Ch 6 - Short- and medium-term finance

Question 1

Medium-term finance (give the 3 types)

Answer 1

1yr < term < 5 yrs
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>credit sale
>leasing
>bank loans
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used by both consumers & commercial transactions

Question 2

Credit sale

Answer 2

def: normal sale of goods together with an agreement that payment will be made by a series of regular instalments over a set period of time. (legal ownership passes to the buyer at outset)
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seller cannot reclaim goods even if the buyer defaults (all the seller can do is sue for payment via courts)

Question 3

Leasing

Answer 3

def: agreement where the owner of an asset gives the lessee the right to use the asset over a period of time, in return for a regular series of payments (legal ownership DOESN’T change hands)
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2 types of leases:
-operating
- finance
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leasing arrangements are widely used by operators of planes, ships, trains & car fleets.

Question 4

Explain the 2 different types of leases

Answer 4

OPERATING- owner of the asset will retain most of the risks associated with owning the asset (period = substantially shorter than the likely life of the asset)
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FINANCE- lessee takes on most of the risks associated with owning the asset (period = similar to the likely life of the asset)
» PV of payments under the agreement is shown in the lessee’s balance sheet twice: as an asset & corresp. liability)

Question 5

Bank loans

Answer 5

def: where the full amount of the loan is paid into the borrower’s current account & the borrower undertakes to make interest payments & capital repayments on the full amount of the loan.
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interest rate is usually variable
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most terms are 7 years or less

Question 6

Loan ‘facilities’ & lines of credit

Answer 6

loan facilities: loans are available where the borrower can take out the loan in instalments, giving the bank a few days’ notice before each new bit is taken out.
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Co’s often arrange lines of credit with their banks, enabling them to borrow money if required, up to agreed limits.
(provide flexibility for the borrower with regards to the timing of the finance & how the borrower uses the money)
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Complex loans incl:
1) multi-currency loans
2) syndicated loans: where the loan facility is provided by a group of banks

Question 7

Short-term company finance (give 5 types)

Answer 7

<1yr
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1) bank overdrafts
2) trade credit
3) factoring
4) bills of exchange (B.O.E)
5) commercial paper
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4) & 5) are securities which means they can be sold from one investor to another

Question 8

Bank overdrafts

Answer 8

def: ST borrowing from a bank where the borrower is granted a facility to draw money out of a current account s.t it becomes negative, down to an agreed limit.
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borrower pays interest only on the amount by which they are actually overdrawn (no capital repayments are made)
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o.d’s made to co’s are usually secured by a floating charge
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interest charged on o.d are usually higher than loan of equivalent amount (variable interest rate - daily basis)
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a bank can demand immediate repayment of an o.d with no prior notice

Question 9

Trade credit

Answer 9

def: agreement between a co & one of its suppliers to pay for goods or services after they have been supplied
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in most cases no explicit interest is charged (late payment is so common that explicit discounts can be negotiated for not using trade credit&raquo_space; giving discounts for C.O.D)

Question 10

Explain the 2 types of factoring

Answer 10

1) NON-RECOURSE: where the supplier sells on its trade debt to a factor in order to obtain cash payment of the accounts before their actual due date (factor takes over all responsibility for credit analysis of new accounts, payment collection & credit losses) – sells all credit risk (factor) -> buys creditors
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2) RECOURSE: provides early payment of invoices. It’s a loan which is secured against the invoices, & has a value which automatically fluctuates with the amount that the co sells. (credit risk remains with the original supplier)

Question 11

Bill of Exhange (B.O.E)

Answer 11

def: claim to the amount owed by a purchaser of goods on credit & ‘accepted’ by a bank (for a fee). This means that the bank guarantees payment against the bill to whomsoever holds the bill at maturity. (bill can be sold to raise ST finance)
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B.O.E known as ‘two name’ papers because they carry both the name of the company who owes the money & the name of the accepting bank
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Where the endorser is an ‘eligible’ bank, the bill is known as an ‘eligible B.O.E’ which is a very secure investment

Question 12

Commerical Paper (C.P)

Answer 12

def: single name form of ST borrowing used by large companies. It comes in the form of bearer docs for large denominations which are issued at a discount & redeemed at par.
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bearer doc = no register of holders
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not listed on S.E
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companies that wish to raise finance by issuing sterling commercial paper have to meet certain minimum stds
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issuing companies must:
> be listed on LSE
> issue a statement to confirm that they comply with the requirements of the SE & that there have been no adverse changes in the company’s circumstances since they last published account. in accordance with S.E rules