Question

Firms generally choose to finance temporary net operating working capital with short-term debt because Select one: a. Matching the maturities of assets and liabilities reduces risk. b. Short-term interest rates have traditionally been more stable than long-term interest rates. c. A firm that borrows heavily long-term is more apt to be unable to repay the debt than a firm that borrows heavily short-term. d. The yield curve has traditionally been downward sloping. e. Sales remain constant over the year, and financing requirements also remain constant

Answer 1

a. Matching of assets and liabilities reduces risk

Step-by-step explanation:

Working capital refers to the funds required by a firm to carry out it's routine and day to day operations. It is also expressed as,

`Working\ Capital\ =\ Current Assets\ -\ Cuurent Liabilities`

Both current assets and current liabilities represent benfits and obligations with their respective durations being less than an year i.e short term.

When funding it's working capital requirements, a firm resorts to short term financing in the form of debt. The reason being, such funds are only required for short term i.e within an operating cycle.

Matching of assets and liabilities reduces liquidity risk in the sense that, when such short term debt matures and requires repayment, the short term assets financed by such debt also mature and the proceeds from such assets can be used to pay off such debt.

Secondly, the cost of short term debt, is usually lesser than the cost of availing long term debt since, debt issued for long term carries greater risk and thus requires higher interest rate as compensation.