Habine Inc produced stationary for 75 years. However, due to lifestyle changes fewer people are using fancy stationary to write letters. This has resulted in declining revenues and therefore, the company has a need for a short term loan to help them while they reformulate their business model. The company has loyal customers but its lender have become somewhat concerned about the company's financial situation. Recently, the owner went to the lender and was quoted a rate of 12% for a one year loan - this rate is higher than previous loan rates.
The owner wants your help to figure out what might be causing this problem. He tells you inflation is stable at 3%, and the pure interest rate is 4%. Liquidity risk for companies of this size and long standing reputation is 1% and for a 1 year loan maturity risk is zero. In the past the company has had a default risk premium of 2%. Using the interest rate model determine what the reason is for the high rate quote on the loan. Solve and write a sentence which would explain the reason.