Question

Use the five core principles of money and banking to answer the following questions: pleasee thank you

Whydo creditcardissuerschargesuchhigh ratesof interest?

IBM is considering expandingitsoperations.Theexpansionwillrequire$400 millionfor twonewfactorieswhichthecorporationplanstoraisebysellingstockandbonds. Explain the core principles that willcomeintoplayasinvestorsdecidewhetheror nottobuythe stockandthebonds?

If offered the choice of receiving $1,000 today or $1,000 in one year’s time, which option would you choose, and why?

If time has value, why are financial institutions often willing to extend you a 30-year mortgage at a lower annual interest rate than they would charge for a one-year loan?

Answer 1

1. Why do credit card issuers charge such high rates of interest?

Solution: The reason for the seemingly high rates goes beyond corporate profit or greed: It’s about risk to the lender. Generally the more risk you take, the better potential payoff you expect. For banks and other card issuers, credit cards are decidedly risky because lots of people pay late or don’t pay at all. So issuers charge high interest rates to compensate for that risk.

2. IBM is considering expanding its operations. The expansion will require $400 million for two new factories which the corporation plans to raise by selling stock and bonds. Explain the core principles that will come into play as invest or decide whether or not to buy the stock and the bonds?

Solution: Core Principle 4: Markets Determine Prices and Allocate Resources will come into play for the above question. Since IBM wants to expand, the firm can go directly into the financial markets and issue stocks or bonds. The higher the price investors are willing to pay in the market, the more appealing the idea will be, and the more likely it is that the firm will issue securities to raise the capital for the investment.

3. If offered the choice of receiving $1,000 today or $1,000 in one year’s time, which option would you choose, and why?

Solution: Using Core Principle 1: Time Has Value, use option 1, i.e. receiving $1,000 today. By receiving $1,000 today, yo can immediately put the money to use to either purchase something or deposit it into a bank for later use. Regardless of what you do with the mney, waiting to recieve the money a year later involves opportunity cost.

4. If time has value, why are financial institutions often willing to extend you a 30-year mortgage at a lower annual interest rate than they would charge for a one-year loan?

Solution: Using Core Principle 1: Time Has Value: With a mortgage, the house you purchase acts as a collateral for the loan. In the event you default, the bank can sell the house and recoup its funds. The existence of collateral reduces the risk associated with the loan and so redices the compensation the bank requires.