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

question 5

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. After the fact, under which set of circumstances would you prefer strategy #2? (Assume your firm is borrowing money.)

• A) Your credit rating stayed the same and interest rates went up.
• B) Your credit rating stayed the same and interest rates went down.
• C) Your credit rating improved and interest rates went down.
• D) Not enough information to make a judgment.

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Definitions:

Standard Deviation

A measure of the dispersion or variability around the mean of a set of data values, often used in finance to gauge investment risk.

Correlation Coefficient

A numerical measure ranging from -1 to 1 that represents the degree to which two variables are linearly related.

Covariance

Covariance is a measure indicating the extent to which two random variables change in tandem from their expected values.

Standard Deviation

A statistical measure of the dispersion or variability of a set of data points or investment returns, indicating the degree of risk involved.