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ACCA Strategic Professional · Advanced Financial Management · The role and responsibility of senior financial executive/advisor

A multinational's finance director notes that the central bank has unexpectedly raised its policy interest rate. Which is the most direct effect on the company's financial strategy, other things equal?

A rise in the policy interest rate increases the cost of floating-rate borrowing and pushes up the risk-free rate, so the discount rate applied to projects tends to rise. Coupons on fixed-rate debt already issued stay unchanged and repayment is not triggered.

  1. AIts cost of floating-rate debt rises and the discount rate used in project appraisal tends to riseCorrect
  2. BIts cost of fixed-rate debt already issued falls immediately
  3. CIts existing fixed-rate bonds must be repaid early
  4. DIts equity beta falls to zero

Explanation

A higher policy rate raises the risk-free rate and short-term borrowing costs, so floating-rate interest increases and required returns, hence discount rates, tend to rise. Existing fixed-rate debt coupons do not change, so option 2 is wrong.

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