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Discuss loans as a source of short term finance.

      

Discuss loans as a source of short term finance.

  

Answers


Lellah
1. Overdrafts
Overdraft is a short term borrowing from a bank where the borrower is granted the permission to draw money out of a current account such that it becomes negative, but only to a specified amount. The overdraft is flexible since the borrower only pays interest on the amount actually withdrawn. For example if the bank allows you to withdraw up to sh 1,000,000 more than is in your account but you only withdraw sh 400,000 you will pay interest only on the sh 400,000 not on the sh 1,000,000 unlike in a normal loan where you pay interest on the total amount. However, banks can demand immediate repayment of an overdraft without notice.

2. Line of credit
A line of credit is an arrangement between a bank and its customer, specifying the maximum amount of unsecured credit the bank will permit the business entity to owe at any one time. They are established for a one year period and are subject to one year renewal. Mostly the customer is required to withdraw the entire maximum amount within the year.
However if the creditworthiness of the customer deteriorates the bank may withdraw its offer of the line of credit.

3. Revolving credit agreement
This is a legal commitment by a bank to extend credit up to a maximum amount. While the commitment is in force, the bank must extend credit whenever the borrower wishes to borrow, provided it does not exceed the maximum. If revolving credit is sh 5 million and sh 3 million has been withdrawn in the year, then the two million can be loaned out any time the customer wants but he has to pay a commitment fee on the sh 2 million not borrowed. It allows him to access the money when in need of it and may extend beyond one year.

4. Commercial paper
Is a short term form of unsecured borrowing by large business entities. The duration of the loan can be short as a few days to one year. Since the business entities are large and so have a credit rating, they can get huge amounts of funds at interest rates lower than the bank can charge them. The interest rates are slightly higher than the risk free rate (Treasury bill rate). The commercial paper is issued at a discount.


Lellah answered the question on November 8, 2021 at 07:17


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