Question

A firm will usually increase the ratio of short-term debt to long-term debt when

A. short-term debt has a lower cost than long-term equity.

B. the term structure is inverted and expected to shift down.

C. the term structure is upward sloping and expected to shift up.

D. the firm is undertaking a large capital budgeting project.

Answer 1

A firm is likely to increase short-term debt relative to long-term debt when short-term rates are high but expected to decrease, allowing the firm to refinance at a lower cost in the future.

Step-by-step explanation:

A firm will usually increase the ratio of short-term debt to long-term debt when the term structure of interest rates is inverted and expected to shift down, which is option B. This situation means that short-term borrowing costs are currently higher than long-term borrowing costs but are expected to decrease in the future. Firms might capitalize on this expectation by taking on more short-term debt currently, with the plan to refinance at a lower rate when the rates fall, thus reducing their overall borrowing costs over time.