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ACCA Applied Skills · Financial Management · Causes of exchange rate differences and interest rate fluctuations

A central bank unexpectedly raises its base rate to curb inflation. Which is the most likely immediate effect on a company with substantial floating-rate bank borrowing?

The company's interest cost rises immediately, because floating-rate borrowing reprices when the central bank increases the base rate. This reduces profit before tax and cash flow, unlike fixed-rate debt whose interest payments stay the same.

  1. AIts interest cost rises, reducing profit and cash flowCorrect
  2. BIts interest cost falls because inflation falls
  3. CThe value of its fixed-rate debt rises
  4. DIts interest cost is unchanged until the loan is repaid

Explanation

Floating-rate loans reprice with base rate, so interest payments rise straight away, reducing profit and cash flow. Fixed-rate debt would be unaffected in cash terms, and the effect is not delayed until repayment.

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