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Q1. Which of the following most accurately describes trade credit?
1. The creditworthiness of firms in the view of bank lenders.
2. The creditworthiness of customers in the view of suppliers.
3. Suppliers are not paid immediately on supply of goods or services.
4. When goods and services are delivered to a firm, they are financed by a trade
credit company.
UNANSWERED! Right answer is 3
EXPLANATION :
Trade credit represents the credit extended by the suppliers of goods and servic
es.
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Q2. From the following options select the most favorable credit term:
1. 3/10, net 30.
2. 2/15, net 40.
UNANSWERED! Right answer is 2
EXPLANATION :
Cost of trade credit =
(Discount percent/(1 - Discount percent) * (360 / (Credit period - Discount peri
od))
i.e.{3% ? (100% - 3%)} * {360 ? (30 - 10)} = 55.67% Per annum
{2% ? (100% - 2%)} * {360 ? (40 - 15)} = 29.39% Per annum
On comparing both a & b, cost of trade credit is less in case of b. Hence it is
favorable credit term.
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Q3. Which of the following is not an advantage to a firm in raising finance by b
orrowing through a bank overdraft?
1. The borrowing firm is not asked to forecast the precise amount and duration o
f its borrowing at the outset but retains the flexibility to borrow up to a stat
ed limit.
2. When the funds are no longer required they can be quickly and easily repaid w
ithout suffering a penalty.
3. A minimum charge may be payable, irrespective of the level of borrowing, for
availing this facility.
4. Interest is charged on the daily outstanding balance and can therefore be che
aper than other sources of finance
UNANSWERED! Right answer is 3
EXPLANATION :
Options 1, 2, and 4 indicate the flexibility of overdraft facility. On the other
hand option 3 is a demerit of the overdraft facility.
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Q4. Which one of the following most accurately describes factoring as a source o
f finance?
1. A factor sells a financial security to the firm needing funds. The firm can t
hen use this to obtain finance from banks.
2. A factor lends money to a firm on the security of its fixed assets. It charge
s fees and interest.
3. A factor will give an advance payment on the security of outstanding invoices
. When the invoices are paid the factor provides the company with the amount of
invoice not advanced, less fees and interest.
4. None of the above.
UNANSWERED! Right answer is 3
EXPLANATION :
Factoring is a case of outsourcing the management of receivables to an outsider
usually a financial institution. The factor services would include credit invest
igation, sales ledger maintenance, purchase & collection of debts, credit protec
tion, provision of finance to the client against receivables account etc.
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Q5. Which of the following statements about commercial paper is false?
1. Commercial paper is secured by collateral.
2. Commercial paper has a maturity of less than 270 days
3. Commercial paper is sold on a discount basis.
4. Commercial paper is a form of short-term financing where notes are sold to in
vestors.
UNANSWERED! Right answer is 1
EXPLANATION :
Commercial paper represents short-term unsecured promissory notes issued by firm
s which enjoy a fairly high credit rating.
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Q6. Which of the following would be consistent with a more aggressive approach t
o financing working capital?
1. Financing short-term needs with short-term funds.
2. Financing permanent inventory buildup with long-term debt.
3. Financing seasonal needs with short-term funds.
4. Financing some long-term needs with short-term funds.
UNANSWERED! Right answer is 4
EXPLANATION :
When an organization uses short-term financing to finance a part of its permanen
t assets, it is said to be aggressive. Increased use of short-term financing inc
reases the risk for the organization.
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Q7. Which asset-liability combination would most likely result in the firm's hav
ing the greatest risk of technical insolvency?
1. Increasing current assets while lowering current liabilities.
2. Increasing current assets while incurring more current liabilities.
3. Reducing current assets, increasing current liabilities, and reducing long-te
rm debt.
4. Replacing short-term debt with equity.
UNANSWERED! Right answer is 3
EXPLANATION :
It is a case of paying-off long-term debt from current assets. It is a dangerous
situation that leads to insolvency as the current liabilities keep on increasin
g.
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Q8. While deciding the appropriate level of current assets for the firm, managem
ent is confronted with:
1. A trade-off between profitability and liquidity.
2. A trade-off between liquidity and marketability.
3. A trade-off between equity and debt.
4. A trade-off between short-term versus long-term borrowing.
UNANSWERED! Right answer is 1
EXPLANATION :
The firm, in deciding the appropriate level of current assets, may confront with
a trade-off between profitability and liquidity. For example, a firm may be abl
e to generate higher profits by way of credit sales (that results in increase in
current assets). But at the same time, the firm will have to face the liquidity
problem, as the cash cannot be realized immediately in case of credit sales.
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Q9. Spontaneous financing includes:
1. Accounts receivable.
2. Accounts payable.
3. Short-term loans.
4. A line of credit.
UNANSWERED! Right answer is 2
EXPLANATION :
Spontaneous financing refers to the automatic sources of short-term funds arisin
g in the normal course of business. For example, when goods and services are del
ivered to a firm, they are not paid for immediately. This constitutes spontaneou
s financing.
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Q10. Generally, a line of credit is:
1. Less costly than stretching accounts payable
2. Provided by a bank
3. Unsecured bank borrowing
4. All of the above
UNANSWERED! Right answer is 4
EXPLANATION :
A line of credit is a facility provided by the bank without security, to meet th
e short-term needs of the firm. This source of finance is less costly as compare
d to trade credit.
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Q11. A firm can increase its liquidity by:
1. Shifting its asset mix toward longer-term assets.
2. Lowering it debt to equity ratio
3. Making sure it has no short-term liabilities
4. Shifting its asset mix toward short-term assets.
UNANSWERED! Right answer is 4
EXPLANATION :
By shifting the asset mix towards short-term assets, the firm would be able to g
enerate the cash within a short period. This enables the firm to increase its li
quidity.
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Q12. Which of the following is not a way to reduce a firm's need for working cap
ital ?
1. Lengthening the payables period
2. Reducing the receivables period
3. Reducing the inventory period
4. Reducing the lag between the ordering and delivery of raw materials
UNANSWERED! Right answer is 4
EXPLANATION :
Options 1, 2, and 3 are pertaining to and have the impact on operating cycle whi
ch in turn will have the impact on working capital needs of a firm. However, opt
ion 4 is concerned with the required stock level of the firm at a given point of
time