Which of the following is the simplest form of loan?
A. An interest-only loan B. A pure discount loan C. An amortized loan D. A partially amortized loan
The Correct Answer and Explanation is :
The simplest form of loan among the options provided is B. A pure discount loan.
Explanation
A pure discount loan, also known as a zero-coupon loan, is a type of loan where the borrower receives a lump sum at the beginning but does not make any periodic interest payments. Instead, the loan is repaid in full at maturity, including the interest that has accrued over the term of the loan. The interest is effectively “built into” the loan amount, as the borrower receives less than the face value of the loan upfront. For example, if a borrower takes a pure discount loan of $10,000 that matures in five years, they might receive only $7,500 today, and at the end of the term, they would repay the full $10,000.
This structure is straightforward because it involves a single transaction at the beginning (the loan issuance) and another at the end (the repayment). There are no complex payment schedules or calculations of interest that would require ongoing management.
In contrast, the other types of loans involve more complexity:
- A. An interest-only loan requires the borrower to make periodic interest payments while deferring the repayment of the principal until the end of the term. This structure can lead to a larger payment at maturity.
- C. An amortized loan involves regular payments that cover both principal and interest, resulting in a gradual reduction of the loan balance over time. This necessitates more complex calculations and record-keeping.
- D. A partially amortized loan has characteristics of both amortized and interest-only loans, where some of the principal is paid down during the term, but a larger balloon payment is due at maturity.
In summary, the pure discount loan is the simplest because it has the least complicated structure, requiring only a single payment at the end of the term without intermediate payments or calculations.