Question

8. 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

Answer 1

Answer: B. No, the firm needs to take the volitility of short term rates into account.

Explanation:

Yield curves are usually upward sloping because long term rates will generally be higher than short term rates to reflect the maturity risk. This does not mean that a company should always borrow short term however because short term rates have a problem in the form of volatility.

Short term rates can fluctuate which means that a borrower will not always get a good rate whereas long term rates are generally more stable. It is therefore imperative that the volatility of short term rates is taken into account when borrowing.