Question

The cost of issuing a large loan and a small loan are about the same in dollars, but the cost is ______.

Answer 1

The cost of issuing both large and small loans are similar, but inflation causes the cost to be 'worth less' over time, benefiting demanders of financial capital who can pay back with depreciated dollars. Interest rates and borrower riskiness also impact the value of loans and bonds, while firms of different sizes may choose between banks and bonds based on the level of financial monitoring and the amount of capital required.

Step-by-step explanation:

The cost of issuing a large loan and a small loan are about the same in dollars, but the cost is proportionally greater for a small loan due to the fixed costs being spread over a smaller amount. However, due to inflation, the value of the loan decreases over time, making the cost 'worth less' in real terms. Hence, demanders of financial capital tend to benefit, as they repay the loans in dollars that are worth less than when the loan was originally taken out.

Additionally, the value of loans and bonds can also fluctuate based on changes in interest rates. For instance, if interest rates rise, a bond issued at a lower rate becomes less attractive to new investors, which means the bond or loan will be worth less in the market, prompting investors to pay less for it. Conversely, if interest rates fall, existing loans or bonds issued at higher rates become more valuable because they promise relatively higher returns, making them more attractive to buyers who are willing to pay more.

Real-world calculations of a loan's value will take into account not only market interest rates but also the riskiness of the borrower defaulting on the loan. For bonds, this means the price is always the present value of the expected future payments, adjusted for the risk of default. Finally, while banks tend to provide more customized borrowing solutions for smaller firms due to their better ability to monitor the firm's financials, larger, well-known firms often prefer issuing bonds to raise capital.

Answer 2

The cost of large and small loans is similar, but due to inflation, the latter often becomes less valuable over time, benefitting borrowers. Changes in interest rates affect bond prices, with a rise in rates leading to a decrease in bond values, and a fall in rates resulting in an increase. Moreover, the risk associated with the borrower's ability to repay affects bond pricing.

Step-by-step explanation:

The cost of issuing a large loan and a small loan are about the same in dollars, but the cost is worth less because of inflation. This inflationary effect means that lenders of financial capital may lose purchasing power, while demanders of financial capital benefit since they can repay their loans with dollars that have less value than when the loan was taken out. Regarding bond valuation, if interest rates have changed, the price paid for a bond would also change accordingly.

If interest rates have risen, a loan made at prior, lower interest rates becomes less attractive, and you would pay less for it (bond price decreases). Conversely, if interest rates have fallen, loans made before the decrease are now more attractive, and their value increases. Additionally, the riskiness of the borrower repaying the loan affects the price of a bond, with the price being the present value of future expected payments. Large and well-known firms might issue bonds to raise capital, while smaller firms often prefer bank borrowing, which is more customized.