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 do specify a maximum limit on how much a firm can owe the bank at any point in time. This limit can be adjusted over time as the bank reviews the firm's creditworthiness.

Question 2

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 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

Lines of credit provide a maximum credit limit for a borrower but are not guaranteed loans. The borrower is only charged interest on the amount that they borrow from the line of credit, up to the maximum limit.

Question 4

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, also known as material adverse change (MAC) clauses, give the bank the right to revoke a line of credit if a major change occurs in the borrower's financial condition or operations. This protects the bank's investment and reduces the risk of default.

Question 5

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 some lenders that the borrower maintain a minimum balance in a checking account equal to a certain percentage of the outstanding loan amount. This helps to mitigate the risk for the lender and may lower the interest rate charged to the borrower.

Question 6

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 7

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.)

Accepted Answer

First, we need to calculate the interest on the loan:
Interest = Principal x Rate x Time
Principal = $250,000
Rate = 4% + 1.5% = 5.5%
Time = 90 days / 365 days = 0.2466 years

Interest = $250,000 x 5.5% x 0.2466 ≈ $3,390.41

Next, we need to calculate the effective annual rate using the following formula:
Effective Annual Rate = (1 + (Rate / n))^n - 1
Where n = number of compounding periods per year

Since the loan is for 90 days, there are approximately 4 compounding periods per year (365 days / 90 days ≈ 4.056)

Effective Annual Rate = (1 + (5.5% / 4))^4 - 1 ≈ 5.62%

Therefore, the best choice is A.

Question 8

The major type of loan made by banks to businesses is the ________.

Accepted Answer

Short-term,self-liquidating loan is the best choice. This type of loan is typically used to finance a specific project or purchase and is designed to be repaid through the cash flow generated by the project or through the sale of the asset being financed. This type of loan is typically lower risk for lenders and can provide businesses with the capital they need to grow and expand without taking on unnecessary debt.

Question 9

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 10

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 11

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 12

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 is a minimum amount of funds a borrower must keep on deposit with a bank as a condition of a loan or credit. This is done to ensure that the bank has access to the borrower's funds in case the borrower defaults on the loan. The amount of the compensating balance may be based on a percentage of the loan amount, and the borrower does not earn interest on the funds held in the account. This means that the borrower is effectively paying interest on the funds held in the account, which raises the interest cost of the loan. In addition, if the borrower fails to maintain the minimum balance, the bank may impose a penalty or renegotiate the terms of the loan. All of these factors make compensating balances a costly option for borrowers.

Question 13

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 14

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

Accepted Answer

It is generally true that the higher the riskiness of a borrower, the higher the premium charged above the prime rate by a banker. This is because banks want to mitigate the risk of lending to high-risk borrowers by charging a higher interest rate, which helps to compensate for the higher likelihood of default or other losses. Conversely, for low-risk borrowers, banks may charge a lower premium or offer a more favorable interest rate, as these borrowers pose less of a risk to the bank.

Question 15

Short-term,self-liquidating loans are intended to ________.

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

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 ________.

Accepted Answer

A single-payment note is a type of loan that is usually made for a specific purpose and for a short period of time. This type of loan is often used to bridge a temporary gap in funding, such as when a borrower needs cash for a short period of time until they receive payment from a different source. Compared to other types of loans, single-payment notes typically have a shorter repayment term and higher interest rates.

Question 17

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

Accepted Answer

This is because with a discount loan, the interest is deducted from the loan amount upfront, so the borrower receives less money than the stated loan amount. This means that the borrower effectively pays back more money than they received, resulting in a higher effective interest rate.

Question 18

Short-term loans that businesses obtain from banks and through commercial paper are ________.

Accepted Answer

Short-term loans obtained from banks and commercial paper are typically negotiated, meaning the terms are agreed upon between the borrower and lender. However, they are often unsecured, meaning there is no collateral put up to secure the loan.

Question 19

The ________ is a rate of interest charged on business loans by the nation's leading banks to creditworthy business borrowers.

Accepted Answer

The prime rate is the rate of interest that banks charge their most creditworthy customers for short-term loans. It is widely used as a benchmark for setting interest rates on other loans, such as those for mortgages and credit cards.

Question 20

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

Accepted Answer

A commitment fee is a fee that a borrower pays to a lender to compensate the lender for the time and effort it takes to set up a credit facility, regardless of whether the borrower actually uses the credit. It is commonly associated with revolving credit agreements, where the lender makes a certain amount of funds available to the borrower, but the borrower only uses the funds as needed. The commitment fee ensures that the lender is compensated for the risk and administrative costs associated with having the funds available.

Quiz 15: Current Liabilities Management