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Under Risk-premium Analysis, if the borrower increases its loan amount from 10 million to 100 million,...

Under Risk-premium Analysis, if the borrower increases its loan amount from 10 million to 100 million, the lending outcome is not impacted. Is this statement true or false? If this statement is true, please explain why banks are still using this method. If this statement is false, explain why.  

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Answer #2

The statement is false.

If the borrower increases his loan amount from 10 million to 100 million, the lending outcome is impacted. This is because as per risk premium analysis, the risk for the lender will increase multiple folds if such a huge amount is lent to a borrower. If all other things remain consistent the lender will still expect a higher risk premium. Risk premium is the additional return over and above the risk free rate to compensate for the risk the investor is taking by investing in a risky asset.

so in this case if the risk increases, the risk premium will also increase resulting in the outcome being impacted as a whole.

answered by: anonymous
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