If interest is expected to rise, should a bank issue loans at a fixed rate or...

If interest is expected to rise, should a bank issue loans at a fixed rate or variable rate? Why?

Expert Solution

A variable interest rate loan is a loan at which the rate of interest on the outstanding balance changes as the market interest rate changes.

A fixed interest rate loan is a loan at which the rate of interest remains fixed throughout the loan's entire term, no matter how market interest rates fluctuate.

From the bank's point of view, if interest rate is expected to rise, a bank should issue loans at a variable rate. This is because the customer would have to pay interest at the variable rate which would be higher than the current interest rate, generating more income to the bank.

On contrary, a fixed interest rate would generate the same interest income irrespective of the rise in interest rate.

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