A bank offers a corporate client a choice between borrowing cash at 11% per annum and borrowing gold at 2% per annum. (If gold is borrowed, interest must be repaid in gold. Thus, 100 ounces borrowed today would require 102 ounces to be repaid in 1 year.) The risk-free interest rate is 9.25% per annum, and storage costs are 0.5% per annum. Discuss whether the rate of interest on the gold loan is too high or too low in relation to the rate of interest on the cash loan. The interest rates on the two loans are expressed with annual compounding. The risk-free interest rate and storage costs are expressed with continuous compounding.

The rate of interest on the gold loan is too high in relation to the rate of interest on the cash loan.

Explanation:

Let first assume that the price of gold is $550 and the amount that the corporate client wants to borrow is $550,000.

This implies there is an option for the client to choose between borrowing $550,000 in cash and borrowing 1,000 ounces of gold.

If $550,000 borrowed in cash, the amount that must be repaid can be calculated as follows:

Amount to repaid if borrowed in cash = Amount of cash borrowed * (100% + Interest rate on cash borrowing)^Number of years = $550,000 * (100% + 11%)^1 = $610,500

If the client borrows 1,000 ounces of gold it must repay 1,020 ounces.

The forward price of gold is calculated as follows:

Forward price of gold = Price of gold * e^(Risk-free interest rate - storage costs) = $550 * e^(9.25% + 0.5%) = $606.33

Cost of repayment of gold loan = Forward price of gold * Ounces of gold to repay = $606.33 * 1,020 = $618,457

Since Amount to repaid if borrowed in cash is less than Cost of repayment of gold loan (i.e. $610,500 < $618,457), this implies that the rate of interest on the gold loan is too high in relation to the rate of interest on the cash loan.

1   all nations face the problem of scarcity because there are limited resources and unlimited wants. nations do not have enough factors of production to produce everything that their population wants. entrepreneurial resources initiate businesses to make new goods and services; labor resources produce goods and services.

2 there are four factors of production: natural resources, labor resources, capital resources, and entrepreneurial resources. natural resources are raw materials from nature that are used to produce goods. trees, water, and grains are natural resources. some natural resources, such as wheat and cattle, are renewable

3 wants

things that you do not need to have in order to survive, but would like to have

needs

things that you must have in order to survive

goods

physical products

services

tasks that a business perform for customers

resources

items that people can use to make or obtain what they need or want

determine

to settle or decide by choice of alternatives or possiblities

4 i really dont know

answer; societal marketing;