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Interest Rates Fluctuations and the Advantage of Long-Term Debt Financing: A Note on the Effect of the Tax-Timing Option

Author

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  • Brick, Ivan E
  • Palmon, Oded

Abstract

When interest rates fluctuate, issuing long-term debt may implicitly generate a valuable tax-timing option. The holder of long-term debt has an optimal-trading tax-timing option to immediately realize capital losses if an increase in interest rates lowers the price of the bond below the original issue price. In contrast, if interest rates decrease and the bond price is greater than the original issue price, the holder would prefer to defer the realization of capital gains. This tax-timing option confers an advantage for issuing long-term debt. The authors' formal presentation also highlights how the tax-timing options of long-term debt may increase the debt capacity of the firm. Copyright 1992 by MIT Press.

Suggested Citation

  • Brick, Ivan E & Palmon, Oded, 1992. "Interest Rates Fluctuations and the Advantage of Long-Term Debt Financing: A Note on the Effect of the Tax-Timing Option," The Financial Review, Eastern Finance Association, vol. 27(3), pages 467-474, August.
    • Handle: RePEc:bla:finrev:v:27:y:1992:i:3:p:467-74
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    Cited by:

    1. Zheng, Xiaolan & El Ghoul, Sadok & Guedhami, Omrane & Kwok, Chuck C.Y., 2012. "National culture and corporate debt maturity," Journal of Banking & Finance, Elsevier, vol. 36(2), pages 468-488.
    2. Chang Nam & Doina Radulescu, 2010. "Effects of corporate tax reform on optimum debt maturity," Annals of Finance, Springer, vol. 6(3), pages 369-389, July.
    3. Kashefi Pour, Eilnaz & Khansalar, Ehsan, 2015. "Does debt capacity matter in the choice of debt in reducing the underinvestment problem?," Research in International Business and Finance, Elsevier, vol. 34(C), pages 251-264.
    4. Lensink, Robert & Tra, Pham Thi Thu, 2005. "Collateral and Debt Maturity Choice. A Signaling Model," Research Report 05E08, University of Groningen, Research Institute SOM (Systems, Organisations and Management).
    5. Cai, Jun & Cheung, Yan-Leung & Goyal, Vidhan K., 1999. "Bank monitoring and the maturity structure of Japanese corporate debt issues," Pacific-Basin Finance Journal, Elsevier, vol. 7(3-4), pages 229-249, August.
    6. repec:dgr:rugsom:05e08 is not listed on IDEAS
    7. Prisman, Eliezer Z. & Roberts, Gordon S. & Tian, Yisong, 1996. "Optimal bond trading and the tax-timing option in Canada," Journal of Banking & Finance, Elsevier, vol. 20(8), pages 1351-1363, September.
    8. Ali Gungoraydinoglu & Özde Öztekin, 2021. "Financial Leverage and Debt Maturity Targeting: International Evidence," JRFM, MDPI, vol. 14(9), pages 1-36, September.

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