10.3 Bank and institutional loans

Question 1

What is the most popular type of external finance?

Answer 1

Bank and institutional loans

Question 2

Why are bank and institutional loans so popular?

Answer 2

They are quick and straightforward and provided over a fixed period of time.

Question 3

When is a loan considered “short term”?

Answer 3

When the loan term is under one year.

Question 4

What is a secured loan?

Answer 4

A loan secured over an asset which the lender may seize if the lendee defaults.

Question 5

What is an unsecured loan?

Answer 5

A loan which is not secured over any asset, but which usually has a shorter term and greater interest rate to account for this.

Question 6

What are the advantages of bank and institutional loans?

Answer 6

• can be quickly arranged
• good for budgeting as set payments are spread over a specific time period
• loans are more flexible in term than other options
• banks do not out much emphasis on credit history for short term loans
• do not require a share of the business to be relinquished
• interest is normally tax deductible
• not repayable on demand unless defaulted

Question 7

What are the disadvantages of bank and institutional loans?

Answer 7

• short term loans usually have high interest
• loans can compound debt issues
• the bank can demand repayment of the loan if the business defaults
• normally an extra charge for early repayment

Question 8

What is a loan covenant?

Answer 8

A restrictive clause in a loan agreement that places certain constraints on the borrower, such as forbidding the borrower from undertaking certain activities or taking out further debt.