class 20 bankruptcy, spring, 2009 interest rates randal c. picker leffmann professor of commercial...
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Class 20Bankruptcy, Spring, 2009
Interest RatesRandal C. PickerLeffmann Professor of Commercial Law
The Law School
The University of Chicago
773.702.0864/[email protected] © 2005-09 Randal C. Picker. All Rights Reserved.
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One-Period Present Value
Numbers 10% interest rate From Today to Tomorrow
$1 today is worth $1.10 one year from now From Tomorrow to Today
$1.10 one year from now is worth $1 today
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One-Period Present Value
Formulas
FV PV 1r PV FV
1r
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Two-Period Present Value
Numbers From Today to Tomorrow to The Period
After Tomorrow $1 today—present value—is worth $1.10
one year from now, is worth 1.21 two years from now
From Two Years from Now to Today A future value of $1.21 two years from now
is worth $1 today
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Two-Period Present Value
Formulas
FV PV 1r1 1r2 PV
FV1r1 1r2
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Two-Period Stream
Question What is $1.10 one year from now + $1.21
two years from now worth today? We have done this already!
$1.10 one year from now is worth $1 today $1.21 two years from now is worth $1 today Together, they are worth $2 today
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Two-Period Stream Again
Question What is $1 one year from now + $1 two
years from now worth today? Answer
$1/1.1 + $1/1.21 = 1.735
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N-Period Stream
Assumptions Stream will pay fixed amount C in every
period One-period interest rate r is same in every
period What is the formula that tells us the present
value of a stream of N periodic payments of C?
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N-Period Stream
Formula
PV C
r1
1
1 r N
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Applying the Formula Do The Numbers in our Prior Example
What is $1 one year from now + $1 two years from now worth today? $1.735
C = 1; N = 2; r = .1 C/r = 10 1.1*1.1 = 1.21 1/1.21 = 0.826 1 – 0.826 = .1735 10 * 0.1735 = 1.735
PV C
r1
1
1 r N
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A Real Example
Buying the Used Truck We start with the PV—the amount of the debt—
and we find C PV = 6,395 + 330.75 – 300 = 6425.75 N = 68 (payments every two weeks for 136 weeks) Interest rate is 21% annually But we need an interest rate for each two-week
period
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A Real Example
Two Tries Just Divide
• r = .21/26 = 0.008077 Compounded 2-Week Rate
• Find r such that the compounded two-week rate results in the annual rate
– (1+r)^26 = 1 + .21 = 1.21– That gives r = .007358494
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A Real Example Resetting
PV = 6425.75 N = 68 r1 = 0.008077 or r2 = .007358494 At r1, C = 123.18, with total interest of 68*C – PV =
1950.61 At r2, C = 120.44, with total interest of 68*C – PV =
1764.29 Note that (1950.61 + 1764.29)/2 = 1857.45 The figure in the case is 1859.49
PV C
r1
1
1 r N
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Till
Core Facts Borrowing in the way just described Default and C13 filing
Debt amount: $4894.89 Collateral Value: $4000 Sec 506(a) bifurcation [but not after 2005]
Plan: Keep truck and meet 1325(a)(5)(B)
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1325
Confirmation of plan (a) Except as provided in subsection (b), the
court shall confirm a plan if-- (1) the plan complies with the provisions of
this chapter and with the other applicable provisions of this title;
(2) [omitted] (3) the plan has been proposed in good faith
and not by any means forbidden by law;
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1325 (cont.)
Confirmation of plan (cont.) (a) (cont.)
(4) the value, as of the effective date of the plan, of property to be distributed under the plan on account of each allowed unsecured claim is not less than the amount that would be paid on such claim if the estate of the debtor were liquidated under chapter 7 of this title on such date;
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Pre-2005 1325(a)(5) Confirmation of plan (cont.)
(a) (cont.) (5) with respect to each allowed secured claim
provided for by the plan--• (A) the holder of such claim has accepted the plan;• (B) (i) the plan provides that the holder of such claim
retain the lien securing such claim; and (ii) the value, as of the effective date of the plan, of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; or
• (C) the debtor surrenders the property securing such claim to such holder;
Post-2005 1325(a) Confirmation of plan (cont.)
(a) (cont.) (5) with respect to each allowed secured claim
provided for by the plan--• (A) the holder of such claim has accepted the plan;• (B) (i) the plan provides that
– (I) the holder of such claim retain the lien securing such claim until the earlier of—
– (aa) the payment of the underlying debt determined under nonbankruptcy law; or
– (bb) discharge under section 1328; and– (II) if the case under this chapter is dismissed or converted without
completion of the plan, such lien shall also be retained by such holder to the extent recognized by applicable nonbankruptcy law; and
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Post-2005 1325(a) • (ii) the value, as of the effective date of the plan,
of property to be distributed under the plan on account of such claim is not less than the allowed amount of such claim; and
• (iii) if—– (I) property to be distributed pursuant to this subsection is in the
form of periodic payments, such payments shall be in equal monthly amounts; and
– (II) the holder of the claim is secured by personal property, the amount of such payments shall not be less than an amount sufficient to provide to the holder of such claim adequate protection during the period of the plan; or
• (C) the debtor surrenders the property securing such claim to such holder;
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Post-2005 1325(a)
Hanging Paragraph For purposes of paragraph (5), section 506 shall not apply
to a claim described in that paragraph if the creditor has a purchase money security interest securing the debt that is the subject of the claim, the debt was incurred within the 910-day preceding the date of the filing of the petition, and the collateral for that debt consists of a motor vehicle (as defined in section 30102 of title 49) acquired for the personal use of the debtor, or if collateral for that debt consists of any other thing of value, if the debt was incurred during the 1-year period preceding that filing.
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What Interest Rate
Consider Five Rates The risk-free rate
Possibly the rate the US gov’t borrows at? The cost of funds rate
The rate that the creditor in question borrows at
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What Interest Rate
The formula rate Start with the prime rate—that is, the rate
that banks offer to their best borrowers—and adjust upwards depending on the risks associated with this borrower
The contract rate The coerced loan rate
What rate would the creditor get on a new loan to a similarly situated debtor?
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Choosing
Key Questions What does the Code require? Independent of that, which of these is right? What are the likely consequences of the
choice?