1. 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/r-picker@uchicago.edu Copyright © 2005-09 Randal C. Picker. All Rights Reserved.

2. October 25, 2015Copyright © 2005-09 Randal C. Picker2 One-Period Present Value n Numbers u 10% interest rate u From Today to Tomorrow w $1 today is worth $1.10 one year from now u From Tomorrow to Today w $1.10 one year from now is worth $1 today

3. October 25, 2015Copyright © 2005-09 Randal C. Picker3 One-Period Present Value n Formulas

4. October 25, 2015Copyright © 2005-09 Randal C. Picker4 Two-Period Present Value n Numbers u From Today to Tomorrow to The Period After Tomorrow w $1 today—present value—is worth $1.10 one year from now, is worth 1.21 two years from now u From Two Years from Now to Today w A future value of $1.21 two years from now is worth $1 today

5. October 25, 2015Copyright © 2005-09 Randal C. Picker5 Two-Period Present Value n Formulas

6. October 25, 2015Copyright © 2005-09 Randal C. Picker6 Two-Period Stream n Question u What is $1.10 one year from now + $1.21 two years from now worth today? n We have done this already! u $1.10 one year from now is worth $1 today u $1.21 two years from now is worth $1 today u Together, they are worth $2 today

7. October 25, 2015Copyright © 2005-09 Randal C. Picker7 Two-Period Stream Again n Question u What is $1 one year from now + $1 two years from now worth today? n Answer u $1/1.1 + $1/1.21 = 1.735

8. October 25, 2015Copyright © 2005-09 Randal C. Picker8 N-Period Stream n Assumptions u Stream will pay fixed amount C in every period u One-period interest rate r is same in every period n What is the formula that tells us the present value of a stream of N periodic payments of C?

9. October 25, 2015Copyright © 2005-09 Randal C. Picker9 N-Period Stream n Formula

10. October 25, 2015Copyright © 2005-09 Randal C. Picker10 Applying the Formula n Do The Numbers in our Prior Example u What is $1 one year from now + $1 two years from now worth today? $1.735 u C = 1; N = 2; r =.1 u C/r = 10 u 1.1*1.1 = 1.21 u 1/1.21 = 0.826 u 1 – 0.826 =.1735 u 10 * 0.1735 = 1.735

11. October 25, 2015Copyright © 2005-09 Randal C. Picker11 A Real Example n Buying the Used Truck u We start with the PV—the amount of the debt— and we find C u PV = 6,395 + 330.75 – 300 = 6425.75 u N = 68 (payments every two weeks for 136 weeks) u Interest rate is 21% annually u But we need an interest rate for each two-week period

12. October 25, 2015Copyright © 2005-09 Randal C. Picker12 A Real Example u Two Tries w Just Divide r =.21/26 = 0.008077 w 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

13. October 25, 2015Copyright © 2005-09 Randal C. Picker13 A Real Example n Resetting u PV = 6425.75 u N = 68 u r1 = 0.008077 or r2 =.007358494 u At r1, C = 123.18, with total interest of 68*C – PV = 1950.61 u At r2, C = 120.44, with total interest of 68*C – PV = 1764.29 u Note that (1950.61 + 1764.29)/2 = 1857.45 u The figure in the case is 1859.49

14. October 25, 2015Copyright © 2005-09 Randal C. Picker14 Till n Core Facts u Borrowing in the way just described u Default and C13 filing w Debt amount: $4894.89 w Collateral Value: $4000 w Sec 506(a) bifurcation [but not after 2005] u Plan: Keep truck and meet 1325(a)(5)(B)

15. October 25, 2015Copyright © 2005-09 Randal C. Picker15 1325 n Confirmation of plan u (a) Except as provided in subsection (b), the court shall confirm a plan if-- w (1) the plan complies with the provisions of this chapter and with the other applicable provisions of this title; w (2) [omitted] w (3) the plan has been proposed in good faith and not by any means forbidden by law;

16. October 25, 2015Copyright © 2005-09 Randal C. Picker16 1325 (cont.) n Confirmation of plan (cont.) u (a) (cont.) w (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;

17. October 25, 2015Copyright © 2005-09 Randal C. Picker17 Pre-2005 1325(a)(5) n Confirmation of plan (cont.) u (a) (cont.) w (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;

18. Post-2005 1325(a) n Confirmation of plan (cont.) u (a) (cont.) w (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 October 25, 2015Copyright © 2005-09 Randal C. Picker18

19. 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; October 25, 2015Copyright © 2005-09 Randal C. Picker19

20. Post-2005 1325(a) n Hanging Paragraph u 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. October 25, 2015Copyright © 2005-09 Randal C. Picker20

21. October 25, 2015Copyright © 2005-09 Randal C. Picker21 What Interest Rate n Consider Five Rates u The risk-free rate w Possibly the rate the US gov’t borrows at? u The cost of funds rate w The rate that the creditor in question borrows at

22. October 25, 2015Copyright © 2005-09 Randal C. Picker22 What Interest Rate u The formula rate w 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 u The contract rate u The coerced loan rate w What rate would the creditor get on a new loan to a similarly situated debtor?

23. October 25, 2015Copyright © 2005-09 Randal C. Picker23 Choosing n Key Questions u What does the Code require? u Independent of that, which of these is right? u What are the likely consequences of the choice?