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First, good evening John!!!! .. very good to see you again..:)
i am confused as to whether an OD is cheaper than a long term loan?
in the kaplan text it says:
“some companies use OD as part of their long term finance [……]. In questions you could suggest that the OD be rescheduled as a loan. Not only will this be cheaper but it wd also improve liquidity rations”
and in the kit, one question gave the OD rate as 5% and loan rate as 7%. obviously thisis the other way around. and in answer to this question, it said that OD is riskier since its payable on demand.
can u pls explain
thank u
In terms of the interest rate, long-term loans tend in fact to be at lower interest rates (but this is not a rule – sometimes it is higher).
What really makes overdrafts tend to be cheaper is that you only pay interest on what you actually borrow from day-to-day (and some days you will need to borrow more and some days less). Whereas with long-term loans you are paying interest on the same fixed amount, whether you actually need it all or not.
However, the reason overdraft borrowing is more risky is that the bank can demand repayments whenever they want, whereas with long-term loans you know when the repayments will be required – it is borrowed for a fixed period and so you can plan for the repayment.
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