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 7.1. The risk of strategy #1 is that interest rates might go down or that your credit rating might improve. What is the risk of strategy #3? (Assume your firm is borrowing money.)
A) Interest rates might go down or your credit rating might improve.
B) Interest rates might go up or your credit rating might improve.
C) Interest rates might go up or your credit rating might get worse.
D) none of the above.

Question

Quizplus · Accepted Answer

The risk of strategy #3 is that interest rates might go up when the loan is renewed annually, or the borrower's credit rating might get worse, leading to higher borrowing costs.

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