Question

Suppose a bank makes a loan to a small business so that business can purchase a new machine press. Which of the following are true of that event--that is, of the bank lending to the business? (you can choose multiple answers)

a. The business takes on a liability in the form of the loan agreement (the business' promise to repay the loan)

b. The bank becomes more liquid

c. The bank holds an asset in the form of the checking account opened up for the business.

d. The bank holds an asset in the form of the loan agreement (the business' promise to repay the loan)

e. The business becomes more liquid

Answer 1

Answer :

The correct options are :

Option d) The bank holds an asset in the form of the loan agreement (the business' promise to repay the loan)

What happens when the bank lends to a small business is that it creates an asset since now the business is liable to pay the money back to the bank as per the given loan agreement and the set terms of lending (say the interest rate and the period of loan). So the bank is expecting cash inflows from the business in due time which is an asset basically.

Option e) The business becomes more liquid

Although when the business takes money from the bank in the form of a loan it basically gets a liability to pay back to the bank but the amount that the bank grants as a loan to the business is a cash inflow for the business in the present and thereby this money provides extra liquidity to the business in order to carry out its day to day business activities say the buying of a new machine press for which they took a loan in the first place.