Question 1

Interest rates for bank loans are frequently linked to either the London Interbank Offered Rate (LIBOR) or the Treasury bill rate.

Accepted Answer

Interest rates for bank loans are often tied to either LIBOR or the Treasury bill rate. LIBOR is the interest rate at which banks can borrow funds from other banks in the London interbank market, while the Treasury bill rate is the interest rate at which the US government can borrow money by issuing short-term debt.

Question 2

The factoring firm bears responsibility for default on accounts receivable purchased from a firm.

Accepted Answer

When a factoring firm purchases accounts receivable from a firm, it assumes responsibility for collecting payment from the debtor. If the debtor defaults on payment, the factoring firm bears the responsibility for the loss. This is because the factoring firm has already paid the original firm for the receivables, and therefore assumes the risk of non-payment.

Question 3

The cost of issuing commercial paper is generally lower than that of a revolving line of credit.

Accepted Answer

Commercial paper is typically issued at a lower interest rate than a revolving line of credit, which makes it a cheaper source of short-term funding.

Question 4

Some companies solve their financing problem by borrowing on the strength of their current assets; others solve it by selling their current assets.

Accepted Answer

Companies can choose to borrow money using their current assets as collateral, or they can sell their current assets to generate cash flow. Both options can be used to solve financing problems, depending on the specific circumstances and goals of the company.

Question 5

In field warehousing the inventory is kept by the:

Accepted Answer

In field warehousing, the inventory is stored in a warehouse operated by an independent warehousing company. The borrowing firm uses this facility to store crops or products until they are ready to be sold. The lending institution may inspect the inventory to secure the loan, but they do not keep the inventory themselves. The firm and the lender do not jointly keep the inventory either. Therefore, the correct answer is option C, which is an independent warehousing company.

Question 6

When a loan is secured by receivables, the firm assigns the receivables to the bank. If the firm fails to repay the loan, the bank can collect the receivables from the firm's customers and use the cash to pay off the debt. The risk of default on the receivables is now borne by the bank.

Accepted Answer

When a loan is secured by receivables, the firm does assign the receivables to the bank as collateral, but the risk of default on the receivables remains with the firm, not the bank. The bank can collect the receivables if the firm fails to repay the loan, but any shortfall due to defaults on those receivables would still be the firm's responsibility.

Question 7

An increase in accounts payable is a source of cash.

Accepted Answer

An increase in accounts payable means that a company has not yet paid for its purchases on credit. This means that the company has more cash on hand to use for other purposes. Therefore, an increase in accounts payable is a source of cash.

Question 8

An increase in long-term assets is a source of cash.

Accepted Answer

An increase in long-term assets is not a source of cash. Long-term assets (such as property, plant, and equipment) are typically purchased with cash and therefore represent a use of cash rather than a source of cash. Sources of cash include cash inflows from operations, issuance of debt or equity, and sale of assets.

Question 9

An increase in current liabilities is a source of cash for the firm.

Accepted Answer

An increase in current liabilities means the firm has borrowed more in the short term or has not yet paid off its short-term obligations, which increases its cash position as it is using external funds to finance its operations or delaying payments.

Question 10

The time interval between paying for raw materials and collecting on sales of finished goods made from those materials is known as the:

Accepted Answer

The time interval between paying for raw materials and collecting on sales of finished goods made from those materials is known as the cash conversion cycle. This cycle includes the inventory cycle (time elapsed from acquiring raw materials to producing and selling finished goods) and the accounts receivable cycle (time elapsed from selling finished goods to collecting payment). The matching cycle is not directly related to this time interval.

Question 11

An increase in short-term interest rates will increase the carrying costs of the firm.

Accepted Answer

When short-term interest rates increase, it becomes more expensive for companies to borrow money, which increases their carrying costs (the costs of holding inventory, accounts receivable, etc.). Therefore, the statement is true.

Question 12

Permanent working capital requirements are generally financed with commercial paper.

Accepted Answer

Permanent working capital requirements are typically financed with long-term sources of funding such as equity, long-term debt, or retained earnings, rather than short-term financing options like commercial paper.

Question 13

A firm can reduce the cash conversion cycle by selling fewer goods on credit and more for cash.

Accepted Answer

The cash conversion cycle is the time it takes a firm to convert their investment in inventory to cash received from customers. Selling fewer goods on credit and more for cash would result in faster cash flow and a shorter cash conversion cycle. This is because the firm would be receiving cash immediately instead of waiting for payment from customers who purchased on credit, which can take longer to receive.

Question 14

With a revolving line of credit, a firm can borrow and repay whenever it wants so long as the balance does not exceed the credit limit.

Accepted Answer

A revolving line of credit allows a firm to borrow and repay funds as needed, up to a certain credit limit. As long as the balance does not exceed the credit limit, the firm has the flexibility to borrow and repay funds as they see fit.

Question 15

Banks will not usually lend the full value of the assets that are used as security. The safety margin is likely to be even larger in the case of loans that are secured by inventory.

Accepted Answer

This statement is true as banks typically only lend a certain percentage of the value of the assets that are used as security in order to ensure they have a buffer in case the assets decrease in value. In the case of inventory, there may be additional concerns about obsolescence or damage, which could require an even larger safety margin.

Question 16

When a loan is secured by receivables, the firm assigns the receivables to the bank. If the firm fails to repay the loan, the bank can collect the receivables from the firm's customers and use the cash to pay off the debt.

Accepted Answer

This is a correct description of a typical receivables financing arrangement, also known as factoring.

Question 17

The credit crisis of 2007 to 2009 largely left the market for commercial paper unaffected.

Accepted Answer

The credit crisis of 2007 to 2009 had a significant impact on the market for commercial paper. Many investors, concerned about the risks of investing in these short-term debt instruments, pulled their money out of the market, causing a sharp decline in issuance and higher interest rates. This, in turn, made it more difficult and expensive for companies to access short-term funding, which contributed to the overall liquidity crisis of the period.

Question 18

Investments in marketable securities are generally a positive NPV investment for tax-paying firms.

Accepted Answer

Investments in marketable securities are not automatically considered positive NPV investments for tax-paying firms, as the NPV depends on the specific returns of the securities relative to their cost and the firm's cost of capital, not just on tax considerations.

Question 19

Once the firm has sold its receivables, the factor bears all the responsibility for collecting on the account.

Accepted Answer

When a firm sells its receivables to a factor, the factor becomes responsible for collecting on the accounts. This is known as factoring and is a common practice for businesses looking to improve their cash flow. By selling their receivables, they can receive immediate payment for their outstanding invoices, rather than waiting for their customers to pay. However, it is important to note that the factor may charge a fee for their services and may also take on the risk of non-payment by the customer.

Question 20

What is the cash conversion cycle for a firm with a receivables period of 40 days, a payables period of 30 days, and an inventory period of 60 days?

Accepted Answer

Cash conversion cycle = 60 + 40 - 30 = 70 days

Quiz 19: Short-Term Financial Planning