From the standpoint of the borrower, is long-term or short-term credit riskier? Explain. Would it ever make sense to borrow on a short-term basis if short-term rates were above long-term rates?

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From the standpoint of the borrower, is long-term or short-term credit riskier? Explain. Would it ever make sense to borrow on a short-term basis if short-term rates were above long-term rates?

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From the standpoint of the borrower, is long-term or short-term credit riskier? Explain. Would it ever make sense to borrow on a short-term basis if short-term rates were above long-term rates?

Explanation & AnswerSolution by a verified expert

Explanation

From the standpoint of the borrower, a short-term loan is riskier than a long-term loan because the interest rate on a long-term basis is stable over time, however, the interest rate on short-term loans keeps on fluctuating because of inflation.
Moreover, on a short-term basis, companies are not able to renew their loan due to the temporary back down in their financials which can also result in bankruptcy.
 
While deciding the basis of the loan; the firms apart from interest rates also takes into consideration other factors such as if firms need money for a shorter period of time or not.
If the firms borrow a loan for a short-term basis then the higher interest rate associated with it would be offset by no prepayment penalty and lower administrative costs.

Verified Answer

From the standpoint of the borrower, the short-term credit is riskier because it is a high-cost loan as the loan is divided into fewer installements. Also, it becomes expensive to use short-term loans to pay for long-term projects.
 
Companies often borrow on a short-term basis even if short-term interest rates are higher than compared to the long-term interest rates because these higher interest rates compensate for any administrative cost or prepayment cost that the long term loans carry.

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