Unformatted text preview: itment fee of 0.5%. Because the
average unused portion of the committed funds was $500,000 ($2 million $1.5
million), the commitment fee for the year was $2,500 (0.005 $500,000). Of
course, REH also had to pay interest on the actual $1.5 million borrowed under
the agreement. Assuming that $160,000 interest was paid on the $1.5 million
borrowed, the effective cost of the agreement was 10.83% [($160,000
$2,500)/$1,500,000]. Although more expensive than a line of credit, a revolving
credit agreement can be less risky from the borrower’s viewpoint, because the
availability of funds is guaranteed. Commercial Paper
A form of financing consisting of
short-term, unsecured promissory notes issued by firms with a
high credit standing. Commercial paper is a form of financing that consists of short-term, unsecured
promissory notes issued by firms with a high credit standing. Generally, only
quite large firms of unquestionable financial soundness are able to issue commercial paper. Most commercial paper has maturities ranging from 3 to 270 days.
Although there is no set denomination, it is generally issued in multiples of
$100,000 or more. A large portion of the commercial paper today is issued by
finance companies; manufacturing firms account for a smaller portion of this
type of financing. Businesses often purchase commercial paper, which they hold
as marketable securities, to provide an interest-earning reserve of liquidity. 7. Many authors classify the revolving credit agreement as a form of intermediate-term financing, defined as having
a maturity of 1 to 7 years. In this text, we do not use the intermediate-term financing classification; only short-term
and long-term classifications are made. Because many revolving credit agreements are for more than 1 year, they can
be classified as a form of long-term financing; however, they are discussed here because of their similarity to line-ofcredit agreements.
8. Some banks not only require payment of the commitment fee but also require the borrower to maintain, in addition to a compensating balance ag...
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