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Why does CD's bond rating and cost of debt depend on the amount of money borrowed?

Question:

Why does CD's bond rating and cost of debt depend on the amount of money borrowed?

Source of Finance:

Source of finance is defined as the different options that a firm has to rise funds and finance its operations or develop new projects. A firm should pay attention to the type of source of finance that will use depending on the goal. For a firm there are short or long term and internal or external financing options.

Answer and Explanation:

Firms deal with many types of risks that are result of the type and amount of debt that firms use to finance their operations. These risks are not only faced by firms but also by stockholders. Bond rating is a classifications published by specialized agencies to evaluate the credit worthiness of a bonds issued by entities. This rating is based on different types of criteria which include the ability of a firm to repay the debt. Therefore, if the amount of money borrowed is very high, this can cause a failure of repayment and as a consequence a decreased in the bond rating. This is similar for the cost of debt, since it is related to the risk exposure that investors have at the moment to finance the firm, if there are large amounts of money borrowed by the firm, there is risk of no repayment which increases the cost of debt.


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Sources of Long-Term Financing

from Business 100: Intro to Business

Chapter 23 / Lesson 4
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