Investment Tutorials
Chapter 8
Discussion Questions
8-1.
It is advisable to borrow in order to take a cash discount when the cost of borrowing is less than the cost of forgoing the discount. If it cost us 36 percent to miss a discount, we would be much better off finding an alternate source of funds for 8 to 10 percent.
8-2.
Larger firms tend to be in a net creditor position because they have the financial resources to be suppliers to credit. The smaller firm must look to the larger manufacturer or wholesaler to help carry the firm's financing requirements.
8-3.
The prime rate is the rate that a bank charges its most creditworthy customers. The average customer can expect to pay one or two percent (or more) above prime. In competitive markets banks may actually charge preferred customers less than prime.
8-4.
The use of a compensating balance or minimum required account balance allows the banker to generate a higher return on a loan because not all funds are actually made available to the borrower. A $125,000 loan with a $25,000 compensating balance requirement means only
$100,000 is being provided on a net basis. This benefit to the lender need not be a disadvantage to the borrower. The borrower may, in turn, receive a lower quoted interest rate and certain gratuitous services because of the compensating balance requirement. Bankers have tended towards eliminating both compensating balances and gratuitous services.
8-5.
The stated interest rate is the percentage rate unadjusted for time or method of repayment.
The annual interest rate is the true rate and considers all these variables. A 5 percent stated rate for 90 days provides a 20 percent annual rate. The financial manager should recognize the annual rate as the true cost of borrowing. An effective rate would include any compounding effects over the relevant period.
8-6.
Commercial paper can be either purchased or issued by a corporation. To the extent one corporation purchases
Discussion Questions
8-1.
It is advisable to borrow in order to take a cash discount when the cost of borrowing is less than the cost of forgoing the discount. If it cost us 36 percent to miss a discount, we would be much better off finding an alternate source of funds for 8 to 10 percent.
8-2.
Larger firms tend to be in a net creditor position because they have the financial resources to be suppliers to credit. The smaller firm must look to the larger manufacturer or wholesaler to help carry the firm's financing requirements.
8-3.
The prime rate is the rate that a bank charges its most creditworthy customers. The average customer can expect to pay one or two percent (or more) above prime. In competitive markets banks may actually charge preferred customers less than prime.
8-4.
The use of a compensating balance or minimum required account balance allows the banker to generate a higher return on a loan because not all funds are actually made available to the borrower. A $125,000 loan with a $25,000 compensating balance requirement means only
$100,000 is being provided on a net basis. This benefit to the lender need not be a disadvantage to the borrower. The borrower may, in turn, receive a lower quoted interest rate and certain gratuitous services because of the compensating balance requirement. Bankers have tended towards eliminating both compensating balances and gratuitous services.
8-5.
The stated interest rate is the percentage rate unadjusted for time or method of repayment.
The annual interest rate is the true rate and considers all these variables. A 5 percent stated rate for 90 days provides a 20 percent annual rate. The financial manager should recognize the annual rate as the true cost of borrowing. An effective rate would include any compounding effects over the relevant period.
8-6.
Commercial paper can be either purchased or issued by a corporation. To the extent one corporation purchases