Question 1

A compensating balance is a balance in checking account that is equal to a certain percentage of the borrower's short-term unsecured loan.

Accepted Answer

A compensating balance is a requirement by a lender that a certain percentage of the borrower's short-term unsecured loan is kept in a checking account with the lender as a form of collateral.

Question 2

Revolving credit agreements are guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Accepted Answer

Revolving credit agreements are guaranteed loans that provide a maximum credit limit, but the borrower can borrow, repay, and re-borrow funds as needed within that limit.

Question 3

Lines of credit are non-guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Accepted Answer

A line of credit is a type of loan that establishes a maximum borrowing amount that a borrower can draw from, without having to reapply each time they need funds. It is typically not secured by specific collateral, meaning that the borrower is not required to pledge any assets as security for the loan. However, the borrower's creditworthiness and ability to repay the loan may be evaluated by the lender before approving the line of credit.

Question 4

A loan that is usually a one-time loan made to a borrower who needs funds for a specific purpose for a short period is called a ________.
A) term loan
B) bill of exchange
C) mortgage loan
D) single-payment note

Accepted Answer

A single-payment note is a type of loan that is typically given for a short period of time and involves a one-time payment made by the borrower at the end of the loan term. This type of loan is often used for emergency expenses or to bridge a temporary gap in funding. A term loan, on the other hand, is a loan that is given for a longer period and repaid in installments, while a mortgage loan is specifically used for purchasing real estate, and a bill of exchange is a financial document used for payment between parties.

Question 5

A compensating balance not only forces the borrower to be a good customer of the bank but may also raise the interest cost to the borrower.

Accepted Answer

A compensating balance typically requires the borrower to maintain a certain amount of money in their account with the bank. This incentivizes the borrower to maintain a good relationship with the bank and use their services. However, because the borrower is required to hold onto a certain amount of money, the effective interest rate on the loan may be higher than the stated interest rate, which can increase the cost to the borrower.

Question 6

Operating-change restrictions gives the bank a right to revoke the line of credit if any major changes occur in a firm's financial condition or operations.

Accepted Answer

Operating-change restrictions are put in place to protect the bank's security interest by limiting the borrower's ability to radically change their operations or financial condition without the bank's knowledge and consent. If the borrower violates these restrictions, the bank has the right to revoke the line of credit.

Question 7

Tangshan Mining borrowed $10,000 for one year under a line of credit with a stated interest rate of 8 percent and a 10 percent compensating balance. Thus, the firm keeps a balance of about $800 in its checking account.

Accepted Answer

The information given states that Tangshan Mining keeps a balance of about $800 in its checking account, which is not enough to meet the 10 percent compensating balance requirement for the $10,000 line of credit. Therefore, it is not possible for Tangshan Mining to have obtained the line of credit under the terms described.

Question 8

If one borrows $1,000 at 8 percent interest on a discount basis, the effective rate of interest is 7.2 percent.

Accepted Answer

The effective rate of interest is higher than the nominal rate of 8 percent when calculated on a discount basis because the interest is deducted from the loan amount upfront, reducing the actual amount received by the borrower.

Question 9

Higher the riskiness of a borrower, higher is the premium charged above the prime rate by a banker.

Accepted Answer

This statement is true. When a borrower is considered to be risky, the banker may charge a higher interest rate above the prime rate to compensate for the increased risk of default. This is known as a risk premium.

Question 10

Because the bank guarantees the availability of funds, a commitment fee is normally charged on a simple line of credit agreement.

Accepted Answer

A commitment fee is typically charged on the unused portion of a revolving line of credit or a term loan, not on a simple line of credit agreement, to compensate the lender for keeping funds available.

Question 11

Short-term loans that businesses obtain from banks and through commercial paper are ________.
A) negotiated and secured
B) negotiated and unsecured
C) spontaneous and secured
D) spontaneous and unsecured

Accepted Answer

Short-term loans obtained from banks and commercial paper are typically negotiated between parties, but they are generally unsecured (meaning they are not backed by collateral).

Question 12

Short-term, self-liquidating loans are intended to ________.
A) provide one-time loan to the borrower who needs funds for a specific purpose
B) cover seasonal peaks in financing caused by inventory and receivable buildups
C) provide maximum amount to the firm that it can owe to the bank
D) recapitalize the firm

Accepted Answer

Short-term, self-liquidating loans are specifically designed to cover temporary financing needs, such as those caused by seasonal increases in inventory or receivables. These loans are expected to be paid off as the business cycle completes, for example, when inventory is sold or receivables are collected.

Question 13

The ________ is the lowest rate of interest charged on business loans by the nation's leading banks to their best business borrowers.
A) prime rate
B) commercial paper rate
C) federal funds rate
D) treasury bill rate

Accepted Answer

The prime rate is the lowest rate of interest charged on business loans by the nation's leading banks to their best business borrowers.

Question 14

Revolving credit agreements are non-guaranteed loans that specify the minimum amount that a firm can owe the bank at any point in time.

Accepted Answer

Revolving credit agreements are flexible financing arrangements where the bank sets a maximum loan balance that the borrower can maintain, allowing the borrower to draw down, repay, and redraw loans up to this maximum amount, rather than specifying a minimum amount they can owe.

Question 15

Lines of credit are guaranteed loans that specify the maximum amount that a firm can owe the bank at any point in time.

Accepted Answer

Lines of credit are not guaranteed loans; they are arrangements between a lender and a borrower that set a maximum loan balance the borrower can access, but the borrower is not guaranteed to be lent any amount until they actually draw on the line.

Question 16

A fixed-rate loan is a loan whose rate of interest is established at a fixed increment above the prime rate and is allowed to vary above the prime rate only when the prime rate varies until maturity.

Accepted Answer

A fixed-rate loan has an interest rate that remains the same for the entire term of the loan, regardless of changes in the prime rate.

Question 17

The major type of loan made by banks to businesses is the ________.
A) fixed-asset-based loan
B) short-term secured loan
C) short-term, self-liquidating loan
D) capital improvement loan

Accepted Answer

Short-term, self-liquidating loans are the most common type of loans made by banks to businesses. These loans are typically used to fund operations that will generate enough revenue to repay the loan within a short period. Fixed-asset-based loans are typically used for larger, long-term investments like equipment or property. Short-term secured loans may be used for operational expenses, but they require collateral. Capital improvement loans are used for long-term investments in a company's infrastructure, such as expanding production facilities.

Question 18

Cull Incorporated recently borrowed $250,000 from Century Bank when the prime rate was 4%. The loan was for 90 days with interest to be paid at the end of the period with a rate fixed at 1.5% above the prime rate. What is the total interest paid on this loan and what is the effective annual rate? (Assume a 365 day year.)
A) The total interest paid is $3390.41 and the effective annual rate is 5.62%.
B) The total interest paid is $13,750 and the effective annual rate is 5.62%.
C) The total interest paid is $13,750 and the effective annual rate is 5.55%.
D) The total interest paid is $3390.41 and the effective annual rate is 1.36%.

Accepted Answer

The interest on the loan can be calculated using the following formula:

Interest = Principal x Rate x Time
where Principal = $250,000, Rate = Prime Rate + 1.5% = 4% + 1.5% = 5.5%, and Time = 90/365

Interest = $250,000 x 5.5% x (90/365) = $3390.41

The effective annual rate can be calculated using the following formula:

Effective Annual Rate = (1 + Interest Rate / m) ^ m - 1
where Interest Rate = 5.5%, m = 365/90

Effective Annual Rate = (1 + 5.5% / (365/90)) ^ (365/90) - 1 = 5.62%

Therefore, the total interest paid on the loan is $3390.41 and the effective annual rate is 5.62%. Choice A is correct.

Question 19

Commitment fee is the fee that is normally charged on a revolving credit agreement.

Accepted Answer

This is because a commitment fee is a fee charged to a borrower to compensate the lender for the cost of keeping a line of credit open, even if the borrower does not draw down on it. This fee is usually charged annually as a percentage of the unused portion of the credit line.

Question 20

The effective interest rate for a discount loan is greater than the loan's stated interest rate.

Accepted Answer

This is because the borrower receives less money upfront due to the discount (which is deducted from the loan amount), but is still required to repay the full amount of the loan plus interest. Therefore, the effective interest rate includes the reduction from the discount, which results in a higher rate than the stated interest rate.

Quiz 16: Current Liabilities Management