Question

Suppose you are in charge of the financial department of your company and you have to decide whether to borrow short or long term. Checking the news, you realize that the government is about to engage in a major infrastructure plan in the near future. Predict what will happen to interest rates. Will you advise borrowing short or long term?

Short answer

The corporation should take out a long-term loan.

Step-by-step solution

Introduction

The amount demanded of an asset is directly related to wealth, expected return on asset, and liquidity of the asset, and negatively proportional to expected return on alternative asset, liquidity of the alternative asset, according to the theory of portfolio choice.

Explanation

If the government is planning to embark on a significant infrastructure project, it will need to borrow funds. The government will issue security to meet its requirements, increasing the quantity of security on the market.

Because the supply of the security will be increased, the supply curve of the security will be moved rightward, lowering the price of the security. The interest rate will rise due to a decrease in pricing. As a result, borrowing long term is a better option because interest rates are expected to grow in the future.

As a result, the corporation should take out a long-term loan.