Chapter 14 - Short-term finance and investments

Question 1

What are the main types of short-term finance?

Answer 1

• Trade payables
• Factoring
• Overdrafts
• Short-term loans
• Financing exports

Question 2

How are payables used as a source of short-term finance?

Answer 2

By delaying payment to suppliers

Question 3

What are the benefits of paying suppliers late?

Answer 3

• Alleviate cash flow difficulties
• Cash can earn a return whilst still in the paying entity’s account

Question 4

What are some potential problems when paying suppliers late?

Answer 4

• Loss of any settlement discount
• Could obtain poor credit rating
• Supplier may stop further supplies
• Supplier may increase future selling prices to compensate
• Could face legal action

Question 5

How can receivables be used as a source of short-term finance?

Answer 5

• Factoring
• Invoice discounting

Question 6

What is factoring?

Answer 6

Debts are sold to a factoring company (factor)

Question 7

What 3 services does a factor offer?

Answer 7

• Debt collection
• Financing
• Credit insurance

Question 8

What is debt collection?

Answer 8

Credit control department outsourced to factoring entity

Question 9

What is financing?

Answer 9

Funds may be advanced to the company prior to debt collection

Question 10

What is credit insurance?

Answer 10

Factor may take responsibility for irrecoverable debt

Question 11

What are the main 2 sources of bank lending?

Answer 11

Overdraft and loans

Question 12

What are the advantages of an overdraft?

Answer 12

• Flexibility
• Only pay for what’s used, therefore cheaper

Question 13

What are the disadvantages of an overdraft?

Answer 13

• Repayable on demand
• May require security
• variable finance costs

Question 14

What methods are available for dealing with the problems of financing exports and controlling credit risk?

Answer 14

• Documentary credits
• Bills of exchange
• Export factoring
• Forfaiting

Question 15

What is a bill of exchange?

Answer 15

Binds one party to pay a fixed sum to another party on demand or at a predetermined date

Question 16

What are the 2 types of bills of exchange?

Answer 16

• Sight draft/bill (payable immediately)
• Time draft/bill (payable at predetermined date)

Question 17

What are significant characteristics of bills of exchange?

Answer 17

• Drawee given a period of credit before having to pay a term bill
• Drawer can obtain payment earlier than the bill’s maturity date

Question 18

What does the size of the discount on the sale of a bill reflect?

Answer 18

Rate of interest that the buyer of the bill requires from holding the bill to maturity

Question 19

What services do export factor’s provide?

Answer 19

• Admin of receivables ledger
• Collecting payment
• Factor finance

Question 20

What is forfaiting?

Answer 20

Same as export factoring except seller receives 100% of the receivable as a lump sum

Question 21

What are the key features of forfaiting?

Answer 21

• Importer obtains medium-term finance for much of the purchases cost of goods
• Exporter receives immediate payment
• Credit risk accepted by forfaiting bank

Question 22

What can cash surpluses be invested into in the short term?

Answer 22

• Interest bearing bank accounts
• Negotiable instruments
• Short-dated gov bonds
• Other short term investments

Question 23

What is the criteria used to assess short-term investments?

Answer 23

• Maturity
• Return
• Risk
• Liquidity
• Diversification

Question 24

How long should the maturity be of a short-term investment?

Answer 24

Maturity should be no longer than the duration of the cash surplus

Question 25

What is the target return of a short-term investment?

Answer 25

Interest yield

Question 26

What are the 2 types of interest bearing accounts?

Answer 26

• Deposit accounts
• Money market deposits

Question 27

When can money invested in the money market be withdrawn?

Answer 27

Until deposit has matured

Question 28

What is the formula for interest earned?

Answer 28

(amount deposited x annualised interest rate x (no. of days interest earned/annual day count))

Annual day count is number of days in the year

Question 29

What are negotiable instruments?

Answer 29

Financial instruments that may be obtained as investments

Title passes when the instrument is handed from one person to another

Question 30

What are some examples of negotiable instruments?

Answer 30

• Bank notes
• Bearer bonds
• Certificates of deposit
• Bills of exchange
• Treasury bills

Question 31

What is a Certificate of deposit (CD)?

Answer 31

Provides evidence of a short-term deposit with a bank for a fixed term and earning a specified amount of interest

Min deposit $100k

Question 32

For how long can a CD be held?

Answer 32

Until maturity and can then claim money

Question 33

Are CDs more or less liquid than money market deposits?

Answer 33

More liquid as can be sold to quickly obtain funds

Question 34

How long does it take for a treasury bond to mature?

Answer 34

3 months (91 days)

Question 35

What are the traits of treasury bills?

Answer 35

• High credit quality
• Low risk
• Lower yields

Question 36

What are corporate bonds?

Answer 36

High risk long term investments

Question 37

What is commercial paper (CP)?

Answer 37

Short-dated negotiable debt instruments issued by an entity