Question

Assuming you're considering borrowing $100 million to finance your business for 2 years. One option is to use fixed-rate financing with interest payments on a semi-annual basis. The other alternative is a floating rate financing based on Libor with interest payments on a quarterly basis.

How and when could Libor or other index change to impact the decision? How will the current and near-term economic environment impact your recommendation?

Answer 1

If you are considering to borrow the money and the options you have are either fixed rate or floating rate then you should choose an option depending on what is you interest rate expectation in the near future. If you are expecting interest rates to increase choose fixed rate, if you are expecting interest rates to fall choose floating rates.

The interest rates on floating loans are set at the beginning of each period and it can change if the LIBOR rates change in the market. Let’s say the first payment is due next quarter so for that the interest rate would be set today as to what interest rate would be charged and for the next quarter payment the interest rate would be set at the beginning of the period. The LBOR rates keeps on changing as its is determined by the market. Although now the LIBOR rates are being discontinued.

Given the current economic scenario where the interest rates are not expected to rise because of the pandemic of Covid-19 spread across the world it would be a good decision to go for floating rate on interest rates as for some time the federal reserve can not go for interest rate hike as it would want to spur the economic activity and for that it would want to cut the interest rates to increase economic activity.