Deck 8: Sources of Short-Term Financing

Question 1

Approximately 40% of all short-term financing is in the form of loans from the bank.

Answer 1

False

Question 2

Larger firms tend to be net users of trade credit, rather than net providers.

Answer 2

False

Question 3

Myrdal Boots can take a cash discount but has to borrow money from the bank to do so. The bank offers a 12% interest rate. The terms of the cash discount are 3/10, net 90. Because of this, Myrdal Boots should borrow from the bank to take the discount.

Answer 3

True

Question 4

Although the prime rate is the rate that U.S. banks charge their most credit-worthy customers, the prime rate is normally higher than the London Interbank Offered Rate (LIBOR).

Question 5

Compensating balances are important for banks because their existence allows them to make loans at lower quoted rates.

Question 6

Even during slack loan periods, banks will never loan out money at an interest rate lower than the prime rate because the prime rate is their best rate.

Question 7

Leontief's Wigs can take a cash discount but has to borrow money from the bank to do so. The bank offers a 16% interest rate. The terms of the cash discount are 2/10, net 60. Because of this; Leontief's should borrow from the bank to take the discount.

Question 8

Small companies finance a relatively greater proportion of their assets through trade credit than do larger firms.

Question 9

The lender's primary concern is whether the borrower's capacity to generate accounts receivables is sufficient to liquidate the loan as it comes due.

Question 10

On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days of free credit

Question 11

"Stretching the payment period" refers to the practice of trying to take a trade discount after the discount period.

Question 12

Accounts payable is a spontaneous source of funds that usually grows as the business expands.

Question 13

Firms can almost always increase the amount of time they take to pay for purchases without incurring problems.

Question 14

The London Interbank Offered Rate (LIBOR) is used to set a base lending rate for some U.S. domestic corporate loans.

Question 15

A cash discount calls for a reduction in price if payment cannot be made within a specified time period.

Question 16

The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
Cost of failing to take discount =

Question 17

Approximately 40% of all short-term financing is in the form of accounts payable or trade credit.

Question 18

Trade credit is usually extended for periods of one year or more.

Question 19

The largest source of short-term funds for most companies is suppliers (trade credit).

Question 20

The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.

Question 21

The commercial paper market is available to all New York Stock Exchange companies.

Question 22

Monthly installment loans usually increase the effective interest rate of borrowing by approximately 2 times the stated interest rate.

Question 23

Commercial paper represents secured short-term borrowing by large companies.

Question 24

Finance paper, unlike commercial paper, represents a long-term, unsecured promissory note.

Question 25

Compensating balances represent unfair hidden costs of borrowing.

Question 26

Commercial paper is an unsecured short-term IOU from a large financially secure company.

Question 27

Issuers of commercial paper can be divided into finance paper or direct paper, dealer paper, and asset-backed commercial paper.

Question 28

A compensating balance will be lower in periods of tight money than in periods of credit easing.

Question 29

It is easier for small firms to obtain financing through bank loans than through the commercial paper market.

Question 30

One major advantage of commercial paper is that it can always be "rolled over" (reissued) when it matures.

Question 31

One major disadvantage of commercial paper is that if the company's credit quality declines, refinancing existing commercial paper might be impossible to achieve through a new issue of commercial paper.

Question 32

Finance paper usually carries a higher rate of interest than direct paper.

Question 33

Compensating balances are a way for banks to recover the cost of corporate services provided, but not directly charged.

Question 34

The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an annualized basis.

Question 35

Small businesses frequently find commercial paper a useful means of obtaining funds when it is not possible to raise funds by other means.

Question 36

Firms using commercial paper are generally required to maintain commercial bank lines of credit equal to the amount of the paper outstanding.

Question 37

Factoring accounts receivable, unlike pledging accounts receivable, typically passes the risk of loss on the accounts receivable to the buyer.

Question 38

The term "credit crunch" refers to a period in which the interest rate on credit is so high that firms cannot afford to borrow money.

Question 39

All commercial paper involves the physical transfer of actual paper certificates.

Question 40

One advantage to an issuer of commercial paper is that the issuer eliminates the need for maintaining compensating balances and credit lines with a commercial bank.

Question 41

A trust receipt acknowledges that the lender trusts the borrower to repay the loan before any dividends are paid.

Question 42

A self-liquidating loan is preferable to a bank because it generally provides them with a higher return.

Question 43

A blanket inventory lien is where items are not identified or tagged, and there is no physical transfer of control of the inventory from the borrower.

Question 44

General Motors Acceptance Corporation (GMAC) is one of the biggest issuers of asset-backed securities.

Question 45

One major advantage of factoring accounts receivable is that the selling firm receives money from its accounts receivable faster than if it waited until the customers paid.

Question 46

The annual percentage rate (APR) is generally lower than the interest rate stated by the bank.

Question 47

The higher the cost of bank financing, the more beneficial it is to take the cash discount.

Question 48

In times of tight credit in the United States, Eurodollar loans become difficult to obtain.

Question 49

The most common form of short-term financing is a bank loan.

Question 50

The sale of asset-backed securities can sometimes enable the issuing firm to acquire lower-cost funds than it normally would receive from a bank loan or bond offering.

Question 51

A term loan is less risky to the bank, thus they provide a fixed rate to the customer.

Question 52

It is difficult to acquire a loan in U.S. dollars outside the United States.

Question 53

The movement of the exchange rate between two currencies can increase the total cost of a loan by making the principal repayment require more money than the original amount of the loan.

Question 54

The biggest categories of asset-backed securities are the home equity loans, automobile receivables, and credit card receivables.

Question 55

The sale of securities backed by the receivables of large credit-worthy firms is a large and growing source of financing.

Question 56

Companies to can hedging to eliminate all or some foreign currency risk.

Question 57

What is generally the largest source of short-term credit for small firms?

A) Bank loans
B) Commercial paper
C) Installment loans
D) Trade credit

Question 58

Eurodollar loans are similar to U.S. bank loans in that they are usually short-term to intermediate-term in nature.

Question 59

Hedging refers to a transaction that avoids any financial risks.

Question 60

At historically low interest rate levels, compensating balances increase.

Question 61

Trade credit is considered what type of loan?

A) when a firm owes money to a supplier.
B) when a firm owes money to a customer.
C) when a firm owes money to a bank.
D) all of the answers are true.

Question 62

A term loan is usually characterized by

A) a maturity of one to seven years.
B) a variable interest rate.
C) monthly or quarterly installment payments.
D) all of these options are true.

Question 63

Analog Computers needs to borrow $475,000 from the Midland Bank. The bank requires a 15% compensating balance. How much money will Analog need to borrow in order to end up with $475,000 spendable cash?

A) $546,250
B) $758,264
C) $558,824
D) $71,250

Question 64

The prime rate

A) is the rate a bank charges its risky customers.
B) has been quite volatile during the past two decades, moving several percentage points in a 12-month period.
C) is usually lower than Treasury bill rates.
D) None of these options are true.

Question 65

The cost of not taking the discount on trade credit of 3/20, net 90 is approximately ______.

A) 15.9%
B) 16.3%
C) 18.0%
D) 17.4%

Question 66

General Rent-All's officers arrange a $50,000 loan for the company. The company is required to maintain a minimum checking account balance of 10% of the outstanding loan. This practice is called

A) an installment loan.
B) a compensating balance.
C) a discounted loan.
D) a balloon payment.

Question 67

From the banker's point of view, short-term bank credit is an excellent way of financing

A) fixed assets.
B) permanent working capital needs.
C) repayment of long-term debt.
D) seasonal bulges in inventory and receivables.

Question 68

The cost of not taking the discount on trade credit of 2/10, net 30 is approximately ______.

A) 44.54%
B) 43.20%
C) 36.73%
D) None of these options are true

Question 69

In determining the cost of bank financing, which is the most important factor?

A) The prime rate
B) The nominal rate
C) The effective rate
D) The discount rate

Question 70

Kantorovich Company normally takes 30 days to pay for its average daily credit purchases of $2,000. It has average daily sales of $3,000, and collects accounts in 25 days. What is its net credit position?

A) $15,000
B) $1,000
C) ($1,000)
D) ($15,000)

Question 71

Trade credit may be used to finance a major part of a firm's working capital when

A) the firm extends less liberal credit terms than the supplier.
B) the firm extends more liberal credit terms than the supplier.
C) the firm and the supplier both extend the same credit terms.
D) neither the firm nor the supplier extends credit.

Question 72

Bank loans to business firms

A) are usually short-term in nature.
B) are preferred by the banker to be self-liquidating.
C) may require compensating balances.
D) All of these options are true.

Question 73

LIBOR is

A) a resource used in production.
B) an interest rate paid on Eurodollar loans in the London market.
C) an interest rate paid by European firms when they borrow Eurodollar deposits from U.S. banks.
D) the interest rate paid by the British government on its long-term bonds.

Question 74

Commercial bank term loans

A) usually carry fixed interest rates.
B) are very short-term in nature.
C) are offered to superior credit applicants.
D) are very short-term in nature and are offered to superior credit applicants.

Question 75

Large firms tend to be

A) net users of trade credit.
B) net suppliers of trade credit.
C) firms with high levels of profitability.
D) firms with low levels of inventory turnover and accounts receivable turnover.

Question 76

Compensating balances

A) are used by banks as a substitute for charging service fees.
B) are created by having a sweep account.
C) generate returns to customers from interest-bearing accounts.
D) are used to reward new accounts.

Question 77

Recent problems facing the U.S. financial system were the result of all but which one of the following?

A) A huge increase in the amount of mortgage-backed securities being bundled up and sold in the markets
B) A huge drop in the value of mortgage-backed securities
C) An increase in the use of commercial paper for short-term financing
D) The government permitting commercial and investment banks to merge

Question 78

A large manufacturing firm has been selling on a 3/10, net 30 basis. The firm changes its credit terms to 2/20, net 90. What change might be expected on the balance sheets of the manufacturing firm?

A) Decreased receivables
B) Increased receivables
C) Increased payables
D) Decreased payables

Question 79

The London Interbank Offered Rate (LIBOR)

A) competes with the U.S. Prime Rate for those companies with an international presence.
B) has been lower than the U.S. Prime Rate for at least the last decade.
C) is an estimate of the interbank lending rate for London banks.
D) all of these options are correct.

Question 80

If Analog Computers can borrow at 8% annually for three years, what is the effective rate of interest on a $1,000,000 loan where a 15% compensating balance is required?

A) 11.18%
B) 17.27%
C) 9.41%
D) 24%