13) The cost of borrowing through the sale of commercial paper is typically ________ the prime
bank loan rate.
A) lower than
B) the same as
C) unrelated to
D) higher than
14) A firm issued $2 million worth of commercial paper that has a 90-day maturity and sells for
$1,900,000. The annual interest rate on the issue of commercial paper is ________ (assume 360
days in a year).
A) 5.26 percent
B) 10 percent
C) 17.77 percent
D) 21.05 percent
15) 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
16) 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%
17) 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
18) 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
19) 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?
20) 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).
15.5 Explain the characteristics of secured short-term loans and the use of accounts receivable
as short-term-loan collateral.
1) Secured short-term financing has specific assets pledged as collateral.
2) The security agreement is an agreement between the borrower and the lender that specifies the
collateral held against a secured loan.
3) 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.
4) 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.
5) Commercial finance companies are lending institutions that make only unsecured loans-both
short-term and long-term—to businesses.
6) 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.
7) The interest rate charged on secured short-term loans is always equal to the rate on unsecured
short-term loans.
8) The outright sale of accounts receivable at a discount in order to obtain funds is called
pledging accounts receivable.
9) 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.
10) The higher cost of unsecured as opposed to secured borrowing is due to the greater risk of
default.
11) 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.
12) 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.
13) 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.
14) 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.
15) The percentage advanced by a lender constitutes the principal of a secured loan and varies
according to the type and liquidity of the collateral.
16) The pledging cost of accounts receivable is normally 2 to 5 percent above the prime rate.
17) In pledging accounts receivable, the percentage advanced against the adjusted collateral is
determined by the borrower based on its overall evaluation on the quality of the acceptable
receivables and the expected cost of the liquidation.
18) Factoring accounts receivable is relatively an inexpensive source of unsecured short-term
funds.
19) Factoring accounts receivable is relatively an expensive source of unsecured short-term
funds.
20) Factoring accounts receivable is relatively an inexpensive source of unsecured short-term
funds that allows firms to turn accounts receivable immediately into cash.
21) Factoring accounts receivable is relatively an expensive source of secured short-term funds
that allows firms to turn accounts receivable immediately into cash.
22) Collateral is typically required for a ________.
A) secured short-term loan
B) line of credit
C) short-term, self-liquidating loan
D) single-payment note
23) An appropriate collateral for a secured short-term loan is ________.
A) fixed assets
B) accounts receivables
C) common stock in a privately-held corporation
D) bank over-draft
24) Financing that matures in one year or less and has specific assets pledged as collateral is
called ________.
A) unsecured long-term financing
B) unsecured short-term financing
C) secured short-term financing
D) secured long-term financing
25) Lenders of secured short-term funds prefer collateral ________.
A) as it reduces the risk of default
B) that are liquid assets
C) to reduce the losses if the borrower defaults
D) so that they can charge a higher interest rate
26) ________ involves the sale of accounts receivable.
A) Trust receipt loan
B) Factoring
C) Field warehouse arrangement
D) Pledging of accounts receivable
27) A ________ agreement normally states the exact conditions and procedures for the purchase
of an account.
A) factoring
B) pledging accounts receivable
C) revolving credit
D) line of credit
28) The stated cost of a pledge of accounts receivable is normally ________ above the prime
rate.
A) 6 to 8 percent
B) 2 to 5 percent
C) 4 to 9 percent
D) 6 to 10 percent
29) Which of the following is a disadvantage of factoring?
A) ensures an uneven pattern of cash flows
B) eliminates credit and collection departments
C) turns accounts receivable into cash quickly
D) highly expensive source of short-term financing
30) Which of the following creates a secured short-term loan with accounts receivable?
A) lines of credit
B) commercial paper
C) pledge of accounts receivable
D) factoring of accounts receivable
31) The primary source of secured short-term loans to businesses are ________.
A) commercial banks and commercial finance companies
B) lines of credit and revolving lines of credit
C) commercial paper dealers and investment bankers
D) life insurance companies and government securities brokers
32) Pledges of accounts receivable are made on ________ basis, respectively.
A) a nonrecourse and a notification
B) a nonnotification and a notification
C) a notification and a recourse
D) a notification and a nonrecourse
33) Which of the following is an advantage of factoring?
A) accounts receivable immediately turned into cash
B) addition of credit and collection departments
C) less costly form of secured short-term loans
D) improves current ratio
34) Lenders recognize that by having an interest in collateral they can reduce losses if the
borrowing firm defaults, ________.
A) and the presence of collateral reduces the risk of default
B) but the presence of collateral has no impact on the risk of default
C) therefore lenders prefer to lend to customers from whom they are able to demand collateral
D) therefore lenders will impose a higher interest rate on unsecured long-term borrowing
35) Aunt Tilly’s Feeds, Inc. is considering obtaining funding through advances against
receivables. Total annual credit sales are $600,000, terms are net 30 days, and payment is made
on an average of 30 days. Western National Bank will advance funds under a pledging
arrangement for 13 percent annual interest. On average, 75 percent of credit sales will be
accepted as collateral. Commodity Finance offers factoring on a nonrecourse basis for a 1
percent factoring commission, charging 1.5 percent per month on advances and requiring a 15
percent factor’s reserve. Under this plan, the firm would factor all accounts and close its credit
and collections department, saving $10,000 per year.
(a) What is the effective interest rate and the average amount of funds available under pledging
and under factoring?
(b) Which plan do you recommend? Why?
15.6 Describe the various ways in which inventory can be used as short-term-loan collateral.
1) A floating inventory lien is a lender’s claim on the borrower’s general inventory as collateral
for a secured loan.
2) A trust receipt inventory loan is an arrangement in which the lender receives control of the
pledged inventory collateral, which is stored by a designated agent.
3) Inventory is more attractive than accounts receivable as a short-term collateral since it
normally has a market value greater than its book value, which is used to establish its value as
collateral.
4) A floating inventory lien is most attractive when the firm has a stable level of inventory that
consists of a diversified group of relatively inexpensive merchandise.
5) Under the floating inventory lien, the borrower is free to sell the merchandise and is expected
to remit the amount lent against each item, along with accrued interest, to the lender immediately
after the sale. The lender then releases the lien on the appropriate item.
6) Appropriate collateral for a loan secured under a floating inventory lien is ________.
A) cars
B) granite slabs
C) air conditioners
D) paper clips
7) Appropriate collateral for a loan secured under a trust receipt inventory loan is ________.
A) drill bits
B) pencils
C) vehicles
D) bolts
8) A terminal warehouse is ________.
A) a warehouse located beyond city limits for storing the merchandise
B) a warehouse on the borrower’s premises to store the merchandise
C) a central warehouse storing the merchandise of various customers
D) a warehouse located near the lender’s home for storing the merchandise
9) A field warehouse is ________.
A) a warehouse outside the metropolitan area
B) a warehouse on the borrower’s premises
C) a central warehouse storing the merchandise of several businesses
D) a warehouse located near the lender
10) Discuss and contrast the three types of loans discussed in the text that use inventory as
collateral: floating inventory liens, trust receipt inventory loans, and warehouse receipt loans.