A) From the standpoint of the borrower, is long-term or short-term credit riskier? Explain. B)...

Question:

A) From the standpoint of the borrower, is long-term or short-term credit riskier? Explain.

B) Would it ever make sense to borrow on a short term basis if short term rates were above long-term?

Debt Financing:

This question relates to the concept of monetary debt, which is a legally binding agreement between a borrower of funds and a lender. Debt is an important source of financing for corporations and governments and typically has a prominent place within a corporation's capital structure.

Answer and Explanation:

Part A

From the perspective of the borrower, short-term credit is riskier than long-term credit. I say this because short-term interest rates are more volatile than long-term rates. Furthermore, a company with short-term financing could be exposed to higher borrowing costs in a rising rate environment. Conversely, a long-term borrower has some protection against rising rates when locked into longer-term arrangements.

Part B

If short term rates were above long-term, it could make sense to borrow on a short-term basis - if short-term rates were expected to decline. This could be an especially astute financing maneuver during a period of monetary easing. Here, the borrower would have the opportunity to refinance his short-term arrangement at continually lower rates, saving money by not entering into a long-term arrangement.


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Long-Term Debt: Definition, Cost & Formula

from Financial Accounting: Help and Review

Chapter 8 / Lesson 7
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