Chapter 08 – Sources of Short-Term Financing
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.
3. Small companies finance a relatively greater proportion of their assets through trade credit
than do larger concerns.
4. A trade discount is a percentage reduction from the invoice price given for purchasing
certain minimum quantities.
Chapter 08 – Sources of Short-Term Financing
5. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
6. Accounts payable is a spontaneous source of funds which grows as the business expands.
7. The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
8. Stretching the payment period refers to the practice of trying to take a trade discount after
the discount period.
9. On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days
of free credit.
10. Firms can almost always increase the amount of time they take to pay for purchases
without incurring problems.
11. Approximately 40% of short-term financing is in the form of accounts payable or trade
credit.
12. Trade credit is usually extended for periods of one year or more.
Chapter 08 – Sources of Short-Term Financing
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 borrow from its bank at 16 percent to take a cash discount. The terms
of the cash discount are 2/10, net 60. Leontief’s should borrow from the bank to take the
discount.
15. Myrdal Boots can borrow from its bank at 12 percent to take a cash discount. The terms of
the cash discount are 3/10, net 90. Myrdal Boots should borrow from the bank to take the
discount.
Chapter 08 – Sources of Short-Term Financing
16. Bank deregulation has eased competition between commercial banks, savings and loans,
brokerage houses, and new financial services companies.
17. 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.
18. The lender’s primary concern is whether the borrower’s capacity to generate receivables is
sufficient to liquidate the loan as it comes due.
19. Although the LIBOR has remained competitive and comparable to the US Prime rate, it
has remained slightly higher than the prime rate in the past 15 years.
Chapter 08 – Sources of Short-Term Financing
20. The London Interbank offered rate is used to set a base lending rate for some US domestic
corporate loans.
21. Although the prime rate is the rate that US banks charge their most credit-worthy
customers, the prime rate is normally higher than the London Interbank Offer Rate (LIBOR).
22. Compensating balances are important for banks because their existence allows them to
make loans at lower quoted rates.
23. A compensating balance will be lower in periods of tight money than in periods of credit
ease.
24. Compensating balances are a way for banks to recover the cost of corporate services
provided, but not directly charged.
25. Compensating balances represent unfair hidden costs of borrowing.
26. Monthly installment loans usually increase the effective rate of borrowing by
approximately 2 times the stated rate.
27. The annual percentage rate (APR) is a measure of the effective rate of interest on a loan
on an annualized basis.
Chapter 08 – Sources of Short-Term Financing
28. 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.
29. Commercial paper is an unsecured short-term IOU from a large financially secure
company.
30. It is easier for small firms to obtain financing through bank loans than through the
commercial paper market.
31. Small businesses frequently find commercial paper a useful means of obtaining funds
when it is not possible to raise funds by other means.
Chapter 08 – Sources of Short-Term Financing
32. Commercial paper represents secured short-term borrowing by large companies.
33. Issuers of commercial paper can be divided into direct paper, dealer paper, and asset-
backed commercial paper.
34. One major advantage of commercial paper is that it can always be “rolled over”(reissued)
when it matures.
35. All commercial paper involves the physical transfer of actual paper certificates.
36. Firms using commercial paper are generally required to maintain commercial bank lines
of credit equal to the amount of the paper outstanding.
Chapter 08 – Sources of Short-Term Financing
37. The commercial paper market is available to all New York Stock Exchange companies.
38. 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.
39. Finance paper usually carries a higher rate of interest than direct paper.
40. 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.
Chapter 08 – Sources of Short-Term Financing
41. Factoring accounts receivable, unlike pledging accounts receivable, typically passes the
risk of loss on the receivable to the buyer.
42. Eurodollar loans are similar to U.S. bank loans in that they are usually short-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 US dollars outside the United States.
Chapter 08 – Sources of Short-Term Financing
45. Even though a firm factors its receivables to a finance company, it is still liable if the
account becomes uncollectible.
46. The sale of securities backed by the receivables of large credit worthy firms is a large and
growing source of financing.
47. General Motors Acceptance Corp is one of the biggest issuers of asset-backed securities.
48. When Ford Motor found that it couldn’t utilize the asset-backed automobile receivables
market, they turned to the commercial paper market for financing.
Chapter 08 – Sources of Short-Term Financing
49. The biggest category of asset backed securities is the home equity loan, followed by
automobile receivables and credit card receivables.
50. 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.
51. The simplest inventory financing method is a blanket inventory lien where items are not
identified or tagged, and there is no physical transfer of control of the inventory from the
borrower.
52. A trust receipt acknowledges that the lender trusts the borrower to repay the loan before
any dividends are paid.
Chapter 08 – Sources of Short-Term Financing
53. The movement of the exchange rate can increase the total cost of a loan by making the
principal repayment require more money than the original amount of the loan.
54. The most common form of short-term financing is a bank loan.
55. The higher the cost of bank financing the more beneficial it is to take the cash discount.
56. A self-liquidating loan is preferable to a bank because it generally provides them with a
higher return.
Chapter 08 – Sources of Short-Term Financing
57. At historically low interest rate levels, compensating balances increase.
58. A term loan is less risky to the bank thus they provide a fixed rate to the customer.
59. The APR is generally lower than the stated rate by the bank.
60. What is generally the largest source of short-term credit small firms?
Chapter 08 – Sources of Short-Term Financing
61. Trade credit may be used to finance a major part of the firm’s working capital when
62. 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 its
customers?
63. The cost of not taking the discount on trade credit of 2/10, net 30 is equal to
Chapter 08 – Sources of Short-Term Financing
64. Large firms tend to be
65. From the banker’s point of view, short-term bank credit is an excellent way of financing
66. The cost of not taking the discount on trade credit of 3/20, net 90 is equal to
Chapter 08 – Sources of Short-Term Financing
67. Bank loans to business firms
68. Commercial bank term loans
69. Kantorovich Company normally takes 30 days to pay for its average daily credit purchases
of $2,000. Its average daily sales are $3,000, and it collects accounts in 25 days. What is its
net credit position? Note that a negative position implies receivables exceed payables.
Chapter 08 – Sources of Short-Term Financing
70. Recent problems facing the US financial system were the result of all of the following
except:
71. The prime rate
72. The London Interbank Offered Rate (LIBOR)
Chapter 08 – Sources of Short-Term Financing
73. LIBOR is
74. Compensating balances
75. General Rent-All’s officers arrange a $50,000 loan. The company is required to maintain a
minimum checking account balance of 10% of the outstanding loan. This practice is called