Final answer:
As a financial crisis unfolds, a firm that issued a large amount of commercial paper beforehand may see its credit rating downgraded due to heightened credit risks, increased default risk, and uncertainty in the market.
Step-by-step explanation:
If a firm issued a large quantity of commercial paper prior to a financial crisis, the credit rating of the commercial paper would likely be negatively impacted as the crisis unfolds. Credit rating agencies, such as Standard and Poor's and Moody's, assess the creditworthiness of borrowers, which can be significantly influenced by their borrowing history and their reliabilty in repaying loans. During a financial crisis, the firm's ability to service its debt may be perceived as weakened, leading to concerns over credit risk. Thus, the credit rating agency might downgrade the firm's commercial paper rating as a reflection of the increased risk associated with the firm's ability to repay the debt.
Deterioration in the financial condition of the firm, increased default risk, and broad economic uncertainty during a crisis all contribute to the likelihood of a rating downgrade. This can have a serious effect on a firm's cost of capital, as a lower credit rating typically results in higher interest rates, reflecting the greater risk that lenders or bondholders are taking on. Moreover, during a crisis, wider issues such as the health of the financial system, government regulations, and market stability often impact credit ratings. For example, prior to the 2008 crisis, the collapse of institutions like Lehman Brothers highlighted the impact of high-risk strategies such as the securitization food chain on credit ratings.