Instruction 8.1: For the Following Problem(s), Consider These Debt Strategies Being Considered

question 17

Multiple Choice

Instruction 8.1:
For the following problem(s) , consider these debt strategies being considered by a corporate borrower. Each is intended to provide $1,000,000 in financing for a three-year period.
• Strategy #1: Borrow $1,000,000 for three years at a fixed rate of interest of 7%.
• Strategy #2: Borrow $1,000,000 for three years at a floating rate of LIBOR + 2%, to be reset annually. The current LIBOR rate is 3.50%
• Strategy #3: Borrow $1,000,000 for one year at a fixed rate, and then renew the credit annually. The current one-year rate is 5%.
-Refer to Instruction 8.1. Choosing strategy #2 will:

• A) guarantee the lowest average annual rate over the next three years.
• B) eliminate credit risk but retain repricing risk.
• C) maintain the possibility of lower interest costs, but maximizes the combined credit and repricing risks.
• D) preclude the possibility of sharing in lower interest rates over the three-year period.

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Definitions:

Voidable Contracts

Agreements that may be legally rejected or enforced by one or more parties, often due to elements like misrepresentation or lack of capacity.

Stare Decisis

“Standing by the decision” a principle stating that rulings made in higher courts are binding precedent for lower courts.

Watered Stock

Stock that is issued to individuals below its fair market value.

Fair Market Value

The price a willing buyer would pay a willing seller in a transaction where both parties have reasonable knowledge of the relevant facts and neither is under compulsion to act.