Type: Difficult
81. Medium-term notes (MTNs) can be thought of as a hybrid between:
A. stocks and bonds
B. corporate bonds and commercial paper C. corporate bonds and T-bills
D. stocks and T-bills
Type: Medium
True / False Questions
82. Trade credit term 3/10, EOM, net 60, is not a valid one.
FALSE
Type: Medium
83. If goods are sold on open account, the customer is asked to sign an IOU.
FALSE
84. If a firm sells goods on terms 2/30 net 60, customers who do not take the cash discount are effectively borrowing money at approximately 2% per year.
FALSE
Type: Medium
85. A commercial draft is simply an order to pay.
TRUE
Type: Easy
86. If a commercial draft is an order to pay immediately, it is called a time draft.
FALSE
Type: Medium
87. Bankers' acceptances are used in overseas trade.
TRUE
Type: Medium
88. A factor buys the firm's receivables, and the customer then makes payments directly to the factor.
TRUE
89. In the United States export credit insurance is provided by the Export-Import Bank in association with a group of insurance companies known as the Foreign Credit Insurance Association (FCIA).
TRUE
Type: Medium
90. One good reason to hold cash is that cash provides more liquidity than securities.
TRUE
Type: Easy
91. Concentration banking is used to slow down disbursements.
FALSE
Type: Medium
92. Lock-box systems are used to speed up collections.
TRUE
Type: Easy
93. Fedwire is a system that can be used to transfer money between banks.
TRUE
Type: Medium
94. Direct deposits are processed through Automated Clearing House (ACH) system.
TRUE
95. The market for short-term investments is known as the capital market.
FALSE
Type: Easy
96. LIBOR is the acronym for London Interbank Offered Rate.
TRUE
Type: Easy
Short Answer Questions
97. What are the major objectives of credit management?
The major objectives of credit management are:
• Establishing terms of sale
• Establishing firm's credit policies
• Evaluating customer creditworthiness
• Establishing customer credit lines
• Keeping up-to-date- records of accounts receivables and initiating collection procedure when necessary
Type: Medium
98. Briefly explain different terms of sale used in practice.
Sale terms can be cash before delivery (CBD) or cash on delivery (COD) for customers with special needs or irregular customers. Generally for regular customers firms offer credit terms.
99. What is the effective cost of not taking a discount under terms 3/30 net 60?
Annualized cost of trade credit = [Early Payment discount/(1 - Early Payment discount)] * [365/(net payment period-Discount payment period] Annualized Cost of trade credit = [0.03/(1 - 0.03)] * [365/(60 - 30)] = 0.3763 = 37.63%
Type: Medium
100. Briefly describe the most widely used commercial credit instruments.
There are several commercial credit instruments that are used commonly. They are:
Promissory note; commercial draft (sight draft & time draft); trade acceptance; bankers' acceptance; irrevocable letter of credit.
Type: Medium
101. Discuss the general principles that should be used for credit decisions.
In general, there are three principles of credit management. First, the overall goal of the credit decision is to maximize shareholders' wealth. Second, the credit manager must focus on the dangerous accounts and large accounts. Third, the credit manager must have a long-term strategy.
Type: Medium
102. What is the main objective of a collection policy?
The main objective of collection policy is to collect on overdue accounts using least offensive methods. But it is not always possible to do so. Most companies use collection agencies to collect on overdue accounts.
Type: Easy
103. Briefly explain the process of factoring accounts receivables.
Factoring is the sale of accounts receivables to a factor. Typically, a factor charges 1% to 2%
of the value of the invoice as a fee. Once the factor has purchased the accounts receivables, the customers make payments directly to the factor.
Type: Medium
104. Briefly explain how firms can protect against bad debt?
Firms can get protection against bad debt by obtaining credit insurance. The insurance can be claimed not only if the customer becomes insolvent but also if the account is overdue.
Generally, insurance companies establish maximum coverage for the accounts of a particular credit rating. Also, most governments have established agencies to insure export credit. In the United States export credit insurance is provided by the Export-Import Bank in association with a group of insurance companies known as the Foreign Credit Insurance Association (FCIA).
Type: Medium
105. Discuss the fundamental trade-off involved in cash management.
The trade-off is between holding cash, which provides liquidity but no interest, and holding securities, which provide interest, but less liquidity. This trade-off is used to develop cash management models.
Type: Medium
106. Discuss the two important ways of speeding up collection.
First many companies, in order to speed up collections, use concentration banking. In this case customers send payment to the nearest branch office. The local branch office then deposits the checks into a local bank account. Surplus funds are transferred to a concentration account at one of the company's principal banks. Second, the lock-box system is used for speeding up collection. The company rents a post office box in each region. Customers send their payments to the post office box. The local bank empties the box and deposits checks in the company's local account. Surplus funds are transferred to the company's principal banks.
Type: Medium
107. Briefly explain electronic funds transfer.
In the United States there are two systems for making large value electronic payments. They are the Fedwire system and CHIPS. Fedwire is operated by the Federal Reserve System and is a real-time gross settlement system. CHIPS is a privately owned system and is a net system.
CHIPS accumulate payment instructions throughout the day and at the end of each day net payments are settled using Fedwire.
Type: Medium
108. Briefly explain the additional complexities involved in international cash management.
Large multinational corporations operating in many countries have to deal in different
systems and legal frameworks. They have dealt with these complexities by setting up regional systems and managing cash through them.
Type: Medium
109. What are Eurodollars (international dollars)?
Eurodollars are dollar deposits in banks outside the US. These are not subject to Federal Reserve regulations and hence the borrowing rates are slightly lower than in the US.
Type: Medium
110. Briefly explain different money-market instruments.
There are several money-market instruments available for investments. The most important ones in the US are: US Treasury bills; Federal Agency Securities; Certificates of Deposit;
commercial paper; bankers' acceptances; repurchase agreements.
Type: Difficult
111. What are short-term tax-exempts?
These are short-term obligations issued by state and local governments and are exempt from federal taxes.
Type: Medium
112. What are Banker's Acceptances?
Banker's Acceptance is an unconditional promise of a bank to make payment on a draft when it matures. The acceptance is in the form of the bank's endorsement ("Acceptance") of a draft drawn against that bank in accordance with the terms and conditions of a letter of credit issued by the bank. These are traded at a discount. Banker's acceptances have their origin in international trade transactions.
113. What is LIBOR?
The London Interbank Offered Rate (LIBOR) is the most commonly used benchmark for borrowing.
Type: Easy
114. What is a bridge loan? Briefly explain.
A bridge loan is a short-term loan that is used, for example, to finance the purchase of new equipment or acquisition of another firm. Here the loan serves as interim financing till the purchase or acquisition is completed and long-term financing is arranged.
Type: Medium
115. What is a self-liquidating loan? Briefly explain.
A self-liquidating loan is a short-term loan that is used, for example, to finance a temporary increase in inventory. Such a loan is described as self-liquidating because the sale of goods provides the cash to repay the loan.
Type: Medium
116. What is a syndicated loan?
Sometimes bank loans are too large for a single bank to handle. Under these circumstances, loans arranged by one or more lead banks and then shared among group of banks called a syndicate. This reduces the risk exposure of banks to a single loan.
Type: Medium
117. What is a commercial paper?
Commercial paper is an unsecured promissory note issued by a firm to raise short-term funds.
They have maturities ranging from overnight to 270 days. Limiting the maturity of commercial paper to 270 days avoids the SEC (Securities and Exchange Commission) registration requirement. They are traded in the market on a discount basis.
Type: Medium
118. Briefly describe the quality ratings for commercial paper.
Moody's, Standard and Poor's, and Fitch publish quality ratings for commercial paper. For Example, Moody's provides three ratings, from P-1 (Prime-1), the highest rating to P-3. Most investors are reluctant to buy low rated commercial paper. For example, money-market Funds are mostly limited to holding P-1 paper.
Type: Medium
119. What are medium-term notes (MTNs)?
Medium-term notes (MTNs) can be thought of as a hybrid between corporate bonds and commercial paper. They are sold in maturities of nine months to thirty years. Many
companies are increasingly using MTNs to finance their needs because of its flexibility. They are sold through dealers or sold directly to investors.
Type: Medium