Advantages And Disadvantages Of Capital Rationing
However, this type of action involves a trade-off between the risk of illiquidity and the firm's return on invested funds. By increasing its investment in cash and marketable securities, the firm reduces its risk of illiquidity. However, the firm has increased its investment in assets, which earn little or no return. The firm can reduce its risk of illiquidity only by reducing its overall return on invested funds and vice versa.
18-3. What is the primary advantage and disadvantage associated with the use of short-term
debt? Discuss. The advantages of Short-Term Debt are the interest rate is usually lower (i.e., the term structure of interest rates is generally upward sloping) for short-term debt. And funds are paid for only when they are used. Conversely, the disadvantages are short-term debts must be repaid sooner; thus, there is a greater risk of illiquidity. And interest costs on short-term debts vary from year-to-year, whereas long-term debt agreements "lock in" the cost of funds to the firm.
18-11. Define the following: a. Line of credit: An informal agreement or understanding between the borrower and the bank as to the maximum amount of credit, which the bank will provide the borrower at any one time. b. Commercial paper: consists of unsecured promissory notes of firms that are sold in the money