It is a formal, legal commitment to extend credit up to some maximum amount over a stated period of time.
Click on the arrows to vote for the correct answer
A. B. C. D.B
Certainly! The question you provided is from the CTFA (Certified Trust and Financial Advisor) exam, specifically related to credit arrangements. Let's discuss each answer choice and provide a detailed explanation for each option:
A. Letter of credit: A letter of credit is a financial instrument often used in international trade. It is a commitment issued by a bank on behalf of a buyer to pay a seller a specific amount of money, provided that the seller meets certain conditions specified in the letter of credit. It guarantees payment to the seller when certain documentary requirements are met, typically related to the shipment of goods. However, a letter of credit is not a commitment to extend credit over a stated period of time, as mentioned in the question.
B. Revolving credit agreement: A revolving credit agreement is a contractual arrangement between a lender and a borrower. It allows the borrower to access funds up to a predetermined maximum amount over a specified period, usually referred to as the term of the agreement. The borrower can borrow, repay, and re-borrow within the approved credit limit, as long as they meet the terms and conditions outlined in the agreement. Interest is charged on the outstanding balance, and the borrower has flexibility in using and repaying the credit within the agreed timeframe. This option aligns with the definition provided in the question.
C. Line of credit: A line of credit is similar to a revolving credit agreement, as it also provides access to funds up to a certain maximum amount. However, a line of credit is typically more flexible and can be used for various purposes, including personal or business needs. It allows the borrower to draw funds from the available credit limit as needed, and interest is charged only on the borrowed amount. The borrower can repay and borrow again within the specified period, similar to a revolving credit agreement. This option is also consistent with the definition given in the question.
D. Trade credit: Trade credit refers to credit arrangements between suppliers and buyers in the context of business transactions. It is an agreement in which the supplier allows the buyer to delay payment for goods or services received, typically for a specified period. The buyer receives the goods or services upfront and is expected to settle the outstanding amount within the agreed-upon timeframe, which could be days, weeks, or months. Trade credit is not a commitment to extend credit over a stated period of time, as mentioned in the question.
Considering the explanations provided above, the correct answer for the question is:
B. Revolving credit agreement