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How Does the Level of Risk Associated with a Borrower Affect the Inter 1. The Higher the Risk, the Lower the Interest Rate 2. The

Question

How does the level of risk associated with a borrower affect the inter 1. The higher the risk, the lower the interest rate 2. The higher the risk, the higher the interest rate 3. Risk does not affect the interest rate 4. Interest rates are fixed regardless of risk

Solution

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Anika Master ยท Tutor for 5 years

Answer

The correct answer is **2. The higher the risk, the higher the interest rate.**Here's why:Lenders charge interest as compensation for the risk they take in lending money. A higher-risk borrower is more likely to default (fail to repay the loan) than a lower-risk borrower. To compensate for this increased risk of loss, lenders charge higher interest rates. This higher rate is meant to offset the potential losses if the borrower defaults. Conversely, lower-risk borrowers are seen as safer investments and are charged lower interest rates.