UNSECURED

SOURCES OF SHORT-
TERM LOANS

Presented by:
Lorainne Anne Madronero
TWO MAJOR SOURCES OF
UNSECURED SHORT-TERM LOANS

BANK LOANS

SALES OF
COMMERCIAL
PAPER
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BANK LOANS
• Banks are a major source of unsecured short-term
loans to businesses.

• Short-term, self-liquidating loan - the use to

which the borrowed money is put provides the
mechanism through which the loan is repaid

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THREE BASIC WAYS BANK LEND
UNSECURED, SHORT-TERM FUNDS

Revolving
Single credit
Lines of
payment agreements
credit
notes

Loan Interest Rates

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LOAN INTEREST RATES
The interest rate is often based on the prime rate of interest (lowest
rate of interest charged by leading banks on business loans to their most
important business borrowers).

• Fixed-rate Loan - the rate of interest is determined at a set

increment above the prime rate on the date of the loan and remains
unvarying at that fixed rate until maturity.

• Floating-rate loan - the rate of interest is allowed to “float,” or

vary, above prime as the prime rate varies until maturity.

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 EXAMPLE:

Fixed-rate loan Floating-rate loan

BANK A BANK B
Interest rate – 7% Interest rate – 7%, 6.5%, 6.25%
Effective Annual Rate – 7.73% Effective Annual Rate – 7.46%

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METHOD OF COMPUTING INTEREST
FORMULA
If interest is paid at maturity, the effective
(or true) annual rate—the actual rate of
interest paid—for an assumed 1-year
period is equal to

Loans on which interest is paid in advance

are called discount loans. The effective
annual rate for a discount loan, assuming a
1-year period, is calculated as

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EXAMPLE:
MN Company, a manufacturer of athletic apparel, wants to borrow ₱ 10,000 at a stated annual rate of 10%
interest for 1 year. If the interest on the loan is paid at maturity, the firm will pay ₱1,000 (0.10 * ₱10,000) for
the use of the ₱10,000 for the year.
At the end of the year, MN will write a check to the lender for ₱ 11,000, consisting of the ₱ 1,000 interest as
well as the return of the ₱ 10,000 principal.

₱ 1,000_ = 10.0%
₱ 10,000

If the money is borrowed at the same stated annual rate for 1 year but interest is paid in advance, the firm
still pays P 1,000 in interest, but it receives only P 9,000 (P10,000 - P1,000).

_____₱ 1,000____ = ₱ 1,000_ = 11.1%

₱ 10,000 - ₱ 1,000 ₱ 9,000

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SINGLE-PAYMENT
NOTES
• This type of loan is usually a one-time loan
made to a borrower who needs funds for a
specific purpose for a short period.

• This type of short-term note generally has a

maturity of 30 days to 9 months or more.

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LINES OF CREDIT
• An agreement between a commercial bank and a business specifying
the amount of unsecured short-term borrowing the bank will make
available to the firm over a given period of time.

Interest Rates • stated as a floating rate: the prime rate plus a premium.

• Contractual restrictions that a bank may impose on a firm’s

Operating-Change financial condition or operations as part of a line-of-credit
Restrictions agreement.

• A required checking account balance equal to a certain

Compensating percentage of the amount borrowed from a bank under a line-of-
Balances credit or revolving credit agreement.

• The requirement that for a certain number of days during the

Annual Cleanups year borrowers under a line of credit carry a zero loan balance
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REVOLVING CREDIT
AGREEMENTS
• A line of credit guaranteed to a borrower by a
commercial bank regardless of the scarcity of
money

• Commitment fee - This fee often applies to the

average unused balance of the borrower’s credit
line.

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 EXAMPLE:
ST Company needs ₱750,000 to finance the investment in operating cycle. The firm is considering three alternatives of
financing below.

I. A line credit of ₱1,000,000 from YZ Bank at an interest rate of 8% and a commitment fee of 3% on the
unused balance.
II. A loan from FG Bank at 10% discounted interest rate. A 15% compensating balance will be required.

Advise the firm on which sources of financing to choose. Support your answer with workings.

1st Alternative: Revolving Line of 2nd Alternative: Bank Credit

Credit

EAR- Effective Annual Rate

AB – Amount Borrowed
AR – Amount Received
DI –Discount Interest
CB – Compensating Balance

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THANK YOU!
\

Sources:
Gitman-Lawrence-J._-Zutter-Chad-J.-Principles-of-Manager
Finance-Pearson-2014
https://www.youtube.com/watch?v=Va5c0XWnyrM