Read the following and answer the questions:
Megha has taken a loan of Rs 5 lakhs from a bank to purchase a house. The bank asked her to submit employment records and salary documents before approving the loan. The annual interest rate is 12 per cent and the loan must be repaid in monthly instalments over 10 years. The bank retained the papers of the new house as security and will return them only after the entire loan with interest is repaid.
(i) What is the term used for the house papers that the bank has retained as security? (1 mark)
(ii) Identify any two components of the 'terms of credit' evident in this loan arrangement. (1 mark)
(iii) Why do banks insist on such documentation and security before granting loans? What risk does this help the bank manage? (2 marks)
Generated by claude-sonnet-4-6 · 2026-06-26 13:24 · grounding rag
Model Answer
(i) The term used for the house papers retained by the bank as security is collateral.
(ii) Two components of terms of credit evident in this arrangement:
- Interest rate — 12% per annum
- Mode of repayment — monthly instalments over 10 years
(Documentation requirement / collateral are also valid components.)
(iii) Banks insist on documentation (employment records, salary slips) and collateral (house papers) to ensure that the borrower has a stable income and the ability to repay the loan. Collateral serves as a guarantee — if the borrower fails to repay, the bank has the right to sell the asset to recover its money. This helps the bank manage the risk of default (non-repayment of the loan).
Source: Chapter 3 — Money and Credit, Terms of Credit / A House Loan
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Explanation
- Q(i) is a direct 1-mark definition recall — "collateral" is the exact textbook term; writing "security" alone may lose the mark.
- Q(ii) needs only two named components from the four listed in the textbook (interest rate, collateral, documentation, mode of repayment). Pick any two clearly identified in the passage.
- Q(iii) carries 2 marks — examiners look for two distinct points: (a) purpose of documentation/collateral = ensure repayment capacity; (b) specific risk managed = risk of default/non-repayment. Both must appear for full marks.