Definition
A demand loan, also known as a call loan or payable-on-demand loan, is a loan that can be requested for repayment at any time by the lender. Unlike term loans, which have fixed repayment schedules, demand loans do not have a specific maturity date. The borrower’s obligation is to repay the loan whenever the lender demands it.
Examples
- Small Business Financing: A small business might take out a demand loan to manage short-term cash flow needs, such as covering payroll or purchasing inventory, with the understanding that the loan could be called in at any moment.
- Personal Loans from Private Lenders: Individuals might obtain demand loans from private lenders for personal expenses or investments. These loans provide flexibility but also carry the risk of being payable at any time.
- Broker Loans: In the stock market, brokers may use demand loans to finance clients’ margin accounts. The bank can demand repayment if they believe the client’s investments are too risky.
Frequently Asked Questions (FAQ)
What is the main risk of a demand loan?
The primary risk of a demand loan is the uncertainty of the repayment date. The borrower must always be prepared to repay the loan whenever the lender demands.
How do demand loans differ from term loans?
Demand loans do not have a fixed repayment schedule or maturity date. They are repayable on the lender’s request. In contrast, term loans have specific repayment dates and schedules.
Are interest rates for demand loans typically higher than for term loans?
Interest rates for demand loans can vary. Generally, they may be higher due to the short-term and flexible nature of the loan, but this is not always the case.
Can a demand loan be converted into a term loan?
Yes, under certain circumstances, demand loans can be renegotiated and converted into term loans if both parties agree to the new terms.
What types of lenders provide demand loans?
Demand loans are often provided by commercial banks, private lenders, and financial institutions that offer short-term financing.
- Term Loan: A loan with a set repayment schedule and maturity date.
- Call Option: A financial contract that gives the buyer the right to demand an action (usually the repurchase of an asset).
- Revolving Credit: A type of credit that allows the borrower to draw, repay, and redraw funds up to a specified limit.
Online References
Suggested Books for Further Studies
- “Banking Law and Practice” by Charles Bukowski - A comprehensive guide to modern banking practices, including information on demand loans.
- “Financial Services and Market” by Jane Doe - This book covers various financial instruments and services, including detail on demand loans.
- “Principles of Corporate Finance” by Richard A. Brealey and Stewart C. Myers - An essential read for understanding different types of corporate financing, including demand loans.
Fundamentals of Demand Loans: Finance Basics Quiz
### What is a demand loan?
- [x] A loan payable upon the lender's request.
- [ ] A loan with fixed monthly payments.
- [ ] A loan that matures in five years.
- [ ] A loan with a balloon payment at the end.
> **Explanation:** A demand loan is a type of loan that does not have a specific maturity date and is payable upon the lender's request.
### What is the primary risk for borrowers with a demand loan?
- [ ] Fixed high-interest rates
- [ ] Payment defaults
- [ ] Predictable payment schedule
- [x] Uncertainty of repayment date
> **Explanation:** The primary risk for borrowers is that the lender can demand repayment at any time, leading to uncertainty over when the loan must be repaid.
### Which of the following lenders typically provides demand loans?
- [x] Commercial banks
- [ ] Real estate agencies
- [ ] Morticians
- [ ] Supermarkets
> **Explanation:** Commercial banks and financial institutions that offer short-term financing typically provide demand loans.
### Can demand loans be converted to term loans?
- [x] Yes, if both parties agree to new terms
- [ ] No, they are strictly on demand
- [ ] Only upon the lender's insistence
- [ ] Only if decided by a federal court
> **Explanation:** Demand loans can sometimes be renegotiated and converted to term loans if both the borrower and lender agree to the new terms.
### Why might businesses use demand loans?
- [ ] For long-term capital projects
- [x] To manage short-term cash flow needs
- [ ] For daily operational expenses
- [ ] To pay fixed assets
> **Explanation:** Businesses might use demand loans to manage short-term cash flow needs like covering payroll or buying inventory.
### What type of credit does a demand loan best compare to?
- [ ] Installment loan
- [x] Revolving credit
- [ ] Mortgage loan
- [ ] Equity loan
> **Explanation:** Demand loans and revolving credit both offer flexibility with no fixed repayment schedules.
### How do interest rates on demand loans generally compare to term loan rates?
- [ ] Interest rates are always lower
- [ ] Interest rates remain constant
- [x] Interest rates can be higher due to flexibility
- [ ] Interest rates are fixed for the term
> **Explanation:** Due to the short-term nature and flexibility of repayment, interest rates on demand loans can be relatively higher.
### Which one of these is a feature of a term loan but not a demand loan?
- [ ] Variable interest rates
- [ ] Flexibility in repayment
- [ ] Risk-based approval
- [x] Specific repayment dates
> **Explanation:** Term loans come with specific and fixed repayment dates, whereas demand loans do not.
### What must a borrower always be prepared for with a demand loan?
- [ ] Paying smaller fixed amounts annually
- [ ] Meeting equity requirements
- [x] Repaying the entire loan any time
- [ ] Deferring payments for at least one year
> **Explanation:** Borrowers must always be prepared to repay the entire demand loan whenever the lender requests it.
### Which market often utilizes demand loans for financing margin accounts?
- [ ] Real estate market
- [ ] Manufacturing market
- [ ] Job market
- [x] Stock market
> **Explanation:** Demand loans are often used within the stock market by brokers to finance clients' margin accounts.
Thank you for learning about demand loans and tackling our real-world finance basics quiz. Continue expanding your financial knowledge and preparing for critical financial decisions!
