Two restaurants are on the same block. One has been opened for 10 years and its

Question

Two restaurants are on the same block. One has been opened for 10 years and its a thriving business. The other one has been open for only a year. They both want to expand. When the two owners to to the local bank looking for a loan, which one is likely to get a lower interest rate? Explain in terms of the risk-return principle. The currency of Iceland is called the Krona, in July, 2007 the exchange rate was roughly 60 krona to a dollar. In July 2011, the exchange rate was roughly 120 krona to a dollar. Over this period, would you expect exports from the US to Iceland to get cheaper or more expensive in Iceland? Would you expect living standards in Iceland to rise or fall? Is the krona appreciating or depreciating against the dollar?

Explanation / Answer

1. Bank will charge lower interest rate from the restaurant who has opened for last 10 years because it has certain goodwill and position in the market. Bank has creditworthiness on the existence of the restaurant.

2. a) Exports from the US to Iceland get more expensive in Iceland because now Iceland has to pay more to purchase the same commodity. Initially if Iceland has to pay 60 krona for a purchase of laptop in US then now it has to pay 120 krona for the same laptop.

b) Due to decrease in the value of krona compared to dollar, exports of Iceland increases as compared to imports. So, supply of dollar increases in the Iceland and improves the living standard in Iceland.

c) Krona depreciates against the dollar because of value of krona decreases when compared to dollar.

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