Question

For each situation described below, indicate which financial instrument you think would be the most appropriate to use and why?

a. The City Of Philadelphia needs to raise $100 million for improvements and repairs to the Walt Whitman toll bridge.
b. Citizens Bank discovers they have reserves in excess of the level required that are expected to last for 3 days.
c. DiBruno Bros. imports hundreds of wheels of cheese from Italy each month that typically take between 30 and 60 days to arrive. Due to the perishable nature of the cargo, they prefer to postpone payment until delivery.
d. Tasty Baking Company finds itself in need of some short-term working capital to finance an increase in the value of their ingredients inventory.
e. Bank of America has substantial Treasury bill holdings but finds itself with an insufficient level of required reserves. The reserve deficiency is expected to last only for a day.
f. Revere Cookware imports copper from Chile and is concerned that the value of the Chilean peso will rise in relation to the US dollar in coming months.

Answer 1

The most appropriate financial instruments would be municipal bonds for city improvements, federal funds lending for excess bank reserves, a letter of credit for importing goods, a short-term loan for working capital, a repurchase agreement for brief reserve deficiencies, and foreign exchange forward contracts for currency risk.

Step-by-step explanation:

For each situation described below, indicate which financial instrument you think would be the most appropriate to use and why?

• a. The City of Philadelphia could use municipal bonds to raise $100 million for improvements to the Walt Whitman toll bridge. Municipal bonds are a common tool for financing public projects, offering tax advantages to investors.
• b. Citizens Bank, with excess reserves, could engage in federal funds lending. Banks with temporary excess reserves often lend them overnight to other banks needing to meet reserve requirements.
• c. DiBruno Bros. might use a letter of credit, specifically a usance or time letter of credit, which allows them to pay for the imported cheese upon delivery, rather than upfront. This aligns payment with the receipt of goods and mitigates the risk of non-delivery.
• d. Tasty Baking Company could opt for a short-term loan or a line of credit to finance their inventory needs. These instruments provide quick access to capital to manage short-term cash flow requirements.
• e. Bank of America might use a repurchase agreement (repo) to deal with the reserve deficiency. Repos are short-term borrowing agreements using securities as collateral and are suitable for handling temporary liquidity needs.
• f. Revere Cookware, to hedge against potential currency fluctuations, could use foreign exchange forward contracts. These contracts lock in an exchange rate now for transactions to be completed in the future, mitigating currency risk.