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 correct answer is B. A pure discount loan.
Explanation:
A pure discount loan is the simplest form of loan structure. In this type of loan, the borrower receives a lump sum amount from the lender at the beginning, and instead of making periodic interest payments or repaying the principal in installments, the borrower pays back the entire principal plus interest in a single lump sum at the end of the loan term. This structure makes it straightforward, as there are no complex calculations for amortization or the need to manage ongoing payments.
In contrast, the other loan types involve more complexity:
- A. An interest-only loan: In this loan, the borrower pays only the interest for a specific period, typically followed by a lump sum payment of the principal at the end. This structure can lead to financial strain if the borrower has not planned for the large final payment.
- C. An amortized loan: This is a common loan type where the borrower makes regular payments that cover both principal and interest over the loan term. Each payment reduces the principal gradually, which involves more complex calculations to determine how much of each payment goes toward interest and how much reduces the principal.
- D. A partially amortized loan: This type of loan involves making regular payments that cover only part of the principal and interest, with a large final balloon payment due at the end of the term. This setup can also lead to uncertainty and financial planning challenges, as borrowers must prepare for the larger final payment.
In summary, a pure discount loan is the simplest due to its straightforward nature of a single payment at the end, while other types involve more intricate structures and payment strategies.