Lecture 11 - Borrowing Part 1

Question 1

Income inequality OECD

Answer 1

Compared to 1981, 650 million fewer people living in extreme poverty is less than $1.25 a day

Even though population has risen by about 2 billion

China accounts for 1/2 a billion people moving out of extreme poverty

Question 2

Income inequality

Answer 2

Oxfam calculated that 85 people owned as much wealth as the poorest half of the humanity

Growing economic inequality exacerbates social problems such as youth employment, gender based violence and many others

Also people their dignity and their voice, which deepens social frustration and the likelihood of conflict

At the same time, inequality entrenches wealth and power in the hands of a few, creating societies and structures that are shaped to represent the interests of the elite minority at the expense of the majority of society

Question 3

Income (in)equality OECD PART 2

Answer 3

Richest 10% of the population earn 9.5 times the income of the poorest 10%, up from 7 x in the 1980s

Result has been slower, not faster growth
Rising inequality is estimated to have knocked more than

• 10% points off growth in Mexico and New Zealand
• nearly 9 in the UK, FINLAND AND NORWAY
• 6-7 points United States, Italy and Sweden

Question 4

Income vs wealth

Answer 4

Income - flow of resources

Wealth - stock of economic resources

Question 5

Wealth uk

Answer 5

Wealth uk £11.1 trillion total wealth (ONS)

Question 6

Debt uk 2016 Sept

Answer 6

Average debt per adult in the UK
£55,442 per household

No. Of plastic card purchase transactions in July
41 million/£1.57 billion

Cash machine transactions made daily
£9.2million/381m

Outstanding mortgage lending
£1.31 trillion

Question 7

How much did people own in 2016 U.K.

Answer 7

£1,496 trillion

Question 8

Dentition of debt

Answer 8

Total amount owed at a particular point in time

Question 9

Credit

Answer 9

An arrangement to receive cash, goods or services now and to pay for them in the future

Question 10

Secured debt

Answer 10

Debt secured against an asset such as a home. If the debtor fails to make adequate repayments, the lender has the right to obtain money by selling the asset

Question 11

Usecured debt

Answer 11

Debt not backed by any asset

Question 12

Costs of debt financing

Answer 12

Purchases are more expensive 
Temptation to overspend 
Possible financial difficulties 
Possible loss of merchandise due to late or non-payment 
Ties up future income 
- true for governments and individuals

Question 13

Benefits of debt financing

Answer 13

Current use of goods and services 
- buy now and pay later 
The ability to raise debt demonstrates financial stability 
Use for financial emergencies 
Convenience when shopping 
Safer than cash

Question 14

Uk financial companies

Answer 14

Commonly subsidiaries of banks and building societies specialising in personal loans, car finance

Question 15

Direct lenders

Answer 15

Commonly subsidiaries of banks, building societies and insurance firms who don’t have branches but deal with customers by phone or Internet

Question 16

Credit unions

Answer 16

Small cooperative organisations run on a local basis. Tend to be work or community based

Question 17

Banks

Answer 17

Mostly PLCs owned by shareholders including a number of former building societies

Question 18

Building societies

Answer 18

Mutual organisations owned by their savers and borrowers (customers). Originally used to purchase land for home building and evolved to permanent organisations

Question 19

Student loans company

Answer 19

Owned by the uk government and lends to students in higher education to enable them to meet their expenses

Question 20

Alternative credit market

Answer 20

Aimed primarily at people on low incomes.
Includes door-to-door lenders, rental purchase shops and pawnbrokers.
Also covers unlicensed lenders (loan sharks) who provide loans at very high interest rates

Question 21

Changes in the market

Answer 21

Lending activities changed dramatically since 1980's 
Demutualisation of building societies 
-joint ventures between banks and supermarkets 
In 2008/9
Nationalisation of banks 
- banks going bust (Lehman) 
- banks that should have gone bust 
- dramatic reduction in borrowing

Question 22

Bank of England monetary policy committee

Answer 22

New labour government passed the power to set interest rates to the banks of England in May 1997 to make them less politically influenced

• base rate of interest is the rate at which the Bank of England will lend the other banks and sets the general level for the whole economy
• primary determinant of interest rates is government policy on inflation- currently a 2% target for the consumer price index

Question 23

Variable rates

Answer 23

Can move up and down during the life of the loan and typically in line with the base rate
Common for overdrafts and credit cards

Question 24

Fixed rates

Answer 24

When the rage is determined at the start of the loan.

Based on what the lender has to pay to obtain fixed rate funds of the same term. Common for personal loans

Question 25

Capped rates

Answer 25

Rates cannot rise above a defined maximum but below the cap it can move in line with base rates

Question 26

Floor rates

Answer 26

Rate will not fall below a defined floor but above this it can move in line with base rates

Question 27

Collared rate

Answer 27

Rates can move in line with base rate but cannot go below the floor or above the capped rates

Question 28

What must be quoted for all borrowing products?

Answer 28

Savings - ANNUAL EQUIVALENT RATE

Uk borrowing - ANNUAL PERCENTAGE RATE

Question 29

APR must take into account the following

Answer 29

Arrangement fees paid to lender 
Intermediary fees 
Early repayment/ prepayments fees 
Tied insurance required by a loan 
But given difficulties in calculating APR it has been found that different method and assumptions are used in practice

Question 30

Calculating APR AND AER IN PRACTICE

Answer 30

Assuming no additional charges beyond the basic rate of interest we can calculate the annualsied rates of interest as follows

EAR =[(1+r)t^ - 1
Where r is the periodic interest rate and t is the number of time periods over which interest is compounded

Question 31

Closed- end credit

Answer 31

For a specified period of time and amount
Personal loans - secured or unsecured
Hire purchase - secured, ownership passes after the final payment
Mortgages - secured against land/property

Question 32

Open-end credit

Answer 32

Use as needed until reaching the end of a line of credit
Overdraft - limit set by lenders and charges for unauthorised use
Credit/store cards - only minimum payment required
Charge card - full balance paid each month
Alternative credit - high rates for unsecured lending