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What is the difference between a loan commitment and a letter of credit? A. A loan...

What is the difference between a loan commitment and a letter of credit?

A. A loan commitment is a promise made by a bank that allows a customer to borrow up to a specified maximum for the remaining time of the commitment. The bank normally charges a commitment fee and a fee for any unused portion of the commitment.

B. Letters of credit are insurance policies sold for a fee that state that the bank will pay in event of nonpayment by the party that draws the line of credit. It is not expected that bank funds will be necessary to cover the letter except in unusual circumstances.

C. Both A and B are correct.

D. Only A is correct.

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Answer #1

Only A is correct and is the right definition of a loan commitment. There is an upper cap upto which the borrower can borrow and a fee is charged on the unused portion of the commitment.

It is not expected that bank funds will be necessary to cover the letter except in unusual circumstances - This statement is not correct. Bank is liable to pay the payee if the original payer of the LC defaults.

A loan commitment is an off balance sheet asset while a LC is an off balance sheet liability for the bank.

The correct answer is Option D - Only A is correct.

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