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IAI Actuarial Core Principles · Business Economics · Impact of the macroeconomic environment on business

A central bank raises its policy interest rate to curb inflation. Which of the following is the most likely immediate effect on a manufacturing firm that finances its working capital through floating-rate bank loans?

A firm with floating-rate loans sees its interest cost rise when the central bank raises rates. With revenue initially unchanged, this squeezes profit margins. The loan repricing is direct and immediate, unlike any hoped-for offsetting changes in sales or inflation.

  1. AIts interest cost rises and its net profit margin is squeezed, other things equalCorrect
  2. BIts interest cost falls because borrowing becomes less attractive
  3. CIts real cost of debt is unaffected because inflation always rises by the same amount
  4. DIts revenue rises because consumers save more
  5. Its fixed costs fall because loan principal is repaid automatically

Explanation

Floating-rate borrowing reprices when the policy rate rises, so interest expense increases and, with revenue unchanged, profit margin falls. The other options either reverse the direction of the cost change or assume offsetting effects that do not follow automatically.

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