What risk premium will a financial institution require on a $25 million loan given the following information:
the financial institution needs an expected return of 6.75% in order to generate the desired profit for its investors;
the expected default rate on loans of this type is 3%;
if the borrower defaults on the loan, the financial institution expects to recover 70% of the total return;
the financial institution’s base rate covers its costs of funds (2.5%) and overhead (2%);
the lender charges an origination fee of 0.375% of the loan amount; and the lender requires the borrower to maintain a compensating balance in an amount equal to 5% of the loan balance in an interest bearing certificate during the full term of the loan.