Commercial loan borrower’s optimal borrowing and prepayment decisions under uncertainty

Abstract

We model a firm which faces continuing stochastic money needs and fluctuating interest rates. The borrower minimizes the expected present value of the sum of interest payments and prepayment penalty costs subject to a liquidity constraint. Since contingent opportunities are absent from the model, we find (i) the firm should not inventory cash, (ii) the firm should prepay the maximum amount possible if it prepays at all.

Acknowledgments

The author would like to thank Dr Matthew J. Sobel for his kind suggestions and comments.