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

Question

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? Short-term interest rates are more volatile than long-term interest rates. Firms will always be better off when they borrow using long-term financing even if the yield curve is upward-sloping. A firm will only borrow at short-term rates when the yield curve is upward-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

Scenario 1. Demand for the company bond has increased, because company is considered less risky now. As a result of which Yield is decreased and Cost of borrowing becomes less expensive

Scenario 2. Company has issued more debt, so the company has become more risky now. As a result of which Yield is increased and Cost of borrowing becomes more expensive

Scenario 3. Ratings are downgraded because company is considered more risky now. As a result of which Yield is increased and Cost of borrowing becomes more expensive

Scenario 4. Company’s financial health improved, so the company has become less risky now. As a result of which Yield is decreased and Cost of borrowing becomes less expensive

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