CTP Working Capital Management 5 — Questions and Answers
Question 1: Which of the following is a characteristic of spontaneous financing?
- It requires formal credit agreements with lenders
- It arises automatically from normal business operations, such as trade payables (Correct answer)
- It involves issuing commercial paper in the capital markets
- It must be approved by the board of directors each quarter
Correct answer: It arises automatically from normal business operations, such as trade payables
Spontaneous financing arises automatically as a byproduct of operating activity—trade payables and accrued liabilities grow naturally as sales increase.
Question 2: A treasury professional is evaluating whether to extend credit to a new customer. Which metric is MOST directly useful?
- The customer's market capitalization
- The customer's debt service coverage ratio (DSCR) (Correct answer)
- The customer's dividend payout ratio
- The customer's stock price trend over the past year
Correct answer: The customer's debt service coverage ratio (DSCR)
DSCR measures whether a customer generates enough cash flow to service its debt obligations, directly indicating capacity to pay trade credit on time.
Question 3: A notional pooling arrangement differs from physical cash pooling primarily because:
- Notional pooling requires physical transfer of funds between accounts
- Notional pooling offsets balances for interest calculation without moving actual funds (Correct answer)
- Physical pooling does not reduce net interest expense
- Notional pooling is only available to domestic companies
Correct answer: Notional pooling offsets balances for interest calculation without moving actual funds
In notional pooling, the bank calculates interest on the net position across accounts without physically moving funds, preserving local subsidiary autonomy.
Question 4: Which of the following best describes 'stretching payables' as a working capital strategy?
- Paying suppliers before the invoice due date to earn discounts
- Delaying payment to suppliers beyond agreed terms to retain cash longer (Correct answer)
- Offering customers extended payment terms to win new business
- Factoring receivables to accelerate cash collection
Correct answer: Delaying payment to suppliers beyond agreed terms to retain cash longer
Stretching payables means intentionally delaying supplier payments beyond terms, using trade credit as an interest-free short-term funding source—though it risks damaging supplier relationships.
Question 5: The Baumol model for cash management is analogous to which inventory management model?
- ABC analysis
- Just-in-Time (JIT)
- Economic Order Quantity (EOQ) (Correct answer)
- Safety stock model
Correct answer: Economic Order Quantity (EOQ)
The Baumol model applies the EOQ concept to cash management, balancing the transaction cost of converting securities to cash against the opportunity cost of holding idle cash.
Question 6: A company's operating cycle is 90 days and its days payable outstanding (DPO) is 30 days. What is its cash conversion cycle?
- 30 days
- 60 days (Correct answer)
- 90 days
- 120 days
Correct answer: 60 days
CCC = Operating Cycle – DPO = 90 – 30 = 60 days; the company must finance 60 days of operations from its own resources.
Question 7: Which of the following is the MOST significant disadvantage of commercial paper as a short-term financing instrument?
- It cannot be issued by investment-grade companies
- It typically has maturities exceeding one year
- It is only available to companies with high credit ratings and may dry up in market stress (Correct answer)
- It requires collateral equal to 100% of the face value
Correct answer: It is only available to companies with high credit ratings and may dry up in market stress
Commercial paper is an unsecured instrument available only to high-quality issuers; during financial market stress, the CP market can freeze, leaving issuers unable to roll maturing paper.
CTP Working Capital Management 5
Which of the following is a characteristic of spontaneous financing?