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(Solution document) Charles Jackson, the founder and president of the Jackson Company, is concerned about his firm's image in the financial community.


Charles Jackson, the founder and president of the Jackson Company, is concerned about his firm's image in the financial community. The concern arose when he went to the bank for a one-year loan and was quoted a rate of 12.2%, which was considerably more than the firm had been paying recently. He has asked you, the treasurer, for an analysis that could shed some light on what might be causing the bank to ask for such a high rate.

Your research indicates the following. The economy is stable with a 2% inflation rate that isn't expected to change in the near future. The local banking community consistently considers the pure interest rate to be about 4%. Liquidity risk for companies of Jackson's size and reputation is generally not more than 1%, and maturity risk is virtually zero for one-year loans. In the past Jackson's reputation has warranted a low default risk premium of 2%. The firm's financial condition has been stable for some time. Two months ago Jackson had a major dispute with one of its suppliers. Charles refused to pay for a large shipment due to poor quality. The vendor did not agree and claimed that Jackson was just using the quality issue to avoid paying its bills. (Hint: Suppose the vendor reported the dispute to a credit agency.


What is the default risk (to one decimal place):

 


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