Sources of Short-term financing-Ch 8

Changes in banking sector today

-centered around concept of full service banking -expanded internationally to accommodate world trade and international corporations -deregulation creates greater competition among other financial institutions

Recession of 2007-2009

-longest record since great depression of 1930s -forced many large banks to verge of collapse -Gramm-Leach-Billey Act in 1999, commercial banks and investment banks were allowed to merge -mergers allowed banks to take excess risk which led to credit problems that started to show up in 2007

Limitations on the issuance of commercial paper

-many lenders have become risk-averse after multitude of bankruptcies -firms with downgraded credit rating do not have access to market -associated funds generation less predictable -lacks degree of commitment and loyalty associated with bank loans

Advantages of commercial paper

-may be issued at below prime interest rate 2-3% -no associated compensating balance requirements -associated prestige for firm to float paper in snobbish market

Asset back public offering/securities

-offering backed up by an asset A/R as collateral increasing trend in public offerings of security backed by receivables as collateral -int paid to owners is tax free Advantages: immediate cash flow, high credit rating of AA or better, provides corporate liquidity and short-term financing Disadvantage to buyer: risk- receivables actually being paid

Credit conditions can change

-unexpected defaults -economic recessions -changes in monetary policy -other economic setbacks

Forms of commercial paper

1. finance paper/direct paper(paper sold by financial firms directly to lender) 2. dealer paper (paper sold by companies through dealer network) 3. asset-backed commercial paper

Trade Credit

40% of short-term financing is in form of A/P or trade credit -extended for 30-60 days

A/R financing

Includes: pledging A/R and factoring or outright sale of receivables Advantage: permits borrowing to be tied directly to level of asset expansion at any point in time Disadvantage: relatively expensive method of acquiring funds

Factoring firm

absorbs risk-for which fee is collected actually advances funds to seller at lending rate

Cash discount policy

allows reduction in price if payment is made within time period -2/10 net 30 cash discounts mean: reduction of 2% if funds remitted 10 days after billing -failure to do so means full payment of amount by 30th day

Compensating balances

average minimum account balance maintained as alt to fee charge by bank for services rendered -when interest rates are lower, compensating balances rise -required account balance computed on the basis of % of customer loans outstanding and % of bank commitments towards future loans to give account

Warehousing

common way receipt issue-goods can be moved only with lenders approval -public warehousing: with warehousing firm -field warehousing: on borrower's premises

Book-entry transactions

computerized handling of commercial paper where no actual certificate created

Term loan

credit extended for 1-7 years loan usually repaid in monthly or quarterly installments only superior credit applicants qualify interest rate fluctuates with market conditions -int rates may be tied to prime rate or LIBOR

Net-credit position

difference between A/R and A/P -positive if A/R greater than A/P, vice versa -larger firms tend to be net providers of trade credit -smaller firms typically in user position high payables

Hedging to reduce borrowing risk

engaging in transaction that partially or fully reduces prior risk exposure -the financial futures market- allows trading of financial instrument at future point in time -no physical delivery of goods 1. If int rate increase: extra cost of borrowing money to finance the business can be offset by profit of futures contract 2. If int rate decrease: loss on futures contract as bond prices rise and offset by lower borrowing costs of financing firm

Credit crunch phenomenon

federal reserve tightens growth in money supply to combat inflation: this decreases funds to be lend and increases interest rates, increases demand for funds to carry inflation inventory and receivables, have to increase interest rates

Cost of commercial bank financing

in case of discounted loan interest deducted in advance, effective rate increases

Trust receipts(floor planning)

instrument: proceeds from sales in trust for lender

Effective interest on loan

is based on loan amount, dollar int paid, length of loan, and method of repayment

Blanket inventory liens

lender has general claim against inventory or collateral

Pledging A/R

lending firm decides on receivables it will use as collateral -loan % depends on firms financial strength and creditworthiness -interest rate well above prime rate-computed against balance outstanding

Why borrow in foreign currency?

loan can get cheaper for you to pay off -devalues the amount -our advantage

Eurodollar loan

loan denominated in dollars and made by a foreign bank holding dollar deposits -usually short-term

Inventory financing

marketability of pledged goods associated price stability perishability of product degree of physical control that lender can exercise over product

Lender control

provides assurance to lender but higher administrative costs -blanket inventory liens, trust receipts, and warehousing

Prime Rate

rate bank charges to the most creditworthy customers -increases as customer's credit risk increases -average customer can expect to pay one or two percentage points above prime and also in tight money period around 5% more

LIBOR(London Interbank Offered Rate)

rate offered to companies with international presence and ability to use london eurodollar market for loans -interest rates are driven by inflation

Stages of production

raw materials and finished goods usually provide best collateral and goods in process may qualify only small % of loan

Installment loans

requires series of equal payments over period of loan -effective rate of interest on installment loans would be almost double quoted rate of interest

Commercial paper

short-term, unsecured pro missionary note -usually issued to public in minim units of $25,000

Factoring A/R

sold to finance company -factoring firms do not have recourse against seller of receivables -finance companies may do all or part of credit analysis to ensure quality of accounts

A/P

spontaneous source of funds grows as business expands contracts when business declines

Annual % rate

truth in lending act of 1968 requires actual APR given to borrower -rule: requires use of actuarial method of compounded interest during computation -on outstanding loan balance at beginning of period

Self-liquidating loan

use of funds ensures built-in or automatic repayment scheme -Short term banks like to take collateral by getting paid off

Appraisal of inventory control devices

well-maintained control measures involve: substantial administrative exp, raising overall cost of borrowing, extension of funds well with needs