Class 20 Bankruptcy, Spring, 2009 Interest Rates Randal C. Picker Leffmann Professor of Commercial Law The Law School The University of Chicago 773.702.0864/[email protected]

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.

April 21, 2023 Copyright © 2005-09 Randal C. Picker 2

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


One-Period Present Value

Formulas

FV PV 1r PV FV

1r


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


Two-Period Present Value

Formulas

FV PV 1r1 1r2 PV

FV1r1 1r2


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


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


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?


N-Period Stream

Formula

PV C

r1

1

1 r N


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


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


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


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


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)


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;


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;


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


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;


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.



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


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?


Choosing

Key Questions What does the Code require? Independent of that, which of these is right? What are the likely consequences of the

choice?

Documents

Class 20 Bankruptcy, Spring, 2009 Interest Rates Randal C. Picker Leffmann Professor of Commercial Law The Law School The University of Chicago 773.702.0864/[email protected]