Loan Schedules Flashcards
Who are the three key players in the loan market
Borrower, lender and the government
Explain how the borrower contributes to the loan market
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
Explain how the lender contributes to the loan market
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
Explain how the government contributes to the loan market
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.
What are two main forms of loan products to study and explain the main difference between them
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
What does L stand for
Loan capital - inital loan amount
What does Lt stand for
Amount of the loan outstanding at Time t immediately after any repayment due at this time.
Let [0,T] be the term what do we assume in terms of the loan capital - 2 assumptions
L0=L
LT=0
Loan is fully repaid over the term
We assume fixed interest but what is more likely in reality
Interest rate may be relative to some benchmark rate laid down by the government or its central bank
What is an interest only loan
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
What is the flat rate of interest and its purpose
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,
What is a loan schedule
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
Why are interest only loans only good for small expenses
Huge risk involved - longer term and larger amounts of money to wait for repayment would expose the bank to alot of risk
Describe a repayment loan/mortgage
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
What does the graph of Lt over t look like for a repayment loan if repayments are equal
Convex function decreasing shape with the rate of change of tangent slope getting steeper and steeper
Why is the flat rate of interest not appropriate for repayment loans
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.
What is the appropriate measure of interest on a repayment loan for consumers to compare and its restrictions
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
Define APR
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.
Why is government definition of APR important
Without standardisation the rate comparisons may not be fair - may have misleading marketing practices
Explain the convex decreasing nature of loans
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.
What does T, Xt, Lt, It, and Ct stand for in a loan schedule
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
Name two methods to quickly calculate the loan outstanding on a repayment loan
Prospective method and retrospective method
What is the prospective method
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,
What is the retrospective method
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
Under/ because of what condition do the retrospective an prospective methods give the same answer
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.
