Question 1

To ensure that a borrower is not using short-term bank credit to finance a part of its permanent needs for funds,banks often require borrowers to clean up their short-term loans for a 30 - 45 day period during the year.

Accepted Answer

Banks often require borrowers to clean up their short-term loans for a 30 - 45 day period during the year to ensure that they are not using short-term credit to finance permanent needs for funds.

Question 2

The effective cost to the borrower of an unsecured bank loan is increased if a compensating balance is required.

Accepted Answer

A compensating balance is an amount of money that the borrower must maintain in their account with the bank as a condition for receiving the loan. The borrower does not earn interest on this balance, and it effectively increases the cost of the loan because the borrower is paying interest on a larger amount than they actually receive. Therefore, requiring a compensating balance will increase the effective cost to the borrower of an unsecured bank loan.

Question 3

Trade credit appears on a company's balance sheet as accounts payable.

Accepted Answer

Trade credit represents the amount of money a company owes to its suppliers for goods or services purchased on credit. This amount is recorded as accounts payable on the company's balance sheet.

Question 4

Credit terms of 1/10 net 30 means that the buyer may take a 10% discount (1/10)if the bill in paid within 30 days.

Accepted Answer

Credit terms of 1/10 net 30 mean that the buyer can take a 1% discount if the bill is paid within 10 days; otherwise, the full amount is due within 30 days.

Question 5

Issuers of commercial paper usually maintain lines of credit with banks to back up their short-term financing needs.

Accepted Answer

This statement is true. Issuers of commercial paper often have lines of credit with banks to support their short-term financing needs in case they are unable to sell enough commercial paper to meet their obligations. This gives them added financial security and reduces their risk of default.

Question 6

Floating lien agreements are the least secure form of inventory collateral.

Accepted Answer

Floating lien agreements allow the borrower to continue selling and replacing inventory without seeking the lender's approval for each transaction, making it more difficult for lenders to ensure that their collateral is protected.

Question 7

Credit terms of 2/10,net 30 have a lower effective cost than credit terms of 2/10,net 60 because in the first case the loan will be repaid sooner.

Accepted Answer

The effective cost of credit terms is determined by the discount offered and the period over which the full payment can be delayed, not by the speed of repayment within the discount period. Both terms offer the same discount for early payment; the difference in net days (30 vs. 60) affects the length of the free credit period, not the cost of taking the discount.

Question 8

Factoring accounts receivable is the sale of a firm's receivables while pledging accounts receivable is the use of accounts receivable as collateral for a loan.

Accepted Answer

Factoring and pledging are two different methods of financing that involve using accounts receivable, with factoring involving the sale of receivables and pledging involving their use as collateral for a loan.

Question 9

A revolving credit agreement is a legally binding agreement between a borrower and lender.

Accepted Answer

A revolving credit agreement is a type of loan agreement that allows the borrower to draw down, repay, and redraw funds as needed up to a certain credit limit, in exchange for interest and fees. It is a legally binding agreement between the borrower and lender.

Question 10

Under terms of a field warehouse financing agreement,the collateral inventories are physically separated from the borrower's other inventories but remain under the borrower's control.

Accepted Answer

In a field warehouse financing agreement, the collateral inventories are physically separated and placed under the control of a third-party warehouse company, not under the borrower's control.

Question 11

Major sources of secured credit include commercial banks,finance companies,and factors.

Accepted Answer

Secured credit can be provided by commercial banks, finance companies, and factors, therefore the statement is true.

Question 12

The cost of trade credit varies directly with the size of the cash discount and inversely with the length of time between the end of the discount period and the final due date.

Accepted Answer

This relationship is known as the cost of trade credit formula and is widely accepted in financial management. The cost of trade credit increases as the size of the cash discount decreases and as the length of the credit period increases.

Question 13

When the accounts receivable of a firm have been factored,bad debt losses remain the responsibility of the borrowing firm and must be made good.

Accepted Answer

When accounts receivable are factored, the responsibility for bad debt losses typically transfers to the factor (the party purchasing the receivables), unless the arrangement specifies recourse factoring, where the selling firm remains liable for bad debts.

Question 14

The primary sources of collateral for secured loans are accounts receivable and inventory.

Accepted Answer

Accounts receivable and inventory are the primary sources of collateral for secured loans, making them less risky for lenders as they have tangible assets to recover in case of default.

Question 15

A major risk in using commercial paper for short-term financing is the inflexible repayment schedule.

Accepted Answer

Commercial paper typically has a fixed maturity date, meaning that the repayment schedule is inflexible. This can be a risk if a company is unable to repay the paper when it matures.

Question 16

Accrued wages and taxes are secured sources of financing because companies are obligated to make these payments before they make payments on any other loans or pay dividends.

Accepted Answer

Accrued wages and taxes are liabilities, not sources of financing. They represent amounts owed by the company for wages earned by employees and taxes due to the government, not funds the company can use for its operations.

Question 17

Idaho Mining,Inc borrows at prime plus 1.5% on its line of credit.The line requires a 15% compensating balance.If prime rate is 9%,what is the nominal APR of the line of credit?

Accepted Answer

The nominal APR is calculated by adding the prime rate (9%) to the additional percentage (1.5%), resulting in 10.5%. However, due to the 15% compensating balance requirement, the effective borrowing amount is reduced, increasing the effective interest rate. The nominal APR is calculated as (10.5% / (1 - 0.15)) = 12.35%, which rounds to 12.4%.

Question 18

A secured loan should have a higher interest rate because the lender has less risk and therefore values the loan more highly.

Accepted Answer

A secured loan is backed by collateral, which reduces the lender's risk. Therefore, the borrower should receive a lower interest rate as compensation for providing collateral.

Question 19

Commercial paper is an unsecured form of credit.

Accepted Answer

Commercial paper is a short-term debt instrument that is typically issued by large corporations to raise funds. It is unsecured, meaning that there is no collateral backing the debt, unlike secured forms of credit like mortgages or car loans.

Question 20

The amount that can be obtained on an inventory loan depends on both the marketability and perishability of the items in the inventory.

Accepted Answer

The marketability and perishability of items in the inventory affect their value and therefore can impact the amount that can be obtained on an inventory loan. If the items are highly marketable and have a long shelf life, they may be more valuable and result in a higher loan amount. Conversely, if the items are not in demand or have a short shelf life, the loan amount may be lower.

Quiz 15: Working-Capital Management