Online Quiz 5 • Available from 8:00 am on Monday, Oct 21 until 5:00 pm on Friday, Oct 25th under the Assessments tab on the Blackboard Learn. • Covers: • 2 videos • 2 articles • You can find the files under Assignments/Quizzes tab on course website • Windows Media Player is required to watch the videos • 22 questions, 22 points 25 minutes
TVM and Credit • As with investments such as stocks and bonds, TVM has a direct connection to credit • TVM concepts are used by creditors in deciding: • Fees charged in the form of finance charges on credit balances • How much your regular payments will be on a loan
Borrower Types • A “deadbeat”, in credit card jargon, means that you pay off your entire balance every month, and do not carry anything over, the credit card company gets minimal profits and calls you unflattering names. • In the case that you become a “revolver” and do not pay your credit card balance in full, you will face finance charges
Finance Charge • The finance charge is the total cost of borrowing a sum of money which is given either as credit or as a loan. • Contrary to what some people believe, the finance charge is not the same as the interest rate. Interest rates along with all other applicable fees are the factors used in the calculation of the finance charge. • The finance charge typically is calculated based on the credit card balance so the amount will vary from month to month. As required by law, every credit card issuer will provide in the card holder agreement a detailed explanation of the way finance charges will be calculated.
Average Daily Balance (ADB) • Finance charges are based on the “Average Daily Balance Method” of which there are four basic forms
Types of ADB • ADB excluding new purchases • The most consumer friendly • ADB including new purchases • The most common- no grace period on new purchases if you carry a balance • Two-Cycle ADB excluding new purchases • Calculated using last two billing cycles • Two-Cycle ADB including new purchases • Least consumer-friendly method
Procedure to finding ADB • Monthly interest
Example: ADB • Assuming you have a 21% APR, what would your finance charge be based on the following? Use single cycle ADB method including new purchases.
Solution Continued • , • Monthly interest :
TVM & Loan Amortization • Another application of TVM to credit is amortization • In most loans, you will have a series of equal payments over a period of time • The equal payments serve two functions • Paying back the principal (the original amount of the loan) • Servicing the interest associated with the loan • The cost of credit
Where does the money go? • The portion of your payment that goes towards principal and the portion towards interest (varies over time) • In the beginning, more of your payment goes towards servicing the interest • Towards the end of the loan, more of your payment goes towards paying down the principal • This is why it takes time to build equity in a home • In a home loan, the interest is tax deductible, so it’s not a completely bad thing. If you refinance, you pull the equity back out
Procedure for Loan Amortization • Calculate the payment per period • Determine the interest payment in Period t • Compute principal payment in Period
Procedure for Loan Amortization • Determine ending balance in Period t. • For next payment start again at Step 2 and repeat
Example: Loan Amortization • You take out a loan for $4,000 at an annual interest rate of 7%. You must pay back the loan in 5 annual installments. What is your annual payment? How much of the principal is still outstanding after you make the first payment?
Solution • 4 000 – 695.56= 3.304.44
Example: Loan Amortization • I decide to purchase a new car for $33,165. What is the outstanding balance on the loan after I make the second payment if I have a 5 year loan with monthly payments and a 6.84 APR?
Solution • 32 699.41 – 468.23= 32 231.18