The major attraction of a line of credit from the

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Unformatted text preview: ements. If the bank finds the customer acceptable, the line of credit will be extended. The major attraction of a line of credit from the bank’s point of view is that it eliminates the need to examine the creditworthiness of a customer each time it borrows money. Interest Rates The interest rate on a line of credit is normally stated as a floating rate—the prime rate plus a premium. If the prime rate changes, the interest rate charged on new as well as outstanding borrowing automatically changes. CHAPTER 15 Current Liabilities Management 645 The amount a borrower is charged in excess of the prime rate depends on its creditworthiness. The more creditworthy the borrower, the lower the premium (interest increment) above prime, and vice versa. operating-change restrictions Contractual restrictions that a bank may impose on a firm’s financial condition or operations as part of a line-of-credit agreement. compensating balance A required checking account balance equal to a certain percentage of the amount borrowed from a bank under a line-of-credit or revolving credit agreement. EXAMPLE Hint Sometimes the compensating balance is stated as a percentage of the amount of the line of credit. In other cases, it is linked to both the amount borrowed and the amount of the line of credit. annual cleanup The requirement that for a certain number of days during the year borrowers under a line of credit carry a zero loan balance (that is, owe the bank nothing). Operating-Change Restrictions In a line-of-credit agreement, a bank may impose operating-change restrictions, which give it the right to revoke the line if any major changes occur in the firm’s financial condition or operations. The firm is usually required to submit up-to-date, and preferably audited, financial statements for periodic review. In addition, the bank typically needs to be informed of shifts in key managerial personnel or in the firm’s operations before changes take place. Such changes may affect the future success and debt-paying ability of the firm and thus could alter its credit status. If the bank does not agree with the proposed...
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This document was uploaded on 01/19/2014.

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