Question

Review questions chapter 7

How does a single-payment or balloon loan differ from an installment loan? What is a bridge loan?

Describe the differences between a secured and unsecured loan. How does Principle 8: Risk and Return Go Hand in Hand apply?

Describe a variable- or adjustable-rate loan. List four features that should be compared when shopping for this type of loan. What is a convertible loan?

Are the initial rates lower on a fixed-rate loan or a variable-rate loan? Why?

Credit contracts often include the acceleration clause, the deficiency payments clause, and the recourse clause to give the lender options for collecting the debt. Explain each clause. What is the purpose of the insurance agreement clause?

Home equity credit loans and credit lines are very popular sources of consumer credit. List the advantages and disadvantages of borrowing against home equity.

Student loan programs are available to students and parents to finance college- related expenses. Compare and contrast the programs available to students and parents. How are the interest rates determined?

8. Home equity, student, and auto loans are special-purpose consumer loans. Which ones offer the unique benefit of tax deductibility for interest paid?

9. What loan costs are included in the determination of finance charges? What is APR? How is it used?

10. What are payday loans? Besides the high interest rates, what are some of the dangers associated with this type of loan?

11. What methods are used to calculate interest on a single-payment loan? Which method is preferable to the consumer?

12. Why are loans based on the simple interest method a better option than loans using the add-on method? Is this true even if the consumer decides to repay the loan early?

13. Loan costs vary significantly with the lender. Identify at least two inexpensive loan sources, two more expensive loan sources, and two most expensive loan sources.

14. Based on Principle 8: Risk and Return Go Hand in Hand, name five ways you can reduce the risk for the lender thereby reducing the return for the lender and saving yourself money.

15. Why are mortgage payments not included in the debt limit ratio?

16. According to the debt resolution rule, what is the time frame for repayment of short-term debt? What types of borrowing are not considered in the debt resolution rule?

17. Remedies for overcoming excessive credit use can impact your present and future financial situation. Name eight remedies to consider when you are having

trouble paying your bills. List the advantages and disadvantages of each.

18. What is the fundamental difference between Chapter 7 and Chapter 13 bank- ruptcy? What three major criteria differentiate a filer's eligibility for each chapter?

What debts cannot be discharged in a Chapter 7 bankruptcy?

Answer 1

Answer:

1) Single-Payment or Balloon Loan

A loan that is paid back in a single lump-sum payment at maturity, or the due date of the loan, which is usually specified in the loan contract. On that day you paid back the amount you borrowed plus all interest you owe.

Installment Loan

A loan that calls for repayment of both interest and the principal at regular intervals, with the payment levels set in such a way that the loan expired at present date.

2) Bridge Loan

a short-term loan that provides funding until a longer-term source can be secured or until additional financing is found.

3) Secured loans are loans that are backed by an asset, like a house in the case of a mortgage loan or a car with an auto loan.

This asset is collateral for the loan. When you agree to the loan, you agree that the lender can repossess the collateral if you don't repay the loan as agreed.

Even though lenders repossess property for defaulted secured loans, you could still end up owing money on the loan if you default. When lenders repossess the property, they sell it and use the proceeds to pay off the loan. If the property doesn't sell for enough money to completely cover the loan, you will be responsible for paying the difference.

The same isn't true for an unsecured loan. An unsecured loan is not tied to any of your assets and the lender can't automatically seize your property as payment for the loan. Personal loans and student loans are examples of unsecured loans because these are not tied to any asset that the lender can take if you default on your loan payments.

You typically need to have a good credit history and solid income to be approved for an unsecured loan.

Loan amounts may be smaller since the lender doesn't have any collateral to seize if you default on payments.

In case of bankruptcy, Secured Loans are paid off first as they are backed up with an asset and if in case of bankruptcy if the bankrupted person is able to pay off its debts in proportionate, Secured Loans are given preference over Unsecured Loans. Any amounts left after paying off Secured Loans are then remitted to the Unsecured Loan.

4)

Risk and returns go hand in hand. Higher the risk, higher is the possibility of earning a good return. Thus, it follows that all types of investments have some form of risk attached to them. Theoretically, even 'safe' investments (such as bank deposits) are not without some element of risk.

Risk refers to the possibility that the actual outcome of an investment will deviate from its expected outcome. Risk means variability of returns. Broadly, here are the various types of risks that you might have to face as an investor.

Credit Risk

This issuer of the security will default, or not repay the principal amount. This is valid for corporate bonds etc.

Liquidity Risk

If you invest in securities, stocks, bonds, you are risking their sellability. In other words, your money gets stuck unnecessarily, creating an asset-liability mismatch.

Market Risk

Financial markets are volatile in nature. Volatility means sudden swings in value from high to low or the reverse. The more volatile an investment is, the more profit or loss you can make since there can be a big spread between what you pay and what you sell it for. But, you also have to be prepared for the price to drop by the same amount. Those who invest in stocks and mutual funds typically run this risk.

Interest Rate Risk

Depending on the interest rate movement in the economy, the rates of interest in investment instruments may go up or come down, resulting in a subsequent reverse movement of their prices. Such a scenario of economic instability might affect mutual funds etc.

The whole idea behind investment approach is to evaluate the risk associated with the various type of investments and take steps so as to balance it with the desired return.

Return

Return is primarily motivating force that drives investment.

The return of an investment consists of two components

1. Current Return:

The first component that often comes to mind when one is thinking about return is the periodic cash flow (income) such as dividend or interest, generated by the investment. Current return is measured as the periodic income in relation to the beginning price of the investment.

1. Capital return:

The second component of return is reflected in the price change called the capital return it is simply the price appreciation (or depreciation) divided by the beginning price of the asset. For assets like equity stocks, the capital return predominates.

Thus, the total return for any security (or for that matter any asset) is defined as:

          Total return = current return + Capital return

The current return can be zero or positive, whereas the capital return can be negative, zero, or positive.

Purchasing power risk (Real Return): If the inflation is very high then there is purchasing power risk attached to it.