A firm will usually increase the ratio of short-term debt to long-term debt when
A) short-term debt has a lower cost than long-term equity.
B) the term structure is inverted and expected to shift down.
C) the term structure is upward sloping and expected to shift up.
D) the firm is undertaking a large capital budgeting project.

Question

Quizplus · Accepted Answer

When the term structure is inverted (short-term interest rates are higher than long-term rates) and is expected to shift down (meaning that short-term rates are expected to decrease), it makes sense for a firm to increase its ratio of short-term debt to long-term debt. This strategy allows the firm to take advantage of lower borrowing costs in the near future as short-term rates decline.

A Firm Will Usually Increase the Ratio of Short-Term Debt