Question

Monitoring the Cost Of Money: Interest Rates

Interest rates, the cost of money, influence most all factors related to personal and corporate capital budgeting. The more obvious personal information for the cost of money is the rates associated with a mortgage or car loan. As a CFO you would “shop” interest rates to find the best rate for your financing needs.

Would you, as the CFO, finance your projects as soon as possible if cost of capital was expected to drop? Please explain.

More importantly where do you find the information to analyze expected changes in interest rates?

Answer 1

Yes, it would be better to finance the project as soon as possible if cost of capital is expected to drop. The reason behind this is pretty obvious, as for the lower cost of capital the cost that company would need to pay for raising capital would be reduced. But as a CFO you must know till what point you should wait or take a halt to finance your project is cost of capital is dropping.

This is because it would be dropping for say 3-4 years which is a medium term period. But then later on centra bank might increase the benchmark rate and this would now again raise the cost of capital. So now in this case the bonds that would have been issued by your firm initailly would be worth less to the buyers due to higher interest rates in economy. So if any callable or convertable bonds might get exercised and this in turn might create issues in your firm, whereby you might need to payback the debt or pay more interest before you are supposed and this might again affect your financial planning for the firm. Due to increased interest expenses for sometime might in turn reduce the returns going to shareholders and this might make them unhappy. So there must be a threshold till where you as a CFo should wait for cost of capital to drop.

The information to analyze this might be accessed first through the government planning, you might need to analyze some economic factors, conditions such as inflation and other demand-supply of money in economy. This might provide you with an idea what changes can be made by central banks in interest rates in near future. Also there are LIBOR forward curves and similar floating interest rate schedules for different countries that could be analyzed and forecasted before going for your debt schedule. Also the other mortgage rates from few banks might need to be observed to analyze the moverments in lendings etc.