Question 1

The effective interest rate on a bank loan depends on whether interest is paid when the loan matures or in advance.

Accepted Answer

The timing of interest payments affects the calculation of the effective interest rate. If interest is paid in advance, the loan amount is reduced by the amount of interest, which results in a lower effective interest rate. On the other hand, if interest is paid when the loan matures, the borrower is effectively paying interest on the full loan amount, resulting in a higher effective interest rate.

Question 2

Jannet Company, currently pays its employees at the end of a week. The weekly payroll totals $400,000. If it were to extend the pay period so as to pay its employees 1 week later throughout an entire year, the employees would in effect be lending the firm ________ for a year.

Accepted Answer

By extending the pay period to pay its employees 1 week later throughout an entire year, the firm retains an additional $400,000 that it would otherwise pay out each week. This means at any given time during the year, the firm is holding onto an extra $400,000 that it would have paid to employees, effectively being lent this amount by the employees for the year. The total does not accumulate week over week because each week's delay is simply shifting the same $400,000 payment by one week throughout the entire year.

Question 3

A line of credit is an agreement between a commercial bank and a business, specifying the amount of unsecured short-term borrowing the bank will make available to the firm over a given period of time.

Accepted Answer

This is a correct definition of a line of credit. It is a type of financing commonly used by businesses to access short-term funding when needed.

Question 4

Under a line of credit agreement, a bank may retain the right to revoke the line if any major changes occur in the firm's financial condition or operations.

Accepted Answer

A bank can retain the right to revoke the line of credit if there are any major changes in a firm's financial condition or operations. This is a common practice to protect the bank's interest and ensure that the borrower can repay the credit.

Question 5

The risk-free rate is the lowest rate of interest charged by the nation's leading banks on business loans to their most important and reliable business borrowers.

Accepted Answer

The risk-free rate is the rate of return an investor can expect from an investment that carries zero risk, such as a U.S. Treasury bond. It is not directly tied to business loans or bank lending practices.

Question 6

Operating change restrictions are contractual restrictions that a bank may impose on a firm as part of a line of credit agreement.

Accepted Answer

Operating change restrictions are contractual restrictions that a bank may impose on a firm as a condition of extending a line of credit. These restrictions limit the ability of the borrower to make significant changes to its business operations without the prior approval of the lender. The purpose of these restrictions is to mitigate the lending risk by ensuring that the borrower continues to operate in a way that supports the repayment of the loan.

Question 7

Self-liquidating loans are intended merely to carry a firm through seasonal peaks in financing needs that are due primarily to buildups of accounts receivable and inventory.

Accepted Answer

Self-liquidating loans are indeed designed to help firms manage their cash flow during seasonal peaks in financing needs, which often occur due to increased inventory and accounts receivable. These loans are meant to be repaid using the funds generated from the increased sales during the seasonal peak, making them a self-liquidating form of financing.

Question 8

________ are liabilities for services received for which payment has yet to be made.

Accepted Answer

Accruals are liabilities for services received for which payment has yet to be made. Notes payable are liabilities that arise from borrowing money, accounts payable are liabilities for goods or services purchased on credit, and accounts receivable are assets for money owed to a company for goods or services provided.

Question 9

Self-liquidating loans are mainly invested in productive assets (i.e., fixed assets) which provide the mechanism through which the loan is repaid.

Accepted Answer

Self-liquidating loans are typically used to finance current assets, such as inventory or accounts receivable, which are sold or converted into cash to repay the loan, rather than fixed assets.

Question 10

The interest rate on a line of credit is normally stated as a fixed rate-the prime rate.

Accepted Answer

The interest rate on a line of credit is usually variable and tied to the prime rate, which can fluctuate over time.

Question 11

An increment above the prime rate on a floating-rate loan will be higher than on a fixed-rate loan of equivalent risk because the lender bears higher risk with a floating-rate loan.

Accepted Answer

The increment above the prime rate on a floating-rate loan typically reflects the interest rate risk borne by the borrower rather than the lender, as the interest rate can fluctuate. In contrast, a fixed-rate loan locks in the interest rate, transferring interest rate risk from the borrower to the lender, potentially justifying a higher rate for equivalent risk due to the lender bearing this risk.

Question 12

A revolving credit agreement is a form of financing consisting of short-term, unsecured promissory notes issued by firms with a high credit standing.

Accepted Answer

A revolving credit agreement is a type of loan that provides a borrower with a maximum aggregate amount of capital, accessible at any time up to the maximum limit. It is not specifically related to short-term, unsecured promissory notes, which are more accurately described as commercial paper.

Question 13

The major attraction of a line of credit from the bank's point of view is that it eliminates the need to examine the creditworthiness of a customer each time it borrows money within the year.

Accepted Answer

A line of credit is a pre-approved borrowing limit that a customer can draw from as needed, up to a certain amount. The bank sets the credit limit based on the customer's creditworthiness and financial history, and once approved, the customer can access the funds without having to apply for a new loan every time. This reduces the bank's administrative workload and speeds up the lending process. However, the bank still needs to periodically review the customer's creditworthiness to ensure they can continue to make repayments and are not at risk of defaulting on the loan.

Question 14

A discount loan is a loan on which interest is paid in advance by deducting it from the loan so that the borrower actually receives less money than is requested.

Accepted Answer

In a discount loan, the interest is deducted in advance from the loan amount so that the borrower actually receives less money than requested.

Question 15

Under a line of credit agreement, a bank may require an annual cleanup, which means that the borrower must pay off all its outstanding debts to all its operational creditors for a certain number of days during the year.

Accepted Answer

An annual cleanup in a line of credit agreement typically requires the borrower to fully pay down their outstanding balance on the line of credit to $0 for a certain period each year, not to pay off all outstanding debts to all operational creditors.

Question 16

A single-payment note is a secured fund which can be obtained from a commercial bank when a borrower needs additional funds for a short period.

Accepted Answer

A single-payment note is actually an unsecured type of promissory note that is used to borrow money for a short period of time. It requires the borrower to repay the principal amount in full plus any applicable interest at the end of the loan term. It is not necessarily obtained from a commercial bank, it can also be from a private lender or an individual.

Question 17

Compensating balance is a checking account balance equal to a certain percentage of the amount borrowed from a bank under a line-of-credit or revolving credit agreement.

Accepted Answer

This statement accurately defines a compensating balance, which is a common requirement for lines of credit or revolving credit agreements with banks. The borrower must maintain a certain balance in a checking account with the bank to offset the risk of providing credit. This balance cannot be withdrawn or used by the borrower for other purposes until the credit agreement is terminated.

Question 18

Although more expensive than a line of credit, a revolving credit agreement can be less risky from the borrower's viewpoint.

Accepted Answer

A revolving credit agreement typically has fixed monthly payments and a set repayment term, which can make it easier for the borrower to manage their debt and budget. In contrast, a line of credit is often more flexible but can be riskier as it may allow the borrower to borrow more than they can realistically repay.

Question 19

The prime rate of interest fluctuates with changing supply-and-demand relationships for short-term funds.

Accepted Answer

The prime rate of interest is based on the supply-and-demand relationships for short-term funds, and as such, it can fluctuate over time as these relationships change. Therefore, the statement is true.

Question 20

Unlike the spontaneous sources of unsecured short-term financing, bank loans are negotiated and result from deliberate actions taken by the financial manager.

Accepted Answer

Bank loans are generally planned and negotiated by the financial manager, rather than being an impromptu source of financing like unsecured short-term financing.

Quiz 16: Current Liabilities Management