Chapter 10 - Other Financial Products Flashcards
What are the 3 ways that individuals can borrow money from banks and other lenders?
Other Financial Products
- Overdrafts
- Credit card borrowing
- Loans
What is an Overdraft?
When an individual draws out more money than they hold in their current account.
What is an ‘authorised’ overdraft?
An overdrawn amount that is within the limit previously agreed with the bank.
What is an ‘unauthorised’ overdraft?
An overdrawn amount that is not within the limit previously agreed with the bank.
What are the fees accosiated with ‘authorised’ overdrafts?
Agreed in advance so usually have lower rates of interest. Some banks allow small overdrafts with no fees to prevent angry customers.
What are the fees of ‘unauthorised’ overdrafts?
Often very expensive - high interest and a fee. Bank may refuse to honour payments from unauthorised overdrawn account.
Are overdrafts a good way to borrow money?
No.
* Expensive
* Borrowers should restrict use to temporary periods
* Avoid unauthorised overdrafts.
Where are Credit Cards most commonly used?
In the UK
Not so much in the rest of Europe
How do the credit card companies make money from retailors?
They charge a fee to them so that customers can use the credit card at their store. Where the credit card company pays on behalf of the customer and the customer is expected to pay that back at some other point.
Is interest high on Credit Cards?
Yes, compared to other forms of borrowing.
What 2 groups can Loans be divided into?
Secured and Unsecured Loans
What is an unsecured loan?
A loan that has no collatoral (i.e. no item to back it up if the borrower cant afford it)
Can be hard for the lender to get money back if it is unsecured. Usually they have to get legal proceedings (balifs) to reposses any of the borrowers property or items to recoup losses.
What are unsecured loans typically used to purchase?
Consumer Goods
i.e. if you were to finance a computer or papa johns pizza
What do lenders assess when deciding to offer out a loan?
The lender will check the creditworthiness of the borrower.
income, credit score - main quesiton is, can they afford to pay this?
Will an unsecured loan or secured loan have a higher interest rate?
Unsecured loan.
What is a commercial loan?
A loan given to a company (can be an overdraft or long-term borrowing)
Property can also be bought with this
What influences the cost of borrowing?
- Form of borrowing
- How long the money is required for
- Security offered
- Amount offered
What is the effective annual rate formula?
Other Financial Products (Loans)
To get the total amount to be paid:
A=P(1+(r/n))^(nt)
You can divide A by P and convert to a % to get the effective annual rate.
Alternative:
Take Quoted Rate per year, divide by frequency of charges per year and express the result as a decimal and add 1. Then multiple that by the frequency, take away one to have it easily converted into a percent.
- 12% divided by 4 = 3%, expressed as 0.03.
- 1 + 0.03 = 1.03.
- 1.034 = 1.03 x 1.03 x 1.03 x 1.03 = 1.1255.
- 1.1255 – 1 = 0.1255 x 100 = 12.55%.
A= final amount
P = Initial Amount
r = Interest rate
n = Number of times interest is applied per time period
t = Number of time periods elapsed
What is comprised in the APR (Annual Percentage Rate)
Other Investment Products (Loans)
Effective annual rate and any fees (e.g. loan arrangement fees)
APR is also known as the true cost of borrowing
This helps standardise and compare loans
