Term loans usually require firms to pay a fluctuating interest rate. For example, the interest rate may be set at “1 percent above prime.” The prime rate sometimes varies by several percentage points within a single year. Suppose that your firm has decided to borrow $40 million for five years. It has three alternatives. It can

(a) Borrow from a bank at the prime rate, currently 10 percent. The proposed loan agreement requires no principal repayments until the loan matures in five years. It can

(b) Issue 26-week commercial paper, currently yielding 9 percent. Since funds are required for five years, the commercial paper will have to be rolled over semiannually. That is, financing the $40 million requirement for five years will require 10 successive commercial paper sales. Or, finally, it can

(c) Borrow from an insurance company at a fixed rate of 11 percent. As in the bank loan, no principal has to be repaid until the end of the five-year period. What factors would you consider in analyzing these alternatives? Under what circumstances would you choose (a)? Under what circumstances would you choose (b) or (c)?