Deck 8: Sources of Short-Term Financing

Question 1

Financial managers may prefer financial futures markets in the United States to the Montreal Futures Exchange because of:

A) political uncertainty.
B) the use of U.S. dollars.
C) Chicago is closer to Toronto than Montreal.
D) greater liquidity.

Answer 1

D

Question 2

Which of the following is not a method for lenders to control pledged inventory?

A) Blanket inventory liens.
B) Trust receipts.
C) Warehousing.
D) Factoring.

Answer 2

D

Question 3

The cost of not taking the discount on trade credit of 3/10, net 30 is equal to:

A) 57.75%.
B) 55.67%.
C) 56.44%.
D) 36.50%.

Answer 3

C

Question 4

Canadian Tire Financial receives a better credit rating than Canadian Tire Canada because:

A) credit card receivables have a low default rate.
B) the interest rate on receivables is better than a Sears credit card.
C) a trust has the backing of the government through financial legislation.
D) securitization automatically qualifies for a better rating.

Question 5

The bank rate is determined by:

A) the chartered banks.
B) the yield on 91-day Treasury bills.
C) the prime rate.
D) the Bank of Canada overnight rate.

Question 6

The extent to which inventory financing may be used depends on:

A) prime rate of interest.
B) cost of goods.
C) how fragile the goods are.
D) how perishable the goods are.

Question 7

In financing accounts receivable, pledging uses receivables _______ while factoring uses receivables _________.

A) as collateral; to purchase
B) as collateral; to sell
C) to sell; as collateral
D) to sell; to purchase

Question 8

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?

A) Decreased receivables and increased bank loans.
B) Increased receivables and increased bank loans.
C) Increased payables and decreased bank loans.
D) Increased payables and increased bank loans.

Question 9

Multinational firms have found that they can lower borrowing costs:

A) by borrowing US dollars.
B) by issuing more debt.
C) by using more bankers' acceptances.
D) by borrowing foreign currencies through foreign subsidiaries at rates lower than the Canadian prime and then converting these foreign loans into dollars.

Question 10

The factoring of accounts receivable consists of:

A) selling accounts receivable at a profit.
B) pledging accounts receivable as collateral for a loan.
C) selling accounts receivable to raise working capital.
D) buying accounts receivable from a factor.

Question 11

Net credit position refers to:

A) the difference between receivables and payables.
B) the difference between receipts and disbursements.
C) the average collection period.
D) the average payment period.

Question 12

From the banker's point of view, short-term bank credit is an excellent way of financing:

A) capital assets.
B) permanent working capital needs.
C) repayment of long-term debt.
D) seasonal bulges in inventory and receivables.

Question 13

Commercial paper has an advantage that:

A) it has low probability of default.
B) it requires small compensating balances.
C) it is secured by an independent third party.
D) it requires no compensating balances.

Question 14

LIBOR is:

A) a resource used in production.
B) an interest rate paid on deposits of US dollars in the London market.
C) an interest rate paid by European firms when they borrow Eurodollar deposits from Canadian banks.
D) the interest rate paid by the British government on its long-term bonds.

Question 15

Trade credit may be used to finance a major part of the firm's working capital when:

A) the firm extends less liberal credit terms than the supplier.
B) the firm extends more liberal credit terms than the supplier.
C) the firm and the supplier both extend the same credit terms.
D) neither the firm nor the supplier extends credit.

Question 16

Which of the following is not a characteristic of commercial paper?

A) Issued by large prestigious firms.
B) One-to-two year maturity.
C) Rates are usually below prime rates on business loans.
D) Usually in denominations of $100,000 or more.

Question 17

General Rent-All's officers arrange a $50,000 loan. The company is required to maintain a minimum account balance of 10% of the outstanding loan in their chequing account. This is referred to as:

A) an instalment loan.
B) a compensating balance.
C) a discounted loan.
D) a balloon payment.

Question 18

In determining the cost of bank financing, which is the important factor?

A) Prime rate.
B) Nominal rate.
C) Annual rate.
D) Discount rate.

Question 19

What is generally the largest source of short-term credit for small firms?

A) Bank loans.
B) Commercial paper.
C) Installment loans.
D) Trade credit.

Question 20

Holland Construction Co. has an outstanding 180-day bank loan of $400,000 at an annual interest rate of 9.5%. The company is required to maintain a 15% compensating balance in its chequing account. What is the annual interest cost on the loan? Assume the company would not normally maintain this average amount.

A) 11.18%
B) 9.5%
C) 15.00%
D) 20.00%

Question 21

The required compensating balance is usually computed as a:

A) percentage of customer loans outstanding.
B) factor of accounts receivable.
C) the bank's commitment to LIBOR.
D) pledge of inventory value.

Question 22

Ms. Smith borrowed $1,250 at an 11% stated rate of interest and was to pay back the installment loan in 24 monthly payments. What is her annual rate of interest?

A) 10.56%
B) 11.60%.
C) 18.96%
D) 22.00%

Question 23

Hedging refers to:

A) avoiding high-risk investment opportunities.
B) a transaction that reduces risk exposure.
C) the same thing as asset diversification.
D) avoiding the financial futures market.

Question 24

Mr. Jones borrows $3,000 for 90 days and pays $35 interest. What is his annual rate of interest?

A) 1.2%
B) 3.5%
C) 4.7%
D) 11.7%

Question 25

Commercial paper that is sold without the use of an actual paper certificate is known as:

A) finance paper.
B) dealer paper.
C) book-entry paper.
D) term paper.

Question 26

The prime rate:

A) is the annual rate of interest for banks' best customers.
B) changes infrequently.
C) is usually lower than treasury bill rates.
D) is the annual rate of interest for the bank.

Question 27

Large firms tend to be:

A) net users of trade credit.
B) net suppliers of trade credit.
C) firms with high levels of profitability.
D) firms with low levels of inventory turnover and accounts receivable turnover.

Question 28

Which method of controlling pledged inventory provides the greatest degree of security to the lender?

A) Blanket inventory liens.
B) Overall inventory liens.
C) Trust receipts.
D) Warehousing.

Question 29

Bank loans to business firms:

A) are usually long-term in nature.
B) are preferred by the business not to be self-liquidating.
C) may require commercial paper to be issued.
D) may require compensating balances.

Question 30

Other things being equal, an increase in the number of days that a commercial bank loan is outstanding will mean:

A) a reduction in the banks risk.
B) an increase in the administration costs.
C) an increase in the dollar amount of the interest.
D) a reduction in the principal amount borrowed.

Question 31

If Analog computers can borrow at 9.5% for 3 years, what is the annual rate of interest on an $800,000 loan where a 15% compensating balance is required?

A) 11.18%.
B) 17.27%.
C) 9.50%.
D) 3.16%.

Question 32

The financial futures market:

A) is a place in Chicago or Toronto where future stocks are traded.
B) allows for the trading of a financial instruments at a future point in time.
C) is of particular value to small investors in managing their portfolios.
D) increases the cost of hedging.

Question 33

When calculating a loan with a 20% compensating balance a firm would borrow ____ in order to have available funds of $200,000.

A) $160,000
B) $200,000
C) $250,000
D) $260,000

Question 34

Bank term loans:

A) usually carry fixed interest rates.
B) are very short-term in nature.
C) are offered to superior credit applicants.
D) are risky for the borrower due to interest rate fluctuation.

Question 35

Firms exposed to the risk of interest rate changes may reduce that risk by:

A) obtaining a Eurodollar loan.
B) hedging in the financial futures market.
C) hedging in the commodities market.
D) pledging or factoring accounts receivable.

Question 36

A firm has invested in corporate bonds; it may engage in a financial futures contract in order to protect itself from:

A) declining interest rates.
B) rising interest rates.
C) inflation.
D) changes in hedging activities.

Question 37

Analog Computers needs to borrow $800,000 from the Midland Bank. The bank requires a 15% compensating balance. How much money will Analog need to borrow in order to end up with $800,000 spendable cash?

A) $920,000.
B) $1,058,264.
C) $941,177.
D) $800,000.

Question 38

Accounts receivable may be used as a source of financing by:

A) collecting the receivables.
B) writing off the receivables as bad debt expense.
C) buying securities backed by the receivables.
D) factoring the receivables to a finance company.

Question 39

The prime rate:

A) is the rate that banks are charged by the Bank of Canada.
B) was over 30% in the early 1980s.
C) is fixed over a long period of time.
D) is affected by economic and political factors.

Question 40

Commercial paper that is sold without going through a broker or dealer is known as:

A) direct paper.
B) dealer paper.
C) book-entry transactions.
D) term paper.

Question 41

The cost of forgoing the discount on trade credit of 1/10, net 30 is equal to:

A) 22.35%.
B) 18.43%.
C) 20.52%.
D) 12.00%

Question 42

You are considering buying a new big screen TV from the BIG Electronics Co. BIG has offered to finance your purchase by extending credit to you. The terms of the credit are 12 easy monthly payments of $95. If you choose to finance this purchase, rather than pay the cash price of $850, what would your annual interest on this loan be?

A) 20.63%
B) 34.12%
C) 57.99%
D) 74.56%

Question 43

The cost of forgoing the discount on trade credit of 4/10, net 90 is equal to:

A) 18.25%.
B) 19.01%.
C) 20.52%.
D) 12.13%.

Question 44

The London Interbank Offered Rate (LIBOR):

A) does not compete with the prime rate domestically for international firms.
B) often is lower than the domestic prime rate.
C) is the loan rate offered by London banks to its best customers.
D) is a stable international rate.

Question 45

Securitized paper:

A) is not part of the money market.
B) is off balance sheet financing.
C) is guaranteed by security firms.
D) is backed by a variety of assets.

Question 46

Francis Construction Co. has an outstanding 180-day bank loan of $600,000 at an annual interest rate of 8%. The company is required to maintain a 20% compensating balance in its chequing account. What is the annual interest cost on the loan? Assume the company would not normally maintain this average amount.

A) 8.0%
B) 9.5%
C) 10.0%
D) 6.40%

Question 47

Which of the following best describes the benefits to the borrower of selling asset backed securities?

A) Due to the portfolio effect, the borrower can package up low quality accounts receivable and sell them for a premium price.
B) The borrower trades current cash flows for future cash flows.
C) The asset-backed security may carry a better credit rating.
D) The borrower has collateral tied to the asset backed security.

Question 48

Bank loans to business firms:

A) are usually long-term in nature.
B) are preferred by the banker to be self-liquidating.
C) require compensating balances.
D) are always at a fixed rate.

Question 49

Which of the following is not a true statement about commercial paper?

A) Finance paper is sold directly to the lender by the finance company.
B) Finance paper is also referred to as direct paper.
C) Dealer paper is sold directly to the lender by a finance company.
D) Industrial companies, utility firms, or finance companies too small to sell direct paper will sell dealer paper.

Question 50

After treasury bills, the largest outstanding short-term security is:

A) commercial paper.
B) bankers' acceptances.
C) bearer deposit notes.
D) certificates of deposit.

Question 51

A large manufacturing firm has been selling on a 3/10, net 30 basis. The firm changes its credit terms to 3.5/9, net 25. What change might be expected on the balance sheets of its customers?

A) Decreased receivables and increased bank loans.
B) Increased receivables and increased bank loans.
C) Decreased payables and increased bank loans.
D) Increased payables and increased bank loans.

Question 52

The bank rate:

A) is the rate that the Bank of Canada charges Chartered banks.
B) is very stable over time.
C) is affected by economic and political factors.
D) is available to all bank customers.

Question 53

Compensating balances:

A) are used by banks as a substitute for charging service fees.
B) are created by having a concentration account.
C) generate returns to customers from interest bearing accounts.
D) are used to reward new accounts.

Question 54

Which of the following is a characteristic of commercial paper?

A) Issued by large firms.
B) One-to-two year maturity.
C) Rates are usually above prime rates on business loans.
D) Issued by small firms.

Question 55

Mrs. Robinson borrows $5,000 for 90 days and pays $80 interest. What is her annual rate of interest?

A) 1.6%
B) 6.49%
C) 12.98%
D) 6.40%

Question 56

Your employer needs to borrow $550,000 to finance inventory for the upcoming seasonal rush. BIG Bank has offered to finance the inventory at 8% provided that your employer keeps a compensating balance in its operating account of 8%. How much must your employer borrow to end up with the $550,000?

A) $597,826
B) $594,000
C) $588,500
D) $87,926

Question 57

Mr. Phelps borrows $3,000 for 30 days and pays $80 interest. What is his annual rate of interest?

A) 2.67%
B) 16.24%
C) 32.44%
D) 24.54%

Question 58

The cost of forgoing the discount on trade credit of 4/10, net 25 is equal to:

A) 101.32%.
B) 87.33%.
C) 28.8%.
D) 12.13%.

Question 59

The London Interbank Offered Rate (LIBOR):

A) competes with the prime rate domestically for international firms.
B) often is higher than the domestic prime rate.
C) is the loan rate offered by chartered banks to its best customers.
D) is the rate used when banks lend to each other.

Question 60

A term loan is usually characterized by:

A) maturity of ten to fifteen years.
B) a zero interest rate.
C) monthly or quarterly instalment payments.
D) securitization of inventory.

Question 61

Compensating balances represent unfair hidden costs of borrowing.

Question 62

It is difficult to acquire a loan in Canadian dollars outside Canada.

Question 63

A compensating balance will be lower in periods of tight money than in periods of credit ease.

Question 64

Compensating balances are a way for banks to recover the cost of corporate services provided, but not directly charged.

Question 65

A trade discount is a percentage reduction from the invoice price given for purchasing certain minimum quantities.

Question 66

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.

Question 67

Financial institution deregulation has eased competition between banks and foreign financial institutions.

Question 68

The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.

Question 69

Small businesses frequently find commercial paper a useful means of obtaining funds when it is not possible to raise funds by other means.

Question 70

Laura's Book Shoppe is going to borrow $50,000 for 90 days at an annual rate of 9%. The amount of interest owing in 90 days will be:

A) $4,500.00
B) $1,109.59
C) $1,225.00
D) $1,009.59

Question 71

Small companies finance a relatively greater proportion of their assets through trade credit than do larger concerns.

Question 72

Commercial paper was a popular financing method before the credit crunch of 2007-08 due to:

A) Higher borrowing rates for qualified firms compared to bank rates.
B) Decreased ability of corporations to raise short-term funds.
C) Decrease in government borrowing.
D) Lower costs to borrowers for bankers' acceptances.

Question 73

Compensating balances have been important for banks because their existence allows them to make loans at lower quoted rates.

Question 74

Commercial paper is an unsecured short-term IOU from a large financially secure company.

Question 75

Although the LIBOR has remained competitive and comparable to the Canadian prime rate, it has remained slightly higher than the prime rate.

Question 76

Accounts payable is a spontaneous source of funds that grows as the business expands.

Question 77

Stretching the payment period refers to the practice of trying to take a trade discount after the discount period.

Question 78

Larger firms tend to be net users of trade credit.

Question 79

The largest source of short-term funds for most companies is suppliers (trade credit).

Question 80

On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days of free credit.