Question 1

Appropriate collateral for a loan secured under a floating inventory lien is

Accepted Answer

A floating inventory lien is typically used for inventory that is constantly changing, such as paper clips, which are consumable and frequently replenished.

Question 2

A bank lends a firm $500,000 for one year at 8 percent and requires compensating balances of 10percent of the face value of the loan. The effective annual interest rate associated with this loan is

Accepted Answer

The effective annual interest rate (EAR) takes into account any fees, such as the compensating balance requirement, charged by the lender when calculating the actual annual cost of borrowing.

To calculate the EAR in this scenario, we need to determine the actual amount borrowed after factoring in the compensating balance requirement.

Compensating balance = 10% x $500,000 = $50,000
Actual amount borrowed = $500,000 - $50,000 = $450,000

Using the formula for EAR:

EAR = (1 + APR/n)^n - 1
where APR is the annual percentage rate (in decimal form) and n is the number of compounding periods per year.

APR = 8%
n = 1 (since the loan is for one year)

EAR = (1 + 0.08/1)^1 - 1
EAR = 0.08 or 8%

However, since the loan requires a compensating balance of 10%, the actual annual cost of borrowing is higher than 8%.

To adjust for the compensating balance, we can use the following formula:

Adjusted APR = APR / (1 - Compensating balance rate)
Adjusted APR = 0.08 / (1 - 0.1)
Adjusted APR = 0.089 or 8.9%

Therefore, the effective annual interest rate associated with this loan is 8.9%, which is option C.

Question 3

A firm issued $2 million worth of commercial paper that has a 90-day maturity and sells for$1,900,000. The annual interest rate on the issue of commercial paper is

Accepted Answer

The formula to calculate the annual interest rate on commercial paper is:

Annual interest rate = (face value - selling price) / (selling price x days to maturity / 360)

Substituting the given values, we get:

Annual interest rate = (2,000,000 - 1,900,000) / (1,900,000 x 90 / 360) = 0.21 or 21%

Therefore, the annual interest rate on the commercial paper is 21%. Hence, the correct choice is D.

Question 4

The prime interest rate charged by leading Canadian banks is based on the

Accepted Answer

The prime interest rate charged by Canadian banks is typically based on the Bank of Canada rate, which is the benchmark interest rate in Canada. This rate is set by the Bank of Canada and is used to guide monetary policy and influence borrowing and lending rates for individuals and businesses across the country. While other rates, such as T-bill or bond rates, may also have some impact on banks' lending rates, the Bank of Canada rate is the primary driver of changes in the prime rate. The U.S. Federal Reserve rate is not relevant to the prime rate in Canada.

Question 5

The cost of giving up a cash discount on a credit purchase is

Accepted Answer

The cost of giving up a cash discount on a credit purchase is the implied interest rate paid in order to delay payment for an additional number of days. It is not deducted or added on to the price of goods, but rather represents the additional cost of not paying cash upfront. Therefore, the best answer is C.

Question 6

The effective interest rate

Accepted Answer

The effective interest rate takes into account the time value of money and all fees associated with the loan. In case of a discount loan, the interest is deducted upfront from the loan amount, which means the borrower receives less money and pays more interest; hence, the effective interest rate is higher. On the other hand, if interest is paid at maturity, the borrower receives the full loan amount upfront and pays interest at maturity, resulting in a lower effective interest rate. Therefore, the effective interest rate is higher on a discount loan, and so option D is the correct choice.

Question 7

__________ensure that money loaned under a line of credit agreement is actually being used to finance seasonal needs.

Accepted Answer

Annual cleanups require the borrower to pay off the line of credit completely for a short period each year, ensuring that the credit is used for short-term needs rather than long-term financing.

Question 8

A terminal warehouse is

Accepted Answer

A terminal warehouse is a central warehouse that can store the merchandise of multiple businesses or tenants. It is usually located at a transportation hub like a port or airport, and the businesses using the warehouse may be charged fees for handling, storage, and transportation services.

Question 9

__________are liabilities for services received for which payment has yet to be made. The most common accounts are taxes and wages.

Accepted Answer

Accruals are liabilities for services received for which payment has yet to be made, such as taxes and wages.

Question 10

A letter written by a company's bank to the company's foreign supplier, stating that the bank willguarantee payment of an invoiced amount if all the underlying agreements are met is called

Accepted Answer

A letter written by a company's bank to the company's foreign supplier, stating that the bank will guarantee payment of an invoiced amount if all the underlying agreements are met is called a letter of credit.

Question 11

Accruals and accounts payable are__________sources of short-term financing.

Accepted Answer

Accruals and accounts payable are both spontaneous liabilities, meaning they are generated as a result of the company's day-to-day operations without any negotiation or agreement with another party. Additionally, they are unsecured as there is no collateral backing the liability. Therefore, the correct choice is C: spontaneous, unsecured.

Question 12

If the firm decides to take the cash discount that is offered on goods purchased on credit, the firm should

Accepted Answer

The best choice is to pay on the last day of the discount period. This will allow the firm to take advantage of the cash discount while also maximizing their available cash flow during the credit period. Paying as soon as possible may not be financially feasible for the firm and paying on the last day of the credit period may result in missed opportunities for the cash discount.

Question 13

In a line of credit arrangement, the firm pays interest on

Accepted Answer

The answer of In a line of credit arrangement, the...

Question 14

A __________is a type of loan made to a business by a commercial bank. This type of loan is madewhen the borrower needs additional funds for a short period but does not believe the need willcontinue or reoccur on a seasonal basis.

Accepted Answer

A single payment note is a type of loan where the borrower receives the funds and agrees to repay the entire amount, plus interest, in one lump sum at a specified future date, typically used for short-term funding needs.

Question 15

Compared to a line of credit, a revolving credit agreement generally will be

Accepted Answer

Revolving credit agreements typically have higher costs due to fees and interest rates, but they offer more flexibility and less risk of non-renewal compared to lines of credit.

Question 16

The cost of giving up a cash discount under the terms of sale 1/10 net 60 (assume a 360-day year) is

Accepted Answer

The answer of The cost of giving up a cash...

Question 17

The prime rate of interest fluctuates with

Accepted Answer

The prime rate of interest is the interest rate that banks charge their most creditworthy customers for short-term loans. As a result, it fluctuates with the changing supply and demand relationship for short-term funds, making choice B the correct answer.

Question 18

The cost of borrowing through the sale of commercial paper is typically__________ the prime bank loan rate.

Accepted Answer

The prime bank loan rate is typically the lowest interest rate at which banks lend to their most creditworthy customers. As a result, borrowing through the sale of commercial paper is typically lower than the prime bank loan rate.

Question 19

Financing that arises from the normal operations of the firm are said to be

Accepted Answer

Financing that arises from the normal operations of the firm, such as accounts payable and accruals, are called spontaneous financing. This is because they occur naturally as a result of the company's operations and do not require any additional effort or planning to obtain.

Question 20

Commercial banks lend unsecured short-term funds in the following three basic ways

Accepted Answer

Commercial banks lend unsecured short-term funds through single-payment notes, lines of credit, and revolving credit agreements. Commercial paper is typically issued by corporations, not directly by banks.

Quiz 15: Management of Current Liabilities