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IAI Actuarial Core Principles · Business Economics · Impact of macroeconomic policies on businesses

A central bank unexpectedly cuts its policy repo rate by 50 basis points. Which of the following is the most direct first-round effect on a firm that borrows from banks on a floating-rate basis linked to the repo rate?

A cut in the repo rate lowers the interest cost of floating-rate bank borrowing, so the firm's interest payments fall and its cash flow after interest improves. The other effects, such as principal reduction or an equal rise in sales, do not follow directly from the rate cut.

  1. AIts interest payments on the floating-rate loan tend to fall, raising its cash flow after interestCorrect
  2. BIts interest payments on the loan tend to rise because bank margins widen automatically
  3. CIts loan principal is reduced by the central bank
  4. DIts fixed costs of production fall in proportion to the rate cut
  5. Its sales revenue rises immediately by the same percentage as the rate cut

Explanation

A floating-rate loan reprices with the benchmark, so a lower repo rate cuts the interest the firm pays and improves cash flow after interest. The other options either reverse the direction or claim effects that are not direct or automatic, such as a principal reduction or an immediate proportional rise in sales.

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