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CHAPTERS 3 & 4:
CASH & CREDIT MANAGEMENT
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Simple Interest—
Interest—interest paid only
on initial amount of deposit.
Compound Interest—
Interest—interest paid
at set intervals and added back to
principal.
r = (1+i(m)/i)m – 1
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Inflation Risk
Fisher’s equation, the real return, r ,
1 + r = (1+ i ) / (1 + e)
i = nominal interest rate
e = expected inflation rate
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Question
If the inflation rate is 2%, bank pays you
(a) 3% interest per annum, what is your
real rate of return?
(b) 1.5%
1 5% iinterest
t t per annum, what
h t iis
your real rate of return?
Choosing a bank
Credit standing
Interest rate
Convenience
Quality of service
Minimum balance requirements
Bank charges
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Credit Management
Credit or Debit is a financial tool
Uses of Credit
– convenient, e.g. credit card
– source off funds
f d ini an emergency,
unexpected expenses
Problems associated with Credit
– possibility of overspending
– cost, credit is not free
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Types of Credits:
Open Account Credit
Credit Card
Charge cards
Overdrafts
Loans
Housing loan
Car loan
Personal loan
Education loan
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Comparison:
Loan and Open Credit Account
Loan Open Credit Account
• Formal Agreement • Informal agreement
• Primarily for specific • For general purpose
purpose • Finance small
• Finance large purchases
purchases • Numerous transactions
• One
One--off transaction • No collateral for credit
• Collateral usually and charge cards and
required unsecured overdrafts
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Loans
Housing loan
Car loan
Personal loan
Education loan
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Example
If your monthly gross income is $3,000, what would be
your maximum mortgage payment if the lender’s
affordability ratios stipulated that your mortgage
payment not exceed 30% nor your total instalment
paymentst exceed d 40% off your monthly
thl gross income?
i ?
What will be your monthly mortgage repayments for a
$150,000, 30 years, 5.5% mortgage?
Would you meet the lenders’ guideline if you also have a
personal loan of $500 monthly payment.
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Commercial banks
Finance Companies
Insurance Companies
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Choosing a loan:
Interest rate – most important
Margin of financing
Repayment schedule
Processing fee
Maturity – duration of loan
Collateral
Penalty fees for prepayment and late
payment of instalments
Administrative efficiency
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Interest rate
Fixed Rate Mortgage
- Interest rate and periodic repayments
(monthly) are fixed
- Process of repayment called
amortization
ti ti
Single--payment Loan
Single
Simple interest method
- If you borrow $1,000 for 6 months at 10% per
annum, at maturity, what is your repayment at
the
t eeend
doof 6 months?
o t s
Discount Method
- Finance charges are paid in advance
- A personal loan which charges 10% per
annum discounted, what is the amount lent to
the borrower?
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Instalment Loan
• Interest and principals are repaid with a
series of regular fixed payments
• Common types – monthly
monthly--rest, annual-
annual- rest
or flat rate
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Examplel
A $10,000 loan is to be amortised by equal monthly
payments over the next 5 years. Which is the
cheapest option:
a) monthly
monthly--rest at 6%;
b) annual
annual--rest at 5%; or
c) flat rate at 4%?
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Example
A $10,000 loan at 7% interest rate is to be
amortised by equal monthly payments over
the next 2 years. What is the monthly
repayment if the interest charged is at:
(a) monthly rest;
(b) annual rest; or
(c) flat rate?
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Buying or Leasing
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Thank You
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