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.

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18-10-2019
Business

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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.

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NickMagnus NickMagnus · Answer 1 · 2019-10-18T15:51:25+02:00

Answer:

(c) A firm will only borrow at short-term rates when the yield curve is downward-sloping.

Explanation:

"While normal curves point to economic expansion, downward sloping (inverted) curves point to economic recession.

This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates, and it is used to predict changes in economic output and growth. [...]

A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time. An inverted yield curve is one in which the shorter-term yields are higher than the longer-term yields, which can be a sign of an upcoming recession. In a flat or humped yield curve, the shorter- and longer-term yields are very close to each other, which is also a predictor of an economic transition. "

Reference: Chen, James. “Yield Curve.” Investopedia, Investopedia, 9 Oct. 2019