a. Assume that the market's expectations for the economy are similar to those of Carson. Also assume that the yield curve is primarily influenced by interest rate expectations. Would the yield curve be upward sloping or downward sloping? Why?
b. If Carson could obtain more debt financing for 10-year projects, would it prefer to obtain credit at a long-term fixed interest rate, or at a floating rate. Why?
c. If Carson attempts to obtain funds by issuing 10-year bonds, explain what information would help to estimate the yield it would have to pay on 10-year bonds. That is, what are the key factors that would influence the rate it would pay on the 10-year bonds?
d. If Carson attempts to obtain funds by issuing loans with floating interest rates every six months, explain what information would help to estimate the yield it would have to pay over the next ten years. That is, what are the key factors that would influence the rate it would pay over the 10-year period?
e. An upward-sloping yield curve suggests that the initial rate that financial institutions could charge on a long-term loan to Carson would be higher than the initial rate that they could charge on a loan that floats in accordance with short-term interest rates. Does this imply that creditors should prefer to provide a fixed-rate loan rather than a floating-rate loan to Carson? Explain why Carson's expectations of future interest rates are not necessarily the same as those of some financial institutions.
Recall that Carson Company has obtained substantial loans from finance companies and commercial banks. The interest rate on the loans is tied to the six-month Treasury bill rate (and includes a risk premium) and is adjusted every six months. Thus, Carson's cost of obtaining funds is sensitive to interest rate movements. Because of its expectations that the U.S. economy will strengthen, Carson plans to grow in the future by expanding its business and through acquisitions. Carson expects that it will need substantial long-term financing to finance its growth, and plans to borrow additional funds either through loans or by issuing bonds. It is also considering the issuance of stock to raise funds in the next year.