Question 1

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 allow a firm to borrow up to a specified limit at any time, with interest charged only on the amount borrowed. The limit acts as a guarantee for the bank, ensuring they will not be liable for more than the agreed amount.

Question 2

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 3

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

Accepted Answer

This is because a discount loan involves deducting the interest upfront from the loan amount. The borrower receives less than the face amount of the loan, but they still have to repay the full loan amount plus interest. This means that the effective interest rate is higher than the stated interest rate.

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 made for a short period of time and is repaid in full with a single payment at the end of the term. It is often used for small, short-term loans for specific purposes, such as to cover unexpected expenses or bridge a financial gap until the borrower's next payday. Term loans, mortgage loans, and bills of exchange are all different types of loans with different terms and repayment schedules.

Question 5

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. The commercial paper rate refers to the interest rate on short-term unsecured promissory notes issued by companies. The federal funds rate is the interest rate at which banks lend reserves to each other overnight. The treasury bill rate is the rate at which the U.S. government sells its debt obligations.

Question 6

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 that businesses obtain from banks and through commercial paper are typically negotiated between the parties involved, but unsecured, meaning that they are not backed by collateral.

Question 7

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 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

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 10

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

Accepted Answer

A commitment fee is a fee that is typically charged on a revolving credit agreement. It is paid to the lender by the borrower and is usually a percentage of the unused portion of the credit line. The fee is meant to compensate the lender for keeping the credit line available to the borrower and for the risk that the borrower may not use the credit line.

Question 11

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 12

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 set by a lender where the borrower must keep a certain percentage of funds in a checking account to offset any risk associated with the loan. This percentage is usually based on the amount of the loan and can vary among lenders.

Question 13

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 requirement means the borrower must maintain a minimum balance in their account with the lender. This requirement can increase the overall cost of borrowing as the borrower may have to keep more money in the account than they would otherwise choose to. Additionally, if the borrower fails to maintain the required balance, they may face penalties or even default on the loan. Therefore, a compensating balance incentivizes the borrower to maintain a good relationship with the lender, but it can also increase the interest cost.

Question 14

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

Lines of credit are typically not guaranteed, meaning that the bank does not require collateral to secure the loan. They do specify the maximum amount that can be owed at any point in time, but this is not a guarantee or a requirement for the borrower to use the full amount.

Question 15

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 16

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 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

The major type of loan made by banks to businesses is short-term, self-liquidating loan. This type of loan is used to finance specific projects or inventory that generates enough revenue to pay off the loan within a short period of time. It is also known as a working capital loan. Fixed-asset-based loans and capital improvement loans are typically used for longer-term investments in the business, and short-term secured loans may be used for a variety of purposes but are typically secured by collateral.

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 rate on the loan is 4% + 1.5% = 5.5%.
To find the total interest, we need to calculate the interest for 90 days, using the simple interest formula:

Interest = Principal x Rate x Time
Interest = $250,000 x 0.055 x (90/365)
Interest = $3390.41

To find the effective annual rate, we need to use the following formula:

Effective annual rate = (1 + (nominal rate/m))^m - 1

where m is the number of compounding periods per year. In this case, the loan has a simple interest, so we need to set m = 1. Thus,

Effective annual rate = (1 + (0.055/1))^1 - 1
Effective annual rate = 0.055
Effective annual rate = 5.62%

Therefore, the best choice is A, with a total interest of $3390.41 and an effective annual rate of 5.62%.

Question 19

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 common covenants in a line of credit agreement that allows the bank to limit or restrict a borrower's ability to make significant changes in their operations or financial condition without approval. If the borrower violates these restrictions, the bank may choose to revoke the line of credit.

Question 20

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

Accepted Answer

This statement is true. Banks charge higher interest rates to risky borrowers to compensate for the higher probability of default. The premium charged above the prime rate is known as the risk premium.

Quiz 15: Current Liabilities Management