Instruction 9.1: For the Following Problem(s), Consider These Debt Strategies Being Considered

question 21

Multiple Choice

Instruction 9.1:
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 9.1. Choosing strategy #1 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:

Per Capita Income

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WARP

Weak Axiom of Revealed Preference, a theory in economics that assumes if a consumer prefers product A over B when both are available, then they will not choose B when A is available.

Bundle

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Laspeyres Price Index

A measure of inflation computed by taking the ratio of the total cost of purchasing a specified basket of goods at current prices to the cost of those same goods at base-year prices.