Question

You are the financial manager of a wholesale company. One of your job responsibilities is to forecast what interest rates are going to look like in the foreseeable future. You are considering borrowing money and will forecast interest rates to determine if you should get a fixed or variable interest rate. You are being told the following : Inflation has been 2% over each of the last 3 years and is not expected to change over the next year. Also, the government has announced major cuts in its spending. Economic growth is expected to be stagnant over the next year. Based on the preceding information, you are asked to evaluate the following:

You can obtain a 1 year loan at a fixed rate of 6% or a floating rate loan that is currently 6% but would be revised every month in accordance with general interest rate movements. Which type of loan is more appropriate based on the information provided?

Answer 1

interest rate increases with inflation. this is so, because to control high inflation interest rate is increased. given that inflation is increasing at a rate of 2% every year. thus, it can be reasonably expected that the interest rate also will increase. hence it is better to borrow a 6% fixed interest loan that a 6% floating rate bond. because, the floating rate bonds ar eadjusted every year according to market movemnts which in case of an inlfationary situation will be an upward adjustment.