question archive FINANCIAL MARKETS: ANSWER WITH NO PLAGIAR
FINANCIAL MARKETS: ANSWER WITH NO PLAGIAR
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FINANCIAL MARKETS: ANSWER WITH NO PLAGIAR. Question 3 As the treasurer of a manufacturing company, your task is to forecast the direction of interest rates. Your company plans to borrow funds and it may use the forecast of interest rates to determine whether it should obtain a loan with a fixed interest rate or a floating interest rate. The following information can be considered when assessing the future direction of interest rates; . Economic growth has been high over the last two years, but you expect that it will be stagnant over the next year. . Inflation has been 3 percent over each of the last few years, and you expect that it will be about the same over the next year. . The federal government has announced major cuts in its spending, which should have a major impact on the budget deficit. . The Federal Reserve is not expected to affect the existing supply of loanable funds over the next year. . The overall level of savings by households is not expected to change. Questions: 1) Given the preceding information, assess how the demand for and the supply of loanable funds would be affected (if at all), and predict the future direction of interest rates, 2) Your company can obtain a one-year loan at a fixed-rate of 6 percent or a floating-rate loan that is currently at 8 percent but its interest rate would be revised every month in accordance with general interest rate movements. Which type of loan is more appropriate based on the information provided?
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1. The supply of loanable funds will not change over the next year whereas the demand for loanable funds will rise over the next year.
Future interest rates are expected to rise.
2. A loan with a fixed rate of 8% interest will be recommended in this case.
Step-by-step explanation
1. The supply of loanable funds will not change over the cause of next year since the Federal reserve is not expected to change the supply of loanable funds over next year.
The demand for loanable funds will increase because citizens will try to borrow as much as they can so as to continue with their normal consumption pattern without affecting savings while also trying to correct the current budget deficit following the cuts on government expenditure
To correct the budget deficits, demand for loanable funds will increase, which will be greater than the supply of loanable funds that is not expected to be changed by the Federal reserve. This disequilibrium in the financial market will be corrected by raising interest rates so as to use back interest paid on a loan to finance other loans.
2. A loan with a fixed rate of interest is the wise choice in our scenario since we expect that interest rates will continue to rise over the whole of next year, so as to accommodate the increase in the demand for loanable funds.
