CFA Level I Exam · Working Capital and Liquidity

Short-Term Financing Sources and Costs for CFA Level I

Updated 7 October 2026 · Fact-checked

Short-term financing covers borrowing due within about a year: bank lines of credit, commercial paper, factoring and secured loans. To compare them, add all interest and fees, divide by the cash you actually receive, then annualize with (1 + periodic cost)^(365 ÷ days) − 1. The lowest effective cost wins, subject to availability and risk.

Understand Short-Term Financing Sources and Costs

Firms need short-term funds to cover gaps between paying suppliers and collecting from customers. Short-term financing is borrowing meant to bridge those gaps. The main sources are bank lines of credit, commercial paper, factoring and other secured or asset-based loans. Each differs in cost, certainty of access and who can use it.

A line of credit is a bank arrangement that lets a firm borrow up to a limit. An uncommitted line is informal: the bank can refuse a draw or cancel the line, so it is cheap but unreliable. A committed line is a legal promise to lend up to the limit, so it is more reliable. The bank charges a commitment fee on the unused portion. A revolving credit agreement is a committed line, usually for a longer term such as several years, where the firm can borrow, repay and borrow again. It often carries both interest and fees.

Commercial paper (CP) is short-term, unsecured debt that large, highly rated firms sell to investors. It is sold at a discount to face value, so the interest is the gap between face value and proceeds. It is usually cheaper than bank borrowing, but only strong credits can use it. Issuers often hold a backup line of credit and pay dealer fees, and these add to the true cost. Market access can vanish in a crisis.

Factoring is the sale of accounts receivable to a factor at a discount. The firm receives cash now and the factor collects from customers. In nonrecourse factoring the factor takes the credit loss. In recourse factoring the firm keeps it. Other sources include loans secured by receivables, inventory or other assets (asset-based lending), and loans from nonbank lenders. Secured loans can be larger or easier to get for weaker credits, but they cost more and restrict the pledged assets.

To compare sources, never compare quoted rates alone. Convert each into the effective cost per unit of usable funds, then annualize. Also weigh the non-price factors: certainty of funds, flexibility, collateral demands and the firm's credit strength.

Key formulas to remember

Interest on a borrowing: Interest = Amount borrowed × Annual rate × (Days ÷ Day-count basis); Use the basis the question gives (360 or 365). If none is stated, follow the question's own convention.
Commitment fee: Fee = Fee rate × Unused amount × (Days ÷ Basis); Charged on the part of a committed line not drawn. Include it in total cost.
Periodic cost of borrowing: Periodic cost = (Interest + Fees) ÷ Usable funds received; Divide by the cash the firm actually gets, not the face amount, when fees or discounts are taken upfront.
Effective annual cost: EAC = (1 + Periodic cost)^(365 ÷ Days) − 1; Compounds the periodic cost over a year. Simple annualizing is Periodic cost × (365 ÷ Days).
Discount (commercial paper) proceeds: Proceeds = Face value − Discount, and Periodic cost = (Face − Net proceeds) ÷ Net proceeds; Net proceeds are proceeds minus dealer fees and backup line costs.

How to solve Short-Term Financing Sources and Costs questions

Use the same routine for any question that asks you to find or compare the cost of a short-term source.

1Identify the source and its features: committed or uncommitted, discount or interest-bearing, recourse or nonrecourse.
2List every cost: interest or discount, commitment fees, dealer fees, backup line costs, factoring fees.
3Work out the cash the firm actually receives (usable funds). For a discount instrument, this is face value minus the discount and upfront fees.
4Compute the periodic cost: total cost ÷ usable funds.
5Annualize with (1 + periodic cost)^(365 ÷ days) − 1, unless the question asks for a simple rate.
6Compare options on effective cost, then check non-price features such as certainty of access and collateral.
7Match your answer to the three options and eliminate any that ignore fees or use the wrong denominator.

Quickest way: Total cost over usable funds

When to use it: Any numerical cost question with a stated borrowing period and one or more fees.

Write total cost in currency terms first (interest plus every fee for the period).
Divide by cash received, not face value.
Multiply by 365 ÷ days for a quick estimate. This is slightly below the compounded answer.
Use the estimate to eliminate options. Then compound only if two options are close.
On the BA II Plus, compute the compound rate as: 1 + periodic cost, press yˣ, enter 365 ÷ days, press =, then subtract 1. On the HP 12C, use the same steps with ENTER and yˣ.

Common mistakes in Short-Term Financing Sources and Costs

Dividing total cost by the face amount instead of usable funds.
The quoted loan amount looks like the base, but fees or the discount are taken upfront.
Fix: Always ask what cash the firm receives. Divide by that amount.
Ignoring the commitment fee on the unused part of a committed line.
Students focus on the drawn amount and its interest rate.
Fix: Compute the fee on the undrawn balance and add it to interest before dividing.
Treating uncommitted and committed lines as the same.
Both are called lines of credit.
Fix: Remember that only a committed line is a binding promise to lend. An uncommitted line can be withdrawn and usually carries no commitment fee.
Leaving out dealer and backup line costs for commercial paper.
The discount looks like the whole cost.
Fix: Add all fees to the cost and subtract them from proceeds when the question lists them.
Using the wrong annualizing exponent.
Mixing 360 and 365, or using days ÷ 365 instead of 365 ÷ days.
Fix: The exponent is the number of periods in a year: 365 ÷ days. Follow the day-count the question states.
Assuming factoring always shifts credit risk to the factor.
The word 'sale' suggests the firm is rid of the risk.
Fix: Only nonrecourse factoring transfers credit loss. In recourse factoring the firm bears it.

Worked examples

Example 1

A firm has a $5,000,000 committed line of credit. It borrows $2,000,000 for 90 days at 6% a year (360-day basis). The bank charges a commitment fee of 0.5% a year on the unused $3,000,000, also on a 360-day basis for the 90 days. Using 365 days to annualize, what is the effective annual cost of the borrowing? A) 6.75% B) 7.02% C) 8.25%

Show the solution

Interest = 2,000,000 × 6% × 90 ÷ 360 = $30,000.
Commitment fee = 3,000,000 × 0.5% × 90 ÷ 360 = $3,750.
Total cost = 30,000 + 3,750 = $33,750.
Periodic cost = 33,750 ÷ 2,000,000 = 1.6875%.
EAC = (1.016875)^(365 ÷ 90) − 1 = (1.016875)^4.0556 − 1 ≈ 1.0702 − 1 = 7.02%.
Option A (6.75%) is the simple 4-period rate, so it ignores compounding. Option C overstates the cost.

Answer: B) 7.02%

Example 2

A company issues $10,000,000 of 120-day commercial paper at a price of $9,800,000. Dealer and backup line fees total $50,000, paid upfront. What is the effective annual cost using 365 days? A) 6.34% B) 7.80% C) 8.01%

Show the solution

Net proceeds = 9,800,000 − 50,000 = $9,750,000.
Total cost = 10,000,000 − 9,750,000 = $250,000.
Periodic cost = 250,000 ÷ 9,750,000 = 2.5641%.
EAC = (1.025641)^(365 ÷ 120) − 1 = (1.025641)^3.0417 − 1 ≈ 1.0801 − 1 = 8.01%.
Option A comes from ignoring fees: 200,000 ÷ 9,800,000 = 2.04% compounded gives about 6.34%. Option B is the simple annualized rate, 2.5641% × 3.0417 ≈ 7.80%, which skips compounding.

Answer: C) 8.01%

Exam tips

Most cost questions reward one habit: put every fee in the numerator and use only the cash received as the denominator.
Expect conceptual items on committed versus uncommitted lines. The key difference is the legal obligation to lend and the commitment fee.
Questions often ask which source suits a weak or strong credit. Commercial paper fits large, highly rated issuers. Secured loans and factoring suit firms with weaker credit.
Numerical options go from smallest to largest. If you ignore fees, you usually land on the smallest option, which is a common trap.
With no penalty for wrong answers, never leave a blank. Use the quick estimate to eliminate at least one option.

Practice questions from Working Capital and Liquidity

Short-Term Financing Sources and Costs in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Short-Term Financing Sources and Costs: frequently asked questions

What is the difference between a committed and an uncommitted line of credit?

A committed line is a legal promise by the bank to lend up to a limit, and the firm pays a commitment fee on the unused portion. An uncommitted line is an informal arrangement. The bank may refuse to lend or cancel it, so it is cheaper but less certain.

How do you calculate the cost of short-term borrowing for the CFA exam?

Add interest and all fees, then divide by the cash the firm actually receives. That gives the cost for the period. Annualize it with (1 + periodic cost)^(365 ÷ days) − 1 unless the question asks for a simple rate.

How does factoring differ from commercial paper financing?

Factoring sells receivables at a discount, so the funding is tied to the firm's customers and may be recourse or nonrecourse. Commercial paper is unsecured debt sold to investors, available mainly to strong credits. Commercial paper is usually cheaper if the firm can access it.

Why does commercial paper often need a backup line of credit?

Commercial paper must be repaid or rolled over at maturity, and investors may refuse to buy new paper in stressed markets. A backup line gives the issuer a way to repay. The cost of that line adds to the effective cost of the paper.