Tina Which of the following best explains why a firm that needs to borrow money

Question

Tina Which of the following best explains why a firm that needs to borrow money would borrow at long-term rates when short-terms rates are lower than long-term rates? The use of short-term financing over long-term financing for a long-term project will increase the risk of the firm. The firm's interest payments will be the same whether it uses short-term or long-term financing, so it is essentially indifferent to which type of financing it uses. A firm will only borrow at short-term rates when the yield curve is downward-sloping. 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.

Explanation / Answer

1) the correct option is The use of short-term financing over long-term financing for a long-term project will increase the risk of the firm

this is due the fact that if short term financing is used for long term projects , the firm will need to refinance the project during the term of the project , which will be more costly for the firm since the market conditions and interest rates could change unfavourably , which will be more costly than the long term rate

2)

a) when a company uses debt to buy another company, the yields will Increase and it will me More expensive to borrow money from bond market , since a high level of debt usually raises the risk of the transaction

b) when the credit rating is lowered , the firm is perceived to be more risky and hence the yield will Increase and it will me More expensive to borrow money from bond market

c) when perceived marketability increases , the yield will decrease and it will be less expensive to borrow money from bond market since the marketability reduces the riskiness of the firm

d) when a company's financial health improves, the yield will decrease and it will be less expensive to borrow money from bond market since the financial soundness of firm sends positive signal to the market and reduces the perceived riskiness of the firm

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