$9.$ Interest rates and decisions

Suppose that a firm is facing an upward$-$sloping yield curve and needs to borrow money to invest in production. Does this mean that the firm should consider borrowing only at short$-$term rates?

Yes, using short$-$term financing will give the firm the lowest possible interest rate over the life of the project.

No$,$ an upward$-$sloping yield curve means that the firm will get a lower interest rate if it uses long$-$term financing.

No$,$ the firm needs to take the volatility of short$-$term rates into account.

Credit ratings affect the yields on bonds. Based on the scenario described in the following table, determine whether yields will increase or decrease and whether it will be more expensive or less expensive, as compared to other players in the market, for a company to borrow money from the bond market.

Scenario

Impact on Yield

Cost of Borrowing Money from Bond Markets

XYZ Co$.$s credit rating was downgraded from AA to BBB$.$

A company uses debt to buy another company. Such an event is called a leveraged buyout.

A company$$s financial health improves.

There is an increase in the perceived marketability of a company$$s bonds, so the liquidity premium decreases.