1.Compare and contrast the aggressive and conservative short-term borrowing strategies. 2. During periods of normal credit market...
Question:
1.Compare and contrast the aggressive and conservative short-term borrowing strategies.
2. During periods of normal credit market conditions, which short-term borrowing strategy will result in the lowest borrowing costs? Explain your reasoning.
3. Discuss the risks and primary benefit associated with optimizing a short-term borrowing strategy.
4. Discuss the trade-offs associated with a committed credit line.
5. What factors cause the effective borrowing cost on a credit line to exceed the interest rate quoted on the line?
6. Discuss how credit lines not only help in liquidity management but can also reduce certain costs associated with liquidity provided by cash holdings.
7. Why might a firm opt to create liquidity through a repurchase agreement, as opposed to a credit line?
8. Describe the costs and benefits of factoring.
9. Discuss why the effective borrowing cost of factoring will be much greater than the discount rate quoted by the factor.
10. Why might a firm prefer to borrow funds via a CP issuance rather than through a credit line?
11. What variables cause the effective cost of CP to differ from the discount rate?
12. Describe the key differences in the two CP programs described in this chapter.
13. How would you describe trends in the cost of short-term debt?
Problems
1. Memphis Metro, a service-based firm that provides high-performance training for competitive junior volleyball players, has a credit line with the following specifications:
Average daily borrowings of $400,000 on a $500,000 committed credit line Annual interest expense on the credit line of $14,500, Commitment fee of $500
a. Calculate the effective borrowing cost for the credit line.
b. Recalculate the effective cost of the credit line with a compensating balance requirement of 5 percent.
c. Recalculate the effective cost of the credit line with a compensating balance requirement of 10 percent.
d. Discuss why the effective borrowing cost increases for a, b, and c.
2. Textbook Brokers has a committed credit line in the amount of $2,000,000. The interest rate on the credit line is 4 percent, the commitment fee is 12.5 basis points on the unused portion of the line, and he compensating balance is 5 percent. The CFO believes the firm will require average daily borrow-ings of $1,200,000.
a. To spend $1,200,000 from the line, how much must be drawn from the credit line?
b. Suppose that Textbook Brokers borrows the amount calculated in part a. What will the annual interest expense and commitment fee be based on?
c. Calculate the effective borrowing cost of the credit line.
3. An assistant treasurer is currently reevaluating their firm's banking relationship. The firm's current lender charges an effective borrowing cost of 4.25 percent. A competing lender provides the following quote for a $20,000,000 committed credit line: an interest rate of 3.50 percent and a commitment fee of 0.25 percent on the unused portion of the line. After reviewing the firm's account analysis statement, the assistant treasurer notes that the average daily borrowings on last year's credit line was $6,500,000.
a. Assuming that the firm will borrow the same amount as last year, calculate the effective cost on the competitor's credit line.
b. Based on your answer in a., do you recommend that the assistant treasurer make a change?
c. Suppose that the assistant treasurer is considering negotiating a lower interest rate (say to 3.25 percent) in exchange for a higher commitment fee (0.50 percent). Would you recommend that the assistant treasurer pursue this change?
d. Suppose that the assistant treasurer is considering negotiating a higher interest rate (say to 3.75 percent) in exchange for no commitment fee. Would you recommend that the assistant trea-surer pursue this change?
4. Use the following information to solve for the effective borrowing cost for a repurchase agreement with a three-day term:
Face value of Treasury bills = $10,000,000 Current market value of Treasury bills = $9,850,000 Value exchanged at initiation of repurchase agreement = $9,845,000 Investor agrees to repurchase the Treasury bills for $9,847,000
5. Calculate the effective borrowing cost for a CP issue with the following specs:
$7,500,000 face value 45-day maturity 1 percent discount rate Dealer fees of 0.15 percent Commitment fee of 0.50 percent for $7,500,000 unused line of credit availability
6. Ralph, treasurer for Petrova Imports, recently updated his firm's short-term cash forecast only to discover that the firm will suffer a cash shortage of $15M for a 30-day period. Ralph just learned from a dealer in the CP market that paper with this maturity issued by firms with similar credit ratings is in demand and is priced to sell at a discount rate of 3.7 percent, and a dealer fee of 10 basis points. Assume that a backup line of credit for the CP issuance amount will be required and will cost 25 basis points (and is based on the unused portion of the credit line). As an alternative to issuing CP, assume that Petrova Imports can access short-term financing at an effective borrowing cost of 4.10 percent. Should Ralph go forward with the CP issue?
7. A firm that exports its goods is considering raising short-term financing with a BA with the following specs:
$500,000 face value 30-day maturity $3,000 discount from face value
Calculate the effective borrowing cost for the BA.
Fundamentals Of Financial Management
ISBN: 9780273713630
13th Revised Edition
Authors: James Van Horne, John Wachowicz