Question 1

Lenders recognize that holding collateral can reduce losses if the borrower defaults,but the presence of collateral has no impact on the risk of default.

Accepted Answer

The answer of Lenders recognize that holding collateral can reduce...

Question 2

The interest rate charged on secured short-term loans is always equal to the rate on unsecured short-term loans.

Accepted Answer

The interest rate charged on secured short-term loans is generally lower than the rate on unsecured short-term loans because the lender has collateral to seize in case of default.

Question 3

The outright sale of accounts receivable at a discount in order to obtain funds is called pledging accounts receivable.

Accepted Answer

The correct term for the sale of accounts receivable at a discount is factoring. Pledging accounts receivable refers to offering them as collateral for a loan.

Question 4

Tangshan Mining issued $1,000,000 of commercial paper for $992,500 for 45 days.Based on this information,the effective annual rate of interest on the commercial paper would be ________ (assume 360 days in a year).
A) 6.13%
B) 6.20%
C) 6.32%
D) 6.08%

Accepted Answer

The formula to calculate effective annual rate is:

Effective Annual Rate (EAR) = [(1 + periodic rate)^(number of periods per year) - 1]

Here, the periodic rate would be the discount yield, which can be calculated as:

Discount Yield = (face value - purchase price) / face value
Discount Yield = ($1,000,000 - $992,500) / $1,000,000
Discount Yield = 0.0075

The number of periods per year is 360/45 = 8

Plugging these values into the EAR formula, we get:

EAR = [(1 + 0.0075)^8 - 1]
EAR = 0.061993 or 6.1993%

Rounding this off to two decimal places, we get an effective annual rate of 6.20%. Thus, the best choice is B.

Question 5

Tina's Apple Company would like to manufacture and market a new packaging.Tina's has sold an issue of commercial paper for $1,500,000 and maturity of 90 days to finance the new project.Compute the annual interest rate on the issue of commercial paper if the value of the commercial paper at maturity is $1,650,000 (assuming 360 days in a year).

Accepted Answer

The answer of Tina's Apple Company would like to manufacture...

Question 6

Fixed assets are the most desirable short-term-loan collateral since they normally have a longer life,or duration,than the term of the loan.

Accepted Answer

Fixed assets are not the most desirable short-term-loan collateral because their longer life and potential difficulty in liquidation make them less suitable for short-term loans, which typically prefer more liquid assets as collateral.

Question 7

The higher cost of unsecured as opposed to secured borrowing is due to the greater risk of default.

Accepted Answer

The answer of The higher cost of unsecured as opposed...

Question 8

Commercial finance companies are lending institutions that make only unsecured loans-both short-term and long-term-to businesses.

Accepted Answer

Commercial finance companies may offer both secured and unsecured loans to businesses, not only unsecured loans.

Question 9

Factoring accounts receivable is not a form of secured short-term borrowing.It entails the sale of accounts receivable at a discount to obtain the required short-term funds.

Accepted Answer

Factoring accounts receivable involves selling the receivables at a discount, rather than using them as collateral for a loan. Therefore, it is not a form of secured short-term borrowing.

Question 10

A firm has directly placed an issue of commercial paper that has a maturity of 60 days.The issue sold for $980,000 and has an annual interest rate of 12.24 percent.The value of the commercial paper at maturity is ________ (assume 360 days in a year).
A) $19,992
B) $980,000
C) $1,000,000
D) $960,008

Accepted Answer

The value of the commercial paper at maturity can be calculated as:
Value of commercial paper = Face value + (Face value x annual interest rate x time period)
Time period = 60/360 = 1/6 years
Value of commercial paper = $980,000 + ($980,000 x 0.1224 x 1/6) = $1,000,000

Question 11

Pledges of accounts receivable are normally made on a nonnotification basis,meaning that a customer whose account has been pledged as collateral is not notified.

Accepted Answer

Pledges of accounts receivable are typically made on a nonnotification basis, which means the customer is not notified when their account is used as collateral.

Question 12

Secured short-term financing has specific assets pledged as collateral.

Accepted Answer

Secured short-term financing requires specific assets to be pledged as collateral for the loan or financing. This collateral provides a form of security for the lender in case the borrower defaults on the loan.

Question 13

Bessey Aviation has just sold an issue of 30-day commercial paper with a face value of $5,000,000.The firm has just received $4,958,000.What is the effective annual interest rate on the commercial paper?

Accepted Answer

The answer of Bessey Aviation has just sold an issue...

Question 14

A letter written by a company's bank to the company's foreign supplier,stating that the bank will guarantee payment of an invoiced amount if all the underlying agreements are met is called ________.
A) a letter of invoice
B) a letter of intent
C) a letter of credit
D) commercial paper

Accepted Answer

A letter of credit is a written commitment by a bank to pay an invoiced amount on behalf of its customer, the buyer, to the supplier, provided that all the underlying agreements have been met. The bank's letter assures the supplier that the buyer has the financial capacity to pay for the goods or services ordered, and that the supplier will receive payment as agreed upon. Therefore, a letter of credit minimizes financial risk for both the buyer and supplier in international trade transactions.

Question 15

The security agreement is an agreement between the borrower and the lender that specifies the collateral held against a secured loan.

Accepted Answer

The security agreement is a legally binding contract that outlines the specific assets or property that the borrower pledges as collateral for the loan. It establishes the rights of the lender to seize and sell the collateral if the borrower defaults on the loan.

Question 16

Nonrecourse basis is the basis on which accounts receivable once sold to a factor,the factor accepts all the credit risks on the purchased accounts.

Accepted Answer

Nonrecourse basis means that the factor assumes all the credit risks on the purchased accounts receivable.

Question 17

Pledges of accounts receivable are never made on a notification basis because the lender does not trust the borrower to collect the pledged account receivable and remit these payments as they are received.

Accepted Answer

Pledges of accounts receivable are often made on a notification basis, where the borrower is responsible for collecting the pledged accounts receivable and remitting payments to the lender as they are received. This arrangement is common in factoring and invoice financing.

Question 18

A U.S.-based company that exports goods and has accounts receivable denominated in a foreign currency ________.
A) faces no risk if the relations between the countries get rough
B) faces the risk that the U.S. dollar will depreciate in value relative to the foreign currency
C) faces the risk that the U.S. dollar will appreciate in value relative to the foreign currency
D) faces the risk that the foreign currency would appreciate in value relative to the U.S dollar

Accepted Answer

The U.S.-based company faces the risk that the U.S. dollar will appreciate in value relative to the foreign currency, which would make their export goods more expensive and less competitive in the foreign market. This would result in a decrease in revenue and profits.

Question 19

One advantage of factoring accounts receivable is the ability it gives a firm to turn accounts receivable immediately into cash without having to worry about repayment.

Accepted Answer

Factoring accounts receivable involves selling the receivables to a third party for immediate cash, which eliminates the need to wait for customers to pay and reduces the risk of non-payment. The factoring company then takes responsibility for collecting payments from customers.

Question 20

Commercial finance companies usually charge a higher interest on secured short-term loans than commercial banks because the finance companies generally ends up with higher-risk borrowers.

Accepted Answer

Commercial finance companies often deal with borrowers who may not qualify for loans from traditional commercial banks due to their credit scores and other factors, which increases the risk for the finance company. As a result, they charge a higher interest rate to offset this risk.

Quiz 15: Current Liabilities Management