Question

United Bank issued a 3 years 7% fixed rate loan to a borrower. After 1 year of the issuance government decreased the yield on T-bond by 50 basis point. Will it adversely affect the borrower? If yes, why?

Answer 1

Yes, it will adversely affect the buyer, because this is a 3 year fixed rate loan to the borrower and if the yields on the treasury bills are going to increase, it means that the bond would have been acquired at a cheaper rate by the buyers so if the yields have been decreased by 50 basis points, It will mean that the buyer would have acquired this loan cheaply after one year and the rate of return on his investment would have been higher so so he should be adversely affected as he will be paying higher cost as well as he is also receiving a lower rate of return.

it will also be remembered that the bond yields and bond prices are inversely related so when the bone yields will go down, the bond prices will go high and it is also to be factored that treasury bills would have been a better investment