Question 1

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

Accepted Answer

Commercial paper typically has a fixed repayment schedule and is not flexible like some other forms of short-term financing, such as revolving credit lines.

Question 2

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 accounts receivable are two distinct financing methods with different outcomes. Factoring involves selling the receivables outright to a third party at a discount, while pledging involves using the receivables as collateral for a loan.

Question 3

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 4

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 where the borrower and lender agree to terms regarding the borrower's ability to draw down, repay, and redraw funds up to a pre-set credit limit. It is a legally binding agreement between the two parties that outlines the terms, conditions, and requirements for the loan.

Question 5

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

Accepted Answer

Issuers of commercial paper often have backup lines of credit with banks to provide liquidity in case they are unable to repay the short-term debts.

Question 6

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, such as property or a car, which the lender can repossess if the borrower defaults on the loan. This lowers the lender's risk, and therefore a secured loan typically has a lower interest rate compared to an unsecured loan.

Question 7

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

This statement is true, as banks may require borrowers to clean up their short-term loans for a certain period of time to ensure that they are not relying on temporary financing for permanent needs. This helps banks manage risk and ensure borrower creditworthiness.

Question 8

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

Accepted Answer

Trade credit represents money owed by a company to its suppliers or vendors for goods or services purchased on credit. This unpaid debt appears as accounts payable on the company's balance sheet.

Question 9

Commercial paper is an unsecured form of credit.

Accepted Answer

Commercial paper is an unsecured form of credit, which means there is no collateral backing the loan.

Question 10

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 a balance that a borrower must maintain in their account as a condition of receiving a loan. Since the borrower cannot use this money for other purposes, the effective cost of borrowing increases, as they are not receiving the full amount of the loan.

Question 11

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 the items in the inventory are important factors in determining the amount that can be obtained on an inventory loan.

Question 12

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 13

Consolidated Industries 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 adjusting the interest rate for the compensating balance requirement. The effective interest rate is (9% + 1.5%) / (1 - 0.15) = 12.4%.

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.

Question 15

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 16

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

Accepted Answer

Secured credit can be obtained from commercial banks, finance companies, and factors.

Question 17

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 statement is true according to the cost of trade credit formula, which is: Cost of Trade Credit = [(Discount Percentage/(1-Discount Percentage)) x (365/ (Payment Days - Discount Days))] x 100. The cost of trade credit is directly proportional to the discount percentage (size of cash discount) and inversely proportional to the payment days (length of time between the end of the discount period and the final due date).

Question 18

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 19

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 20

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

Accepted Answer

Floating lien agreements allow the borrower to sell or dispose of inventory without notifying the lender, making it a less secure form of collateral compared to other options such as chattel mortgages or blanket liens.

Quiz 15: Working-Capital Management