Question

13. A.J. Manufacturing has an agreement with the Bank of St. Croix whereby A.J. can ­borrow up $3.5 million should the manufacturing plant suffer a severe fire or windstorm. The interest rate on the loan is guaranteed to not be greater than 7 percent. This is an example of A. contingent debt. C. a letter of credit. D. a line of credit.

I CHOOSE C

Answer 1

The contingent debt is a type of debt that is dependent on unexpected future events such as natural catastrophe, change in government laws etc. Therefore repayment of contingent debt depends on future outcome. A letter of credit is agreement between bank and a borrower in which bank guarantees to pay a specific credit amount to borrower for purchase of asset such as machinery, land etc in the stipulated time. A line of credit is credit amount sanctioned to a borrower by a financial institution such as bank for specific period. Under line of credit agreement, a borrower can draw only up to specific amount and pay interests only for that loan amount.

The case mentioned above is an example of contingency debt where borrower can borrow loan up to $3.5 for unexpected events such as severe fire or windstorm and pay a maximum interest of 7% per annum on the loan amount if the borrower face unexpected events. The correct option is contingent debt