Suppose two firms want to borrow money from a bank for a period of one year. Fir

Question

Suppose two firms want to borrow money from a bank for a period of one year. Firm A has excellent credit, whereas Firm B’s credit standing is such that it would pay prime + 3 percent. The current prime rate is 6.57 percent, the 30-year Treasury bond yield is 4.34 percent, the three-month Treasury bill yield is 3.47 percent, and the 10-year Treasury note yield is 4.18 percent. What are the appropriate loan rates for each firm? (Round percentage to 2 decimal places, e.g 52.32%.)

Explanation / Answer

Prime rate = 6.57%

Maturity risk premium = 10year treasury yield - 3month treasury yield = 4.18% - 3.47% = 0.71%

Borrowing rate for firm A = Prime rate + Market risk premium= 6.57% + 0.71% =7.28%

Borrowing rate for firm B= Prime rate + 3% + Market risk premium= 6.57% + 3% + 0.71% = 10.28%

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