Question

Financial Markets & Produc

ABC company limited has funded its operations by bank loans extensively. The interest rate on the loans is tied to the market interest rates and is adjusted every six months. Thus the cost of funds is sensitive to interest rate movements. Because of expectations that Ghanaian economy would strengthen during the next year, the company plans further growth through investments. The company expects that it will need substantial long-term financing to finance its growth and plans to borrow additional funds in the debt market.

a) What can be the company’s expectations about the change in interest rates in the future? Why?

b) How would these expectations affect the company’s cost of borrowing on its existing loans and on future debt?

c) How these expectations would affect the company’s decision when to borrow funds and whether to issue floating-rate or fixed rate debt?

Answer 1

Answer a= When there is economic growth or an increase in GDP, the interest rate in the economy tends to increase, and vice versa. As the company is expecting the economic development in the next year to increase thus there is a likelihood that interest rates will increase in the future. This is because when the GDP grows, people have more money to spend and in order to control inflation, the government decides the higher interest rates

Answer b= As the company's current interest rates are adjusted every 6 months, the cost of borrowing for the present plan is going to be increased and the same scenario can be expected for future debts as in the future interest rates are expected to increase.

Answer c= The company will decide to borrow now if the interest rates are expected to be increased with the fixed-rate debt as it will prevent the increase in the cost of debt which is expected to be high in the future.