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?
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:
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.
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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from Financial Accounting: Help and ReviewChapter 8 / Lesson 7