Final answer:
Under the indirect method, increases in assets related to operating activities are subtracted from net income to derive net cash flows. The value of loans for purchase in the secondary market can fluctuate based on the borrower's payment history and changes in economy-wide interest rates.
Step-by-step explanation:
Under the indirect method of deriving net cash flows from operating activities, increases in assets relating to operating activities must be subtracted from net income. This is because increases in operating assets are reflective of cash that was used in operations, which does not contribute to cash flow. If a company has more accounts receivable, for example, it means that it has made sales for which it has not yet received payment, thereby reducing the company's available cash.
Explaining why money listed under assets on a bank balance sheet may not actually be in the bank, it is important to understand that a bank's assets include loans it has made to customers. Although these loans represent an asset to the bank, the actual cash has been transferred to the borrowers. Moreover, banks operate on a fractional reserve system, which means they are required to keep only a fraction of their deposits on hand at any given time, with the rest being used to make loans or investments.
When considering the purchase of loans in the secondary market, several factors will affect the amount a buyer may be willing to pay. If the borrower has been late on a number of loan payments, the loan is riskier and will be less valuable. Correspondingly, if interest rates have risen since the bank made the loan, the existing loan's lower interest becomes less attractive, decreasing its value. However, if the borrower is a firm that has just declared a high level of profits, the loan is less risky, and its value would increase. Conversely, if interest rates in the economy have fallen since the loan was made, the loan is more valuable as it is locked at a higher interest rate compared to new loans issued at current lower rates.