Alex wants to borrow a sum of $1,000,000 to finance the expansion of their business. They had

Fantastic news! We've Found the answer you've been seeking!

Question:

Alex wants to borrow a sum of $1,000,000 to finance the expansion of their business. They had spoken to two banks - Banks A and B about it. Bank A is offering a variable rate loan package with a teaser rate for the first two years of the loan. The loan is expected to be fully repaid in five years. The table below shows the annual loan rates applicable at each year of the loan. Time Rate (%) Year 1 0.25% Year 2 0.50% Year 3 10.00% Year 4 15.00% Year 5 25.00%

The yearly payment of a variable rate loan is calculated as if it is a fixed rate loan on the outstanding loan balance and time remaining on the loan, whenever the variable rate is changed. The variable rate is reset at the beginning of each year. To sweeten the deal, Bank A is offering Alex a special deal, where the first payment of the loan will happen at the end of the second year (but interest on the loan is still accruing). For Bank B, they are offering a fixed rate of 3.5% for a five-years loan.

You can assume all loan repayments are made at the end of each year for both Banks A and B. For both plans offered by the two banks, calculate a) the total amount paid by Alex

b) the total interest paid by Alex

c) Discuss briefly the relative merits of both financing plans. From a financial perspective, which bank is offering a better deal to Alex ?

d) If the prevailing interest rate is 1.2% (for all maturities), evaluate the maximum fixed rate that can be charged by Bank B before both loans become comparable.