Answers are given at the bottom of the page

1. A major advantage of using short term funds is:

A. There is no advantage
B. There are always more easily obtained
C. There are no governmental procedures with which to comply
D. Interest rates are normally lower
ANSWER: D

2. When a firm needs short-term funds for a specific purpose, the bank loan will likely be a:
A. compensating balance arrangement.
B. revolving credit agreement.
C. transaction loan.
D. line of credit.
ANSWER: C

3. Inventory is in the possession of a third party under which of the following methods?
A. Floating lien
B. Terminal warehouse receipts
C. Chattel mortgage
D. Trust receipts
ANSWER: B

4. The Houser Company has negotiated a $500,000 revolving credit agreement with Chitwood National B
ank. The agreement calls for an interest rate of 10% on fund used, a 15% compensating balance, and a c
ommitment fee of 1% on the unused amount of the credit line. Assuming that the compensating balance
would not otherwise be maintained, the effective annual interest cost if the firm borrows $200,000 for one
year is closest to
A. 11.5 percent.
B. 15 percent.
C. 26.5 percent.
D. 13.53 percent.
ANSWER: D

5. A formal, legal commitment to extend credit up to some maximum amount over a stated period of time.
A. Letter of credit
B. Revolving credit agreement
C. Line of credit
D. Trade credit
ANSWER: B

6. The type(s) of collateral generally used for a secured short-term loan is(are) .
A. inventory and/or receivables
B. common stock and/or bonds
C. real estate
D. machinery
ANSWER: A

7. Commercial paper may best be defined as:

A. a short term obligation of the government issued to commercial investors
B. short term unsecured promissory notes issued by corporations
C. an insignificant source of funds to large corporations
D. the debt obligations of chartered banks
ANSWER: B
8. The major disadvantage of commercial paper is:
A. the continued availability of funds is less certain than with bank financing
B. that there is no secondary market for commercial paper
C. firms must maintain an account balance equal to the paper outstanding
D. commercial paper is normally issued with a floating interest rate
ANSWER: A

9. Characteristics of pledging accounts receivable include all of the following, except:

A. the sale of receivables to a finance company
B. the lender stipulates which accounts are of sufficient quality
C. 60-80% of the value of the acceptable collateral may be borrowed
D. the interest rate is normally well in excess of prime
ANSWER: A

Explanation to the answers mentioned above

1) A major advantage of using short-term funds is that interest rates are normally lower. Short-term borro
wing typically carries lower interest rates compared to long-term borrowing, which can be advantageous f
or managing costs.

2) When a firm needs short-term funds for a specific purpose, a bank loan will likely be a transaction loan.
A transaction loan is a specific-purpose loan provided by a bank for a predetermined period and amount,
often with specific terms and conditions.

3) Inventory is in the possession of a third party under the method of terminal warehouse receipts. Termin
al warehouse receipts are documents that represent ownership of goods stored in a warehouse, typically
held by a third-party warehousing company.

4) The effective annual interest cost, considering the interest rate, compensating balance, and commitme
nt fee, for borrowing $200,000 for one year under the terms described is closest to 13.53 percent. This cal
culation takes into account the interest expense, compensating balance requirement, and commitment fe
e to determine the overall cost of borrowing.

5) A revolving credit agreement is a formal, legal commitment to extend credit up to some maximum amo
unt over a stated period of time. It allows a borrower to access funds as needed within the credit limit and
duration specified in the agreement.

6) The collateral generally used for a secured short-term loan is inventory and/or receivables. Lenders oft
en require borrowers to pledge their inventory and/or accounts receivable as collateral to secure the loan
and mitigate the lender’s risk.

7) Commercial paper may best be defined as short-term unsecured promissory notes issued by corporati
ons. It is a type of debt instrument issued by corporations to raise short-term funds from investors without
any specific collateral.

8) The major disadvantage of commercial paper is that the continued availability of funds is less certain th
an with bank financing. Unlike a bank line of credit, which provides ongoing access to funds, the issuance
of commercial paper depends on market conditions and investor demand, which can be less predictable.

9) The sale of receivables to a finance company is not a characteristic of pledging accounts receivable. Pl
edging accounts receivable involves using the receivables as collateral for a loan while retaining ownershi
p, rather than selling them outright to a finance company.