Question

Firms manage a variety of current assets. Permanent current assets are necessary for firms to maintain their businesses, and they will be carried even through downturns in business cycles. Temporary current assets fluctuate seasonally or with business cycles. Firms must devise a financing strategy that best fits their business situation and that best manages their risk.

Use the following table to identify the different current asset financing policies
Description Financing policy
Long-term capital finances all fixed assets and the
non-seasonal portion of current assets, as well as
seasonal needs of current assets.
Long-term capital finances some permanent current assets,
but short-term debt finances all temporary current assets
and the remaining permanent current assets.
This current asset financing policy finances current assets
with liabilities that are expected to mature at the same time
the current asset will be liquidated.
Suppose a firm wants to take advantage of an upward-sloping yield curve. If the firm believes that interest rates will stay constant and it wants to use the current yield curve to bolster profits, which approach should the firm follow?
a. Conservative approach.
b. Maturity matching approach.
c. Aggressive approach.

Answer 1

1.a. Long-term capital finances all fixed assets and the non-seasonal portion of current assets, as well as seasonal needs of current assets. ⇒ CONSERVATIVE APPROACH.

b. Long-term capital finances some permanent current assets, but short-term debt finances all temporary current assets and the remaining permanent current assets. ⇒ AGGRESSIVE APPROACH.

c. This current asset financing policy finances current assets with liabilities that are expected to mature at the same time the current asset will be liquidated. ⇒ MATURITY MATCHING APPROACH.

2. Conservative Approach

They should use the conservative approach by seeking long term financing for more permanent assets since the rates will increase in future. For now, seeing as rates are lower, they should use short-term debt for temporary current assets so that they can invest more and make more profit.