Chartered Financial Analyst (CFA) Practice Exam Level 2

How do Special Purpose Entities (SPEs) primarily benefit businesses?

1. By increasing market share

2. By reducing the cost of borrowing

3. By simplifying tax filings

4. By improving inventory management

The correct answer is: By reducing the cost of borrowing

Special Purpose Entities (SPEs) primarily benefit businesses by reducing the cost of borrowing. SPEs are designed to isolate financial risk and can engage in financing activities that allow a parent company to achieve a favorable credit rating. When a company uses an SPE, it often improves its access to capital markets and can achieve lower interest rates due to a perceived decrease in risk from lenders’ perspectives. By separating specific assets or liabilities from the parent company’s balance sheet, the company may be able to indicate improved financial ratios, which can lead to more advantageous borrowing conditions. This strategic financing mechanism enables firms to manage their capital structure more efficiently and take advantage of lower borrowing costs which ultimately enhances their funding capabilities. The other options do not capture the primary purpose of SPEs as effectively. While increasing market share, simplifying tax filings, and improving inventory management may be beneficial outcomes contributed by various strategies within a business, they do not align with the essential function of SPEs as instruments for financial structuring and risk management. Thus, the primary role of SPEs is clearly demonstrated in how they can lead to reduced borrowing costs.