Question 1

Generally, lenders recognize that holding collateral can reduce losses if the borrower defaults, but the presence of collateral has no impact on the risk of default.

Accepted Answer

Collateral reduces losses in case of default, but it does not affect the probability of default.

Question 2

The outright sale of accounts receivable at a discount in order to obtain funds is called pledging accounts receivable.

Accepted Answer

The outright sale of accounts receivable at a discount in order to obtain funds is called factoring, not pledging. Pledging involves using the accounts receivable as collateral for a loan.

Question 3

Pledges of accounts receivable are normally made on a nonnotification basis, meaning that a customer whose account has been pledged as collateral in not notified.

Accepted Answer

Pledges of accounts receivable are typically made on a nonnotification basis, which means the customer whose account has been pledged as collateral is not notified.

Question 4

Pledges of accounts receivable are normally made on a notification basis because the lender does not trust the borrower to collect the pledged account receivable and remit these payments as they are received.

Accepted Answer

Pledges of accounts receivable are typically made on a non-notification basis, meaning the borrower continues to collect the receivables without notifying the customers, as the lender trusts the borrower to remit the payments.

Question 5

Secured short-term financing has specific assets pledged as collateral and appears on the balance sheet as current liabilities.

Accepted Answer

Secured short-term financing involves pledging specific assets as collateral, which are recorded on the balance sheet as current liabilities. Therefore, the statement is true.

Question 6

Factoring accounts receivable is not a form of secured short-term borrowing. It entails the sale of accounts receivable at a discount to obtain needed short-term funds.

Accepted Answer

Factoring accounts receivable involves selling accounts receivable at a discount to a third party, known as a factor, in exchange for immediate cash. This transaction is not considered a form of secured borrowing because the accounts receivable serve as collateral for the financing rather than any tangible assets.

Question 7

Tina's Apple Company would like to manufacture and market a new packaging. Tina's has sold an issue of commercial paper for $1,500,000 and maturity of 90 days to finance the new project. Compute the annual interest rate on the issue of commercial paper if the value of the commercial paper at maturity is $1,650,000.

Accepted Answer

The answer of Tina's Apple Company would like to manufacture...

Question 8

Commercial finance companies usually charge a higher interest on secured short-term loans than commercial banks because the finance companies generally end up with higher-risk borrowers.

Accepted Answer

Commercial finance companies tend to serve borrowers who are considered riskier, such as small businesses or businesses with poor credit scores. As a result, they charge higher interest rates to compensate for the greater risk they take on when lending money. Commercial banks, on the other hand, typically have lower risk borrowers and can therefore afford to offer lower interest rates.

Question 9

The interest rate charged on secured short-term loans is typically higher than the rate on unsecured short-term loans.

Accepted Answer

This is true because secured loans are backed by collateral (such as a car or property), which reduces the lender's risk. Therefore, they often charge higher interest rates to compensate for the risk they are taking. In contrast, unsecured loans do not require collateral, which makes them less risky for the borrower but more risky for the lender, resulting in lower interest rates.

Question 10

Bessey Aviation has just sold an issue of 30-day commercial paper with a face value of $5,000,000. The firm has just received $4,958,000. What is the effective annual interest rate on the commercial paper?

Accepted Answer

The answer of Bessey Aviation has just sold an issue...

Question 11

One advantage of factoring accounts receivable is the ability it gives the firm to turn accounts receivable immediately into cash without having to worry about repayment.

Accepted Answer

Factoring accounts receivable involves selling the rights to receive payment from customers to a third party at a discount, which allows the firm to receive cash immediately. The third party then collects payments directly from the customers, so the firm does not have to worry about collection or repayment.

Question 12

The higher cost of unsecured as opposed to secured borrowing is due to the greater risk of default.

Accepted Answer

The answer of The higher cost of unsecured as opposed...

Question 13

Nonrecourse basis is the basis on which accounts receivable are sold to a factor with the understanding that the factor accepts all credit risks on the purchased accounts.

Accepted Answer

Nonrecourse basis means that the factor assumes all the credit risk on the purchased accounts, so the statement is true.

Question 14

Fixed assets are the most desirable short-term loan collateral since they normally have a longer life, or duration, than the term of the loan.

Accepted Answer

Fixed assets are not short-term assets, and therefore are not the most desirable collateral for short-term loans. The most desirable collateral for short-term loans are current assets, such as accounts receivable or inventory, since they can be easily converted into cash to repay the loan.

Question 15

Tangshan Mining issued $1,000,000 of commercial paper for $992,500 for 45 days. Based on this information, the effective annual rate of interest on the commercial paper would be
A) 6.13%.
B) 6.29%.
C) 6.24%.
D) 6.08%.

Accepted Answer

The formula for calculating effective annual rate (EAR) is as follows:

EAR = (1 + (Discount rate/n))^n -1

where n is the number of compounding periods in a year.

In this case, the discount rate is calculated as follows:

Discount = Face value - Purchase price = $1,000,000 - $992,500 = $7,500

The discount rate can be calculated as follows:

Discount rate = (Discount/Face value) x (360/45) = (7,500/1,000,000) x 8 = 0.06 or 6%

Thus, the EAR can be calculated as follows:

EAR = (1 + (0.06/1))^1 - 1 = 0.0629 or 6.29%

Therefore, the correct answer is B, 6.29%.

Question 16

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
A) 5 percent.
B) 10 percent.
C) 17 percent.
D) 21 percent.

Accepted Answer

The answer of A firm issued $2 million worth of...

Question 17

The percentage advance constitutes the principal of the secured loan and varies not only according to the type and liquidity of collateral but also according to the type of security interest being taken.

Accepted Answer

The statement is true. The percentage advance is an important factor in determining the principal amount of a secured loan, and it can vary based on factors such as the type and liquidity of collateral and the type of security interest being taken.

Question 18

The cost of borrowing through the sale of commercial paper is typically ________ the prime bank loan rate.
A) lower than
B) the same as
C) unrelated to
D) higher than

Accepted Answer

Commercial paper typically carries a lower interest rate than the prime bank loan rate, as it is considered to be a lower-risk investment. This means that borrowing through the sale of commercial paper is generally cheaper than acquiring a bank loan.

Question 19

A firm has directly placed an issue of commercial paper that has a maturity of 60 days. The issue sold for $980,000 and has an annual interest rate of 12.24 percent. The value of the commercial paper at maturity is
A) $19,992.
B) $980,000.
C) $999,992.
D) $960,008.

Accepted Answer

The interest earned on the commercial paper can be calculated as follows:

Interest = (Principal x Annual Interest Rate x Time) / 365
       = ($980,000 x 0.1224 x 60) / 365
       = $20,008

Therefore, the value of the commercial paper at maturity is:

Value at Maturity = Principal + Interest
                  = $980,000 + $20,008
                  = $999,992

Hence, the correct option is (C) $999,992.

Question 20

Commercial finance companies are lending institutions that make only unsecured loans-both short-term and long-term to businesses.

Accepted Answer

Commercial finance companies may offer both secured and unsecured loans to businesses, not just unsecured loans.

Quiz 16: Current Liabilities Management