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(^362) Financial Management
A short-term loan is one having a maturity of less than one year. Loans maturing within
1 to 10 years are considered to be intermediate-term or term loans. Sources for term
loans are banks, insurance companies, and pension funds. Some of the more important
characteristics of term loans are discussed in the following paragraphs.
Characteristics of Term Loans
Term loans are different from other types of loans in a variety of ways including maturity,
repayment schedule, collateral, costs, and provisions.
Maturity. As stated previously, the maturity for a term loan varies from 1 to 10 years.
The 10-year limit is somewhat arbitrary in classifying a loan as a term loan. However,
in recent years financial institutions are becoming less reluctant to issue term loans
with maturities up to 10 years. The classification of loans with maturities of up to
10 years as term loans is becoming very common. The maturity of a term loan is
dependent upon the financial institution lending the funds. Banks are generally reluctant
to issue term loans with maturities in excess of 5 to 6 years. On the other hand,
insurance companies and pension funds frequently underwrite term loans with maturities
of 10 years.
Repayment Schedule. Short-term loans are generally repaid as the firm generates
excess cash flows. Long-term loans are generally repaid in full at maturity. Term loans
are typically repaid according to a specified schedule. The most typical situation requires
fixed payments, which include both principal and interest, on a monthly, semiannual,
quarterly, or annual basis. The size of the periodic payment is such that when the last
payment is made, the loan is fully paid and the lender is provided his required return.
The repayment of term loans is discussed in the following section.
The particular procedure of making equal payments periodically to repay a loan is
called loan amortisation. For example, a company borrows Rs 800,000 for 10 years and
makes year-end equal payments of Rs 124,655.25 every year for 10 years. At the
end of the tenth year the loan will have been fully repaid and will have provided the
lender a 9 per cent interest rate. On rare occasions the loan amortisation is such
that only a portion of the loan is repaid, leaving a large or ìballoonî final payment. For
example, the lender and borrower by mutual agreement may amortise only Rs 600,000
of the Rs 800,000 loan. In this case the 10 annual payments would be Rs 111,491.44
each. The borrower would also have to repay the unamortised Rs 200,000 portion of
the loan at the end of the tenth year. Both of these examples are explained in the next
section.
Collateral. Financial institutions underwriting term loans generally require collateral on
the loans. Since these loans are used for specific purposes such as purchase of computers