FIN30021 Fixed Income and Debts Markets Question 1 Week 8 - Alternative bonds What is the opportunity cost of a discount on an invoice 3/12, n30? Opportunity Cost 100-% discount % discount X 365 days difference between early and late settlement 3.0 × 365 Opportunity Cost = 97.0 18 Opportunity cost = 0.6271 = 62.71% If a credit period and early payment period with a discount are provided, the purchaser has a choice: either pay early and receive the discount or pay in full by the later specified date and obtain a longer period of credit. The choice should be determined by calculating the opportunity cost of the discount versus the benefit of the extended credit period. If the offer of the discount is taken, the purchaser will need to have the funds available to pay for the goods at that date. The purchaser needs to consider the opportunity cost associated with the two alternative situations: the after-tax cost of other available types of short-term credit, and the return that could be obtained from investing surplus cash during that period. Question 2 What is a Factoring? Factoring involves a financier buying the accounts receivable assets of a company. The financier is usually a finance company and is called the factor company. Many businesses offer credit arrangements to their customers. A customer that owes funds to a firm is known as a debtor. The outstanding debt is an asset and is recorded on the firm's balance sheet as an account receivable. If accounts receivable are not actively managed by the firm through the implementation of strategies to ensure that customers pay their debts on time, the firm may experience liquidity problems; that is, it will have to finance its own accounts receivable until the funds are actually received from the customer. For small businesses in particular this may cause a severe cash-flow problem. One solution that has developed is for the firm to sell its accounts receivable assets in order to generate immediate cash flows for the business. Clearly, there will be a cost to the firm in generating cash flows in this manner. The firm will sell the assets at a discount to their face value. The return to the factoring company is the difference between the discounted price and the face value of the accounts receivable when they are eventually paid. This form of finance is relatively expensive for the firm selling its accounts receivable. As MODULE 8 CLASS 1
the factoring company is accepting higher levels of risk in providing this type of finance, the required yield is correspondingly higher. Question 3 What is the matching principle? Matching principle is to match short term assets with short term financing. Similarly with long term assets and financing. Reduces risk. Question 4 For a bill of exchange, what is the responsibility for the acceptor and discounter? The responsibility of the acceptor is to pay the holder of the bill at maturity the outstanding amount. The discounter's responsibility can be limited