Question

Will you be willing to lend RM20,000 directly to your friend who is willing to pay you an annual interest of 5%? Or will you prefer to save that RM20,000 in a bank that pays you an annual interest of 2% and ask your friend to borrow from the bank instead? Explain why or why not.

Answer 1

We will be willing to lend RM20,000 driectly to our friend who is willing to pay us an annual interest of 5%. Our cumulative payment at the end of 1 year would be 20,000 * (1 + 5%) = RM21,000.

If we prefer to save RM20,000 in a bank that pays us an annual interest of 2%, our cumulative payment at the end of 1 year would be 20,000 * (1 + 2%) = RM20,400.

Since, cumulative amount of RM21,000 is higher than RM20,400, we would chose the first option.

However, please note that by lending to our friend, we are taking on the counterparty risk.