Association of Chartered Certified Accountants (ACCA) Certification Practice Test

What is a consequence of high inflation for lenders?

1. Increased interest earnings

2. Loss of real income

3. Gained purchasing power

4. Enhanced borrow capacity

The correct answer is: Loss of real income

High inflation has a significant consequence for lenders, specifically in terms of real income. When inflation rises, the purchasing power of money decreases over time. This means that if a lender has issued a loan at a fixed interest rate, the money they will be repaid in the future will have less purchasing power than the money they lent out. Consequently, even if the nominal amount of interest earned seems substantial, the real income – which adjusts for inflation – will be lower. For instance, if a lender issues a $100,000 loan at a fixed rate of 5%, and inflation rises to 10%, the real value of the interest payments received in future years diminishes. The interest payments will not compensate for the loss in purchasing power of the principal amount, leading to a loss of real income. Thus, high inflation erodes lenders' returns, making this consequence particularly impactful for them. In contrast, while increased interest earnings and enhanced borrowing capacity may seem positive, they do not occur in a straightforward manner during high inflation scenarios, as lenders often adjust their interest rates in response to inflation, which can complicate the prospects for real gains. Gained purchasing power would also be a misleading outcome for lenders in an inflationary environment, as the value