Foundations of Financial Management 15th Edition Block Test Bank 1

Foundations of Financial Management 15th Edition
Block
Full download at:
Solution Manual:
https://testbankpack.com/p/solution-manual-for-foundations-of-financial-
management-15th-by-block-hirt-danielsen-isbn-0077861612-
9780077861612/
Test bank:
https://testbankpack.com/p/test-bank-for-foundations-of-financial-
management-15th-by-block-hirt-danielsen-isbn-0077861612-
9780077861612/
Chapter 08
Sources of Short-Term Financing
True / False Questions
1. The largest source of short-term funds for most companies is suppliers (trade credit).
True False
8-1
Copyright © 2014 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of
McGraw-Hill Education.
2. Larger firms tend to be net users of trade credit, rather than net providers.
True False
3. Small companies finance a relatively greater proportion of their assets through trade credit than do
larger concerns.
True False
4. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
True False
5. Accounts payable is a spontaneous source of funds that grows as the business expands.
True False
6. The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
True False
7. "Stretching the payment period" refers to the practice of trying to take a trade discount after the
discount period.
True False
8. On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days of
free credit.
True False
9. Firms can almost always increase the amount of time they take to pay for purchases without
incurring problems.
True False
10. Approximately 40% of all short-term financing is in the form of accounts payable or trade credit.
True False
11. Trade credit is usually extended for periods of one year or more.
True False
12. A cash discount calls for a reduction in price if payment cannot be made within a specified time
period.
True False
8-2
13. Leontief's Wigs can borrow from its bank at 16% to take a cash discount. The terms of the cash
discount are 2/10, net 60. Leontief's should borrow from the bank to take the discount.
True False
14. Myrdal Boots can borrow from its bank at 12% to take a cash discount. The terms of the cash
discount are 3/10, net 90. Myrdal Boots should borrow from the bank to take the discount.
True False
15. Bank deregulation has eased competition between commercial banks, savings and loans,
brokerage houses, and new financial services companies.
True False
16. 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.
True False
17. The lender's primary concern is whether the borrower's capacity to generate receivables is
sufficient to liquidate the loan as it comes due.
True False
18. Although the LIBOR has remained competitive and comparable to the U.S. prime rate, it has
remained slightly higher than the prime rate for over a decade.
True False
19. The London Interbank Offered Rate (LIBOR) is used to set a base lending rate for some U.S.
domestic corporate loans.
True False
20. Although the prime rate is the rate that U.S. banks charge their most credit-worthy customers, the
prime rate is normally higher than the London Interbank Offered Rate (LIBOR).
True False
21. Compensating balances are important for banks because their existence allows them to make
loans at lower quoted rates.
True False
22. A compensating balance will be lower in periods of tight money than in periods of credit easing.
True False
8-3
23. Compensating balances are a way for banks to recover the cost of corporate services provided,
but not directly charged.
True False
24. Compensating balances represent unfair hidden costs of borrowing.
True False
25. Monthly installment loans usually increase the effective rate of borrowing by approximately 2 times
the stated rate.
True False
26. The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an
annualized basis.
True False
27. The term "credit crunch" refers to a period in which the interest rate on credit is so high that firms
cannot afford to borrow money.
True False
28. Commercial paper is an unsecured short-term IOU from a large financially secure company.
True False
29. It is easier for small firms to obtain financing through bank loans than through the commercial
paper market.
True False
30. Small businesses frequently find commercial paper a useful means of obtaining funds when it is
not possible to raise funds by other means.
True False
31. Commercial paper represents secured short-term borrowing by large companies.
True False
32. Issuers of commercial paper can be divided into finance paper or direct paper, dealer paper, and
asset-backed commercial paper.
True False
8-4
33. One major advantage of commercial paper is that it can always be "rolled over" (reissued) when it
matures.
True False
34. All commercial paper involves the physical transfer of actual paper certificates.
True False
35. Firms using commercial paper are generally required to maintain commercial bank lines of credit
equal to the amount of the paper outstanding.
True False
36. The commercial paper market is available to all New York Stock Exchange companies.
True False
37. One major disadvantage of commercial paper is that if the company's credit quality declines,
refinancing existing commercial paper might be impossible to achieve through a new issue of
commercial paper.
True False
38. Finance paper usually carries a higher rate of interest than direct paper.
True False
39. One advantage to an issuer of commercial paper is that the issuer eliminates the need for
maintaining compensating balances and credit lines with a commercial bank.
True False
40. Factoring accounts receivable, unlike pledging accounts receivable, typically passes the risk of
loss on the receivable to the buyer.
True False
41. Eurodollar loans are similar to U.S. bank loans in that they are usually short-to intermediate-term
in nature.
True False
42. In times of tight credit in the United States, Eurodollar loans become difficult to obtain.
True False
8-5
43. It is difficult to acquire a loan in U.S. dollars outside the United States.
True False
44. The sale of securities backed by the receivables of large credit-worthy firms is a large and growing
source of financing.
True False
45. General Motors Acceptance Corporation (GMAC) is one of the biggest issuers of asset-backed
securities.
True False
46. The biggest category of asset-backed securities is the home equity loan, followed by automobile
receivables and credit card receivables.
True False
47. The sale of asset-backed securities can sometimes enable the issuing firm to acquire lower-cost
funds than it normally would receive from a bank loan or bond offering.
True False
48. The simplest inventory financing method is a blanket inventory lien where items are not identified
or tagged, and there is no physical transfer of control of the inventory from the borrower.
True False
49. A trust receipt acknowledges that the lender trusts the borrower to repay the loan before any
dividends are paid.
True False
50. The movement of the exchange rate between two currencies can increase the total cost of a loan
by making the principal repayment require more money than the original amount of the loan.
True False
51. The most common form of short-term financing is a bank loan.
True False
52. The higher the cost of bank financing, the more beneficial it is to take the cash discount.
True False
8-6
53. A self-liquidating loan is preferable to a bank because it generally provides them with a higher
return.
True False
54. At historically low interest rate levels, compensating balances increase.
True False
55. A term loan is less risky to the bank, thus they provide a fixed rate to the customer.
True False
56. The APR is generally lower than the rate stated by the bank.
True False
Multiple Choice Questions
57. 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
58. Trade credit may be used to finance a major part of a 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.
59. 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
8-7
60. The cost of not taking the discount on trade credit of 2/10, net 30 is approximately ______.
A. 44.54%
B. 43.20%
C. 36.73%
D. None of these options
61. 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.
62. From the banker's point of view, short-term bank credit is an excellent way of financing
A. fixed assets.
B. permanent working capital needs.
C. repayment of long-term debt.
D. seasonal bulges in inventory and receivables.
A. 15.9%
B. 16.3%
C. 18.0%
D. 17.4%
64. Bank loans to business firms
A. are usually short-term in nature.

B. are preferred by the banker to be self-liquidating.
C. may require compensating balances.
D. All of these options
8-8
65. Commercial 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 very short-term in nature and are offered to superior credit applicants.
66. Kantorovich Company normally takes 30 days to pay for its average daily credit purchases of
$2,000. Its average daily sales are $3,000, and it collects accounts in 25 days. What is its net
credit position?
A. $15,000
B. $1,000
C. ($1,000)
D. ($15,000)
67. Recent problems facing the U.S. financial system were the result of all but which one of the
following?
A. A huge increase in the amount of mortgage-backed securities being bundled up and sold in the
markets
B. A huge drop in the value of mortgage-backed securities
C. An increase in the use of commercial paper for short-term financing
D. The government permitting commercial and investment banks to merge
68. The prime rate
A. is the rate a bank charges its risky customers.

B. has been quite volatile during the past two decades, moving several percentage points in a 12-
month period.
C. is usually lower than Treasury bill rates.
69. The London Interbank Offered Rate (LIBOR)
A. competes with the U.S. Prime Rate for those companies with an international presence.
B. has been lower than the U.S. Prime Rate for at least the last decade.
C. is an estimate of the interbank lending rate for London banks.
D. All of these options are correct.
8-9
70. LIBOR is
A. a resource used in production.

B. an interest rate paid on Eurodollar loans in the London market.
C. an interest rate paid by European firms when they borrow Eurodollar deposits from U.S. banks.
D. the interest rate paid by the British government on its long-term bonds.
71. Compensating balances
A. are used by banks as a substitute for charging service fees.

B. are created by having a sweep account.
C. generate returns to customers from interest-bearing accounts.
D. are used to reward new accounts.
72. General Rent-All's officers arrange a $50,000 loan. The company is required to maintain a
minimum checking account balance of 10% of the outstanding loan. This practice is called
A. an installment loan.
B. a compensating balance.
C. a discounted loan.
D. a balloon payment.
73. Analog Computers needs to borrow $475,000 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
$475,000 spendable cash?
A. $546,250
B. $758,264
C. $558,824
74. If Analog Computers can borrow at 8% for three years, what is the effective rate of interest on a
$1,000,000 loan where a 15% compensating balance is required?
A. 11.18%
B. 17.27%
C. 9.41%
8-10
75. A term loan is usually characterized by
A. a maturity of one to seven years.

B. a variable interest rate.
C. monthly or quarterly installment payments.
76. In determining the cost of bank financing, which is the important factor?
A. The prime rate

B. The nominal rate
C. The effective rate
D. The discount rate
77. Mr. Jones borrows $4,500 for 90 days and pays $75 interest. What is his approximate effective
rate of interest?
A. 9.3%
B. 6.7%
C. 11.7%
78. Von Hayek's Kayaks can borrow $12,500 for 60 days at a cost of $220 interest. What is the
effective rate of interest?
A. Less than 9.9%

B. More than 9.9% but less than 10%
C. More than 10.5% but less than 11.5%
D. More than 11.5%
79. Kenneth's Arrows and Bows borrow $15,000 for one year at 8% interest. What is the effective rate
of interest if the loan is discounted?
A. Less than 8.5%

B. More than 8.5% but less than 9.5%
D. More than 10.5%
8-11
80. East Coast Cleaners borrows $20,000 for 120 days and pays $400 interest. What is the effective
rate of interest if the loan is discounted?
A. Less than 5.5%

D. More than 6.5%
81. Ms. Smith borrowed $2,000 at an 8% stated rate of interest and was to pay back the loan in 24
monthly payments. What is her effective rate of interest using the installment loan formula?
A. 10.5%
B. 15.4%
C. 18.9%
D. 22.0%
82. The required compensating balance is usually computed as a
A. percentage of the customer's loans outstanding.

B. factor of accounts receivable.
C. percentage of the bank's commitments toward future loans to the customer.
D. percentage of the customer's loans outstanding or percentage of the bank's commitments
toward future loans to the customer.
83. Holland Construction Co. has an outstanding 180-day bank loan of $475,000 at an annual interest
rate of 7.5%. The company is required to maintain a 15% compensating balance in its checking
account. What is the effective interest rate on the loan? Assume the company would not normally
maintain this average amount.
A. 11.2%
B. 19.0%
C. 22.45%
D. 8.8%
8-12
84. Koopman's Chickens, Inc. plans to borrow $275,000 from its bank for one year. The rate of
interest is 9%, but a compensating balance of 20% is required. What is the effective rate of
interest?
A. Less than 11.4%

D. More than 11.8%
85. Friedman Roses Inc. needs $65,000 in funds for expansion. With a compensating balance
requirement of 20%, how much will the firm need to borrow?
A. $16,000
B. $81,250
C. $100,000
86. Commercial paper is very popular with many firms because
A. it can usually be issued below the prime rate.

B. it satisfies the firm's need for long-term funds.
C. there are no required lines of credit at the bank.
D. it is very simple to roll over (refinance) in times of economic turmoil.
87. The Truth in Lending law is primarily designed to protect
A. corporate borrowers.
B. banks.
C. consumers.
D. investors in municipal bonds.
88. Commercial paper offers which of the following advantages to the issuer?
A. It may be issued below the prime rate.

B. It requires no compensating balances.
C. It is secured by corporate assets to protect the buyer.
D. It may be issued below the prime rate and requires no compensating balances.
8-13
89. Which of the following is NOT a characteristic of commercial paper?
A. It is issued by large firms.

B. It has a one- to two-year maturity.
C. Its rates are usually below prime rates on business loans.
D. All of these options are commercial paper characteristics.
90. Commercial paper that is sold without going through a broker or dealer is known as
A. direct paper.
B. dealer paper.
C. a book-entry transaction.
D. term paper.
91. 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.
92. 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 sell dealer
paper instead.
93. Multinational firms have found that they can lower borrowing costs
A. by borrowing Eurodollars at a lower rate than the U.S. Prime Rate.

B. by borrowing foreign currencies through foreign subsidiaries at rates lower than the U.S. prime
rate and then converting these foreign loans into dollars.
C. by using more bankers' acceptances.
D. by borrowing Eurodollars at a lower rate than the U.S. prime rate and by borrowing foreign
currencies through foreign subsidiaries at rates lower than the U.S. prime rate and then
converting these foreign loans into dollars.
8-14
94. Accounts receivable may be used as a source of financing by
A. pledging the receivables as loan collateral.

B. "factoring" the receivables to a finance company.
C. selling securities backed by the receivables.
95. 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 future cash flows for current cash flows.
C. The asset-backed security is likely to carry a high credit rating of AA or better.
D. The borrower trades future cash flows for current cash flows and the asset-backed security is
likely to carry a high credit rating of AA or better.
96. Which of the following is associated with the recession of 2007-2009?
A. Hundreds of bank failures occurred.

B. The Federal Reserve and the Federal Deposit Insurance Corporation forced large banks at risk
of collapse to be taken over by healthy banks.
C. Commercial banks and investment banks were allowed to merge.
97. The extent to which inventory financing may be used depends on the
A. marketability of pledged goods.

B. price stability of goods.
C. perishability of goods.
98. 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
8-15
99. Which method of controlling pledged inventory provides the greatest degree of security to the
lender?

B. Overall inventory liens
C. Trust receipts
D. Warehousing
100.Which of the following is NOT a method for controlling pledged inventory?

B. Floor planning
C. Public warehousing
D. Each of the above is an inventory control method.
101.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.
102.The "financial futures market"
A. is a place in Chicago where future stocks are traded.

B. allows for the delivery of financial instruments at a future point in time.
C. is of particular value to small investors in managing their portfolios.
D. is a place in Chicago where future stocks are traded and is of particular value to small
investors in managing their portfolios
103.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.
8-16
104.If 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.
105.The effective rate on a loan with a 7% stated rate and 15% compensating balance is
approximately ______.
A. 11%
B. 7.2%
C. 8.2%
106.The effective rate on a $20,000 installment loan with quarterly payments and $2,000 in interest for
two years is approximately ______.
A. 16%
B. 7.4%
C. 29.5%
D. 8.9%
107.Which of the following is NOT evident during a credit crunch?
A. The Fed tightens the money supply.

B. There are higher business requirements for funds.
C. A decrease in interest rates occurs.
D. Massive withdrawals from savings deposits occur.
108.Which of the following is NOT a benefit of commercial paper to a corporation?
A. It is often issued at below the prime interest rate.

B. There are no compensating balance requirements.
C. It is less risky.
D. It provides prestige to the issuer.
8-17
109.Which of the following is NOT a reason why a company may choose to pledge accounts
receivable?
A. A lower interest rate.

B. The borrowing capacity fluctuates with A/R.
C. It provides another source of financing for companies with lower credit ratings.
D. All of these are reasons for pledging accounts receivable.
Matching Questions
8-18
110.Match the following with the items below:
A measure of the relationship between

1. commercial accounts receivable and accounts payable
paper for the firm. ____
2. asset-backed
public offering A measure of the effective rate of a loan. ____
The practice of using accounts receivable
from sales of computers and automobiles, for
3. bank holding example, to collateralize an offering of
company securities in the secondary market. ____
A reduction in the amount payable by the
customer if a payment is made within a
4. cash discount specified time. ____
5. spontaneous An extension of credit generally for a time
sources of funds period of from one to seven years. ____
Arise through the normal course of
6. LIBOR business from various points within the firm. ____
Use a series of equal payments to retire a
7. net trade credit loan. ____
A loan from a foreign bank denominated
8. term loan in U.S. dollars. ____
A legal entity in which one key bank owns
a number of affiliate banks as well as other
9. compensating nonbank subsidiaries engaged in related
balances activities. ____
10. annual
percentage rate An unsecured promissory note issued by
(APR) a large corporation to investors. ____
A bank requirement that business
11. self-liquidating customers maintain a minimum level of cash
loan in their account. ____
A benchmark interest rate set in Europe
12. prime rate that is competitive with the U.S. prime rate. ____
Bank loans that are usually paid off as the
13. installment loan inventory is sold and cash is collected. ____
The interest level charged to a U.S.
14. Eurodollar loan bank's most creditworthy customers. ____
8-19
111.Match the following with the items below:
1. public Selling accounts receivable to a financial

warehousing institution. ____
2. futures Using accounts due to the firm as collateral
contract for a loan. ____
An inventory financing arrangement in which
collateralized inventory is stored on the
3. securitization premises of the borrower, but is controlled by
of assets an independent warehousing company. ____
Lessening or eliminating risk by taking a
position that is the opposite of your initial
4. dealer paper position. ____
A secured borrowing arrangement in which
5. blanket the lender has a general claim against the stock
inventory lien in trade of the borrower. ____
An instrument acknowledging that the
6. installment borrower holds the inventory and proceeds from
loan a sale in trust for the lender. ____
An inventory-financing arrangement in which
inventory used as collateral is stored with and
controlled by an independent warehousing
7. direct paper company. ____
This loan features subtraction of the
8. trust receipt calculated interest payment in advance. ____
9. commercial Uses a series of equal payments to retire a
paper loan. ____
10. field An unsecured promissory note issued by a
warehousing large corporation to investors. ____
A form of commercial paper sold from a
finance company to a lender. (Also referred to
11. trade credit as financial paper.) ____
12. factoring The issuance of a security that pledges the
receivables backing of an asset. ____
A legal agreement to buy or sell a
commodity or currency at some specified price
13. hedging in the future. ____
14. pledging small company to an intermediary network to
receivables distribute the paper. ____
15. discounted Financing provided by sellers or suppliers in
loan the normal course of business. ____
Essay Questions
8-20
112.Slipshod Machine Tool Co. owes $55,000 to one of its suppliers. The supplier has offered a trade
discount of 2/10, net 30. Slipshod can borrow the funds from either of two banks: First City Bank
will loan the funds for 20 days at a cost of $500; Upstart Bank offers a discounted loan for 20 days
at a cost of $375.
a) What is the cost of failing to take the discount?

b) What is the effective interest rate on each of the loans?
c) Should Slipshod take the cash discount?
d) Which bank loan should Slipshod use?
113.Brand Advertising is offered a 3/10, net 40 trade discount by its supplier. In the past, Brand has
been able to get away with paying for supplies on credit in 60 days. Since it doesn't have money
on hand to take advantage of the discount, it tries to negotiate a loan with Portland State Bank.
The amount of $400,000 with a 12% compensating balance and a $6,200 interest charge has
been negotiated for the month of May. Brand already maintains a $16,250 balance at the bank.
Compute the effective rate of interest on the loan, and the cost of not taking the discount. Should
Brand take advantage of the cash discount?
8-21
114.Business Book Publishing needs to borrow $800,000 in order to finance its new inventory. Two
banks they were considering offered different annual loan terms: Marine Bank offered a 7% loan
with a 15% compensating balance to be paid back in quarterly payments. McLean National Bank
offered Business Book Publishing an 8.25% loan to be paid back semi-annually. Which loan terms
should Business Book Publishing take?
115.The Magic Pumpkin Limousine Company wants to purchase a car entertainment system for one
of its automobiles. The entertainment system vendor has offered to finance the $2,000 purchase
over one year in 12 installments, with a total of $200 in interest to be paid on the loan. Magic
Pumpkin's bank has offered to finance the purchase with an installment loan, where $155 in
interest will be repaid and payments on the loan must be made quarterly. What are the effective
interest rates on these loans? Which loan should they select?
8-22
116.In order to finance a shipment of badminton sets, Rujisawa Import-Export is seeking a $700,000
one-year bank loan. The Marine Bank requires that Rujisawa maintain a 25% compensating
balance and requires four quarterly payments. The Lincoln Bank requires only a 15%
compensating balance, but requires 12 monthly payments. In addition, Lincoln discounts the loan.
Both banks state that their interest rate is 8%.
a) Which bank has the lowest effective interest rate?

(NOTE: Deduct the compensating balances from the principal in determining the effective rate.)
b) If Lincoln Bank eliminated its compensating-balance requirement, would your answer change?
117.Ohlin, Meade, and Assoc. plans to borrow $1,500,000 for 12 months. Citibank gives the firm a
stated rate of 10% interest.
What is the effective rate of interest if the loan carries a simple 10% interest with a 20%
compensating balance?
8-23
What is the effective rate of interest if the bank uses a discounted loan?
What is the effective rate of interest if the loan is an installment loan with 12 payments?
What is the effective rate of interest if the loan is a discounted loan with a 10% compensating
balance?
8-24
121.If you borrow $15,000 at $1,000 interest for one year, what is your effective interest cost for the
following payment plans?
Annual payment.
Semiannual payments.
Quarterly payments.
8-25
Monthly payments.
8-26
Chapter 08 Sources of Short-Term Financing Answer Key
True / False Questions
1. The largest source of short-term funds for most companies is suppliers (trade credit).
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
Learning Objective: 08-01 Trade credit from suppliers is normally the most available form of short-term financing.
2. Larger firms tend to be net users of trade credit, rather than net providers.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
3. Small companies finance a relatively greater proportion of their assets through trade credit than
do larger concerns.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: Intermediate
4. The cost of not taking a 2/10, net 30 cash discount is usually less than the prime rate.
FALSE
AACSB: Analytic
Blooms: Apply
5. Accounts payable is a spontaneous source of funds that grows as the business expands.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
8-27
6. The cost of NOT taking a discount is higher for terms of 2/10, net 60 than for 2/10, net 30.
FALSE
AACSB: Analytic
Blooms: Apply
7. "Stretching the payment period" refers to the practice of trying to take a trade discount after the
discount period.
FALSE
AACSB: Analytic
AACSB: Ethics
Blooms: Understand
8. On 2/10, net 30 trade terms, if the discount is not taken, the buyer is said to receive 20 days of
free credit.
FALSE
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
9. Firms can almost always increase the amount of time they take to pay for purchases without
incurring problems.
FALSE
AACSB: Analytic
AACSB: Ethics
Blooms: Understand
8-28
10. Approximately 40% of all short-term financing is in the form of accounts payable or trade
credit.
TRUE
AACSB: Reflective Thinking

Blooms: Remember
11. Trade credit is usually extended for periods of one year or more.
FALSE

Blooms: Remember
12. A cash discount calls for a reduction in price if payment cannot be made within a specified time
period.
FALSE
AACSB: Analytic
Blooms: Understand
13. Leontief's Wigs can borrow from its bank at 16% to take a cash discount. The terms of the cash
discount are 2/10, net 60. Leontief's should borrow from the bank to take the discount.
FALSE
AACSB: Analytic
Blooms: Apply
Difficulty: Challenge
8-29
14. Myrdal Boots can borrow from its bank at 12% to take a cash discount. The terms of the cash
discount are 3/10, net 90. Myrdal Boots should borrow from the bank to take the discount.
TRUE
AACSB: Analytic
Blooms: Apply
15. Bank deregulation has eased competition between commercial banks, savings and loans,
brokerage houses, and new financial services companies.
FALSE

Blooms: Remember
Difficulty: Basic
Learning Objective: 08-02 Bank loans are usually short term in nature and should be paid off from funds from the normal
operations of the firm.
16. 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.
FALSE
AACSB: Analytic
Blooms: Understand
17. The lender's primary concern is whether the borrower's capacity to generate receivables is
sufficient to liquidate the loan as it comes due.
FALSE
AACSB: Analytic
Blooms: Understand
8-30
18. Although the LIBOR has remained competitive and comparable to the U.S. prime rate, it has
remained slightly higher than the prime rate for over a decade.
FALSE
AACSB: Analytic
Blooms: Understand
19. The London Interbank Offered Rate (LIBOR) is used to set a base lending rate for some U.S.
domestic corporate loans.
TRUE

Blooms: Remember
Difficulty: Basic
20. Although the prime rate is the rate that U.S. banks charge their most credit-worthy customers,
the prime rate is normally higher than the London Interbank Offered Rate (LIBOR).
TRUE
AACSB: Analytic
Blooms: Understand
21. Compensating balances are important for banks because their existence allows them to make
loans at lower quoted rates.
TRUE
AACSB: Analytic
Blooms: Understand
Difficulty: Basic
22. A compensating balance will be lower in periods of tight money than in periods of credit
easing.
FALSE
AACSB: Analytic
Blooms: Understand
8-31
23. Compensating balances are a way for banks to recover the cost of corporate services
provided, but not directly charged.
TRUE

Blooms: Remember
Difficulty: Basic
24. Compensating balances represent unfair hidden costs of borrowing.
FALSE
AACSB: Analytic
AACSB: Ethics
Blooms: Understand
25. Monthly installment loans usually increase the effective rate of borrowing by approximately 2
times the stated rate.
TRUE
AACSB: Analytic
Blooms: Understand
26. The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an
annualized basis.
TRUE

Blooms: Remember
27. The term "credit crunch" refers to a period in which the interest rate on credit is so high that
firms cannot afford to borrow money.
FALSE
AACSB: Analytic
Blooms: Understand
8-32
28. Commercial paper is an unsecured short-term IOU from a large financially secure company.
TRUE

Blooms: Remember
Difficulty: Basic
Learning Objective: 08-03 Commercial paper represents a short-term; unsecured promissory note issued by the firm.
29. It is easier for small firms to obtain financing through bank loans than through the commercial
paper market.
TRUE
AACSB: Analytic
Blooms: Understand
30. Small businesses frequently find commercial paper a useful means of obtaining funds when it
is not possible to raise funds by other means.
FALSE
AACSB: Analytic
Blooms: Understand
31. Commercial paper represents secured short-term borrowing by large companies.
FALSE

Blooms: Remember
Difficulty: Basic
32. Issuers of commercial paper can be divided into finance paper or direct paper, dealer paper,
and asset-backed commercial paper.
TRUE
AACSB: Analytic
Blooms: Understand
8-33
33. One major advantage of commercial paper is that it can always be "rolled over" (reissued)
when it matures.
FALSE

Blooms: Remember
34. All commercial paper involves the physical transfer of actual paper certificates.
FALSE
AACSB: Analytic
Blooms: Understand
35. Firms using commercial paper are generally required to maintain commercial bank lines of
credit equal to the amount of the paper outstanding.
TRUE

Blooms: Remember
36. The commercial paper market is available to all New York Stock Exchange companies.
FALSE

Blooms: Remember
37. One major disadvantage of commercial paper is that if the company's credit quality declines,
refinancing existing commercial paper might be impossible to achieve through a new issue of
commercial paper.
TRUE

Blooms: Remember
Difficulty: Basic
38. Finance paper usually carries a higher rate of interest than direct paper.
FALSE
AACSB: Analytic
8-34
Blooms: Understand
39. One advantage to an issuer of commercial paper is that the issuer eliminates the need for
maintaining compensating balances and credit lines with a commercial bank.
FALSE
AACSB: Analytic
Blooms: Understand
40. Factoring accounts receivable, unlike pledging accounts receivable, typically passes the risk of
loss on the receivable to the buyer.
TRUE

Blooms: Remember
Learning Objective: 08-04 By using accounts receivable and inventory as collateral for a loan; the firm may be able to borrow
larger amounts.
41. Eurodollar loans are similar to U.S. bank loans in that they are usually short-to intermediate-
term in nature.
TRUE

Blooms: Remember
42. In times of tight credit in the United States, Eurodollar loans become difficult to obtain.
FALSE
AACSB: Analytic
Blooms: Understand
43. It is difficult to acquire a loan in U.S. dollars outside the United States.
FALSE
AACSB: Analytic
Blooms: Understand
8-35
44. The sale of securities backed by the receivables of large credit-worthy firms is a large and
growing source of financing.
TRUE
AACSB: Analytic
Blooms: Understand
larger amounts.
45. General Motors Acceptance Corporation (GMAC) is one of the biggest issuers of asset-backed
securities.
TRUE

Blooms: Remember
Difficulty: Basic
larger amounts.
46. The biggest category of asset-backed securities is the home equity loan, followed by
automobile receivables and credit card receivables.
TRUE

Blooms: Remember
larger amounts.
47. The sale of asset-backed securities can sometimes enable the issuing firm to acquire lower-
cost funds than it normally would receive from a bank loan or bond offering.
TRUE
AACSB: Analytic
Blooms: Understand
larger amounts.
48. The simplest inventory financing method is a blanket inventory lien where items are not
identified or tagged, and there is no physical transfer of control of the inventory from the
borrower.
TRUE

Blooms: Remember
8-36
larger amounts.
49. A trust receipt acknowledges that the lender trusts the borrower to repay the loan before any
dividends are paid.
FALSE

Blooms: Remember
larger amounts.
50. The movement of the exchange rate between two currencies can increase the total cost of a
loan by making the principal repayment require more money than the original amount of the
loan.
TRUE
AACSB: Analytic
Blooms: Understand
51. The most common form of short-term financing is a bank loan.
FALSE

Blooms: Remember
Difficulty: Basic
52. The higher the cost of bank financing, the more beneficial it is to take the cash discount.
FALSE
AACSB: Analytic
Blooms: Evaluate
53. A self-liquidating loan is preferable to a bank because it generally provides them with a higher
return.
FALSE
AACSB: Analytic
Blooms: Understand
8-37
54. At historically low interest rate levels, compensating balances increase.
TRUE

Blooms: Remember
55. A term loan is less risky to the bank, thus they provide a fixed rate to the customer.
FALSE

Blooms: Remember
56. The APR is generally lower than the rate stated by the bank.
FALSE
AACSB: Analytic
Blooms: Understand
Multiple Choice Questions
57. 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

Blooms: Remember
Difficulty: Basic
8-38
58. Trade credit may be used to finance a major part of a 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.
AACSB: Analytic
Blooms: Understand
59. 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
AACSB: Analytic
Blooms: Analyze
A. 44.54%
B. 43.20%
C. 36.73%
AACSB: Analytic
Blooms: Apply
8-39
61. 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.
AACSB: Analytic
Blooms: Understand
62. From the banker's point of view, short-term bank credit is an excellent way of financing
A. fixed assets.
B. permanent working capital needs.
C. repayment of long-term debt.
D. seasonal bulges in inventory and receivables.
AACSB: Analytic
Blooms: Understand
A. 15.9%
B. 16.3%
C. 18.0%
D. 17.4%
AACSB: Analytic
Blooms: Apply
8-40
64. Bank loans to business firms
A. are usually short-term in nature.

B. are preferred by the banker to be self-liquidating.
C. may require compensating balances.

Blooms: Remember
Difficulty: Basic
65. Commercial 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 very short-term in nature and are offered to superior credit applicants.

Blooms: Remember
Difficulty: Basic
66. Kantorovich Company normally takes 30 days to pay for its average daily credit purchases of
$2,000. Its average daily sales are $3,000, and it collects accounts in 25 days. What is its net
credit position?
A. $15,000
B. $1,000
C. ($1,000)
D. ($15,000)
Net credit position = Accounts receivable - Accounts payable

Accounts receivable = Avg. daily credit sales × Avg. collection period
$75,000 = $3,000 × 25 days
Accounts payable = Avg. daily credit purchases × Avg. payment period
$60,000 = $2,000 × 30 days
Net credit position = $75,000 - $60,000 = $15,000; Kantorovich is therefore a "net provider of
trade credit."
AACSB: Analytic
Blooms: Apply
8-41
67. Recent problems facing the U.S. financial system were the result of all but which one of the
following?
A. A huge increase in the amount of mortgage-backed securities being bundled up and sold in
the markets
B. A huge drop in the value of mortgage-backed securities
C. An increase in the use of commercial paper for short-term financing
D. The government permitting commercial and investment banks to merge

Blooms: Remember
68. The prime rate
A. is the rate a bank charges its risky customers.

B. has been quite volatile during the past two decades, moving several percentage points in a
12-month period.
C. is usually lower than Treasury bill rates.

Blooms: Remember
69. The London Interbank Offered Rate (LIBOR)
A. competes with the U.S. Prime Rate for those companies with an international presence.
B. has been lower than the U.S. Prime Rate for at least the last decade.
C. is an estimate of the interbank lending rate for London banks.
D. All of these options are correct.

Blooms: Remember
8-42
70. LIBOR is
A. a resource used in production.

B. an interest rate paid on Eurodollar loans in the London market.
C. an interest rate paid by European firms when they borrow Eurodollar deposits from U.S.
banks.
D. the interest rate paid by the British government on its long-term bonds.

Blooms: Remember
71. Compensating balances
A. are used by banks as a substitute for charging service fees.

B. are created by having a sweep account.
C. generate returns to customers from interest-bearing accounts.
D. are used to reward new accounts.

Blooms: Remember
Difficulty: Basic
72. General Rent-All's officers arrange a $50,000 loan. The company is required to maintain a
minimum checking account balance of 10% of the outstanding loan. This practice is called
A. an installment loan.
B. a compensating balance.
C. a discounted loan.
D. a balloon payment.
AACSB: Analytic
Blooms: Understand
8-43
73. Analog Computers needs to borrow $475,000 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 $475,000 spendable cash?
A. $546,250
B. $758,264
C. $558,824
AACSB: Analytic
Blooms: Apply
74. If Analog Computers can borrow at 8% for three years, what is the effective rate of interest on a
$1,000,000 loan where a 15% compensating balance is required?
A. 11.18%
B. 17.27%
C. 9.41%
AACSB: Analytic
Blooms: Apply
8-44
75. A term loan is usually characterized by
A. a maturity of one to seven years.

B. a variable interest rate.
C. monthly or quarterly installment payments.

Blooms: Remember
Difficulty: Basic
76. In determining the cost of bank financing, which is the important factor?
A. The prime rate

B. The nominal rate
C. The effective rate
D. The discount rate
AACSB: Analytic
Blooms: Understand
77. Mr. Jones borrows $4,500 for 90 days and pays $75 interest. What is his approximate effective
rate of interest?
A. 9.3%
B. 6.7%
C. 11.7%
AACSB: Analytic
Blooms: Apply
8-45
78. Von Hayek's Kayaks can borrow $12,500 for 60 days at a cost of $220 interest. What is the
effective rate of interest?
A. Less than 9.9%

B. More than 9.9% but less than 10%
D. More than 11.5%
AACSB: Analytic
Blooms: Apply
79. Kenneth's Arrows and Bows borrow $15,000 for one year at 8% interest. What is the effective
rate of interest if the loan is discounted?
A. Less than 8.5%

D. More than 10.5%
AACSB: Analytic
Blooms: Apply
8-46
80. East Coast Cleaners borrows $20,000 for 120 days and pays $400 interest. What is the
effective rate of interest if the loan is discounted?
A. Less than 5.5%

D. More than 6.5%
AACSB: Analytic
Blooms: Apply
81. Ms. Smith borrowed $2,000 at an 8% stated rate of interest and was to pay back the loan in 24
monthly payments. What is her effective rate of interest using the installment loan formula?
A. 10.5%
B. 15.4%
C. 18.9%
D. 22.0%
AACSB: Analytic
Blooms: Apply
8-47
82. The required compensating balance is usually computed as a
A. percentage of the customer's loans outstanding.

B. factor of accounts receivable.
C. percentage of the bank's commitments toward future loans to the customer.
D. percentage of the customer's loans outstanding or percentage of the bank's commitments
toward future loans to the customer.
AACSB: Analytic
Blooms: Understand
83. Holland Construction Co. has an outstanding 180-day bank loan of $475,000 at an annual
interest rate of 7.5%. The company is required to maintain a 15% compensating balance in its
checking account. What is the effective interest rate on the loan? Assume the company would
not normally maintain this average amount.
A. 11.2%
B. 19.0%
C. 22.45%
D. 8.8%
Method 1:
Method 2: Interest rate/(1 - c) = 7.5%/(1 - .15) = 8.8%
AACSB: Analytic
Blooms: Apply
8-48
84. Koopman's Chickens, Inc. plans to borrow $275,000 from its bank for one year. The rate of
interest is 9%, but a compensating balance of 20% is required. What is the effective rate of
interest?
A. Less than 11.4%

D. More than 11.8%
Method 1:
Method 2: Interest rate/(1 - c) = 9%/(1 - .2) = 11.25%
AACSB: Analytic
Blooms: Apply
85. Friedman Roses Inc. needs $65,000 in funds for expansion. With a compensating balance
requirement of 20%, how much will the firm need to borrow?
A. $16,000
B. $81,250
C. $100,000
AACSB: Analytic
Blooms: Apply
8-49
86. Commercial paper is very popular with many firms because
A. it can usually be issued below the prime rate.

B. it satisfies the firm's need for long-term funds.
C. there are no required lines of credit at the bank.
D. it is very simple to roll over (refinance) in times of economic turmoil.

Blooms: Remember
87. The Truth in Lending law is primarily designed to protect
A. corporate borrowers.
B. banks.
C. consumers.
D. investors in municipal bonds.
AACSB: Ethics
Blooms: Remember
Difficulty: Basic
88. Commercial paper offers which of the following advantages to the issuer?
A. It may be issued below the prime rate.

B. It requires no compensating balances.
C. It is secured by corporate assets to protect the buyer.
D. It may be issued below the prime rate and requires no compensating balances.

Blooms: Remember
Difficulty: Basic
8-50
89. Which of the following is NOT a characteristic of commercial paper?
A. It is issued by large firms.

B. It has a one- to two-year maturity.
C. Its rates are usually below prime rates on business loans.
D. All of these options are commercial paper characteristics.

Blooms: Remember
90. Commercial paper that is sold without going through a broker or dealer is known as
A. direct paper.
B. dealer paper.
C. a book-entry transaction.
D. term paper.

Blooms: Remember
Difficulty: Basic
91. 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.

Blooms: Remember
Difficulty: Basic
92. 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 sell
dealer paper instead.

Blooms: Remember
8-51
93. Multinational firms have found that they can lower borrowing costs
A. by borrowing Eurodollars at a lower rate than the U.S. Prime Rate.

B. by borrowing foreign currencies through foreign subsidiaries at rates lower than the U.S.
prime rate and then converting these foreign loans into dollars.
C. by using more bankers' acceptances.
D. by borrowing Eurodollars at a lower rate than the U.S. prime rate and by borrowing foreign
currencies through foreign subsidiaries at rates lower than the U.S. prime rate and then
converting these foreign loans into dollars.
AACSB: Analytic
Blooms: Understand
94. Accounts receivable may be used as a source of financing by
A. pledging the receivables as loan collateral.

B. "factoring" the receivables to a finance company.
C. selling securities backed by the receivables.
AACSB: Analytic
Blooms: Understand
larger amounts.
95. 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 future cash flows for current cash flows.
C. The asset-backed security is likely to carry a high credit rating of AA or better.
D. The borrower trades future cash flows for current cash flows and the asset-backed security
is likely to carry a high credit rating of AA or better.
AACSB: Analytic
Blooms: Understand
larger amounts.
8-52
96. Which of the following is associated with the recession of 2007-2009?
A. Hundreds of bank failures occurred.

B. The Federal Reserve and the Federal Deposit Insurance Corporation forced large banks at
risk of collapse to be taken over by healthy banks.
C. Commercial banks and investment banks were allowed to merge.

Blooms: Remember
larger amounts.
97. The extent to which inventory financing may be used depends on the
A. marketability of pledged goods.

B. price stability of goods.
C. perishability of goods.
AACSB: Analytic
Blooms: Understand
larger amounts.
98. Which of the following is NOT a method for lenders to control pledged inventory?

B. Trust receipts
C. Warehousing
D. Factoring
AACSB: Analytic
Blooms: Understand
larger amounts.
8-53
99. Which method of controlling pledged inventory provides the greatest degree of security to the
lender?

B. Overall inventory liens
C. Trust receipts
D. Warehousing

Blooms: Remember
Difficulty: Basic
larger amounts.
100. Which of the following is NOT a method for controlling pledged inventory?

B. Floor planning
C. Public warehousing
D. Each of the above is an inventory control method.

Blooms: Remember
larger amounts.
101. 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.

Blooms: Remember
Difficulty: Basic
Learning Objective: 08-05 Hedging may be used to offset the risk of interest rates rising.
8-54
102. The "financial futures market"
A. is a place in Chicago where future stocks are traded.

B. allows for the delivery of financial instruments at a future point in time.
C. is of particular value to small investors in managing their portfolios.
D. is a place in Chicago where future stocks are traded and is of particular value to small
investors in managing their portfolios

Blooms: Remember
Difficulty: Basic
103. 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.
AACSB: Analytic
Blooms: Understand
104. If 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.
AACSB: Analytic
Blooms: Understand
8-55
105. The effective rate on a loan with a 7% stated rate and 15% compensating balance is
approximately ______.
A. 11%
B. 7.2%
C. 8.2%
AACSB: Analytic
Blooms: Apply
106. The effective rate on a $20,000 installment loan with quarterly payments and $2,000 in interest
for two years is approximately ______.
A. 16%
B. 7.4%
C. 29.5%
D. 8.9%
AACSB: Analytic
Blooms: Apply
8-56
107. Which of the following is NOT evident during a credit crunch?
A. The Fed tightens the money supply.

B. There are higher business requirements for funds.
C. A decrease in interest rates occurs.
D. Massive withdrawals from savings deposits occur.
AACSB: Analytic
Blooms: Understand
108. Which of the following is NOT a benefit of commercial paper to a corporation?
A. It is often issued at below the prime interest rate.

B. There are no compensating balance requirements.
C. It is less risky.
D. It provides prestige to the issuer.
AACSB: Analytic
Blooms: Understand
109. Which of the following is NOT a reason why a company may choose to pledge accounts
receivable?
A. A lower interest rate.

B. The borrowing capacity fluctuates with A/R.
C. It provides another source of financing for companies with lower credit ratings.
D. All of these are reasons for pledging accounts receivable.
AACSB: Analytic
Blooms: Understand
larger amounts.
Matching Questions
8-57
110. Match the following with the items below:
A measure of the relationship between

1. commercial accounts receivable and accounts payable for
paper the firm. 7
2. asset-backed
public offering A measure of the effective rate of a loan. 10
The practice of using accounts receivable
from sales of computers and automobiles, for
3. bank holding example, to collateralize an offering of
company securities in the secondary market. 2
A reduction in the amount payable by the
customer if a payment is made within a
4. cash discount specified time. 4
5. spontaneous An extension of credit generally for a time
sources of funds period of from one to seven years. 8
Arise through the normal course of
6. LIBOR business from various points within the firm. 5
Use a series of equal payments to retire a
7. net trade credit loan. 13
A loan from a foreign bank denominated in
8. term loan U.S. dollars. 14
A legal entity in which one key bank owns
a number of affiliate banks as well as other
9. compensating nonbank subsidiaries engaged in related
balances activities. 3
10. annual
percentage rate An unsecured promissory note issued by a
(APR) large corporation to investors. 1
A bank requirement that business
11. self-liquidating customers maintain a minimum level of cash
loan in their account. 9
A benchmark interest rate set in Europe
12. prime rate that is competitive with the U.S. prime rate. 6
Bank loans that are usually paid off as the
13. installment loan inventory is sold and cash is collected. 11
The interest level charged to a U.S. bank's
14. Eurodollar loan most creditworthy customers. 12
AACSB: Analytic
Blooms: Understand
larger amounts.
8-58
111. Match the following with the items below:
1. public Selling accounts receivable to a financial

warehousing institution. 12
2. futures Using accounts due to the firm as collateral
contract for a loan. 14
An inventory financing arrangement in which
collateralized inventory is stored on the
3. securitization premises of the borrower, but is controlled by an
of assets independent warehousing company. 10
Lessening or eliminating risk by taking a
position that is the opposite of your initial
4. dealer paper position. 13
A secured borrowing arrangement in which
5. blanket the lender has a general claim against the stock
inventory lien in trade of the borrower. 5
An instrument acknowledging that the
6. installment borrower holds the inventory and proceeds from
loan a sale in trust for the lender. 8
An inventory-financing arrangement in which
inventory used as collateral is stored with and
controlled by an independent warehousing
7. direct paper company. 1
This loan features subtraction of the
8. trust receipt calculated interest payment in advance. 15
9. commercial Uses a series of equal payments to retire a
paper loan. 6
10. field An unsecured promissory note issued by a
warehousing large corporation to investors. 9
finance company to a lender. (Also referred to
11. trade credit as financial paper.) 7
12. factoring The issuance of a security that pledges the
receivables backing of an asset. 3
A legal agreement to buy or sell a commodity
or currency at some specified price in the
13. hedging future. 2
14. pledging small company to an intermediary network to
receivables distribute the paper. 4
15. discounted Financing provided by sellers or suppliers in
loan the normal course of business. 11
AACSB: Analytic
Blooms: Understand
8-59
larger amounts.
Essay Questions
112. Slipshod Machine Tool Co. owes $55,000 to one of its suppliers. The supplier has offered a
trade discount of 2/10, net 30. Slipshod can borrow the funds from either of two banks: First
City Bank will loan the funds for 20 days at a cost of $500; Upstart Bank offers a discounted
loan for 20 days at a cost of $375.
a) What is the cost of failing to take the discount?

b) What is the effective interest rate on each of the loans?
c) Should Slipshod take the cash discount?
d) Which bank loan should Slipshod use?
a) Cost of failing to take discount
b) Effective rate =
First city =
Upstart =
c) Yes, they should take the cash discount because the cost of financing (borrowing) is less
than the cost of failing to take the cash discount
d) Take Upstart's loan. The effective interest rate is much lower.
AACSB: Analytic
Blooms: Apply
Blooms: Evaluate
8-60
113. Brand Advertising is offered a 3/10, net 40 trade discount by its supplier. In the past, Brand has
been able to get away with paying for supplies on credit in 60 days. Since it doesn't have
money on hand to take advantage of the discount, it tries to negotiate a loan with Portland
State Bank. The amount of $400,000 with a 12% compensating balance and a $6,200 interest
charge has been negotiated for the month of May. Brand already maintains a $16,250 balance
at the bank. Compute the effective rate of interest on the loan, and the cost of not taking the
discount. Should Brand take advantage of the cash discount?
* Take loan and cash discount. The effective rate on the loan is less than the cost of failing to
take the cash discount.
**Since Brand gets away by paying in 60 days instead of 40, we use 60 days as the final due
date.
AACSB: Analytic
Blooms: Apply
Blooms: Evaluate
8-61
114. Business Book Publishing needs to borrow $800,000 in order to finance its new inventory. Two
banks they were considering offered different annual loan terms: Marine Bank offered a 7%
loan with a 15% compensating balance to be paid back in quarterly payments. McLean
National Bank offered Business Book Publishing an 8.25% loan to be paid back semi-annually.
Which loan terms should Business Book Publishing take?
Take McLean's offer. Even though it has a higher stated rate, the effective rate is lower
because it does not have a compensating balance requirement and only requires semi-annual
payments versus quarterly.
AACSB: Analytic
Blooms: Apply
Blooms: Evaluate
8-62
115. The Magic Pumpkin Limousine Company wants to purchase a car entertainment system for
one of its automobiles. The entertainment system vendor has offered to finance the $2,000
purchase over one year in 12 installments, with a total of $200 in interest to be paid on the
loan. Magic Pumpkin's bank has offered to finance the purchase with an installment loan,
where $155 in interest will be repaid and payments on the loan must be made quarterly. What
are the effective interest rates on these loans? Which loan should they select?
Choose the Bank Plan for its lower effective rate.
AACSB: Analytic
Blooms: Apply
Blooms: Evaluate
8-63
116. In order to finance a shipment of badminton sets, Rujisawa Import-Export is seeking a
$700,000 one-year bank loan. The Marine Bank requires that Rujisawa maintain a 25%
compensating balance and requires four quarterly payments. The Lincoln Bank requires only a
15% compensating balance, but requires 12 monthly payments. In addition, Lincoln discounts
the loan. Both banks state that their interest rate is 8%.
a) Which bank has the lowest effective interest rate?

(NOTE: Deduct the compensating balances from the principal in determining the effective rate.)
b) If Lincoln Bank eliminated its compensating-balance requirement, would your answer
change?
Marine Bank has the lowest effective rate.
Yes, Lincoln bank now has a lower effective rate.
AACSB: Analytic
Blooms: Apply
8-64
117. Ohlin, Meade, and Assoc. plans to borrow $1,500,000 for 12 months. Citibank gives the firm a
What is the effective rate of interest if the loan carries a simple 10% interest with a 20%
compensating balance?
Alternative solution = Stated interest rate/(1 - c) = 10/.8 = 12.5%
AACSB: Analytic
Blooms: Apply
What is the effective rate of interest if the bank uses a discounted loan?
AACSB: Analytic
Blooms: Apply
8-65
What is the effective rate of interest if the loan is an installment loan with 12 payments?
AACSB: Analytic
Blooms: Apply
What is the effective rate of interest if the loan is a discounted loan with a 10% compensating
balance?
AACSB: Analytic
Blooms: Apply
121. If you borrow $15,000 at $1,000 interest for one year, what is your effective interest cost for the
Annual payment.
$1,000/$15,000 = 6.7%
AACSB: Analytic
Blooms: Apply
8-66
Semiannual payments.
AACSB: Analytic
Blooms: Apply
Quarterly payments.
AACSB: Analytic
Blooms: Apply
8-67
Monthly payments.
AACSB: Analytic
Blooms: Apply
8-68

Foundations of Financial Management 15th Edition Block Test Bank 1

Uploaded by

Document Information

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Foundations of Financial Management 15th Edition Block Test Bank 1

Uploaded by

Copyright:

Available Formats

Foundations of Financial Management 15th Edition

Full download at:

Sources of Short-Term Financing

True / False Questions

24. Compensating balances represent unfair hidden costs of borrowing.

31. Commercial paper represents secured short-term borrowing by large companies.

51. The most common form of short-term financing is a bank loan.

54. At historically low interest rate levels, compensating balances increase.

Multiple Choice Questions

A. Decreased receivables and increased bank loans

61. Large firms tend to be

A. net users of trade credit.

64. Bank loans to business firms

A. are usually short-term in nature.

A. usually carry fixed interest rates.

68. The prime rate

A. is the rate a bank charges its risky customers.

69. The London Interbank Offered Rate (LIBOR)

A. a resource used in production.

71. Compensating balances

A. are used by banks as a substitute for charging service fees.

A. a maturity of one to seven years.

A. The prime rate

A. Less than 9.9%

A. Less than 8.5%

A. Less than 5.5%

82. The required compensating balance is usually computed as a

A. percentage of the customer's loans outstanding.

A. Less than 11.4%

86. Commercial paper is very popular with many firms because

A. it can usually be issued below the prime rate.

87. The Truth in Lending law is primarily designed to protect

A. It may be issued below the prime rate.

A. It is issued by large firms.

A. Finance paper is sold directly to the lender by the finance company.

A. by borrowing Eurodollars at a lower rate than the U.S. Prime Rate.

A. pledging the receivables as loan collateral.

96. Which of the following is associated with the recession of 2007-2009?

A. Hundreds of bank failures occurred.

A. marketability of pledged goods.

A. Blanket inventory liens

A. Blanket inventory liens

100.Which of the following is NOT a method for controlling pledged inventory?

A. Blanket inventory liens

A. avoiding high-risk investment opportunities.

102.The "financial futures market"

A. is a place in Chicago where future stocks are traded.

A. obtaining a Eurodollar loan.

A. declining interest rates.

107.Which of the following is NOT evident during a credit crunch?

A. The Fed tightens the money supply.

108.Which of the following is NOT a benefit of commercial paper to a corporation?

A. It is often issued at below the prime interest rate.

A. A lower interest rate.

A measure of the relationship between

1. public Selling accounts receivable to a financial

a) What is the cost of failing to take the discount?

a) Which bank has the lowest effective interest rate?

True / False Questions

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking

AACSB: Reflective Thinking