Unsecured financing Is financing that is not backed by collateral.

A company seeking unsecured short-term capital has several options; they include trade credit, promissory notes, bank loans, commercial papers and commercial drafts. Trade Credit We know that wholesalers might provide financial aid to retailers by allowing them thirty to sixty days (or more in which to pay for merchandise. This delayed payment, which may also be granted by manufacturers, is a form of credit known as trade credit. M o r e s p e c i f i c a l l y, t r a d e c r e d i t i s a p a y m e n t d e l a y s t h a t a supplier grants to its customers. Between 80 and 90 percent of all t r a n s a c t i o n s between businesses involve some trade credit. Typically, the purchased goods are delivered along with a bill (or invoice) that states the credit terms. Promissory Notes Issued to Suppliers A promissory note is a written pledge bya borrower to pay a certain sum of money to a creditor at specified future date. Suppliers that are uneasy about extending trade credit may be less reluctant to offer credit to customers that sign promissory notes. Unlike trade credit, however, promissory notes usually provide that the borrower pay interest. Unsecured Bank Loans Commercial banks offer unsecured short-term loans to their customers at interest rates that vary with each borrowers credit rating. The prime interest rate (sometimes called the reference rate) is the lowest rate charged b y a b a n k f o r a short-term loan. This lowest rate is generally reserved for large corporations with excellent credit ratings. B a n k s g e n e r a l l y o f f e r l o a n s t h r o u g h p r o m i s s o r y n o t e s , a l i n e o f c r e d i t , o r a re involving credit agreement. Most promissory notes specify repayment periods of 60to 180 days. The line of credit In essence, is a prearranged short-term loan. A bank that offers a line of credit may require that a compensating balance be kept on deposit at the bank. This balance may be as much as 20% of the line-of-credit amount. The bank may also require that every commercial borrowe r c l e a n u p ( p a y o f f completely) its line of credit at least o n c e e a c h y e a r a n d n o t u s e i t a g a i n f o r a period of 30 to 60 days. This second requirement ensures that the line of credit issued only to meet short-term needs and that it doesnt gradually become a source of long-term financing. Even with a line of credit, a firm may not be able to borrow on short notice if the bank does not have sufficient funds available. For this reason, some firms prefer revolving credit agreement, which is a guaranteed line of credit. Under this type o f a g r e e m e n t , t h e b a n k g u a r a n t e e s t h a t t h e

m o n e y w i l l b e a v a i l a b l e w h e n t h e borrower needs it. In return for the guarantee, the bank charges a commitment fee ranging from 0.25 to 1.0 percent of the unused portion of the revolving credit. The usual interest is charged for the portion that is borrowed. Commercial Paper Is short-term promissory notes issued by large corporations. Commercial paper is secured only by the reputation of the issuing firm; no collateral i s i n v o l v e d . I t i s usually issued in large denominations, ranging from $5,000 t o $100,000. Corporations issuing commercial paper pay interest rates slightly below those charged by commercial banks. Thus, issuing commercial paper is cheaper than getting short-term financing from a bank. A commercial draft I s a w r i t t e n o r d e r r e q u i r i n g a customer (the drawee) t o p a y a s p e c i f i e d s u m o f m o n e y t o a supplier (the drawer) for goods or services. It is often used when the supplier is unsure about the customer's credit standing. The draft would be completed as follows: 1. The draft form is filled out by the drawer. The draft contains the purchase price, interest rate, if any and maturity date. 2. The draft is sent by the drawer to the drawee. 3. If the information contained in the draft is correct and the merchandise has been received, the drawee marks the draft "Accepted" and signs it. 4. The customer returns the draft to the drawer. Now the drawer may (a) Hold the draft until maturity (b) Discount the draft at its bank (c) Use the draft as collateral for a loan. In this case, the draft is similar to an ordinary check with one exception: The draft is filled out by the seller and not the buyer. A sight draft is a commercial draft that is payable on demandwhenever the drawer wishes to collect. A time draft Is a commercial draft on which a payment date is specified. Like promissory notes, drafts are negotiable instruments that may be discounted or used as collateral for a loan. They are legally enforceable