Question: Five weeks ago, RJK Corporation borrowed from the commercial finance company that employs you as a loan officer. At that time, the decision was made (at your personal urging) to base the loan rate on below-prime market pricing, using the average weekly Federal funds interest rate as the money market borrowing cost. The loan was quoted to RJK at the Federal funds rate plus a three-eighths percentage point markup for risk and profit. Today, this five-week loan is due, and RJK is asking for renewal at money market borrowing cost plus one-fourth of a point. You must assess whether the finance company did as well on this account using the Federal funds rate as the index of borrowing cost as it would have done by quoting RJK the prevailing CD rate, the commercial paper rate, the Eurodollar deposit rate, or possibly the prevailing rate on U.S. Treasury bills plus a small margin for risk and profitability. To assess what would have happened (and might happen over the next five weeks if the loan is renewed at a small margin over any of the money market rates listed above), you have assembled these data from a recent issue of the Statistical Supplement to the Federal Reserve Bulletin:
What conclusion do you draw from studying the behavior of these common money market base rates for business loans? Should the RJK loan be renewed as requested, or should the lender press for a different loan pricing arrangement? Please explain your reasoning. If you conclude that a change is needed, how would you explain the necessity for this change to the customer?