BUSI320 Chapter 8

Jones company is considering changing its credit term from 30 days to 45 days. If daily credit sales are $3,000 and the balance in accounts payable is $120,000, then as a result of this change, the company's net trade credit position will become:

$15,000 Reason: Net credit position = (45 × $3,000) - $120,000 = $15,000

Jones Company borrows $125,000 (net) from First National Bank. The bank requires a 20% compensating balance. What is the gross amount of the loan?

$156,250

Calculate the interest rate with compensating balance given annual interest rate of 20 percent and a compensating balance of 4 percent.

20.83 percent

Trade credit is usually extended for

30 to 60 days

Failing to pay in time to take the cash discount when the terms are 2/10 Net 30 results in an interest rate of approximately

37% Reason: Cost of failing to take a cash discount = (2%/(100% - 2%) X (360 / (30 - 10)= 36.73%

Companies sometimes convert receivables to cash before they are due. When a company sells its receivables, it is called (pledging/factoring). When a company uses receivables as collateral for a bank loan, it is called (pledging/factoring).

Blank 1: factoring or factor Blank 2: pledging or pledge

Jones Corporation is considering borrowing money in a foreign country denominated in the foreign currency and converting it to US funds for use in the USA. What should Jones Co. consider before doing this?

Currency risk

Jones Company accepts credit cards resulting in outright sale of receivables to credit card company. Which of the following is true regarding this arrangement?

Jones is factoring receivables.

Jones Company borrows from the bank, using the accounts receivable as security. Which of the following are true of this situation?

Jones still owns the receivables Jones is probably liable if the customer does not pay Jones is pledging the receivables

Jones Company borrows $125,000 from First National Bank. The bank requires a 10% compensating balance. Which of the following are true regarding this loan?

Jones will pay interest on $125,000 Jones will have use of $112,500

Which of the following is true regarding blanket inventory liens?

Lender has lien on all inventory. Lender has lien on inventory obtained after loan is made. Specific inventory items are not identified.

Blank 1Blank 1 London , Correct Unavailable_ is the center of Eurodollar deposits

London

Commercial paper may be issued at below the _____ _____ _____

Prime Interest rate

Which is NOT an example of events that cause lenders in commercial paper market to become risk-averse?

Rapid growth of money market mutual funds

Identify a true statement about self-liquidating loans.

They are often used for seasonal financing and for building up inventories.

Of the following, which one would have the lowest collateral value to a bank or lender?

Work in process

Trade credit is another name for

account payable

What are some characteristics of commercial paper?

at least $25,000 unsecured short term

Carly Corp. factored accounts receivable that had a book value of $100,000 to First Bank. The transfer was made without recourse. First Bank charged a 4% factoring fee and retained $5,000 to provide a reserve against potential sales returns and allowances. Management estimates the fair value of the last 9% of receivables to be equivalent to the book value. The journal entry Carly will make to record the factoring arrangement will include a

debit to loss on sale of receivables for $4,000.

Agreements to maintain compensating balances should be Blank______ in the financial statements.

disclosed

Compensating balances (do or don't) earn interest.

don't

The sale of accounts receivables to obtain short-term financing is referred to as Blank______ receivables.

factoring

Commercial paper are issued by Blank______ corporations.

large

From 1997 to 2012 the LIBOR rate has usually been Blank______ the prime rate.

lower than

Bankers can oftentimes be hesitant to allow a term loan to affix to a single rate. Rather, they prefer the interest rate to change with _ _.

market Blank 2: conditions

A compensating balance requirement is similar to a Blank______ requirement.

minimum balance

Commercial paper is traded in the Blank______.

money markets

The relationship between accounts receivable and accounts payable is called

net credit position

Hedging is used to

reduce a prior risk exposure.

The assets pledged to secure a loan are called

secured assets. collateral.

Assigning or pledging accounts receivable is used in a

secured borrowing.

In contrast to pledging accounts receivables, when factoring is used, the accounts receivables are Blank______ to the non-bank company providing the financing.

sold to

Commercial paper is backed by

the name and reputation of the issuing company.

The time between the sale and the due date of payment is called:

the payment period

The prime rate is best described as

the rate charged to the most credit worthy customers.

Installment loans are a cheaper alternative to credit cards because:

their interest rates are often lower than credit card rates. they are cheaper over many months or years when an extended payment period is needed.

Selling a Treasury bond futures contract will result in a profit if interest rates go down.

False

Another name for trust receipt financing is

Floor planning

The 1968 Truth in Lending Act was intended to protect:

Individual borrowers

What does LIBOR indicate?

It is the rate that most international banks charge one another for dollar denominated loans in the London market.

A positive net credit position would indicate that

Receivables are more than payables

Which of the following are reasons why a transferor prefers the sale approach over the secured borrowing approach of transferring receivables? (Select all that apply.)

The transferor seems more liquid The transferor seems more profitable The transferor seems less leveraged

Foreign loan rates are often lower than U.S. loan rates which creates an incentive for US firms to utilize foreign borrowing.

True

A company that secures a loan from a financial institution by pledging accounts receivable balances as collateral will recognize a Blank______ Blank______ in the financial statements.

loan payable

A company that has a higher accounts payable balance than accounts receivable balance is considered a Blank______ of trade credit.

net user

To combat inflation, the Federal Reserve sometimes will

tighten the money supply.

An installment loan usually requires

- payment of accrued interest & part principal. - a series of equal payments.

The risks of commercial paper include:

- possibility of default - potential for a liquidity freeze

A firm borrows $100,000 at 10 percent annual interest plus a 5 percent compensating balance requirement. As a result, the effective interest rate is Blank______ percent.

10.53 Reason: (.1 × $100,000)/[$100,000 × (1 - .05)] = 10.53%

If the bank uses a _____ loan and deducts the interest in advance, the effective rate of interest _____.

Discounted increases

A 5/10, net 30 cash discount means that the customer will receive a 10% discount if they remit funds 5 days after billing.

False

Oyster Fields has an average payment period of 21 days as compared to its industry average of 33 days. Suppliers in the industry have a 30-day credit policy. Which one of these statements most applies to Oyster Fields?

Oyster Fields is not maximizing its use of free financing.

Oyster Fields has an average payment period of 30 days. If Oyster Fields increases the average payment period to 60 days, Blank______.

Oyster Fields' credit rating may be diminishing with local credit bureaus.

During tight money periods most banks charge Blank______ the prime rate.

more than

An individual borrows $1,000 from the bank for one year from the bank. The loan requires equal monthly payments. The loan officer states the total interest will be $60. The effective rate on the loan will be

more than 6%

A company that has a positive net credit position is considered a Blank______ of trade credit.

net provider

The Truth in Lending act requires

use of the actuarial method to calculate interest disclosure of the effective rate

Calculate the effective interest rate (APR) on a 6-month loan of $6,000 at a 10 percent interest rate (discount basis).

10.53% Reason: = ($6,000 × 10% × (6 / 12)) / (($6,000 - 300) × (6 / 12)) = 10.53%

A firm has an operating cycle of 87 days, an inventory period of 36 days, and an average payment period of 39 days. How long is the cash cycle?

48 days Reason: Cash cycle = 87 days - 39 days = 48 days

Ezze Mattress needs to raise $200,000 for 6 months. The bank quotes a discount interest rate of 7.5% but does not require compensating balances. What is the effective annual interest rate on this loan?

7.79% Reason: $7,500/($200,000-$7,500)*360/180 = 7.79%

Goods in process used as collateral typically qualify a firm for a higher loan than raw material or finished goods.

False

True or false: Commercial paper represents a long-term, secured promissory note issued to the public in minimum units of $25,000.

False

True or false: In the last decade there has been a sharp decline in the use of the term loan

False

When a firm has a high credit rating, the lender will usually require collateral to secure the loan.

False Reason: A firm with a low credit rating will usually be required to pledge collateral for their loan.

What are true statements about pledging accounts receivable? More than one answer may be correct.

The company pledges its accounts receivable as collateral. The firm is liable for the total amount of the loan.

Which of the following statements regarding factoring receivables are correct? (Check all that apply.)

The factoring firm is generally paid a fee or commission equal to 1 to 3 percent of the invoices accepted. The factoring firm generally does not have recourse against the seller of the receivable. Factoring a business' receivables is considered one of the more expensive financing methods.

True or false: Because there are so many ways to structure loan repayment schedules, no one formula is applicable for computing the APR

True Reason: Because there are so many ways to structure loan repayment schedules, no one formula is applicable for computing the APR

The method of controlling pledged inventory in which the lender has a general claim on the borrower's inventory is called a blanket inventory lien.

True Reason: The method of controlling pledged inventory in which the lender has a general claim on the borrower's inventory is called a blanket inventory lien.

Commercial banks use money from their customers' checking accounts to offer Blank______ that provide short-term financial capital to businesses, and to finance consumer purchases of durable goods such as automobiles.

funds loans

A change in credit terms from 1/10 net 30 to 2/10 net 30 would Blank______ the effective rate for not taking the cash discount.

increase

Credit crunch are the result of the following:

increase in interest rates tightening of money supply growth

The arrangement where goods can only be moved with permission of the lender is called

warehousing

Asset backed securities

were responsible for part of the financial crisis of 2007 are nothing more than the sales of receivables through public offering

Accounts receivable sold with the risk of nonpayment by customers assumed by the transferor of the receivables is a sale _____ recourse; whereas, receivables sold with the risk of nonpayment assumed by the transferee is a sale _____ recourse.

with without