Short term financing Flashcards
(2) Financing cost
- Nominal rate
2. Effective rate
Financing cost as the basis of cash payment on borrowing
not primary concern of financial managers
nominal rate/ coupon rate/ stated rate
interest / principal x time
Financing cost recorded as interest expense
primary concern of financial managers
effective rate/ market rate (short term)/ YTM (long run)
(finance cost/ net proceeds) x (365/ credit period)*
*annualized factor
Fisher rate effect
Real rate = Nominal rate - inflation factor
ROI for the last 5 years was 15% with inflation rate of 6% . it is expected that starting next year and beyond, inflation will be 4%.
What is the expected ROI next year?
13%
simple vs compounded interest
Simple
- borrowing only once
- lower interest
compounded
- borrows every time the obligation matures
- higher financing cost
- use future value factor
- for long term financing
2 Sources of Short term financing
Unsecured
- character loans; excellent credit rating
- big firms grant trade credit to their customer as a competitive strategy
Secured
- collateral attached
- to reduce maturity risk
- MRL (maturity; riskiness, life)
Types of Short term Financing
Unsecured 3
Secured 2
Unsecured
- trade or spontaneous
- commercial loan
- commercial paper (similar to bond, pero short term 9maturity is next day or 270 days, always issued at a discount)
Secured
- receivable financing (pledge and assignment)
- inventory financing (similar to commercial bank loan, but with collateral)
Spontaneous Source - Trade credit
Unsecured
Percentage discount 365
—————————————– x —————————–
100% - percentage discount credit - discount ***
period period
***non free trade or costly credit
discount period is free trade credit
Free trade credit has no effective rate
Commercial bank loan
Unsecured
interest days in a year (360)
—————————————– x ————————————
principal- interest*- comp bal** days loan outstanding
*deduct only if DISCOUNTED; silent (undiscounted)
prorate interest with time
the lower the net proceeds, the higher the rate becomes
UNSECURED
Principal / amount to be borrowed
Commercial bank loan
1 - Compensating balance % -Interest %
or
Net proceeds in Php/ Net proceeds %
Special considerations in
effective rate related to commercial bank loans
- If simple and without compensating balance, effective rate = nominal rate
- Discounted and with compensating balance highest effective rate
- with existing deposit***
a. insufficient: deduct from the proceeds the necessary amount
b. sufficient: no deduction for compensating balance
Interest income from compensating balance
a. no existing deposit
- deduct all interest income related to comp bal from int exp
b. with existing deposit
- deduct the interest income related only to ADD’NL comp bal from int exp
Revolving credit agreement vs. credit line
Unsecured
Revolving
- a guaranteed credit set aside by the bank
- finance cost: interest expense (borrowed fund) and commitment fee (unborrowed)
- prime rate: int rate charge to the most credit worthy of the bank; privilege
Credit line
- one time arrangement
- maximum amount
-
Cost of Installment loans
Unsecured
( 1 + no. of installment ) x net proceeds
Cost of commercial paper
Unsecured
Issue price - flotation cost
x
365/ credit period
