Finance chapter answers
MenuItem 10: (Topic 10) Medium- to long-term debt
Question 1: Manufacturer Limited is seeking a five-year term loan from its bank. The bank manager has indicated that a loan can be provided and will be priced at the bank’s base rate, plus a margin.
Which of the following is not a determinant of the margin to be paid by the company?
A: the debt to equity ratio of the borrower
B: the borrower’s past loan-repayment performance
C*: the term structure of interest rates
D: the assets available to be pledged as security
Feedback: The margin added to the bank’s base rate will reflect the credit risk of the individual borrower. In assessing the risk and hence the margin, the bank is likely to consider factors such as the debt to equity ratio of the borrower and its past loan repayment performance. The term structure of interest rates is a market-wide factor and is likely to influence the base rate, but it should not influence the margin that applies to a borrower, so C is the correct answer.
MORE: Financial Institutions, Instruments and Markets 5/e, pp. 390–391.
The interest rate charged on a term loan will also depend on the following:
• The credit risk of the borrower. This is the perceived creditworthiness of the borrower. A lender will analyse factors such as the total debt-to-equity ratio of the firm, projected cash flows, the financial strength of the borrower, past loan repayment performance, the projected performance of the industry and the economy generally, forecast interest rates, the management of the firm and the life cycle of the firm’s products.
• The term of the loan. Under normal circumstances a long-term loan will attract a higher rate of interest than a short-term loan. However, from time to time it is possible that a long-term loan may attract a lower rate. Ultimately, the cost to the borrower will reflect the cost that the lender encounters in funding the loan. If, for example, the rates on short-term-to-maturity deposits are
Question 1: Manufacturer Limited is seeking a five-year term loan from its bank. The bank manager has indicated that a loan can be provided and will be priced at the bank’s base rate, plus a margin.
Which of the following is not a determinant of the margin to be paid by the company?
A: the debt to equity ratio of the borrower
B: the borrower’s past loan-repayment performance
C*: the term structure of interest rates
D: the assets available to be pledged as security
Feedback: The margin added to the bank’s base rate will reflect the credit risk of the individual borrower. In assessing the risk and hence the margin, the bank is likely to consider factors such as the debt to equity ratio of the borrower and its past loan repayment performance. The term structure of interest rates is a market-wide factor and is likely to influence the base rate, but it should not influence the margin that applies to a borrower, so C is the correct answer.
MORE: Financial Institutions, Instruments and Markets 5/e, pp. 390–391.
The interest rate charged on a term loan will also depend on the following:
• The credit risk of the borrower. This is the perceived creditworthiness of the borrower. A lender will analyse factors such as the total debt-to-equity ratio of the firm, projected cash flows, the financial strength of the borrower, past loan repayment performance, the projected performance of the industry and the economy generally, forecast interest rates, the management of the firm and the life cycle of the firm’s products.
• The term of the loan. Under normal circumstances a long-term loan will attract a higher rate of interest than a short-term loan. However, from time to time it is possible that a long-term loan may attract a lower rate. Ultimately, the cost to the borrower will reflect the cost that the lender encounters in funding the loan. If, for example, the rates on short-term-to-maturity deposits are