2. Differentiate between a secured loan and an unsecured loan. Who bears most of the risk...

2. Differentiate between a secured loan and an unsecured loan. Who bears most of the risk in a fixed-rate loan? Why would FI managers prefer to charge floating rates, especially for longer-maturity loans?

Expert Solution

Solution :

Secured loan: Secured loan is a kind of loan which is given after taking something as collateral, and in the condition of the default this collateral can be sold. Example can be a mortgage on house

Unsecured loan: In unsecured loan there is no collateral and loan is given on the basis of goodwill that the borrower will pay in the future. Example can be education loan

Fixed rate loan: In the fixed rate loan the interest rate remains fixed during the period of the loan. In these types of loan the lender bears most of the risk because when interest rate rises in the future he still be charging the lower previous rate.

FI managers prefer to charge the floating rate because future is unpredictable in the long run and interest rate can change in the future by a big margin. If he charge the fixed rate then he will be charging lower and making losses. So they prefer to charge floating rate

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