Finance Exam 2
Money market fund
- for as little as $500-1,000 an investor may purchase shares in a money market fund, which in turn reinvests the proceeds in higher-yielding $100,000 bank CDs, $25,000 to $100,000 commercial paper, and other large-denomination, higher-yielding securities -Investor receives their pro rata portion of the interest proceeds daily as a credit to their shares -Particular interest to the smaller investor- allow them to participate directly in higher-yielding securities
What do banks like for collateral?
-Accounts receivable -Inventory- raw materials or finished goods **These are self-liquidating!!!
Firms can stretch the payment period with what consequences?
-Alienates suppliers -Diminishes rating with Dun & Bradstreet (like the FICO score of businesses) and local credit bureaus
•Aggressive, risk-oriented firm vs. •Conservative firm
-Borrow short term -Maintain relatively low levels of liquidity -Hopes to increase profit -Benefits from low cost financing and high return assets -Vulnerable to a credit crunch -Utilize established long-term financing -Maintain a high degree of liquidity
What do you need cash for?
-Interest to lenders -Dividends to stockholders -Taxes to the government -Account payable to suppliers -Wages to workers and replace inventory
Collection mechanism affecting cash flow:
-Lockboxes -U.S. mail system -International sales
Factors influencing use of inventory for financing (aka use of collateral):
-Marketability of the pledged goods -Associated price stability of pledged goods -Perishability of product (ex. they don't want food as collateral) -Degree of physical control that lender can exercise over product (ex. bank holds car titles until we sell them and can pay the bank back)
Why would I prefer a $1 today instead of $1 5 years from now?
-Prefer $1 today!! It is worth MORE today than 5 years from now -You can invest that $1 and make the money -Due to inflation
Cash inflows- driven/influenced by:
-Sales -Type of costumers -geographical location -product being sold -The industry
"Permanent" current assets
-assets that are not used/sold -As company grows- these continue to increase each year (along with fixed assets) Ex. what is left on the shelves, what is left in the warehouse
Term loan
-credit is extended for one to seven years -Usually repaid in monthly or quarterly installments over its life (vs. one single payment) -Only superior credit applicants qualify (measured by working capital strength, potential profitability, and competitive position) -Interest rate changes with market conditions (may be tied to prime rate or LIBOR)
Required rate of return
-discount rate, depends on the market's perceived level of risk associated with the individual security (_____% return on the money you are loaning) oDepends on: 1) Markets personal risk 2) Competitively determined among the many companies seeking financial capital Ex. Microsoft (due to low financial risk/relatively high return/strong market position) is likely to raise debt capital at a significantly lower cost than can United Airlines (firm with high financial risk
Just-in-time inventory management (JIT)
-don't keep inventory in advance, just make them just in time -Basic requirements: 1.Quality production that continually satisfies customer requirements 2.Close ties between suppliers, manufacturers, and customers 3.Minimization of the level of inventory -Benefits: *Lower levels of inventory/reduced financing costs= cost savings *Reduced warehouse space for inventory= reduced floor space= saves construction costs and reduces overhead expenses for utilities and manpower *Aided in the development of the internet and electronic data interchange systems (EDI) between suppliers and production and manufacturing departments *Firms are able to maintain very little inventory, reduce warehouse storage space, and reduce the cost of financing a large inventory -Downside: *Parts shortages= lost sales (Ex. Honda- loses parts and had to shut down for a few weeks because suppliers were hit by the tsunami) *Production takes a while to get it right/get it going if there are shortages
Recession
-downturn in the economy where GDP (everything produced in the US) is shrinking for two full quarters (6 months) -sales decline (not as much access to money) -People will lose jobs (you don't produce as much so you don't need as many workers) -Consumers do not buy as much
Level vs. seasonal production
-even production, allows for maximum efficiency in the use of manpower and machinery *May result in unnecessarily high inventory buildups before shipment (especially in a seasonal business) -Seasonal production- inventory problem is eliminated, but have unused capacity during slack periods *May be forced to pay overtime wages to labor and to sustain other inefficiencies as equipment is overused
Supernormal growth pattern
-firm experiences supernormal (very rapid) growth for a number of years and then levels off to more normal, constant growth -Most common variable growth model -Experienced by firms in emerging industries (ex. early days of electronics)
Preferred stock
-hybrid security, has neither the ownership priviledge of common stock nor the legally enforceable provisions of debt -Has no maturity date (If it does have a maturity date= analysis is similar to semiannual interest example) -Has a fixed dividend payment (has higher order of precedence than common stock dividends, but not the binding contractual obligation of interest on debt)
Automated clearinghouses (ACH)
-important element in electronic funds transfers -Transfers information between one financial institution and another and from account to account via computer tape Ex. Most common ACH payments: for direct deposits of payroll, social security, tax refunds, consumer bill payment, business-to-business transfers, and federal, state, and local government payments
Carrying costs
-include interest on funds tied up in inventory and the costs of warehouse space, insurance premiums, and material handling expenses -Also a cost for dangers of obsolescence or perishability and rapid price change Ex. Larger the order placed= greater the average inventory we will have on hand= higher the carrying costs
Average collection period
-increase in this may be the result of a predetermined plan to expand credit terms or the consequence of poor credit administration -Average collection period= account receivable/average daily credit sales
Eurodollar loan
-loan denominated in dollars (different than your local currency) and made by a foreign bank holding dollar deposits -Usually short term-intermediate term in maturity -LIBOR- base interest rate paid on such loans for companies of the highest quality -Can be cheaper than U.S. domestic loans Ex. going to Wells Fargo and getting a loan in pounds (they have it in surplus due to doing business with banks in other nations)
International electronic funds transfer
-mainly carried out through SWIFT (Society for Worldwide Interbank Financial Telecommunications) -provides around-the-clock international payments between financial institutions -Uses proprietary secure messaging system (electronic funds transfer system) in which each message represents a transfer of currencies for payments, treasure, securities, and trade -Security standards: each message is encrypted, every money transaction is authenticated by another code
Future value
-measures the value of an amount that is allowed to grow at a given interest rate over a period of time -We care about this because then we can plan for the future
Compensating balance
-minimum account balance maintained as alternative to fee charged by bank for services rendered -Makes loan more expensive- charging you like you borrowed the full amount, but you cant have the same amount (paying more interest than you are getting)
Money market accounts
-modeled after money market funds, not meant to be transaction accounts but a place to keep excess cash balances -Can be offered by commercial banks, savings and loans, and credit unions -More attractive to smaller firms than larger firms (which may have more alternatives available) -Slightly less risky than money market funds (insured up to $100,000 by federal agencies)
Full service banking
-modern banker's functions: oAccepting deposits oMaking loans oProcessing checks oProvide trust and investment services oCredit card operation oReal estate lending oData processing services oCash management services (both domestically and internationally) oPension fund management
Dun and Bradstreet Information Services (DBIS)
-most prominent source of business information -Provides a business information report (BIR) and credit scoring reports
Book-entry transactions
-no actual certificate is created, all transactions occur on the books -Lowers cost and simplifies administration
Federal agency securities
-represent the offerings of such governmental organizations as the Federal Home Loan Bank and the Student Loan Marketing Association -Guaranteed by the issuing agency and provide all the safety that one would normally require (lack the direct backing of the U.S. Treasury)
Truth in Lending Act of 1968
-requires actual annual percent rate (APR) given to borrower •SIDE NOTE: Annual percentage rate (APR)- what you are truly paying for a loan, measure of the effective rate we have presented (congress' way of trying to protect the consumer from paying more than the stated rate without his or her knowledge)
Treasury bills
-short-term obligations of the federal government, popular place to "park funds" because of a large and active market -Maturities of 91 and 182 days -Unique- trade on a discount basis (meaning the yield you receive occurs as a result of the difference between the price you pay and the maturity value)
Self-liquidating assets
-sold at the end of a specified time period -simply by pure operation get converted to cash (temporary current asset) -Can use as collateral for bank loans
Data Universal Number System (D-U-N-S)
-unique nine-digit code assigned by Dun & Bradstreet Information Services (DBIS) to each business in its information base -Can be used to track whole families of companies that are related through ownership
Methods for controlling pledged inventory (name simplest to complex):
1) Blanket inventory liens- lender has a general claim against the inventory of the borrower -No physical control 2) Trust receipt- aka floor planning, instrument acknowledging that the borrower holds the inventory and proceeds from sales in trust for the lender, each item is marked and specified with a serial number, when sold- proceeds are transferred to the lender and the trust receipt is canceled -Provides tighter control but no direct physical control over inventory -Ex. have cattle in different pens so when bank comes out and sees its collateral (aka the calves) they can do it easily 3) Warehousing- goods are physically identified, segregated, and stored under the direction of an independent warehousing company, firm issues warehouse receipt to the lender and goods can be moved only with the lenders approval -Ex. get a loan for grain- store grain in government grainery and once it is sold you pay the government to haul the grain out of their grainery
When extending credit, consider these three things:
1) Credit standards (5 C's of credit) 2) Terms of trade 3) Collection policy
What happens during a credit crunch?
1) Federal reserve tightens the growth in the money supply in its battle against inflation (Causes a decrease in lendable funds and increase in interest rates) 2) Massive withdrawal of saving deposits at banking and thrift institutions (all in search of higher terms) **NOTE: How NOT to deal with credit shortages= impose artificial limits on interest rates in the form of laws or extreme governmental pressure
What are the 3 categories of commercial paper?
1) Finance paper- paper sold by financial firms (also called Direct paper- another name for finance paper since it is sold directly to the lender by the finance company) → Finance companies- issue paper primarily to institutional investors (such as pension funds, insurance companies, and money market mutual funds) 2) Dealer paper- sold by industrial companies, utility firms, or financial companies too small to have their own selling network → Use an intermediate dealer network to distribute their paper 3) Asset-backed commercial paper-
4 ways to calculate present values and future values:
1) Formulas 2) Financial calculator keystrokes 3) Excel functions 4) Time-value-of-money-tables
What Causes Interest Rates to Go Up and Down?
1) Inflation 2) Federal Reserve- central bank of the U.S., tightens growth in money supply to banks •Individually- oMissing a payment (banks charge higher interest rate because they are taking on more risk)
Three theories describe the shape of the yield curve:
1) Liquidity premium theory- long-term rates should be higher than short-term rates (Bank has less liquidity if they are locked in for more time-should be expected to pay more for that) 2) Market segmentation theory- treasury securities are divided into market segments by the various financial institutions investing in the market (Different groups of people that want to invest at different locations) 3) Expectations hypothesis- explains the yields on long-term securities as a function of short-term rates, good in describing the shape and movement of the yield curve (Says long-term rates reflect the average of short-term expected rates over the time period that the long-term security is outstanding) -Useful to financial managers in helping them set expectations for the cost of financing over time and in making choices about when to use short term debt or long term debt
The effective interest rate on a loan is based on the:
1) Loan amount 2) Dollar interest paid 3) Length of the loan 4) Method of repayment
Where do you look if you need money short term??
1) Look at suppliers- Accounts/Trade Payable! -Trade credit from suppliers 2) Short term loans- from banks 3) Commercial Paper- take middle man out and borrow directly from the firm -Large companies are able to issue stock
What are the two types of float?
1) Mail float- occurs because of the time it takes to deliver the mail →Ex. takes three days foe a check to arrive and the check clears on the day of arrival (there will be at least three days that the balance on the company's books is different than the balance on the bank's books) 2) Clearing float- occurs because of the time it takes to clear a check once a payment is made → Ex. once a check is received in the mail and deposit is made- the deposited funds may not be available for use until the check has cleared the banking system and has been credited to the corporate account (now becoming instantaneous)
Inventory is divided into 3 categories:
1) Raw material used in the product 2) Work in process- reflect partially finished products 3) Finished goods- ready for sale
The investor will allow 3 factors to influence their required rate of return:
1) Real rate of return- rate of return the investor demands for giving up the current use of the funds on a noninflation-adjusted basis (financial "rent" the investor charges for using his or her funds for any given period) 2) Inflation premium- investor requires a premium to compensate for the eroding effect of inflation on the value of the dollar 3) Risk premium- premium associated with the special risks of a given investment, greater or less for different types of investments
Banks may provide funds for financing of:
1) Seasonal needs 2) Product line expansion 3) Long-term growth
Reasons for holding cash balances:
1) Transactions balances- use of cash to pay for planned corporate expenses such as supplies, payrolls, and taxes, planned acquisitions of long-term fixed assets (For most firms, primary reason for holding cash) 2) Compensating balances-compensate a bank for services provided rather than paying directly for those services (minimum bank balance required by a loan agreement) 3) Precautionary needs- assumes management wants cash for emergency purposes when cash inflows are less than projected
How could you make a profit but have to close? How do you avoid this?
1) Your revenues were on account (they were not cash) Convert this to cash by: -Get people to pay you by using incentivized payments (give them a discount) - Factoring- sell your accounts receivable -Sell to the bank and then bank uses that line of credit as collateral for a loan
Limitations of commercial paper
1) events cause lenders to become risk-averse: recessions, corporate bankrupticies, major corporate fraud 2) many firms that had their credit quality downgraded by credit rating agencies cant sell their commercial paper (since companies with good credit ratings can only access this market) 3) Less predictable than bank loans -While a firm may pay a higher rate for a bank loan= it is also buying a degree of loyalty and commitment (that is unavailable in the commercial paper market)
Total Costs for Inventory
1. Ordering (# of orders) = units/order size 2. Carrying costs= average inventory in units * carrying cost per unit 3. Total cost= Ordering cost+ carrying cost
How long is trade credit normally extended for?
30-60 days
What normally makes a firm money?
A/R and inventory normally make a firm money (NOT cash)
Business vs. Financial risk
Business risk- relates to the inability of the firm to hold its competitive position and maintain stability and growth in its earnings Financial risk- relates to the inability of the firm to meet its debt obligations as they come due
Cost of taking the discount=
Equivalent to borrowing money at ___% annual interest rate (take this rate * the original amount due= amount you are saving)
Fixed asset
Ex. Property, plant, equipment, land
What caused the Prime Rate to go up in 2016?
Federal reserve (central bank of the U.S. and loans to all other banks) was increasing- raised their rates and bank must pay more for their money
How do you double sales and get quadruple the earnings?
Increasing profit margin- firms hike up their prices at Christmas time
5 C's of Credit
Indicates whether a loan will be repaid on time, late, or not at all 1) Character- refers to the moral and ethical quality of the individual who is responsible for repaying the loan 2) Capital- level of financial resources available to the company seeking the loan and involves an analysis of debt to equity and the firm's capital structure 3) Capacity- refers to the availability and sustainability of the firm's cash flow at a level high enough to pay off the loan, level of cash flows 4) Conditions- refers to the sensitivity of the operating income and cash flows to the economy 5) Collateral- assets that can be pledged against the loan
Who tends to be net providers/lenders and users/borrower of trade credit?
Larger firms- tend to be net providers/lenders of trade credit (relatively high receivables) -Have easier access to local credit markets Smaller firms- tend to be net users/borrowers of trade credit (relatively high payables)
Downside of seasonal production?
May cost you more Ex. 6-month production schedule, 1, 200 in sales= produce 200 month -Labor cost is high- having to retrain employees b/c they don't stay when you lay them off every 6 months, cost of hiring -Equipment and plant cost could be VERY high/double- need to make the same amount twice as fast Vs. Ex. 12-month production schedule, 1, 200 in sales -Inventory cost is higher- need warehouses, need to insure production, hope they don't become obsolete when you produce year round -Utility cost is higher- running plant in the winter
Yield curve
Term structure of interest rates, shows the relative level of short-term and long-term interest rates at a point in time - Useful to make decisions about how to time and structure their borrowing between short and long-term debt o Upward-sloping yield curve= considered normal (more upward sloping= greater the expectations that interest rates will rise) o Downward-sloping yield curve= (more downward sloping= expectations that interest rates will fall)
Eurodollars
U.S. dollars held on deposit by foreign banks and in turn lent by those banks to anyone seeking dollars
London Interbank Offered Rate (LIBOR)
U.S. prime rate competes with this, rate measure for international loans
Key to current asset planning
ability of management to forecast sales accurately and then to match the production schedules with the sales forecast
Sweep account
account that allows companies to maintain zero balances with all their excess cash swept into an interest-earning account
Point-of-sales terminals
allow either digital input or use of optical scanners to record the inventory code number sand the amount of each item sold
Cash discount
allows a reduction in price if payment is made within a specified time period Ex. 2/10, net 30- pay in 10 days, get 2% discount (but fail to do this= must pay full amount by the 30th day)
Current assets
asset converted to cash within one year (over time, NOT at a point in time) -Fluctuate in short run
Eurodollar deposits
balances are held in U.S. bank accounts or in dollar-dominated bank accounts in foreign banks when the dollar is rising relative to other currencies
Valuation of a financial asset
based on determining the present value of future cash flows
Less cash you have= ________
better off you are (but still you do not want to get caught without cash when you need it) -B/c cash doesn't make you any money -Putting your assets to work helps you make money (via interest, paying for loans faster so you can get a discount)
Installment loan
calls for a series of equal payments over the life of the loan Ex. car dealerships, furniture stores
tight money period
capital is scarce, can't get money to borrow (banks increase requirements to get the money) -Short-term financing may be difficult to find or may carry exorbitant rates
Working capital
current assets, thing that can be converted to cash within a short period of time
net trade credit
difference between accounts receivable and accounts payable oPositive when= accounts receivable > accounts payable oNegative when= accounts receivable < accounts payable
Float
difference between the two cash balances (corporations recorded amount and amount credited to the corporation by the bank) -slowly vanishing due to electronic payments through the banking system
Yield to maturity
discount rate, rate of return required by bondholders
Present value of an annuity
each individual payment is discounted back to the present and then all of the discounted payments are added up
Hedging
engage in a transaction that partially or fully reduces a prior risk exposure (ex. can go lock in interest rates for two years from now)
Cost-benefit analysis
expenses compared to the benefits that may accrue
Working capital management
financing and management of the current assets of the firm
Spontaneous source of funds
funds that grow as the business expands on a seasonal or long-term basis and contracting in a like fashion when business declines Ex. accounts payable
Corporate/Treasury bond
government/firm wants to borrow money for a long period of time -When you buy a bond- you are loaning money to the firm/U.S. government -Firm does this (borrows directly from consumer) because the interest rate is cheaper than if they went and borrowed from the bank
Safety stock of inventory
helps to eliminate the risk of losing sales to a competitor, guards against late deliveries due to weather, production delays equipment breakdowns, etc. -Minimum safety stock=increase cost of inventory (because carrying cost will rise)
Less liquid assets have _______ return
higher
When long term rates are much ______ than short term rates= the market is saying it expects short term rates to _______ When long term rates are ________ than short term rates= the market is expecting short term rates to _______
higher, rise lower, fall
Uniform Commercial Code (UCC)
if you don't pay your loan, that aren't collateral on someone elses loan, we can take (establishes security against a loan)
Inflation premium inc.= required rate of return _______ Inflation premium dec.= required rate of return ______
inc. dec.
Accounts receivable should be thought of as an ________
investment
Current assets management
involves cash, marketable securities (investments that receive a return), accounts receivable and inventory
What is an alternative financing plan?
keep refinancing using short-term financing *downside: -they can change the interest rate on you (hike it up) bank could not let you borrow as much as you need
Discounted loan
loan where interest is deducted in advance (increases effective rate of interest) -More expensive loan- giving you less money but getting same amount of money
Stock with high required rate of return (Ke)= ______ Stock with a low required rate of return (Ke)= ________
low P/E ratio (because it is risky) high P/E ratio (because of positive future performance)
Ordering costs
low inventory in stock= order many times= total ordering costs are high
Passbook savings account
lowest-yielding investment at a bank or a savings and a loan, low interest rates
Financial manager critical function:
managing the cash inflows and payment outflows
consumer price index
measures changes in prices we pay
Level production
method to smooth production schedules and use manpower and equipment efficiently at a lower cost Consequences: -Current assets go up and down when sales and production are not equal
The longer you borrow= the ______ you pay in interest rate on what you borrow
more
Economic ordering quantity (EOQ)
most advantageous amount for the firm to order each time
Perpetuity
no maturity date, preferred stock usually represents a perpetuity
Firm may speed up collection and check-clearing process through:
o Utilize a variety of collection centers throughout the marketing area o Lockbox system- may replace the network of regional collection offices, benefits of expeditious check clearance at lower costs
Stockout
occurs when a firm is out of a specific inventory item and is unable to sell or deliver the product
Certificate of deposit (CD)
offered by commercial banks, savings and loans, and other financial institutions, investor places funds on deposit at a specified rate over a given time period as evidenced by the certificate received -Normally insured/guaranteed by the federal government for up to $250,000 -Two-tier market *Small CDs ($500-$10,000)- carry lower interest rates *Larger CDs (100,000 or more)- have higher interest provisions and a degree of marketability of those who wish to sell their CDs before maturity
Aging of accounts receivables
one way of finding out if customers are paying their bills within the time prescribed in the credit terms
Ordinary annuity
payment stream that occurs at the end of each year (putting away money every year for ___ years)
Eurodollar certificate of deposit
popular international short-term investment arising from foreign trade -Higher rate than the rates on U.S. treasury bills and bank certificates of depost at large U.S. banks
Bond Par value Coupon Maturity
provides an annuity stream of interest payments and principal payment at maturity oGenerally issued in $1,000 increments amount the bond is issued at -We don't usually give them the full amount, b/c it isn't worth the same amount bond is issued with this, tells how much the annual interest payment will be on this bond (as a percentage of the par) -Ex. 6% on 1,000 par value= $60 per year or $30 twice a year when lender will receive the money back
Risk-free rate of return
rate of return + inflation premium, rate that compensates the investor for the current use of his or her funds and for the loss in purchasing power due to inflation, but not for taking risks
Best collateral= ________
raw materials and finished goods
Factor receivables
receivables sold outright to a finance company oFor taking the risk, factoring firm is generally paid on a fee or commission (equal to 1-3% of the invoices accepted) -Aka what you actually get is some number less than what the receivables are worth that you sell
Discount below par value is ________ with progressively fewer years to maturity
reduced The longer the maturity= the greater the impact of changes in yield!!
Price-earnings ratio What is it influenced by?
represents a multiplier applied to current earnings to determine the value of a share of stock in the market o Influenced by: -The earnings and sales growth of the firm -Risk -Debt-equity structure of firm -Dividend policy -Quality of management -Number of other factors
Commercial paper
represents a short-term, unsecured promissory note issued to the public in minimum units of $25,000 (Paper certificate issued to the lender to signify the lender's claim to be repaid) -Usually held to maturity by the investor, with no active secondary market in existence -DOWNFALLS: Certificate can be lost, stolen, misplaces, damaged, and in rare cases failed to cash in at maturity
In Managing cash and marketable securities, the primary concern should be ______ and the secondary concern should be _______
safety and liquidity maximizing profitability
Asset-backed securities
sale of receivables
Financial futures market
set up to allow for the trading of a financial instrument at a future point in time (do not physically deliver the goods, just execute a later transaction that reverses your initial position) -Rising interest rates can mean profits in the financial futures market if you initially sell a contract and later buy it back
Banker's acceptances
short-term securities that generally arise from foreign trade (good short term investments) -Acceptance= draft drawn on a bank for payment when presented to the bank SIDE NOTE: Draft (vs. check) = a company does not have to deposit funds at the bank to cover the draft until the bank has accepted the draft for payment and presented it to the company)
Extended disbursement float
slowing of disbursements
#1 goal of business and best way to do this?
stay in business Pay your bills by using working capital
Present value
sum payable in the future is worth less today than the stated
Electronic funds transfer
system in which funds are moved between computer terminals without the use of a "check" -Reduces techniques of delaying payment and using float
Largest provider of short-term credit= _______ Approx. ______ of short-term financing is in the form of accounts payable or trade credit (from the people we buy our products from)
the manufacturer or seller of goods and services 40%
Prime rate
the rate a bank charges its most creditworthy customers, premium is added as customer's credit risk increases (indicator of the rate I would give a great company)
Self-liquidating loan
use of funds will ensure a built-in or automatic repayment scheme, converted to cash through normal business cycles/daily operations -Typical banker prefers this
Accounts receivable vs. accounts payable
use of funds, lending money to customers source of funds, borrowing money from suppliers
Inverted yield curve
when the longer you borrow= interest rates decrease -Signal of a recession coming- BAD, downturn in the economy
In any loan, lenders primary concern is _____
whether the borrower's capacity to generate cash flow is sufficient to liquidate the loan as it comes due -Aka few lenders would make a loan strictly on the basis of collateral (collateral is just a way to protect the lender if all else fails)
Both corporation and government yield curves change daily to reflect:
• Current competitive conditions in the money and capital markets • Expected inflation (if costs go up, so do interest rates- b/c you want your investment back) • Changes in economic conditions
Advantages of Commercial Paper
• Rapid growth of money market mutual funds • Can be issued at below the prime interest rate (save money!!!) • No compensating balance requirements are associated with its issuance (but firm is required to maintain commercial bank lines of approved credit equal to the amount of the paper outstanding- a procedure less costly than compensating balances) • Firms enjoy the prestige associated with being able to float their commercial paper in what is considered a "snobbish market" for funds
Going to borrow money from a bank, how do they decide what interest they are going to loan you at?
•Charge what everyone else is borrowing •How long you are borrowing the money •How much money is being borrowed •Credit risk- measured by a credit score (5 C's of credit)
Accounts Receivable Financing Advantage and Drawback
•Includes: 1) Pledging accounts receivable as collateral for loan- pledge A/R as collateral for a loan or an outright sale (factoring) of receivables 2) Factoring- outright sale of receivables oAdvantage: -Popular because allows borrowing to be tied directly to the level of asset expansion (as level of A/R inc.= firm's ability to borrow inc.) oDrawback: -Relatively expensive method of acquiring funds- must be carefully compared to other forms of credit
•Short term financing and low liquidity= _____ (___ profit, _____ risk) •Short term financing and high liquidity= ________ •Long term financing and low liquidity= _________ •Long term financing and high liquidity=_____
•high profit, high risk •moderate profit, moderate risk •moderate profit, moderate risk •Low profit, low risk