A bank offers you a choice between a 1-year cash loan at 11% pa, or a 1-year gold loan at 2% pa. For the gold loan, interest and principal repayment have to be made in gold. The risk-free interest rate is 9.25% pa and the storage cost for gold is 0.5% pa.
Compare the risk and borrowing costs associated with the cash and gold loan. Which loan do you prefer? (Hint: Don’t worry about convenience yield)