<V <%<<V <%1V <%<=V

oin wants the loan renewed at mone#-mar!et orrowing cost plus N%< percent% &f the ase rate is set at the federal funds rate' the loan rate as re$uested # oin would e:

8!!6 1 8!!6 9 8!!6 0 8!!6 : 8!!6 4

Fed Funds 1%MMV <%NV 1%MIV <%NHV <%N<V

argin N%<V N%<V N%<V N%<V N%<V

Loan ate <%<V <%<MV <%<=V <%=1V <%<7V

&f the interest rates fall o"er the period examined' it ma# result in lower loan re"enues for the  an!% 0ence' the an! would e etter off offering its customers a fixed interest rate o"er the

next fi"e wee!s%

17-1N% 4agle Corporation has posted an a"erage deposit alance this past month of O=<'NNN% Float included in this one-month a"erage alance has een estimated at ON'NNN% e$uired legal reser"es are = percent of net collected funds% 2hat is the amount of net in"estale 5usale funds a"ailale to the an! holding the deposit?

*uppose 4agle(s an! agrees to gi"e the firm credit for an annual interest return of <%<  percent on the net in"estale funds the compan# pro"ides the an!% easured in total dollars'

how much of an earnings credit from the an! will 4agle earn?  6et in"estale 5usale funds for the lender 

Customer a"erage deposit alance +"erage amount of float in the account

-e$uired legal reser"es ehind the depositR 6et amount of collected funds in the acc

(

)

 6et in"estale funds  O=<'NNN D ON'NNN D 5= percent R O<7'NNN  O<HH'7N% +mount of earnings credited to the customer 

+nnual earnings rateR Fraction of the #ear funds are a"ailale from the depositR  6et in"estale 5usale funds

4arnings credit  <%< percent R 1A1< R O<HH'7N ONN%1H%