Set out where firms can raise short-term funds
The idea
Short-term funding runs from the informal to the negotiated. Trade credit from suppliers is the most common and looks free until the discount forgone is annualised. A committed bank line of credit provides certainty for a fee; an uncommitted line does not and can be withdrawn precisely when it is needed. Commercial paper is unsecured short-term debt issued directly to investors and is available only to strong credits, at rates below bank borrowing. Secured borrowing against receivables or inventory costs more but is open to weaker companies, because the lender's recourse does not depend on the borrower's standing alone.
A practice question
What is commercial paper?
- Short-term unsecured debt sold to investors — correct
- Long-term debt secured on assetsWhy not: Commercial paper is short-dated, usually under 270 days, and unsecured.
- A bank's internal record of a loanWhy not: It is a negotiable instrument sold to investors, which is what removes the bank from the transaction.
Commercial paper lets highly rated companies borrow short term, often below bank rates, by going straight to investors. Because it is unsecured, the market generally requires strong credit quality and market access.
A harder one
How does a committed line of credit differ from an uncommitted one?
- A committed line is always cheaperWhy not: It usually costs more, because the commitment fee buys the certainty.
- A committed line obliges the bank to lend, for a fee; an uncommitted one does not — correct
- An uncommitted line must be secured against inventoryWhy not: Neither type is defined by its collateral; the difference is whether the bank is obliged to lend.
The fee buys certainty of availability. An uncommitted line is a convenience in good times and can be pulled in bad ones, which is when the money is actually needed.
The hardest tier
Why might a company with a weak credit rating borrow against its receivables despite the higher cost?
- Secured borrowing carries no interestWhy not: It carries interest like any borrowing, and typically at a higher rate.
- Receivables financing is exempt from covenantsWhy not: Such facilities come with their own conditions, often including tight reporting on the collateral.
- Recourse rests on the assets rather than the name — correct
Pledging specific assets shifts the lender's analysis from the company's overall standing to the quality of the collateral. That is what opens funding to borrowers the unsecured market will not serve.
In the app: 9 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
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