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sir i am not able to understand the difference between the following two statements from kaplan:
1)when interest rate rise:The price of short-term assets will be bid up, the price of long-term
assets will fall, so the yields on short-term and long-term assets will
consequently fall and rise.
2) when interest rate falls:Expectations that interest rates would fall meant it was cheaper to
borrow long-term (less attractive) than short-term (more attractive).
what i dont understand is that when interest rate are expected to fall, the short term borrowing will become more attractive so that it’s market value will increase which will decrease it’s yield, if yield is decreasing on short term borrowing then short term loan should become cheaper but statement 2 the long term borrowing is becoming cheaper??Statement 1
When interest rates rise, the price of short-term assets tends to increase as investors seek higher returns in the short term.
On the other hand, the price of long-term assets tends to fall as investors anticipate higher interest rates in the future.
As a result, the yields on short-term assets will fall because their prices have been bid up, while the yields on long-term assets will rise because their prices have fallen. This relationship between interest rates, asset prices, and yields is known as the yield curve.Statement 2
When interest rates are expected to fall, short-term borrowing becomes more attractive due to the anticipation of lower interest costs. This increased demand for short-term borrowing can drive up its market value, resulting in a decrease in its yield. As a result, short-term loans may become cheaper.
On the other hand, long-term borrowing may become relatively cheaper compared to short-term borrowing because the interest rates on long-term loans are fixed and do not fluctuate with the expected decrease in interest rates. Therefore, borrowers may find it more advantageous to lock in lower interest rates for a longer duration through long-term borrowing.
But sir the yield is our cost of debt and if if is decreasing…that should be the cheaper option …that is short term borrowing
YES …..
The yield on debt represents the cost of borrowing for the company. It is the return that debt investors require in order to lend money to the company.The yield is influenced by various factors such as market conditions, interest rates, and perceived risk. It is important to note that the cost of debt can vary depending on the specific terms and conditions of the debt instrument.
If the yield, which represents the cost of debt, is decreasing, it indicates that the cost of debt is lower. In this case, short-term borrowing maybe be considered a cheaper option compared to other sources of financing. Short-term borrowing, such as treasury bills, is often perceived as low-risk and can provide a cost-effective solution for companies in need of funds.
then sir suppose the interest are expected to fall, the short term borrowing demand will increase, which will drive up its market value and reduce the yield on short term borrowing,so short term borrowing should be the cheaper option.
however the kaplan study text states long term borrowing will be a cheaper option.
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