Chapter 4Consumer Credit
Short Questions
B3C04T2Q001eng
Which kind of consumer credit should the following consumer use if she wants to purchase a second-hand car which costs $20,000?
(a)Natalie, who is a young professional with a monthly income of $60,000
(b)Sally, a shipping clerk at a small trading company who has a salary of about $12,000 per month(4 marks)
Answer:
(a)Natalie may use revolving consumer credit because the second-hand car is asmall purchase relative to her income and wealth. (2 marks)
(b)Sally should use non-revolving consumer credit because the interest ratecharged on the loan is lower than that of revolving consumer credit. As Sally’sincome is not high, she should consider the interest costs. Non-revolving credit also forces Sally to plan for repayment. (2 marks)
B3C04T2Q002eng
In what situation is non-revolving consumer credit preferred over revolving consumer credit?(2 marks)
Answer:
Non-revolving credit is preferred when an individual makes major purchases such as cars and apartments. This kind of credit is also suitable forindividualswho have enough time to plan for repayment. (2 marks)
B3C04T2Q003eng
Wallis has borrowed $8,000 from a bank. She has to pay the amount back by annual instalments over two years. The annual interest rate is 8% and the interest is calculated using the discount method. Therefore the amount she has received from the bank was less than $8,000.
(a)How much did Wallis get from the bank?(2 marks)
(b)What should the loan amount be if she wants to get $8,000 from the bank?(2 marks)
Answer:
(a)Total interest = $8,000 8% 2 = $1,280
The amount Wallis obtained from the bank = $8,000 $1,280 = $6,720(2 marks)
(b)Assume the loan amount is X,
X (1 8% 2)= $8,000
X= $9,524(2 marks)
B3C04T2Q004eng
What problems does an individual face if he/she has a poor credit rating?(3 marks)
Answer:
A poor credit rating indicates that an individual may not be able to repay a loan. In order to deal with the higher risk of defaulting on the loan, lenders may charge the individual a higher interest rate. They may even reject the loan application. Therefore, it is more difficult for an individual with a poor credit rating to get a loan from banks. (3 marks)
B3C04T2Q005eng
How do the following parties benefit from checking credit records?
(a)Credit providers such as banks and credit card companies
(b)Individuals(4 marks)
Answer:
(a)Credit records allow credit providers to evaluate the financial strength ofcredit applicants. This helps them make appropriate decisions on the approval of loans and reduce the risk of bad debts. (2 marks)
(b)Individuals with a good credit record can borrow money from lenders more easily and even at a lower interest rate. They can also check if there has been any identity theft or possible credit fraud. (2 marks)
B3C04T2Q006eng
Kenny plans to go to Japanthis summer. He has decided to borrow $12,000 from a bank for the vacation. He is required to repay the loan by annual instalments within two years. The interest rate is 5% per year and is calculated using the add-on method.
(a)How much should Kenny pay per year?(2 marks)
(b)Suppose the bank changes the interest calculation method. The discount method is used instead of the add-on method. How much should Kenny pay per year if he wants to get the same amount of money? (3 marks)
(c)Suppose the simple interest method is used to calculate the interest payment. Given that the PVIFA5%, 2 is 1.859, how much should Kenny pay per year? (1 mark)
(d)Which interest calculation method would you prefer if you were the following persons?
(i)Kenny
(ii)The bank manager
Explain your answer.(4 marks)
Answer:
(a)The total interest: $12,000 5% 2 = $1,200(1 mark)
The annual instalment :(1 mark)
(b)Assume the amount Kenny should borrow is X,
X (1 5% 2)= $12,000
X= $13,333(2 marks)
∴Annual instalment : (1 mark)
(c)Kenny should pay: (1 mark)
(d)(i)If I were Kenny, I would prefer using the simple interest method because its interest charge is the lowest ($6,455 2 $12,000 = $910). (2 marks)
(ii)If I were the bank manager, I would prefer using the discount method because this allows the bank to earn the highest interest revenue from Kenny ($13,333 $12,000 = $1,333). (2 marks)
B3C04T2Q007eng
Eric is considering purchasing a $1,000 MP3 player by using his credit card. The bank will charge 2% interest per month on the outstanding credit card balance. The minimum monthly payment is set at 5% of the outstanding balance. Eric plans to pay back the loan within six months.
(a)Suppose Eric only repays the minimum monthly payment per month for the first five months. How much should he pay at the end of the sixth month? (6 marks)
(b)Eric has decided to repay the loan in full in six months and make equal payments per month. Given that the PVIFA2%, 6 is 5.601, how much should he pay per month? (1 marks)
(c)Suppose a bank offers a short-term loan to customers. The details of the loan are as follows:
Repayment period / 9 monthsType of payment / Monthly instalment
Monthly interest rate / 1%
Given that the PVIFA1%, 9 is 8.566,how much should Eric pay per month?(1 mark)
(d)Should Eric use this instalment loan instead of a credit card for his purchase? Explain your answer.(4 marks)
(Calculations to one decimal place)
Answer:
(a)According to the table above, Eric should pay $858.8 + $17.2 = $876 atthe end of the sixth month.(1 mark)
Month / Loan balance / Interest / Minimum payment / Principal repaid / Loan balance after payment1 / $1,000 / $20 / $50 / $30 / $970 / (1 mark)
2 / $970 / $19.4 / $48.5 / $29.1 / $940.9 / (1 mark)
3 / $940.9 / $18.8 / $47.0 / $28.2 / $912.7 / (1 mark)
4 / $912.7 / $18.3 / $45.6 / $27.3 / $885.4 / (1 mark)
5 / $885.4 / $17.7 / $44.3 / $26.6 / $858.8 / (1 mark)
6 / $858.8 / $17.2 / / / / (1 mark)
(b)Eric should pay: (1 mark)
(c)Eric should pay: (1 mark)
(d)If Eric repays the credit card loan in six monthsand makes equalpayments per month, the total interest is ($178.5 6 $1,000) = $71. (1 mark)
If Eric uses the instalment loan, the total interest is ($116.7 9 $1,000)= $50.3.(1 mark)
Since the total interest of the instalment loan is lower, Eric should choose the loan instead of the credit card for his purchase. (2 marks)
B3C04T2Q008eng
Keith has borrowed $80,000 from a bank for investment purposes. He has to pay it back in five years by annual instalments. The interest rate is 5% per year.
(a)Given that the PVIFA5%, 5 is 4.329, how much should Keith pay per year?(1 mark)
(b)Based on the given information and the answer in (a), complete the following table.
(5 marks)
Year / Loan balance / Interest / Annual payment / Principal repayment / Loan balance after payment1 / $80,000
2
3
4
5 / 0
(c)Suppose Keith will use the loan to invest in a mutual fund with a guaranteed return of 12%. He will maintain the investment for three years. How much will Keith have if he withdraws the money after three years? (2 marks)
(d)Based on the above information, should Keith borrow money from the bank and invest in the mutual fund mentioned in (c)? Explain your answer. (4 marks)
(Calculations to the nearest dollar)
Answer:
(a)Keith should pay: (1 mark)
(b)
Year / Loan balance / Interest / Annual payment / Principal repayment / Loan balance after payment1 / $80,000 / $4,000 / $18,480 / $14,480 / $65,520 / (1 mark)
2 / $65,520 / $3,276 / $18,480 / $15,204 / $50,316 / (1 mark)
3 / $50,316 / $2,516 / $18,480 / $15,964 / $34,352 / (1 mark)
4 / $34,352 / $1,718 / $18,480 / $16,762 / $17,590 / (1 mark)
5 / $17,590 / $880 / $18,480 / $17,600 / 0 / (1 mark)
(c)Keith can get: $80,000 (1 + 12%)3 = $112,394(2 marks)
(d)The return generated by the mutual fund = $112,394 $80,000 = $32,394(1 mark)
The total interest of the loan = $4,000 + $3,276 + $2,516 + $1,718 + $880 =$12,390(1 mark)
As the return of investment is greater than the total interest of the loan, Keith should borrow money from the bank for investment. (2 marks)
B3C04T2Q009eng
Nick has used his ABC credit card to buy a DVD recorder which costs $3,000. His friend, William, bought the same DVD recorder with an XYZ credit card. The details of the two credit cards are as follows:
ABC credit card / XYZ credit cardInterest rate charged on outstanding balance (per month) / 3% / 4%
(a)Suppose Nick plans to repay the loan in full in six months. William will pay back the loan in three months. Both of them will make monthly instalment payments. Given that the PVIFA3%, 6 andPVIFA4%, 3 are 5.417 and 2.775, respectively,how much should Nick and William pay per month? (2 marks)
(b)Based on the information and the answer in (a), complete the following table which indicates Nick’s repayment schedule. (6 marks)
Month / Loan balance / Interest / Monthly payment / Principal repayment / Loan balance1 / $3,000
2
3
4
5
6 / 0
(c)The following table indicates William’s repayment schedule. Based on the information and the answer in (a), complete the table below. (3 marks)
Month / Loan balance / Interest / Monthly payment / Principal repayment / Loan balance1 / $3,000
2
3 / 0
(d)The monthly interest rate of ABC credit card is lower. Does this mean that Nick will pay less interest? Explain your answer. (3 marks)
(Calculations to one decimal place)
Answer:
(a)Nick: (1 mark)
William: (1 mark)
(b)
Month / Loan balance / Interest / Monthly payment / Principal repayment / Loan balance1 / $3,000 / $90 / $553.8 / $463.8 / $2,536.2 / (1 mark)
2 / $2,536.2 / $76.1 / $553.8 / $477.7 / $2,058.5 / (1 mark)
3 / $2,058.5 / $61.8 / $553.8 / $492 / $1,566.5 / (1 mark)
4 / $1,566.5 / $47 / $553.8 / $506.8 / $1,059.7 / (1 mark)
5 / $1,059.7 / $31.8 / $553.8 / $522 / $537.7 / (1 mark)
6 / $537.7 / $16.1 / $553.8 / $537.7 / 0 / (1 mark)
(c)
Month / Loan balance / Interest / Monthly payment / Principal repayment / Loan balance1 / $3,000 / $120 / $1,081.1 / $961.1 / $2,038.9 / (1 mark)
2 / $2,038.9 / $81.6 / $1,081.1 / $999.5 / $1,039.4 / (1 mark)
3 / $1,039.4 / $41.6 / $1,081.1 / $1,039.5 / 0 / (1 mark)
(d)No. Since William’s repayment period is shorter than that of Nick, William pays less total interest ($120 + $81.6 + $41.6 = $243.2) than Nick ($90 + $76.1 + $61.8 + $47 + $31.8 + $16.1 = $322.8). (3 marks)
B3C04T2Q010eng
Joe will go to Tokyo and Osaka this summer. He has bought a vacation package which includes accommodation and an air ticket. The package costs $15,000 and Joe pays with his credit card. The credit card details are as follows:
Outstanding balance / Monthly interest rate on outstanding balance$10,000 or below / 2%
Above $10,000 / 1.5%
(a)Suppose Joe repays $6,000 at the end of the first month. What is the outstanding balance at the beginning of the second month? (3 marks)
(b)Suppose Joe repays $5,000 at the end of the second month. What is the outstanding balance at the beginning of the third month? (3 marks)
(c)In the third month, Joe decides to repay the remaining balance in instalments over the next six months. Given that the PVIFA2%, 6 is 5.601, how much should Joe pay per month? (2 marks)
(d)How do the following parties benefit from Joe’s credit card transaction?
(i)Joe
(ii)Travel agency(4 marks)
(Calculations to one decimal place)
Answer:
(a)The interest at the end of the first month = $15,000 1.5% = $225(2 marks)
The outstanding balance at the beginning of the second month = $15,000 + $225 $6,000 =$9,225(1 marks)
(b)The interest at the end of the second month = $9,225 2% = $184.5(2 marks)
The outstanding balance at the beginning of the third month = $9,225 + $184.5 $5,000 =$4,409.5(1 mark)
(c)Joe should pay (2 marks)
(d)(i)Joe can pay for the vacation package without bringing a lot of cash with him. He can also settle the payment in the future and he need not pay the full amount immediately. (2 marks)
(ii)Accepting the payment by credit card allows the travel agency to do business without keeping a lot of cash in the shop. This helps the travel agency reduce the risk of theft. (2 marks)