Question

11. Using the notions of ex ante and ex post interest rates, explain how a bank could be expecting a huge return on its investments and end up with very small real returns.

Answer 1

There are two types of interest rates which are mentioned in the question, these are

A. Ex-ante interest rate:- Ex ante interest rate means, the rate before the act (Before giving a loan by the bank). This rate is calculated before the actual inflation rate is known.

B. Ex- post interest rate:- Ex post interest rate means, the rate after the act (after giving the loan by the bank). or the realized act we can say. when the loan is repaid and the inflation rate for the loan periods is known, we can calculate the actual return, which means ex-post return or interest rate.

Explanation:

Banks play an important role in the economy. They are the creators of money and the controller of the money supply as well. Banks give loans to the business and individual firms to undertake production in the economy. The banks are earning huge interest on loans they lend to the business and individuals. The banks play an important role in the investment process, the investment as we know means the excess of production overconsumption. The banks have to keep in view the returns from the investment they are undertaking, the banks have to keep in consideration the effects of inflation and interest rates as well. The interest rates both ex-ante and ex-post before undertaking any investment.

The banks often think huge returns on their investment but at the last, they are ending up with the minimum returns from the investment they once made. The banks undertake the risks but at the same time more the risks more the return. But at the same time, there is no guarantee that investment yields a high return. It is obvious that to have an additional investment will benefit in the long run. Some investments are risky as well, such as those sold on exempt markets are highly speculative and very risky.