Question 1 (15 marks) A bank has been asked by one of its long-term corporate customer for a 5 years loan of $25 million. This customer usually borrows at Libor 1 year+ 200 basis point, and pays a 0.5% commitment fee for any loan that it takes. It also usually earns $50,000 per year to the bank in the form of various commissions and fees. The current level of interest rates (1 year Libor = 1.5% per annum) would make a 5 years loan have a Macaulay duration of 4.5 years. This customer is in the hotel industry, a sector where the change in risk premium to due credit risk deterioration has a steady been 6% over the last few years, and is not expected to change in the foreseeable future by the credit risk management team of the bank. Due to its good standing, the bank has easy access to Libor funding. However, the bank has a strict credit policy that only allows loan making the internal threshold of 12% per annum risk-adjusted return on capital (RAROC) to be approved. Required a) Would this loan be approved by the bank? (10 marks) b) If the loan is not approved in part (a), what need to be changed for it be approved? Show your working. (5 marks)