Instruction 15.1:
For following problem(s), consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
∙ Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
∙ Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%,
to be reset annually. The current LIBOR rate is 3.50%
∙ Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the
credit annually. The current one-year rate is 5%.
-Refer to Instruction 15.1. After the fact, under which set of circumstances would you prefer strategy #1? (Assume your firm is borrowing money.)
A) Your credit rating stayed the same and interest rates went up.
B) Your credit rating stayed the same and interest rates went down.
C) Your credit rating improved and interest rates went down.
D) Not enough information to make a judgment.

Question

Quizplus · Accepted Answer

If interest rates go up, the fixed rate of 7% in Strategy #1 will be more favorable than the floating rate in Strategy #2, as the floating rate would increase as well. Strategy #3 would also not be optimal in this scenario, as the rate would need to be renegotiated each year and could potentially increase if rates rise. Therefore, Strategy #1 would be the preferred choice if interest rates go up.

Instruction 15.1: for Following Problem(s), Consider These Debt Strategies Being Considered by Considered