Question 1

Firms using commercial paper are generally required to maintain commercial bank lines of credit equal to the amount of the paper outstanding.

Accepted Answer

This is true. Firms using commercial paper typically need to have backup lines of credit in place in case they are unable to sell enough commercial paper or if the market for commercial paper dries up. Banks providing these credit lines often require that the amount of the line of credit match the amount of commercial paper outstanding.

Question 2

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.

Accepted Answer

The answer of One advantage to an issuer of commercial...

Question 3

It is easier for small firms to obtain financing through bank loans than through the commercial paper market.

Accepted Answer

Small firms typically have a harder time accessing the commercial paper market as it is primarily used by large, well-established corporations. On the other hand, bank loans are a more common source of financing for small businesses, as they may not have the credit rating or financial history required to issue commercial paper.

Question 4

Monthly installment loans usually increase the effective rate of borrowing by approximately 2 times the stated rate.

Accepted Answer

Monthly installment loans typically come with higher interest rates compared to traditional loans, and the longer repayment duration also adds more interest charges. As a result, the effective rate of borrowing with monthly installment loans can be approximately twice the stated rate or even more, depending on the loan terms and the borrower's creditworthiness.

Question 5

Finance paper usually carries a higher rate of interest than direct paper.

Accepted Answer

The answer of Finance paper usually carries a higher rate...

Question 6

Factoring accounts receivable, unlike pledging accounts receivable, typically passes the risk of loss on the receivable to the buyer.

Accepted Answer

Factoring accounts receivable involves selling the receivables to a third party, who assumes the risk of loss if the customers fail to pay. In pledging, the receivables are used as collateral for a loan, and the company retains the risk of loss.

Question 7

Compensating balances represent unfair hidden costs of borrowing.

Accepted Answer

Compensating balances are not hidden; they are disclosed in the loan agreement and represent a portion of the loan that the borrower agrees to maintain in a deposit account with the lending bank as a condition of the loan, often used to secure better loan terms.

Question 8

Compensating balances are important for banks because their existence allows them to make loans at lower quoted rates.

Accepted Answer

By requiring customers to maintain compensating balances, banks are able to generate additional revenue which helps to offset the risk of lending. This allows them to offer lower interest rates to borrowers.

Question 9

Compensating balances are a way for banks to recover the cost of corporate services provided, but not directly charged.

Accepted Answer

Compensating balances are a common way for banks to recover some of the costs of providing services that they don't charge directly for. These may include things like cash management or credit facilities, and by requiring the customer to maintain a minimum balance in their account, the bank can offset some of the costs of providing these services.

Question 10

The commercial paper market is available to all New York Stock Exchange companies.

Accepted Answer

The commercial paper market is not limited to NYSE companies, it is available to all credit-worthy companies that meet the requirements set by the market.

Question 11

A compensating balance will be lower in periods of tight money than in periods of credit easing.

Accepted Answer

A compensating balance is typically higher in periods of tight money because banks are more concerned about liquidity and risk, and thus may require higher balances to offset the increased risk of lending. In periods of credit easing, banks are more likely to reduce these requirements.

Question 12

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

Accepted Answer

Commercial paper represents unsecured short-term borrowing by large companies. It is a type of promissory note that is issued by corporations to raise money quickly to finance short-term obligations, such as payroll and accounts payable. Commercial paper is typically sold at a discount to its face value and is usually purchased by institutional investors, such as money market funds, rather than individual investors.

Question 13

Commercial paper is an unsecured short-term IOU from a large financially secure company.

Accepted Answer

Commercial paper is indeed an unsecured short-term IOU from a large financially secure company. It is typically issued to meet short-term financing needs and is usually sold at a discount to face value.

Question 14

The annual percentage rate (APR) is a measure of the effective rate of interest on a loan on an annualized basis.

Accepted Answer

The APR represents the true cost of borrowing money, including fees and interest, and is expressed as a percentage of the total loan amount on an annual basis.

Question 15

Issuers of commercial paper can be divided into finance paper or direct paper, dealer paper, and asset-backed commercial paper.

Accepted Answer

This statement is true, as issuers of commercial paper are commonly categorized into these three categories based on the type of paper they issue. Finance paper is issued by finance companies or subsidiaries of manufacturing companies, direct paper is issued by corporations directly to investors, and dealer paper is issued by dealers who buy the paper from the issuer and then sell it to investors. Asset-backed commercial paper is backed by specific assets that serve as collateral for the paper.

Question 16

All commercial paper involves the physical transfer of actual paper certificates.

Accepted Answer

Commercial paper is typically in the form of promissory notes or certificates of deposit that are traded electronically, without requiring physical transfer of paper certificates.

Question 17

One major advantage of commercial paper is that it can always be "rolled over" (reissued) when it matures.

Accepted Answer

Commercial paper cannot always be "rolled over" or reissued upon maturity; this depends on the issuer's financial condition and market conditions at the time of maturity.

Question 18

Small businesses frequently find commercial paper a useful means of obtaining funds when it is not possible to raise funds by other means.

Accepted Answer

Commercial paper is typically used by larger corporations with high credit ratings to obtain short-term funding at lower interest rates, not commonly by small businesses due to its unsecured nature and the creditworthiness required.

Question 19

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.

Accepted Answer

The term "credit crunch" refers to a period in which credit is scarce and difficult to obtain, rather than the interest rate being too high. This can lead to high borrowing costs and firms struggling to obtain financing.

Question 20

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.

Accepted Answer

This is because investors are less likely to invest in the commercial paper of a company with a lower credit rating, and therefore the company may struggle to find buyers for their new commercial paper.

Quiz 8: Sources of Short-Term Financing