Definition of Default Premium
A default premium is an additional amount of interest added to a loan's rate to compensate the lender for the risk of the borrower defaulting. It is calculated as the difference between the interest rate charged on a risky loan and the rate that would have been charged if there were no risk of default.
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Introduction to Macroeconomics Course
Ch.6 The financial sector: Debt, money, and financial markets - The Economy 2.0 Macroeconomics @ CORE Econ
The Economy 2.0 Macroeconomics @ CORE Econ
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Interest Rate Variation Among Borrowers
A financial company, 'SecondChance Lenders', specializes in providing loans to individuals who have been previously denied credit by traditional banks. The average interest rate offered by SecondChance is 28%, whereas traditional banks in the same region offer similar loans at an average rate of 7%. From the lender's perspective, which statement provides the most accurate economic reasoning for SecondChance's higher interest rate?
Loan Application Analysis
Lending Strategy Evaluation
Analyzing Interest Rate Differentials
A 'payday' lending company, which provides short-term, high-risk loans, decides to significantly reduce its interest rates for all customers to attract a larger client base. Based on the principles of risk management in lending, this strategy is likely to increase the company's overall profitability because the larger number of borrowers will compensate for the lower revenue from each individual loan. True or False?
Match each borrower profile with the most likely lender rationale for the interest rate they would be offered.
Explaining a Lender's Decision
Critique of a Lending Policy Proposal
A micro-lender is evaluating two potential borrowers.
- Borrower A has a low but consistent income from a long-term job and is seeking a loan for an unexpected medical expense. They have no assets to offer as security.
- Borrower B is an entrepreneur with a well-researched business plan for a new tech startup but no current income. They are seeking a larger loan for initial capital and can offer a personal vehicle as security.
Which of the following statements best analyzes how the lender would likely approach setting the interest rates for these two borrowers, based on the principle of compensating for risk?
Evaluating an Interest Rate Cap Policy
Definition of Default Premium
Learn After
A technology startup and a well-established utility company both apply for a 10-year loan from the same bank on the same day. The bank determines that the startup has a significantly higher chance of failing and being unable to repay its loan compared to the utility company. How would the interest rates offered to the two companies most likely differ?
Analyzing Changes in Default Premium
Calculating and Explaining the Default Premium
A developing country successfully implements major economic reforms, leading international credit rating agencies to upgrade its sovereign debt rating. This upgrade signals a significantly lower risk of the government failing to repay its loans. Based on this information, what is the most likely impact on the additional interest that lenders demand for holding this country's government bonds?
If two different companies have the identical probability of failing to repay their loans, a lender will add the same percentage-point premium to their interest rates to account for this risk, regardless of the overall size of the loans.
Match each borrower profile with the most likely relative size of the default premium a lender would add to their loan's interest rate.
A bank offers a loan to a small business at an annual interest rate of 9%. The current interest rate on a loan considered to have zero risk of non-repayment is 4%. What does the 5% difference between these two rates represent?
Evaluating the Determinants of a Loan's Risk Premium
To compensate for the possibility that a borrower might not repay a loan, a lender adds an extra amount to the interest rate. This additional charge is known as the ____.
Evaluating Interest Rate Appropriateness