So far, we’ve
assumed that there is only a single interest rate present in the loanable funds
market. In the real world, of course, there are many
interest rates. There is the mortgage
rate, the prime interest rate (the rate charged to
business firms with strong credit ratings),
the consumer loan rate, and the credit card rate, to
name only a few. Interest rates in the loanable funds market will
differ mainly because of differences in the risks associated with the loans. It is riskier,
for example, to loan money to an unemployed worker than to a well-established business with
substantial assets. Similarly, credit card loans are riskier than loans secured by an asset.
An example of a secured loan is a mortgage loan on a house. If the borrower defaults,
the lender can repossess the house. The risk also increases with the duration of the loan.
The longer the time period, the more likely that the ability of the borrower to repay the
loan or market conditions will change perhaps unfavorably.
The money rate of
interest on a loan has three components. The pure-interest component is the real price one must pay
for earlier availability. The inflationary-premium component reflects the
expectation that the loan will be repaid with dollars of less purchasing power as the result of
inflation. The risk-premium component reflects the probability of default-the risk imposed
on the lender by the possibility that the borrower may be unable to
repay the loan.
loan 
(0 vote)