Prior to the financial crisis, some companies issued short-term liabilities (e.g

Question

Prior to the financial crisis, some companies issued short-term liabilities (e.g., commercial paper) to fund investments in long-term assets (e.g., mortgages). They would "roll over" maturing commercial paper by issuing new paper and repaying the maturing issue with the new issue sale proceeds. It was done to profit on the difference between long-term and short-term rates (e.g., if commercial paper yields 4% and the mortgages funded by it yield 6%, the institution makes a 2% spread on the difference between investment returns and the cost of funding). Explain why this is a risky strategy. (Maximum 3 sentences, maximum 100 words.)

Explanation / Answer

This is risky strategy because :

- Mortgages are risky assests and will not always give higher returns.

- if mortgages return falls below the commercial paper return, this stragery will be in a toss

- This will have domino effect because of the roll over.

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