Stand-by-Credit and Commercial Paper

Question 1

Define a “revolving credit agreement”.

Answer 1

A revolving line of credit is a legs agreement between a borrower and a financial institution whereby the financial institution agrees to provide an amount of credit to the borrower. The line of credit may be borrowed, repaid, and then reborrowed in a “revolving” or recurring manner.

Question 2

Define “commercial paper:.

Answer 2

Short-term unsecured promissory notes sold by large, highly creditworthy firms as a form of short-term financing (i.e., 270 days or less).

Question 3

Identify the disadvantages of stand-by-credit for financing purposes.

Answer 3

1. Poor credit rating = high interest rate
2. Usually involves a fee
3. Compensating balance may be required
4. Requires satisfaction in the short-term

Question 4

Define “letter of credit”.

Answer 4

A conditional commitment by a bank to pay a third party in accordance with specified terms and commitments (e.g. bank payments to a supplier upon proof that goods have been shaped to bank client).

Question 5

Define “line of credit”.

Answer 5

An informal agreement between a borrower and a financial institution whereby the financial institution agrees to a maximum amount of credit that it will extend to the borrower at any one time, not legally binding on financial institution.

Question 6

Identify the advantages of stand-by-credit for financing purposes.

Answer 6

1. Commonly available for creditworthy firms
2. Highly flexible (debt incurred only when needed)
3. No collateral required
4. May provide cash for general use

Question 7

Identify the advantages of commercial paper for financing purposes.

Answer 7

1. Large amounts can be obtained
2. Interest rate generally lower than other short-term sources
3. No collateral required
4. Provides cash for general use