Final answer:
Money listed under assets on a bank's balance sheet may not physically be present due to the fractional reserve system. The value of loans in the secondary market can be determined by the borrower's payment history and economic interest rates. A firm's bank loan operates with the expectation to repay the principal with interest, else risking liquidation of its assets to settle debts.
Step-by-step explanation:
The money listed under assets on a bank balance sheet may not actually be in the bank because banks operate on a fractional reserve system. This means that only a fraction of the bank's deposits are kept on hand as liquid cash; the rest is utilized for loans and other investments. When customers deposit money, the bank loans most of this money out to others or invests it, thereby generating income through interest rates or returns on investments.
When buying loans in the secondary market, a financial services company would assess the risk and expected returns of a loan. The valuation of a given loan may fluctuate based on the borrower's payment history and the economic conditions:
- If borrowers have been late on loan payments, the perceived risk increases, so the loan would typically be purchased at a lower value due to the higher risk of default.
- An increase in overall interest rates since the origination of the loan might lower its value because newer loans could be issued at higher, more profitable rates.
- If the borrower is a profitable firm, the loan might command a higher price as the risk of default is perceived to be lower.
- Conversely, if overall interest rates have fallen since the bank made the loan, the existing loan's rate becomes comparatively more attractive, potentially increasing the loan's value.
A bank loan for a firm is similar to personal loans for large purchases such as cars or houses. The firm pledges to repay the borrowed amount plus interest over a set period. Failure to make payments can result in legal action, requiring the firm to liquidate assets like buildings or equipment to fulfill its debt obligations.
To calculate a firm's accounting profit, we subtract the total costs from the sales revenue. In the given example, if a firm had sales revenue of $1 million and incurred costs amounting to $950,000 ($600,000 for labor, $150,000 for capital, and $200,000 for materials), the accounting profit would be $50,000.