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okmarks People Window Help xy Aplia: Student Question > //courses.aplia.com/af/servlet/quiz?quiz_action-takeQuiz&quiz; probGuid-QNAPCOA8010100000041ca26100c000 Attempts: 9. Interest rates and decisions Suppose that a firm is facing an upward-sloping yield curve and needs to borrow money to invest in production. Does Keep the Highest:/9 this mean that the firm should consider borrowing only at short-term rates? O No, an upward-sloping yield curve means that the firm will get a lower interest rate if it uses long-term financing O No, the firm needs to take the volatility of short-term rates into account O Yes, using short-term financing will give the firm the lowest possible interest rate over the life of the project. Credit ratings affect the yields on bonds. Based on the scenario described in the following table, determine whether yields will increase or decrease and whether it will be more expensive or less expensive, as compared to other players in the market, for a company to borrow money from the bond market. Cost of Borrowing Money from Bond Markets Scenario Impact on Yield A company's credit rating was upgraded from AA to [ y A car manufacturing company loses 40% of its market share and has a declining investment in new product development. A company's interest coverage ratio improves. A start-up company is struggling with finances for its projects ave&Continue;

Explanation / Answer

Multiple Choice Question - Answer is Option 3.

Upward sloping yield curve means the long term interest rates are higher than short term interest rates. Long term bonds/debt if raised would need to pay back interest at higher yields. This means long term financing would be more expensive than the short term debt. Hence, company should go for short term debt when there is an upward sloping yield curve.

Scenarios:

We will understand this a basic concept - when the quality of bond declines, its demand decreases. A decrease in demand (by basics of economics) means lower price. Price has an inverse relationship with yield, which would mean higher yield. Higher yield would mean higher cost of financing

1. Credit rating downgraded - Quality decline - demand falls - Price falls - Yield increases - Cost of borrowing money from bond markets is more expensive

2. Company's market share is on decline and the investment capacity of company is also declining - Quality declines - demand drops - Price decreases - Yield Increases - Cost of borrowing money from bond markets is more expensive

3. Improvement in company's financial health - So demand for bond increases and hence it price increases - yield decreases - cost of borrowing money from bond markets is less expensive

4. Start up company struggling with finances - deterioration of financial health - This is generally seen as very risky - higher risk demands higher returns - hence the yield increases - cost of borrowing money from bond markets is more expensive.

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