Define Call Loan:

"A call loan, also known as a demand loan or a callable loan, is a type of short-term loan that can be "called" or demanded for repayment by the lender at any time, usually without any prior notice."

Explain Call Loan:

Introduction

A call loan, also known as a demand loan or a callable loan, is a type of short-term loan that can be "called" or demanded for repayment by the lender at any time, usually without any prior notice. Unlike traditional loans with fixed terms and repayment schedules, call loans are typically made with no set maturity date, and the lender can request repayment whenever they choose.

Key features of a call loan:

1. Flexibility: Call loans offer flexibility for both borrowers and lenders. Borrowers have the advantage of being able to access funds quickly without going through a lengthy application process, while lenders can have their funds repaid on-demand if they need them.

2. Short-Term Nature: Call loans are generally short-term in nature, often used to meet temporary financing needs or to bridge a gap in cash flow. Borrowers might use call loans to cover immediate expenses or to take advantage of short-term investment opportunities.

3. Variable Interest Rates: The interest rates on call loans are usually variable and can change based on market conditions or other factors. The rate may be tied to a benchmark interest rate, such as the prime rate, plus an additional spread determined by the lender.

4. Collateral: To secure a call loan, borrowers may need to provide collateral, such as marketable securities, cash deposits, or other assets that can be easily liquidated in case of loan default.

5. No Fixed Repayment Schedule: Call loans do not have fixed repayment schedules like regular installment loans. The borrower is generally expected to pay interest on the outstanding loan balance regularly, and the lender can request repayment of the principal at any time.

6. Risk for Borrowers: The main risk for borrowers with call loans is the possibility of having to repay the loan on short notice. If the lender calls the loan and the borrower is unable to repay the principal, the lender may have the right to sell the collateral to recover the outstanding balance.

7. Common in Financial Markets: Call loans are more common in financial markets and among financial institutions. They are used to facilitate short-term transactions, finance margin accounts, and provide liquidity for market participants.

Example

Company XYZ, a small business, needs short-term financing to cover its immediate working capital needs. The company approaches its local bank for a call loan and is approved for a $50,000 call loan with the following terms:

• Loan Amount: $50,000
• Interest Rate: 5% per annum (variable, tied to the prime rate)
• Collateral: Marketable securities worth $60,000

Scenario:

1. Loan Approval: Company XYZ is approved for the $50,000 call loan, and it pledges marketable securities worth $60,000 as collateral to secure the loan.

2. Interest Calculation: Assuming the interest rate is 5% per annum, the monthly interest on the call loan is calculated as follows:

   Monthly Interest = (Loan Amount x Interest Rate) / 12 Monthly Interest = ($50,000 x 5%) / 12 Monthly Interest = $208.33

3. Borrowing Period: Company XYZ utilizes the call loan to cover its working capital needs for two months.

4. Monthly Interest Payment: At the end of each month, Company XYZ is required to pay the monthly interest on the outstanding loan balance. For the first month, the interest payment would be $208.33.

5. Call Option: After two months, the bank decides to exercise its right to call the loan and requests repayment of the principal amount. The bank calls the loan due to changes in market conditions, which have increased its need for liquidity.

6. Repayment: Company XYZ is required to repay the entire $50,000 principal balance to the bank immediately. The company uses its available funds, including the marketable securities, to repay the loan in full.

7. Total Interest Paid: Over the two-month borrowing period, Company XYZ paid a total of $208.33 x 2 = $416.66 in interest.

Conclusion

In this example, Company XYZ borrows $50,000 through a call loan to meet its short-term working capital needs. The loan is secured by marketable securities worth $60,000. During the borrowing period, Company XYZ pays monthly interest on the outstanding loan balance. After two months, the bank exercises its right to call the loan, and Company XYZ repays the entire principal amount. The total interest paid by the company during the two-month period is $416.66.

Additionally, lenders assess the creditworthiness of borrowers carefully before extending call loans to mitigate their risk of non-repayment.