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Chapter 21: Q. 12 (page 484)

Explain how the following events would likely affect the relevant interest rate.

a. A major bond-rating agency has improved the risk rating of a developing nation.

b. The government has passed legislation requiring bank regulators to significantly increase the paperwork required when a bank makes a loan.

Short Answer

Expert verified

a. if a major bond rating agency has reduced the risk rating, then the interest rate would be lower.

b. Thus, the hassle would lead to higher rate of interest rate.

Step by step solution

01

Introduction (Part A)

The interest rate is the amount that is applied to the principle and represents the borrower's cost of debt.

02

Explanation (Part A)

There is an inverse relationship between risk and return. The riskier the investment, the higher the interest rate, and vice versa.

When a major bond-rating agency improves a developing country's risk rating, the agency is attempting to lower the risk rating of the country.

As a result, if a major bond rating agency lowers the risk rating, the interest rate will be lowered.

03

Introduction (Part B)

When a bank issues a loan, the amount of paperwork is necessary.

04

Explanation (Part B)

When a bank issues a loan, the amount of paperwork necessary increases dramatically. This will complicate lending because banks will now require more paperwork and time to issue a loan.

As a result of the inconvenience, the interest rate would rise.

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