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Greetings Tutor. I hope you are doing well.
Can you help me with the following questionWhich TWO of the following statements concerning the interest rate risk management method of smoothing are true?
A) The debt portfolio will consist of a mixture of fixed and floating rate debt.
B) Interest payments will still increase if the interest rate rises..
C) Investments with a fixed cash flow will be financed with fixed rate debt.
D) Full benefit will be obtained from a fall in interest rates.
E) The net effect will be an interest payment which is fixed overall.Correct Option are A&B.
Can you explain me why Option B is correct and also why Option E is incorrect.Option B is correct because, under the smoothing method, even if a portion of the debt is at a fixed rate, the variable rate portion will still incur higher interest payments if interest rates rise. Therefore, the overall interest payments will increase due to the variable rate debt.
Option E is incorrect because the smoothing method does not guarantee that the net effect will be a fixed overall interest payment. Since the debt portfolio consists of both fixed and floating rate debt, the total interest payments will vary depending on the performance of the floating rate portion, which can lead to fluctuations in the overall interest payments.
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