Question

Gerald has taken out a loan of $100,000 today to start a business. He has agreed to repay the loan on the following terms: • Repayments will be made on a monthly basis. The first repayment will be made exactly one month from today.

The repayments for the first 5 years will cover interest only to help reduce the financial burden for Gerald’s business at the start. • After the 5-year interest-only period, Gerald will make level monthly payments that will fully repay the loan after an additional 15 years (i.e. 20 years from today, the loan will be fully repaid).

The interest charged is 5% p.a. effective. Using this information, answer the following questions.

a) Calculate the equivalent effective monthly rate on the loan. (1 mark)

b) Calculate the size of the first repayment due exactly one month from now. space (1 mark)

c) Calculate the size of the level repayments that occur after the initial 5-year interest-only period. (2 marks)

10 years have passed, and Gerald’s business is doing well. Further, he has made all the repayments on his loan so far as described above, and has just made the repayment due today. However, it has just been announced that the interest rate on Gerald’s loan will go up to 5.5% p.a. compounding semi-annually.

d) Calculate the new equivalent effective monthly rate on the loan. (1 mark)

e) Calculate the current loan outstanding (again, it is 10 years after the loan was initially taken out).

Note that the new interest rate only applies from today onwards. space (2 marks)

f) Because Gerald’s business is doing well, he decides to repay a lump sum of $10,000 immediately. To further reduce the amount of interest he is paying to the bank, he will increase his monthly repayments to $1,000 per month. How many full repayments of $1,000 does Gerald have to make in order to fully repay this loan? (Note: Gerald may need to make a further, smaller payment in the subsequent month) (2 marks)

g) Calculate the size of the smaller payment.

Answer 1

Part (a):

Equivalent effective monthly rate= 0.407412% as follows:

Part (b):

First payment due in one month= Loan*monthly interest rate= $1,000*0.407412% =$407.41

Part (c):

Size of the level repayments that occur after the initial 5-year interest-only period =$785.02

Calculation at the end of the answer.

Part (d):

New Equivalent effective monthly rate= 0.453168% as shown under part (a).

Part (e):

Current loan outstanding= $41,711.17

Calculation at the end of the answer.

Part (f):

Number of full payments required= 34

Calculation at the end of the answer.

Part (g):

Size of smaller payment= 0.312097*1000 = $312.10

Calculations as follows: