Loan Schedules

Question 1

Who are the three key players in the loan market

Answer 1

Borrower, lender and the government

Question 2

Explain how the borrower contributes to the loan market

Answer 2

Had an immediate need for finance for some sort of personal, commercial or residential expenditure. The borrower is prepared to pay interest in the future in lieu of receiving finance now

Question 3

Explain how the lender contributes to the loan market

Answer 3

Bank, building society, credit union or other registered financial entity with sufficient capital to eb able to provide to borrowers now in order to then receive interest payments form them in the future. They aim to make money from the transaction

Question 4

Explain how the government contributes to the loan market

Answer 4

Ensure the loan market is viable and competitive and that consumers,
as described above, have access to credit on fair terms and that the loan providers manage their risks
appropriately and stay solvent in the long term.
They regulate the loan market
or appoint an agency to do so.

Question 5

What are two main forms of loan products to study and explain the main difference between them

Answer 5

Interest only loans and repayment loans or repayment mortgages

The initial loan amount could be repaid gradually over the term or
remain fully outstanding and be repaid by one single payment at the end of the term

Question 6

What does L stand for

Answer 6

Loan capital - inital loan amount

Question 7

What does Lt stand for

Answer 7

Amount of the loan outstanding at Time t immediately after any repayment due at this time.

Question 8

Let [0,T] be the term what do we assume in terms of the loan capital - 2 assumptions

Answer 8

L0=L
LT=0

Loan is fully repaid over the term

Question 9

We assume fixed interest but what is more likely in reality

Answer 9

Interest rate may be relative to some benchmark rate laid down by the government or its central bank

Question 10

What is an interest only loan

Answer 10

Loan repayable by a regular series of interest payments on the entire loan, together with a return
of the initial loan amount at the end of the term. Loan capital is outstanding for the full term

Question 11

What is the flat rate of interest and its purpose

Answer 11

T total interest paid on a loan per unit of initial loan amount and per unit
of loan term.
This can be used for consumers to be able to compare different loans available with
different terms, repayment schedules,

Question 12

What is a loan schedule

Answer 12

Details in tabular form a number of the key variables associated with a loan contract and how these variables change over the term of the contract

Question 13

Why are interest only loans only good for small expenses

Answer 13

Huge risk involved - longer term and larger amounts of money to wait for repayment would expose the bank to alot of risk

Question 14

Describe a repayment loan/mortgage

Answer 14

Each regular payment to pay back loan does two things:
Pays interest due on loan capital outstanding
What remains of the payment pays off some of the loan capital currently outstanding

The loan is gradually repaid with no large final capital payment

Question 15

What does the graph of Lt over t look like for a repayment loan if repayments are equal

Answer 15

Convex function decreasing shape with the rate of change of tangent slope getting steeper and steeper

Question 16

Why is the flat rate of interest not appropriate for repayment loans

Answer 16

The loan capital reduces gradually over the term of the loan and it is incorrect to unitise the total interest payments with respect to the inital loan amount. It is not a good measure as the denominator is too large and the rate will be too small.

Question 17

What is the appropriate measure of interest on a repayment loan for consumers to compare and its restrictions

Answer 17

Underlying effective rate of interest we call the APR:

Annual effective rate implied by the transaction
Expressed as %
To one place of decimals
Always rounded down

Question 18

Define APR

Answer 18

Annual Percentage Rate (APR) for a loan contract to be the effective annual
rate of (compound) interest solving the equation of value for the contract and expressed as a
percentage to one place of decimals and with that place of decimals always rounded down.

Question 19

Why is government definition of APR important

Answer 19

Without standardisation the rate comparisons may not be fair - may have misleading marketing practices

Question 20

Explain the convex decreasing nature of loans

Answer 20

At the start of loan most of the repayment is going towards interest. Interest component is large compared to capital component. As payment continue the loan capital reduces so near the end of the term the interest component is smaller and alot more of the repayment can be used to repay capital.

Question 21

What does T, Xt, Lt, It, and Ct stand for in a loan schedule

Answer 21

T= Whole number of year in term of loan
Xt = Payment made at time t
Lt = Loan capital outstanding after t years immediately after repayment then due
It = Interest component of the repayment Xt
Ct= Capital component of the repayment Xt

Question 22

Name two methods to quickly calculate the loan outstanding on a repayment loan

Answer 22

Prospective method and retrospective method

Question 23

What is the prospective method

Answer 23

Loan outstanding at time t is the present value (at time t ) of all future repayments
under the loan contract at the effective rate of interest of i p.a. applying,

Question 24

What is the retrospective method

Answer 24

The loan outstanding at time t is the accumulate value of the initial loan amount minus the accumulated value at time t of all past repayments under loan at the effective rate of interest applying

Question 25

Under/ because of what condition do the retrospective an prospective methods give the same answer

Answer 25

Both methods will always give the same loan capital
outstanding once the interest rate involved in the discounting and the accumulation steps is the same
and is the interest rate used to calculate the repayments being made.