Chapter 08 Test Bank – Static Key
1. The largest source of short-term funds for most companies is suppliers (trade credit).
2. Larger firms tend to be net users of trade credit, rather than net providers.
3. Small companies finance a relatively greater proportion of their assets through trade credit than do larger
firms.
4. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
5. Accounts payable is a spontaneous source of funds that usually grows as the business expands.
6. The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
7. “Stretching the payment period” refers to the practice of trying to take a trade discount after the discount
period.
8. On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days of free
credit
9. Firms can almost always increase the amount of time they take to pay for purchases without incurring
problems.
10. Approximately 40% of all short-term financing is in the form of accounts payable or trade credit.
11. Approximately 40% of all short-term financing is in the form of loans from the bank.
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12. Trade credit is usually extended for periods of one year or more.
13. A cash discount calls for a reduction in price if payment cannot be made within a specified time period.
14. Leontief’s Wigs can take a cash discount but has to borrow money from the bank to do so. The bank
offers a 16% interest rate. The terms of the cash discount are 2/10, net 60. Because of this; Leontief’s
should borrow from the bank to take the discount.
15. Myrdal Boots can take a cash discount but has to borrow money from the bank to do so. The bank
offers a 12% interest rate. The terms of the cash discount are 3/10, net 90. Because of this, Myrdal Boots
should borrow from the bank to take the discount.
16. Even during slack loan periods, banks will never loan out money at an interest rate lower than the prime
rate because the prime rate is their best rate.
17. The lender’s primary concern is whether the borrower’s capacity to generate accounts receivables is
sufficient to liquidate the loan as it comes due.
18. The London Interbank Offered Rate (LIBOR) is used to set a base lending rate for some U.S. domestic
corporate loans.
19. Although the prime rate is the rate that U.S. banks charge their most credit-worthy customers, the prime
rate is normally higher than the London Interbank Offered Rate (LIBOR).
20. Compensating balances are important for banks because their existence allows them to make loans at
lower quoted rates.
21. A compensating balance will be lower in periods of tight money than in periods of credit easing.
22. Compensating balances are a way for banks to recover the cost of corporate services provided, but not
directly charged.
23. Compensating balances represent unfair hidden costs of borrowing.
24. Monthly installment loans usually increase the effective interest rate of borrowing by approximately 2
25. The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an
annualized basis.
26. The term “credit crunch” refers to a period in which the interest rate on credit is so high that firms
cannot afford to borrow money.
27. Commercial paper is an unsecured short-term IOU from a large financially secure company.
28. It is easier for small firms to obtain financing through bank loans than through the commercial paper
market.
29. Small businesses frequently find commercial paper a useful means of obtaining funds when it is not
possible to raise funds by other means.
30. Commercial paper represents secured short-term borrowing by large companies.
31. Issuers of commercial paper can be divided into finance paper or direct paper, dealer paper, and asset–
backed commercial paper.
32. One major advantage of commercial paper is that it can always be “rolled over” (reissued) when it
matures.
33. All commercial paper involves the physical transfer of actual paper certificates.
34. Firms using commercial paper are generally required to maintain commercial bank lines of credit equal
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35. The commercial paper market is available to all New York Stock Exchange companies.
36. One major disadvantage of commercial paper is that if the company‘s credit quality declines,
refinancing existing commercial paper might be impossible to achieve through a new issue of commercial
paper.
37. Finance paper usually carries a higher rate of interest than direct paper.
38. Finance paper, unlike commercial paper, represents a long-term, unsecured promissory note.
39. One advantage to an issuer of commercial paper is that the issuer eliminates the need for maintaining
compensating balances and credit lines with a commercial bank.
40. Factoring accounts receivable, unlike pledging accounts receivable, typically passes the risk of loss on
the accounts receivable to the buyer.
41. One major advantage of factoring accounts receivable is that the selling firm receives money from its
accounts receivable faster than if it waited until the customers paid.
42. Eurodollar loans are similar to U.S. bank loans in that they are usually short-term to intermediate-term
in nature.
43. In times of tight credit in the United States, Eurodollar loans become difficult to obtain.
44. It is difficult to acquire a loan in U.S. dollars outside the United States.
45. The sale of securities backed by the receivables of large credit-worthy firms is a large and growing
source of financing.
46. General Motors Acceptance Corporation (GMAC) is one of the biggest issuers of asset-backed
securities.
47. The biggest categories of asset-backed securities are the home equity loans, automobile receivables,
and credit card receivables.
48. The sale of asset-backed securities can sometimes enable the issuing firm to acquire lower-cost funds
than it normally would receive from a bank loan or bond offering.
49. A blanket inventory lien is where items are not identified or tagged, and there is no physical transfer of
control of the inventory from the borrower.
50. A trust receipt acknowledges that the lender trusts the borrower to repay the loan before any dividends
are paid.
51. The movement of the exchange rate between two currencies can increase the total cost of a loan by
making the principal repayment require more money than the original amount of the loan.
52. The most common form of short-term financing is a bank loan.
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53. The higher the cost of bank financing, the more beneficial it is to take the cash discount.
54. A self-liquidating loan is preferable to a bank because it generally provides them with a higher return.
55. At historically low interest rate levels, compensating balances increase.
56. A term loan is less risky to the bank, thus they provide a fixed rate to the customer.
57. The annual percentage rate (APR) is generally lower than the interest rate stated by the bank.
58. Hedging refers to a transaction that avoids any financial risks.
59. Companies to can hedging to eliminate all or some foreign currency risk.
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60. What is generally the largest source of short-term credit for small firms?
61. Trade credit may be used to finance a major part of a firm’s working capital when
62. Trade credit is considered what type of loan?
63. A large manufacturing firm has been selling on a 3/10, net 30 basis. The firm changes its credit terms to
2/20, net 90. What change might be expected on the balance sheets of the manufacturing firm?
64. The cost of not taking the discount on trade credit of 2/10, net 30 is approximately ______.
65. Large firms tend to be
66. From the banker’s point of view, short-term bank credit is an excellent way of financing
67. The cost of not taking the discount on trade credit of 3/20, net 90 is approximately ______.
68. Bank loans to business firms
69. Commercial bank term loans
70. Kantorovich Company normally takes 30 days to pay for its average daily credit purchases of $2,000. It
has average daily sales of $3,000, and collects accounts in 25 days. What is its net credit position?
71. Recent problems facing the U.S. financial system were the result of all but which one of the following?
72. The prime rate