Mike deposited $100,000 in a bank and procured a certificate of deposit on it, payable to himself, for repayment in five years with a five percent interest rate. A year after that, Mike borrowed $25,000 from Jill, and gave her a promissory note to repay it in one year. As collateral, Mike gave Jill the certificate of deposit and asked to put in a prepayment clause, to which Jill agreed. They agreed that Mike could repay in monthly payments, as mentioned in the note. In which of the following ways will the prepayment clause help Jill?
A) It helps Jill to shorten the repayment period when she wishes.
B) It helps Jill acquire the whole amount in one payment in case Mike defaults.
C) It allows Mike to repay earlier than the stipulated time.
D) It obligates Mike to pay interest on the money he defaults.

Question

Quizplus · Accepted Answer

The prepayment clause allows Mike to repay earlier than the stipulated time, which means he can repay the loan before the one-year term, reducing Jill's risk of default. As a result, Jill has a better chance of getting her money back sooner and collecting any interest owed on the loan. Option A is incorrect because there is no reference to Jill having the ability to shorten the repayment period. Option B is incorrect because the prepayment clause would only help Jill receive payment faster if Mike does not default on the loan. Option D is incorrect because the prepayment clause does not obligate Mike to pay interest on any defaulted amount.

Mike Deposited $100,000 in a Bank and Procured a Certificate