Deck 8: Sources of Short-Term Financing

Question 1

Bank deregulation has eased competition between commercial banks, savings and loans, brokerage houses, and new financial services companies.

Answer 1

False

Question 2

Although the LIBOR has remained competitive and comparable to the U.S. prime rate, it has remained slightly higher than the prime rate for over a decade.

Answer 2

False

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

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 7

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

Question 8

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 9

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

Question 10

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

Question 11

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

Question 12

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

Question 13

Leontief's Wigs can borrow from its bank at 16% to take a cash discount. The terms of the cash discount are 2/10, net 60. Leontief's should borrow from the bank to take the discount.

Question 14

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

Question 15

Myrdal Boots can borrow from its bank at 12% to take a cash discount. The terms of the cash discount are 3/10, net 90. Myrdal Boots should borrow from the bank to take the discount.

Question 16

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

Question 17

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

Question 18

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 19

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

Question 20

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

Question 21

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

Question 22

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 23

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

Question 24

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

Question 25

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

Question 26

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

Question 27

Compensating balances represent unfair hidden costs of borrowing.

Question 28

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

Question 29

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

Question 30

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

Question 31

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

Question 32

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

Question 33

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

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

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

Question 36

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

Question 37

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

Question 38

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

Question 39

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 40

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 41

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

Question 42

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

Question 43

The APR is generally lower than the rate stated by the bank.

Question 44

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

Question 45

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

Question 46

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 47

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 48

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

Question 49

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 50

At historically low interest rate levels, compensating balances increase.

Question 51

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

Question 52

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

Question 53

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

Question 54

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

Question 55

The biggest category of asset-backed securities is the home equity loan, followed by automobile receivables and credit card receivables.

Question 56

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

Question 57

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 58

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 its customers?

A)Decreased receivables and increased bank loans
B)Increased receivables and increased bank loans
C)Increased payables and decreased bank loans
D)Increased payables and increased bank loans

Question 59

The simplest inventory financing method is a blanket inventory lien where items are not identified or tagged, and there is no physical transfer of control of the inventory from the borrower.

Question 60

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

Question 61

If Analog Computers can borrow at 8% 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)None of these options

Question 62

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)None of these options

Question 63

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

Question 64

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 65

East Coast Cleaners borrows $20,000 for 120 days and pays $400 interest. What is the effective rate of interest if the loan is discounted?

A)Less than 5.5%
B)More than 5.5% but less than 6.0%
C)More than 6.0% but less than 6.5%
D)More than 6.5%

Question 66

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 67

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 68

General Rent-All's officers arrange a $50,000 loan. 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 69

Von Hayek's Kayaks can borrow $12,500 for 60 days at a cost of $220 interest. What is the effective rate of interest?

A)Less than 9.9%
B)More than 9.9% but less than 10%
C)More than 10.5% but less than 11.5%
D)More than 11.5%

Question 70

Mr. Jones borrows $4,500 for 90 days and pays $75 interest. What is his approximate effective rate of interest?

A)9.3%
B)6.7%
C)11.7%
D)None of these options

Question 71

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 72

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 73

Kenneth's Arrows and Bows borrow $15,000 for one year at 8% interest. What is the effective rate of interest if the loan is discounted?

A)Less than 8.5%
B)More than 8.5% but less than 9.5%
C)More than 9.5% but less than 10.5%
D)More than 10.5%

Question 74

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

Question 75

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

Question 76

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 77

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 78

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

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

Question 79

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 80

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

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