Finance 4412 Short Term Financial Management Topic Outline for Final Exam 1 Know the following the 3 main sources of firm financing how the effective interest rate on a bank line of credit is calculated interest cost commitment fee compensating balance requirement plus loan covenants that have to be satisfied the main short term investment alternatives for a firm e g sweep accounts commercial paper treasury securities and how the discount yield is computed applies to treasury securities commercial paper corporate bonds etc 1a Three main sources of firm financing are Commercial paper Bank loans and Corporate bonds 1b Effective interest rate Out of pocket expenses x 365 Value of usable funds days out of total borrowed borrowed Example A firm borrows 60 000 of its 100 000 bank line of credit Interest rate on used line 10 Out of pocket costs Interest cost 10 60 000 6 000 yr Commitment fee on unused portion 25BP 0025 Commitment fee 0025 100 000 60 000 0025 40 000 100 yr Banks require firms to hold a Demand Deposit Account compensating balance e g 20 of any borrowed amount may be held idle Compensating balance 20 60 000 12 000 held idle at bank Effective Interest 6 000 100 x 365 1271 12 71 10 stated Rate 60 000 12 000 365 interest rate Banks impose loan covenants that need to be met before the line of credit can be used e g if leverage x then no funds 1c Sweep Account Firm s excess collected Demand Deposit Account funds swept into interest earning investments overnight pay bank fees for this service Commercial paper high grade uncollateralized corporate debt Repurchase agreements Firm buys government securities from a bank to earn interest This gives the bank an overnight loan Bank buys back the securities the next day Around 10 of firm S T investments are REPOs 1d Discount Yield Instruments Treasury bills Commercial paper Bankers acceptances Computed Face value Market price Face value Finance 4412 Short Term Financial Management Topic Outline for Final Exam 2 Know how spot and forward exchange rates work Be able to determine if an exchange rate has appreciated or depreciated and what this means for a country s price of imports seen at home and price of exports seen overseas 2a Spot currency rates are exchange rate quotes based on immediate delivery of the currency being traded Generally a corporation needing to purchase foreign currency will contact its bank The bank will purchased the desired currency through the interbank market that is spot exchange rate quotes received from other banks wishing to sell the currency Settlement of the interbank market transaction will generally take one to two days The settlement date is referred to as the value date 2b forward currency rate is an exchange between currencies that is contracted to exist at a future value date The exchange rate is established at the time the forward contract is created but payment and delivery do not occur until the maturity date of the forward contract generally 30 90 or 180 days in the future 2c An appreciating exchange rate will make that country s price of EXPORTS more expensive for overseas buyers and will therefore hurt the country s price of exports so overseas buyers import less and a depreciated exchange rate will make that country s price of EXPORTS less expensive for overseas buyers and will therefore benefit the country s price of exports so overseas buyers import more 3a Be able to use a supply and demand graph to show how a flexible exchange rate is determined and how these supply demand curves are related to the demand for imports and the demand for exports Finance 4412 Short Term Financial Management Topic Outline for Final Exam 3b Know the two main components of a country s balance of payments current account and capital account and why a net capital inflow into a country e g a foreign investment in a domestic firm is like an export of a product Finance 4412 Short Term Financial Management Topic Outline for Final Exam 4 Understand the rule on what determines the expected future spot exchange rate between two countries based on today s interest or inflation rates between two countries How well does this rule work in practice Know how a firm s international Finance 4412 Short Term Financial Management Topic Outline for Final Exam future account receivables or payables could be protected from exchange rate changes before the funds in these accounts are actually received or paid Finance 4412 Short Term Financial Management Topic Outline for Final Exam Finance 4412 Short Term Financial Management Topic Outline for Final Exam 5a Know how a firm can hedge its interest rate risk on a short term fixed or variable rate bank loan or a fixed or variable rate short term investment using the interest rate futures Finance 4412 Short Term Financial Management Topic Outline for Final Exam market or by using interest rate swaps Change a fixed rate liability or investment into a variable rate Or Change a variable rate into a fixed rate Based on i rate mispricing Or SWAP 5b Understand how interest rate cap and floor options work to reduce a firm s interest rate risk premium paid for the option strike price market interest rate Finance 4412 Short Term Financial Management Topic Outline for Final Exam Finance 4412 Short Term Financial Management Topic Outline for Final Exam Finance 4412 Short Term Financial Management Topic Outline for Final Exam 6 Know what EDI and internet commerce are and how a firm can benefit from its use versus just using EFT for payments receipts of accounts payable receivable What are the current limitations of EDI and why is it not used more extensively by firms EDI stands for Electronic Data Interchange EDI has been developed by the United Nations ECE Working Party in the 60s as a standard to simplify and standardize external trade documents 1 It became more important with the internet boom in the mid and late nineties However EDI is not depending on any special technologies 2 The three essential elements of EDI are an electronic transmission medium e g a peer to peer network or the internet an agreed standard for structuring and formatting messages a fast delivery of electronic documents from sender to receiver Finance 4412 Short Term Financial Management Topic Outline for Final Exam