Final answer:
For self-constructed assets, if no specific money is borrowed to construct the asset, but other debt is outstanding, the interest that may be capitalized is limited to the incremental borrowing rate or the actual interest cost, whichever is lower. The money listed as assets on a bank balance sheet may not be physically present as it includes loans and investments expected to be received in the future. The price paid for loans in the secondary market varies with borrower's payment history and changes in overall interest rates in the economy since loan origination.
Step-by-step explanation:
For self-constructed assets, when no specific loans are taken out to finance the construction, and the company has other outstanding debt, the capitalization of interest depends on the accounting policies of the specific jurisdiction or accounting standards being applied. Under U.S. Generally Accepted Accounting Principles (GAAP), interest is capitalized as part of the cost of the constructed asset if the construction takes a considerable amount of time to complete and the company incurs actual interest cost during this period. However, only the incremental borrowing rate of the company or the actual interest cost associated with the outstanding debt, whichever is lower, is capitalized. This means that even if no specific borrowings are made for the construction project, the interest on general borrowings may still be applied to the cost of constructing the asset.
In the context of a bank balance sheet, money listed under assets may not actually be in the bank because it can include loans made to customers, which are legally regarded as assets since they represent future inflow of cash, or it might be invested in securities or other banks. The balance sheet reflects the notion that these amounts are expected to be collected or liquidated at some point in the future.
When buying loans in the secondary market, the price paid for a given loan may vary depending on several factors:
- If a borrower has been late on loan payments, a buyer may pay less for this loan as it represents a higher risk of default.
- If interest rates in the economy have risen since the loan was made, a buyer may pay less for the loan because its fixed interest rate may now be lower than the current market rate.
- In the case of a borrower declaring high profits, the loan may be seen as lower risk, potentially leading a buyer to pay more.
- If interest rates have fallen since the loan was made, the loan could be more attractive because it yields a higher interest rate than is currently available on the market, leading a buyer to pay more for it.
When the government increases borrowing, it affects the private investment by possibly increasing interest rates in the financial markets. This concept is illustrated as a shift to the right in the demand curve (from D0 to D1) in financial markets' graphs. In an increased government borrowing scenario, the new equilibrium reflects a higher interest rate and a potentially crowded-out private investment, as resources are being drawn into government debt securities.