A mining business is seeking a loan of $8 000 000 to finance new exploration activities. Due to fierce competition, the bank expects the following terms and charges: Up-front fee of 0.5 per cent Annual servicing fee of 75 basis points. Maturity of 8 years and a duration of 7.5 years. The cost to finance this lending activity amounts to 11% for the bank. The current market interest rate for loans in this sector is 13%. Assume the bank has estimated the maximum change in the risk premium in the mining sector to be approximately 5 per cent, based on two years of historical data.

Q1. Estimate the risk-adjusted return on capital (RAROC) for the bank.

Q2. Using the RAROC model, explain the banks' decision on the loan approval.

Answer rating: 100% (QA)

1 The RiskAdjusted Return on Capital RAROC is a metric used to measure the profitability of a loan o... View the full answer