Finance

Thad Alger

Week 7 Assignment

16-6 What are the advantages of matching the maturities of assets and liabilities? What are the disadvantages?

One advantage of matching the maturities of assets and liabilities is the opportunity a company has to offset their financing costs. Typically the maturity-matching approach requires that short-term assets be financed by short-term liabilities and long-term assets by long-term liabilities or equity. When a short-term debt matures, the short-term asset it finances also matures and can be used to repay the debt on time. By the same token, a long-term asset should be financed by funds of long-term sources to ensure no interruptions in the asset's use of funds on a long-term basis. Mismatched maturities can cause liquidity issues on both the liability and asset sides.

Some of the disadvantages are when companies finance long-term assets with short-term liabilities, they are taking on a potential liquidity risk. As the short-term liabilities mature, the long-term assets that use the short-term funds do not mature until much later. If companies fail to roll over, or refinance, their short-term liabilities, they face either a default on the debt or a premature asset sale. It's also not wise that companies finance short-term assets with long-term liabilities. As a short-term asset matures quickly, companies have to find other uses for the long-term funds now available again. Matching maturities of assets and liabilities avoids both potential problems.