# The Credit Card Model

Save this PDF as:

Size: px
Start display at page:

## Transcription

1 D The Credit Card Model Prepared for the MIT System Dynamics in Education Project Under the Supervision of Prof. Jay W. Forrester by Manas Ratha June 16, 1997 Vensim Examples added October 2001 Copyright 2001 by the Massachusetts Institute of Technology. Permission granted to distribute for non-commercial educational purposes.

2 D Table of Contents 1. ABSTRACT 8 2. INTRODUCTION 9 3. USING A CREDIT CARD CONCEPTUALIZING THE USE OF A CREDIT CARD FORMULATION OF THE MODEL INFLOW TO BALANCE PAYABLE : CREDIT CARD PURCHASES INFLOW TO BALANCE PAYABLE : INTEREST CHARGES OUTFLOW FROM BALANCE PAYABLE : PAYMENTS OTHER VARIABLES EDITING THE MODEL EVALUATING THE MODEL CONCLUSION APPENDIX CREDIT CARD PROBLEMS CREDIT CARD BILLING EQUATIONS: THE CREDIT CARD MODEL IN FIGURE ESTIMATING MODEL BEHAVIOR INTEREST CHARGES ON CREDIT CARD BALANCES OTHER FORMS OF CREDIT AND THEIR EXPENSES 33

3 4 D VENSIM EXAMPLES 33

4 8 D ABSTRACT Credit cards are one of many ways through which people borrow money. With a credit card, a person can make purchases without using cash. The credit card company pays for the purchase, but the card user has to repay the money borrowed to the card company at a later time. In addition to the amount of the purchase, the card user also has to pay interest on the loan. Interest on a loan is calculated as a fixed fraction of the loan amount and is charged for the time period of the loan. Interest payments reduce the amount of money the user of a credit card can spend on regular purchases. This paper presents a model that studies the way interest payments affect the quality of the credit card user s life by reducing the amount of money he can spend on other purchases. The reader is assumed to have some system dynamics modeling experience, and should build the model along with the paper.

6 10 D USING A CREDIT CARD Credit cards are issued by credit card companies. Joe s credit card, for example was issued by International Express, a premier credit card company. When Joe makes a purchase using his credit card, International Express pays for his purchase. Thus, Joe owes International Express the amount of the purchase. The Balance Payable is the total amount of money Joe owes International Express. At the end of each month, International Express sends Joe a statement listing all purchases he charged to his card during the month and the Balance Payable from the previous month. The new Balance Payable is the sum of the new purchases charged this month, the Balance Payable from the previous month, and the interest charges on the previous month s Balance Payable. Joe then pays a part or the entire amount of the new Balance Payable. The unpaid part of the current Balance Payable and the interest on the unpaid part of the current Balance Payable will be added to next month s purchases to give next month s Balance Payable. This model assumes that International Express starts charging interest on the amount of a purchase the moment Joe charges the purchase to his card. Read Appendix 9.2 to learn how credit card companies really charge interest on the Balance Payable. As mentioned in the Introduction, interest is calculated as a fixed fraction, called INTEREST RATE, of the Balance Payable for the time period that the Balance Payable is unpaid. Joe uses his credit card for convenience, to avoid carrying large amounts of cash. When Joe does not have cash to pay for his purchases, he uses his credit card to pay for the purchases, planning to pay the credit card bill in the future. Therefore, to make the purchase, Joe is using money he does not have at the present time. He is taking a loan from International Express and will repay the loan at a later time. Therefore, he is using his future income today. 3. CONCEPTUALIZING THE USE OF A CREDIT CARD The first step in building a model is identifying the problem to be analyzed. Appendix 9.1 describes some problems caused by the extensive use of credit cards by

7 D people. The purpose of this paper is to model and understand the reasons and the ways using a credit card can affect the quality of Joe Flogg s life. This model will address primarily two issues. The first issue is the amount of Joe s debt, that is, his Balance Payable. The second issue is the effect of the use of the credit card on the quality of Joe s life. Joe uses his card mostly for small expenses, such as eating at restaurants and going to movies. All benefits from his credit purchases are enjoyed today, and no purchases have a long-term effect on Joe s life. Purchases with a long-term effect would include furniture, a computer, or anything that can be used for a long period of time. Hence, the quality of Joe s life is defined by his current spending ability, that is, the total amount of money he can spend at the present moment, and not by purchases made in previous time periods. The next step is to determine the model boundary and identify key variables. The model boundary depends on the issues that the model studies. The model boundary is set by deciding whether or not a certain variable is important in determining the system s behavior. The model boundary can be determined while studying the variables that affect the system. The debt accumulated because of the use of the credit card is the amount Joe has to pay to International Express. The debt is called Balance Payable. Balance Payable is a stock because it is the accumulation of all the money Joe has borrowed from International Express, plus the interest charged on the borrowed money, less the money he has paid back to International Express. Balance Payable increases when Joe charges a purchase to his credit card because Joe is borrowing more money from International Express. The flow of purchases charged to the credit card is called credit card purchases. The interest charged on Balance Payable also increases the Balance Payable. The inflow of interest is called interest charges. Balance Payable is reduced by payments Joe makes to International Express. The payments reduce the amount of money Joe owes to International Express. The stock of Balance Payable and the flows into and out of the stock are shown in Figure 1. Figure 1 forms the core of the model.

8 12 D Balance Payable credit card purchases payments interest charges Figure 1: The stock and flows in the credit card system Discussing the system and studying the stock and flows helps to identify other important variables in the system. To spend any money at all, Joe must have a source of income. The source of income for most people is their weekly or monthly paycheck. Joe s paycheck is the amount of money he receives each month for the work he does at his job. Assume that Joe s paycheck is constant over the time period that the system is studied. Therefore, the model contains a constant called PAYCHECK. Over a period of a few years, inflation will reduce the real buying power of Joe s paycheck amount. However, the effect of the inflation rate 2 is very small in the time period considered and is not important in the model in this paper. Thus, the inflation rate is outside the model boundary. This model also assumes that Joe s pay does not increase, and that he does not receive any bonuses. The amount of money Joe can borrow on his credit card is limited. The maximum amount of money Joe can borrow is called the CREDIT LIMIT. International Express limits the amount Joe can borrow so that he does not overcharge on his credit card. Because Joe s income is fixed, he may be unable to repay his debts if he borrows too much money. The CREDIT LIMIT also helps International Express limit losses in case Joe defaults, that is, if Joe does not repay the debt. If Joe defaults, the maximum amount of money International Express can lose is the CREDIT LIMIT. For Joe, the CREDIT LIMIT is constant. 2 Inflation rate is the rate of increase of price levels in a certain region, usually measured for a country. Price levels in an economy are measured by the Consumer Price Index (CPI). Hence, the inflation rate is the rate of change of the CPI.

9 D Different people have different spending habits and different ways of paying their bills. The spending and repayment policies people use can be formulated in many ways. Joe has two sources of money to spend: the PAYCHECK and the credit available on his credit card. Joe s expenses include purchases, which determine the quality of his life, and payments to International Express. The available credit at any time is the maximum amount Joe can spend on his credit card at that time. The available credit is the difference between the maximum balance allowed, the CREDIT LIMIT, and the current Balance Payable. Joe spends a fixed fraction of the available credit, called SPENDING FRACTION, each month. Each month, International Express sends Joe a statement, showing the Balance Payable and his credit purchases for that month. Joe does not, however, have to pay the entire balance each month. He is required to make a certain minimum payment, and the unpaid amount can be paid later. Joe has to pay an amount equal to or less than the Balance Payable, but more than or equal to the required minimum payment. Because the interest charges are the expense on the debt, Joe pays only the interest charges each month. Therefore, payments equal interest charges. The model also studies the quality of Joe s life. The quality of life has been defined as the total value of purchases Joe can make at any time. The total value of the purchases equals the sum of the amount Joe charges to his credit card, the credit card purchases and the amount of his PAYCHECK he spends on cash purchases. Cash purchases equal the amount left from the PAYCHECK after making the payments. Joe cannot spend the entire PAYCHECK on cash purchases, except when the payments are zero. Payments are zero only when the Balance Payable is equal to zero, that is, when Joe is not using the credit card. 4. FORMULATION OF THE MODEL Section 4 describes the system and the variables. The equations of the variables must be formulated from the written description. The reader should understand the process of converting the words into mathematical terms. The italicized words in this

10 14 D paper are helpful in finding the relationships between variables. For example, ëof implies multiplication, ëper means division, and ësum of means addition. The descriptions also help to find the units of the variables. Amount of money is measured in dollars and amount spent each month is in dollars per month. The only stock in the system is the Balance Payable. Balance Payable is the amount of money Joe owes to International Express. Balance Payable is increased by credit card purchases and interest charges and reduced by payments made to International Express. Balance_Payable(t) = Balance_Payable(t - dt) + (credit_card_purchases + interest_charges - payments) * dt INITIAL VALUE = 0 DOCUMENT: The Balance Payable is the amount of money Joe owes to International Express. UNITS: Dollars 4.1 Inflow to Balance Payable : credit card purchases The credit card purchases are the purchases Joe makes on his credit card each month. The credit card purchases flow is a fixed fraction, the SPENDING FRACTION, of the available credit. The available credit is the maximum amount of money Joe can charge on his card and is equal to the difference between the CREDIT LIMIT and the Balance Payable. Therefore, two factors affect the credit card purchases flow: the available credit and the SPENDING FRACTION. The available credit is also affected by two factors: the CREDIT LIMIT and the Balance Payable. Therefore, the systems diagram looks like Figure 2.

11 D credit card purchases Balance Payable payments SPENDING FRACTION available credit interest charges CREDIT LIMIT Figure 2: Inflow of credit card purchases The credit card purchases represent the amount of credit purchases made each month. Credit card purchases is a fraction, the SPENDING FRACTION, of the available credit. credit card purchases = SPENDING FRACTION * available credit DOCUMENT: Credit card purchases is the amount Joe charges on his credit card each month, and is a fixed fraction, the SPENDING FRACTION of the available credit. UNITS: Dollars / Month The SPENDING FRACTION is the fraction of the available credit Joe spends on credit card purchases each month. The SPENDING FRACTION is constant and can have any value between zero and one. A value of zero means that Joe never uses his credit card because he is not making any credit card purchases. A value of one means that Joe spends all the available credit in the first month. Assume Joe spends ten percent, or 0.1 of the available credit each month. SPENDING FRACTION = 0.1 DOCUMENT: The SPENDING FRACTION is the fraction of the available credit Joe spends on credit card purchases each month. UNITS: 1 / Month

12 16 D The available credit is the maximum amount Joe can spend on his credit card at any given time. The available credit is the difference between the maximum amount Joe is allowed to borrow, the CREDIT LIMIT, and the Balance Payable. The definition gives the following equation: available credit = CREDIT LIMIT - Balance Payable DOCUMENT: Available credit is the difference between the CREDIT LIMIT and Balance Payable. The available credit is the maximum amount of money Joe can charge to his credit card at the time. UNITS: Dollars The CREDIT LIMIT is the maximum amount Joe can accumulate on his credit card. The CREDIT LIMIT is constant and is the maximum value the Balance Payable can have. Let Joe have a credit limit of \$6000. Let time zero be the time when Joe started his job. Joe received his credit card six months after he started his new job. Thus, CREDIT LIMIT is zero for the first six months, and \$6000 after six months. A STEP function can be used to model the CREDIT LIMIT. 3 CREDIT LIMIT = STEP (6000, 6) DOCUMENT: The maximum amount Joe can charge on his credit card. It is the maximum value of the Balance Payable. UNITS: Dollars 4.2 Inflow to Balance Payable : interest charges Another inflow to the Balance Payable stock is the flow of interest charges. As defined earlier, the interest charges on credit are computed as a fixed fraction, the 3 The amount of the CREDIT LIMIT (\$6000) and the time when Joe gets the credit card (six months) can be introduced as two separate constants. The CREDT LIMIT can then be modeled as a step function of the two constants instead of just the numbers. Introducing the constants makes changing the values of the constants more convenient.

13 D INTEREST RATE, of the Balance Payable. The two factors affecting interest charges are the INTEREST RATE and the Balance Payable, as shown in Figure 3. credit card purchases Balance Payable payments SPENDING FRACTION available credit interest charges CREDIT LIMIT INTEREST RATE Figure 3: Inflow of interest charges

14 18 D The interest charges are a fraction, the INTEREST RATE, of the Balance Payable. Interest charges are the amount of money charged each month on the loan. interest charges = INTEREST RATE * Balance Payable DOCUMENT: interest charges is the interest charged each month on the Balance Payable. UNITS: Dollars / Month The INTEREST RATE is constant. International Express charges interest at 18% per year, or approximately 1.5% per month. 4 INTEREST RATE = DOCUMENT: The fraction of the Balance Payable charged as interest per month. UNITS: 1 / Month 4.3 Outflow from Balance Payable : payments The only outflow from Balance Payable is the flow of payments made to International Express. Joe pays only the interest charges on the Balance Payable. Thus, the payments outflow is exactly equal to the inflow of interest charges. Therefore, payments can be modeled as in Figure 4. 4 Eighteen percent interest each year should equal 18? 12 = 1.5% per month. However, because interest is compounded, the monthly interest rate will be less than 1.5%. Read Appendix 9.3 to understand how interest on a credit card balance is calculated.

15 D credit card purchases Balance Payable payments SPENDING FRACTION available credit interest charges CREDIT LIMIT INTEREST RATE Figure 4: Outflow of payments payments = interest charges DOCUMENT: The payments is the money Joe pays to International Express. UNITS: Dollars / Month Flows cannot, however, be measured instantaneously. It is incorrect to set a flow equal to another flow. A new variable called interest on balance, which is equal to the interest charges, can be introduced. Thus, interest charges and payments both equal interest on balance. The model changes as shown in Figure 5. credit card purchases Balance Payable payments SPENDING FRACTION available credit interest charges interest on balance CREDIT LIMIT INTEREST RATE Figure 5: interest on balance interest on balance = Balance Payable * INTEREST RATE

16 20 D Express. DOCUMENT: The interest charged on Joe s Balance Payable by International UNITS: dollars / Month The equations for interest charges and payments also change to: interest charges = interest on balance payments = interest on balance Introducing the variable interest on balance eliminates the problem of setting two flows equal to each other in the model. In principle, rates cannot control other rates. As shown, each rate comes from the same level and constant. Good modeling practice dictates that if easily avoidable, two flows should not be set equal to one another. 4.4 Other variables Joe pays his credit card bills with money from his PAYCHECK. By assumption, Joe spends the money remaining after paying the credit card bill on purchases. Purchases made with money from his PAYCHECK are called cash purchases. The PAYCHECK, the amount Joe earns each month, is constant. The model does not consider raises in salary over time. At his present job, Joe earns \$2000 per month. PAYCHECK = 2000 DOCUMENT: The PAYCHECK is the amount of money Joe earns each month. UNITS: Dollars / Month The cash purchases equal the amount left from the PAYCHECK after paying the interest charges, that is, after making the payments. Because the payments are equal to the interest on balance, cash purchases, as shown in Figure 6, is the difference between the PAYCHECK and interest on balance.

17 D credit card purchases Balance Payable payments interest on balance SPENDING FRACTION available credit CREDIT LIMIT interest charges PAYCHECK INTEREST RATE cash purchases Figure 6: cash purchases cash purchases = PAYCHECK - interest on balance DOCUMENT: The purchases made each month with the money left from the PAYCHECK after making the payments. UNITS: Dollars / Month By definition, the quality of Joe s life at any time is the total amount of money he can spend at that time. Joe can make cash purchases and credit purchases; hence, Joe s quality of life, as shown in Figure 7 is the sum of cash purchases and credit card purchases.

18 22 D credit card purchases Balance Payable payments interest on balance available credit interest charges SPENDING FRACTION quality of life CREDIT LIMIT INTEREST RATE cash purchases PAYCHECK Figure 7: Model of the credit card system quality of life = cash purchases + credit card purchases DOCUMENT: The quality of life is the total amount of money Joe can spend at any time. UNITS: Dollars / Month The stock, flows, constants, and variables in the system have been modeled. Figure 7 shows the complete model of the system. The reader should not simulate the model yet. The model is now complete but has not been edited. Editing is the process of deleting any part of the model that is not important in the system. Be sure to save the model in Figure 7 before making any changes. 5. EDITING THE MODEL After building the model of the entire system, it is important to edit the model. Often, parts of the system are repeated, insignificant, or can be modeled in an easier way. Editing the model makes the model concise by simplification and more useful by removing insignificant parts.

19 D In Figure 7, the interest charges inflow and the payments outflow are equal. Therefore, the interest charges inflow and payments outflow change the Balance Payable by equal amounts but in opposite directions. Thus, the combined effect of interest charges and payments on the Balance Payable is zero. Therefore, both interest charges and payments flows can be deleted to simplify the model. Deleting the flows should not affect the behavior of the model. Editing a model may affect the equations of variables in a model. In Figure 7, only the Balance Payable is directly affected by the payments and interest charges flows. The equation for the Balance Payable becomes: Balance_Payable(t) = Balance_Payable(t - dt) + (credit_card_purchases) * dt INIT Balance_Payable = 0 The final, edited model of Joe using a credit card is shown in Figure 8: credit card purchases Balance Payable interest on balance PAYCHECK SPENDING FRACTION available credit CREDIT LIMIT INTEREST RATE cash purchases quality of life Figure 8: deleting interest charges and payments Because interest on balance represents the interest charged on the Balance Payable, the interest charges can be studied directly by observing the behavior of interest on balance over time. After deleting the flows of interest charges and payments and changing the equation of Balance Payable, the model looks like Figure 8. Save the model in Figure 8 as a new file. The model in Figure 7 will be required later. The documented equations for the model in Figure 8 are in the Appendix 9.3. Do not run the model yet.

20 24 D The behavior of the model in Figure 8 should be the same as the behavior of the model in Figure 7. The only way to make sure that the behavior of the model has not been changed by the editing is to compare the behavior of the variables over time. Do not run the models at this time. Some questions about the models have to be answered first. 6. EVALUATING THE MODEL The key variables in the model are Balance Payable, quality of life, and interest payments. Read the equations for the variables and look at the feedback loops that affect them. Try to estimate the behavior of the variables and plot the expected behavior over time. Appendix 9.4 explains the process of mentally simulating the model to estimate the behavior of the system. Now run both the model in Figure 7 and the edited model in Figure 8 over a time horizon of 72 months. A period of 72 months is probably a long enough time period to observe the long-term dynamics of the system. Change the time period and rerun the models to observe the behavior of the models over different time intervals. Compare the behavior of the models to make sure they demonstrate the same behavior. Clearly, editing the model did not change the behavior of the variables. Analyzing a model gives insight to the feedback loops that drive the behavior of the system. Understanding the system s behavior makes it possible to formulate policies to improve the performance of the system.

21 D The main purpose of the model is to study the quality of Joe s life, represented by the variable quality of life. Look at the graph for quality of life and PAYCHECK, shown in Figure : PAYCHECK 2: quality of life Months Figure 9: Behavior of quality of life The quality of Joe s life equals his PAYCHECK when he does not have a credit card. When Joe does not use a credit card, he does not have to pay any interest because he owes no money to any credit card company. Therefore, Joe can spend his entire PAYCHECK on cash purchases, and quality of life is equal to the PAYCHECK. The graph in Figure 9, therefore, shows the quality of Joe s life under two situations. The PAYCHECK curve shows the quality of Joe s life if Joe never uses a credit card. The quality of life curve shows the quality of Joe s life when he uses a credit card. The quality of life is constant and equal to the PAYCHECK until Joe receives the credit card. Immediately after receiving the card, Joe s quality of life increases sharply. Joe now has a large amount of available credit to spend in addition to the PAYCHECK. When he uses his credit card to make purchases, his quality of life increases because he can spend more than his PAYCHECK. As Joe makes more credit

22 26 D card purchases, his Balance Payable increases. Therefore, the available credit decreases, and so do the credit card purchases. The behavior of credit card purchases is driven by a negative feedback loop. As the credit card purchases decrease, Joe s quality of life also decreases. When Joe has spent an amount equal to the CREDIT LIMIT, he cannot charge any more purchases to his credit card. Joe s quality of life is now equal to his cash purchases. The cash purchases have an equilibrium value of about \$1910 per month, as can be seen from a graph or table of the quality of life. The equilibrium value of cash purchases can also be calculated by setting credit card purchases equal to zero and solving the equations for the variables to get the equilibrium values of interest on balance, cash purchases, credit card purchases, and quality of life. The interest on balance is \$90 per month. The equilibrium value of quality of life, \$1910 per month, is lower than the value of the PAYCHECK. 7. CONCLUSION The quality of Joe s life rises when he starts using his new credit card. Over the next few months, however, the quality of his life gradually declines and reaches an equilibrium value. The equilibrium value is lower than the quality of Joe s life before he started using the credit card. The quality of Joe s life stays lower than the PAYCHECK as long as he follows his current policy of paying only the interest charges on the Balance Payable. Therefore, using the credit card improves the quality of Joe s life for a short period of time, but reduces the quality of his life for a long period. Joe also has a huge debt, the Balance Payable, that he will have to repay to International Express. To repay the loan, Joe s payments will have to be larger than the interest on balance, so his cash purchases will decline further. Therefore, repaying the loan will further reduce the quality of Joe s life. The model presented in this paper is a classic example of the short-term benefit, long-term cost behavior of complex systems. Borrowing on credit cards allows an immediate increase in Joe s quality of life for a short period of time. The consequence in the longer term is a lower quality of life while repaying the loan and interest.

23 D The system presented in this paper shows that a short-term benefit can prove to be expensive in the long-term. The trade-off in short-term and long-term results occurs not only in the system of Joe using his credit card, but in many other systems. Often, policies generate excellent results quickly, but if implemented for a long time, they prove to be detrimental. The opposite is also true. Most strategies which are beneficial in the longterm usually have negative effects in the short-term. Before taking actions or implementing a policy, the long-term effects of the policy should be considered.

24 28 D APPENDIX 8.1 Credit Card Problems An article in the September 25, 1996 issue of The Wall Street Journal carried an article titled Banks Marketing Blitz Yields Rash of Defaults. 5 The article describes the effect of the increased use of credit cards on the lives of many credit card users. In 1995, credit card companies mailed out 2.7 billion pre-approved credit card applications. Credit card delinquencies soared in 1995, reaching a ten year high. Three point six percent of all credit card accounts were delinquent and personal bankruptcies increased by 23% compared to Many people interviewed for the article said that they charged too much to their credit cards because they had large credit limits, but later were unable to pay even the minimum required payments. In some cases, the minimum required payments were greater than the persons income. Clearly, the increasing personal bankruptcies and problems people face in paying credit card bills are a reason for concern. This paper studies the cause of large interest payments that make it more difficult for people to repay their credit card bills because the amounts to be paid back to the card company increase over time. 8.2 Credit Card Billing Credit card companies send a statement to every card user once a month. The user has one month to pay the bill. During the one month allowed to pay the bill, no interest is charged on the card purchases made during the period covered by the statement. Therefore, if the card user always pays the entire amount on the statement within one month, the Balance Payable will be zero for the next billing period, and no interest will ever be charged. For example, the statement listing all the credit card purchases for the month of January will be mailed to Joe on about February 15. Joe is allowed until March 5 Laurie Hays, Banks Marketing Blitz Yields Rash of Defaults. The Wall Street Journal, Wednesday 25, 1996, page B1.

25 D to pay the amount on the statement. Assume that at the beginning of January, Joe had a Balance Payable equal to \$0.00. On February 15, for example, he receives the statement for \$ If Joe pays the \$ before March 15, he will not be charged any interest. If Joe continues the practice of paying the entire amount on the statement within a month of receiving the statement, he will never have to pay any interest. Therefore, it is possible to use a credit card and have a standard of living exactly equal to the paycheck. In this paper, it is assumed that Joe does not have to pay an annual fee for his credit card. Many credit card companies require card users to pay an annual fee to use their credit card. In recent years, however, many credit card companies have canceled the annual fee to encourage people to use their card. It can, therefore, be assumed that Joe does not pay an annual fee on his card. Another benefit of getting a credit card is the advertisement and discount coupons credit card companies usually send with the card. Coupons often give the card user frequent flier miles, airline discount coupons and other discount and gift coupons. If used, the coupons can save the card user a lot of money. There are also other services provided by credit cards, such as buyer replacement options, cash withdrawal, and other special deals which have been ignored in this paper. Therefore, it is beneficial to own credit cards, but credit cards should not be abused, and the suggested policy of always paying the entire balance should be followed. 8.3 Equations: The Credit Card Model in Figure 8 Balance_Payable(t) = Balance_Payable(t - dt) + (credit_card_purchases) * dt INIT Balance_Payable = 0 DOCUMENT: The Balance Payable is the amount of money owed to the credit card company by the card user. UNITS: Dollars INFLOWS: credit_card_purchases = available_credit*spending_fraction DOCUMENT: DOCUMENT: credit card spending is the total amount charged on credit cards, and is a fixed fraction, the SPENDING FRACTION of the available credit. UNITS: Dollars / Month

26 30 D available_credit = CREDIT_LIMIT-Balance_Payable DOCUMENT: DOCUMENT: It is equal to the difference between the CREDIT LIMIT and Balance Payable. The available credit is the maximum amount of money the card user can charge on the card at the time. UNITS: Dollars cash_purchases = PAYCHECK-interest_on_balance DOCUMENT: DOCUMENT: The purchases made each month with the money left from the "PAYCHECK" after paying the interest charges. UNITS: Dollars / Month CREDIT_LIMIT = STEP(6000,6) DOCUMENT: DOCUMENT: The maximum amount Joe can charge on his credit card. It is the maximum value of the Balance Payable. UNITS: Dollars interest_on_balance = Balance_Payable*INTEREST_RATE DOCUMENT: The interest charged on Joe s Balance Payable by International Express. UNITS: dollars / Month INTEREST_RATE = DOCUMENT: DOCUMENT: The fraction of the Balance Payable charged as interest per month. UNITS: I / Month PAYCHECK = 2000 DOCUMENT: DOCUMENT: The PAYCHECK is the money earned each month. UNITS: Dollars / Month quality_of_life = credit_card_purchases+cash_purchases DOCUMENT: DOCUMENT: The quality of life is how much the card user purchases at any time. UNITS: Dollars / Month SPENDING_FRACTION = 0.1 DOCUMENT: DOCUMENT: The SPENDING FRACTION is the fraction of the available credit the user spends on credit purchases each month. UNITS: 1 / Month 8.4 Estimating Model Behavior The flow of credit card purchases is highest when available credit is highest. The available credit is highest when Balance Payable equals zero, that is at six months.

27 D Credit card purchases increase the Balance Payable, which reduces the available credit, which in turn reduces the credit card purchases. Lower credit card purchases still increase the Balance Payable but by a smaller amount than in the previous cycle because the amount of credit card purchases has declined. Therefore, the credit card purchases flow is constantly decreasing and exhibits asymptotic decay. The Balance Payable is the accumulation of the credit card purchases flow; therefore, Balance Payable increases and approaches a maximum value asymptotically. Balance Payable increases fastest as soon as Joe receives his credit card, and the credit card purchases are largest. The maximum value of Balance Payable is the CREDIT LIMIT. Therefore, the Balance Payable asymptotically approaches the CREDIT LIMIT, while credit card purchases asymptotically approach a value of zero dollars per month. Estimating the behavior of Balance Payable and credit card purchases is not difficult. A first-order negative feedback loop 6 drives the behavior of the Balance Payable and credit card purchases. The behavior of quality of life and cash purchases is more difficult to estimate. Looking at the model and the equations, it is clear that:? as Balance Payable increases over time, interest on balance increase;? as interest on balance increase, cash purchases decrease. Therefore, cash purchases and credit card purchases decline asymptotically over time. Hence, the quality of life also decreases. Interest on balance is a fixed fraction of the Balance Payable. Therefore, interest on balance also exhibits asymptotic growth. Therefore, cash purchases decline asymptotically and approach the value equal to PAYCHECK minus the equilibrium value of interest on balance. The interest on balance is highest when the Balance Payable is at the highest value, that is, equal to the CREDIT LIMIT. Therefore, the maximum interest on 6 For an explanation of first-order negative feedback loops, read: Helen Zhu, Beginner Modeling Exercises: Mental Simulation of Simple Negative Feedback (D-4536), System Dynamics in Education Project, System Dynamics Group, Sloan School of Management, Massachusetts Institute of Technology, March 25, 1996, 23 pp.

28 32 D balance is equal to the CREDIT LIMIT times the INTEREST RATE. Using the equations, the equilibrium value of cash purchases can be calculated. After estimating the behavior of the models from Figure 7 and Figure 8, the reader should run the models and compare his graphs with the graphs of the behavior of variables after running the models. 8.5 Interest charges on credit card balances Credit card companies calculate the interest rate in two steps. The annual interest rate (18% in the system this paper studied) is called the Annual Percentage Rate (APR). The APR is calculated by adding the U.S. prime rate and the variable rate. The U.S. prime rate is determined by the financial markets, and the credit card companies have no control over the prime rate value. The variable rate is set by the company. In May 1997, at the time of writing this paper, the prime rate was about nine percent, and most credit card companies charged a variable rate of about nine percent. Therefore, the APR for most credit cards was about 18% in May Interest charges on loans are usually compounded. The formula for compound interest is: periods Final Amount = Initial Amount * (1 + interest rate)^time Irrespective of whether the annual interest rate or the monthly interest rate is used, the Final Amount will be the same for a given Initial Amount and interest rate. Consider a time period of 1 year or 12 months. Using the annual interest rate, Time is equal to 1. Using the monthly interest rate, Time is equal to 12. Let the annual interest rate = 18% = 18? 100 = Irrespective of whether the annual interest rate or the monthly interest rate is used in the calculations, the Final Amount and Initial Amount will be the same. Two 7 Credit card companies usually offer a wide range of credit cards for different users. Different credit cards offered by the same company will have different APRs. For most cards, the APR is about 18%. For credit cards with very large credit limits and cards that offer many options and special services and features, the interest rate may be higher than 18%.

29 D equations can be formulated. The time period when the monthly interest rate is used willbe 12, because there are 12 months in a year. Equation 1: Final Amount = Initial Amount * (1 + annual interest rate)^1 Equation 2: Final Amount = Initial Amount * (1 + monthly interest rate)^12 Therefore, (1 + annual interest rate) 1 = (1 + monthly interest rate)^12 ( ) = (1 + monthly interest rate)^12 Hence, the monthly interest rate is , or 1.39% 8.6 Other forms of Credit and their expenses Credit cards are only one of many forms of credit commonly used. Mortgages, bank loans, corporate and government bonds are other common forms of borrowing money. Various types of credit are different from each other, and are used for various purposes. Interest, however, has to be paid on every kind of loan. Due to the interest payments, the money that has to be paid back to the lender is more than the money borrowed. Many countries have a budget deficit for many years. The government spends more money than it collects. The difference between the expenses and revenues is paid by taking loans from other nations and organizations and by issuing bonds. Bonds are financial instruments used to borrow money in financial markets. The amounts borrowed by countries can be large. Soon, the countries have to spend large sums of money just to service the debt, that is, pay the interest on the debt. As the amount of the debt increases, it becomes more difficult to repay the loan, and the interest payments become larger. Therefore, governments face the same problem as people who use credit cards carelessly, but on a much larger magnitude. 8 8 Under certain economic conditions, such as rapid growth, it may be more beneficial to the economy if the government borrows money and runs a deficit rather than balances the budget. Most countries that run a deficit, however, do not face these special conditions.

30 34 D Vensim Examples :The Credit Card Model By Aaron Diamond October 2001 INITIAL BALANCE PAYABLE credit card purchases Balance Payable payments SPENDING FRACTION available credit interest charges interest on balance PAYCHECK CREDIT LIMIT quality of life INTEREST RATE cash purchases Figure 10: Vensim Equivalent of figure 7: Model of the credit card system. Documentation for the credit card model (01) available credit=credit LIMIT-Balance Payable Units: dollars "Available credit" is the difference between the "CREDIT LIMIT" and the "Balance Payable". The "available credit" is the maximum amount of money Joe can charge to his credit card at the time. (02) Balance Payable= INTEG (credit card purchases+interest charges-payments, INITIAL BALANCE PAYABLE) Units: dollars The "Balance Payable" is the amount of money Joe owes to International Express

31 D (03) cash purchases=paycheck-interest on balance Units: dollars/month The purchases made each month with the money left from the "PAYCHECK" after paying the "interest charges." (04) credit card purchases=spending FRACTION*available credit Units: dollars/month "Credit card purchases" is the amount Joe charges on his credit card each month, and is a fixed fraction, the "SPENDING FRACTION" of the "available credit". (05) CREDIT LIMIT=STEP (6000,6) Units: dollars The maximum amount Joe can charge on his credit card. It is the maximum value of the "Balance Payable." (06) FINAL TIME = 72 Units: Month The final time for the simulation. (07) INITIAL BALANCE PAYABLE=0 Units: dollars (08) INITIAL TIME = 0 Units: Month The initial time for the simulation. (09) interest charges=interest on balance Units: dollars/month

32 36 D "Interest charges" is the interest charged each month on the "Balance Payable." (10) interest on balance=balance Payable*INTEREST RATE Units: dollars/month The interest charged on Joe's "Balance Payable" by International Express. (11) INTEREST RATE=0.015 Units: 1/Month The fraction of the "Balance Payable" charged as interest per month. (12) PAYCHECK=2000 Units: dollars/month The "PAYCHECK" is the money earned each month. (13) payments=interest on balance Units: dollars/month (14) quality of life=cash purchases+credit card purchases Units: dollars/month The quality of life is how much the card user purchases at any time. (15) SAVEPER = TIME STEP Units: Month The frequency with which output is stored. (16) SPENDING FRACTION=0.1

33 D Units: 1/Month The "SPENDING FRACTION" is the fraction of the "available credit "Joe spends on "credit card purchases each month. (17) TIME STEP = Units: Month The time step for the simulation. Graph of PAYCHECK and quality of life 2,900 dollars/month 2,600 dollars/month 2,300 dollars/month 2,000 dollars/month ,700 dollars/month PAYCHECK : quality of life : Time (Month) dollars/month dollars/month Figure 11: Vensim Equivalent of Figure 9: Behavior of quality of life.

### The Credit Card Model

D-4683-2 1 The Credit Card Model Prepared for the MIT System Dynamics in Education Project Under the Supervision of Prof. Jay W. Forrester by Manas Ratha June 16, 1997 Vensim Examples added October 2001

### Guided Study Program in System Dynamics System Dynamics in Education Project System Dynamics Group MIT Sloan School of Management 1

Guided Study Program in System Dynamics System Dynamics in Education Project System Dynamics Group MIT Sloan School of Management 1 Solutions to Assignment #4 Wednesday, October 21, 1998 Reading Assignment:

### 7: Compounding Frequency

7.1 Compounding Frequency Nominal and Effective Interest 1 7: Compounding Frequency The factors developed in the preceding chapters all use the interest rate per compounding period as a parameter. This

### CHAPTER 5. Interest Rates. Chapter Synopsis

CHAPTER 5 Interest Rates Chapter Synopsis 5.1 Interest Rate Quotes and Adjustments Interest rates can compound more than once per year, such as monthly or semiannually. An annual percentage rate (APR)

### Beginner Modeling Exercises Section 2 Mental Simulation of Simple Positive Feedback

D-4487 Beginner Modeling Exercises Section 2 Mental Simulation of Simple Positive Feedback Stock Flow Growth Factor Prepared for the MIT System Dynamics in Education Project Under the Supervision of Dr.

### STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS

C H A P T E R 1 0 STATEMENT OF CASH FLOWS AND WORKING CAPITAL ANALYSIS I N T R O D U C T I O N Historically, profit-oriented businesses have used the accrual basis of accounting in which the income statement,

### Chapter 6 Contents. Principles Used in Chapter 6 Principle 1: Money Has a Time Value.

Chapter 6 The Time Value of Money: Annuities and Other Topics Chapter 6 Contents Learning Objectives 1. Distinguish between an ordinary annuity and an annuity due, and calculate present and future values

### CHAPTER 1. Compound Interest

CHAPTER 1 Compound Interest 1. Compound Interest The simplest example of interest is a loan agreement two children might make: I will lend you a dollar, but every day you keep it, you owe me one more penny.

### Chapter 6. Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams

Chapter 6 Learning Objectives Principles Used in This Chapter 1. Annuities 2. Perpetuities 3. Complex Cash Flow Streams 1. Distinguish between an ordinary annuity and an annuity due, and calculate present

### CHAPTER 4. The Time Value of Money. Chapter Synopsis

CHAPTER 4 The Time Value of Money Chapter Synopsis Many financial problems require the valuation of cash flows occurring at different times. However, money received in the future is worth less than money

### CHAPTER 8 INTEREST RATES AND BOND VALUATION

CHAPTER 8 INTEREST RATES AND BOND VALUATION Answers to Concept Questions 1. No. As interest rates fluctuate, the value of a Treasury security will fluctuate. Long-term Treasury securities have substantial

### CALCULATOR TUTORIAL. Because most students that use Understanding Healthcare Financial Management will be conducting time

CALCULATOR TUTORIAL INTRODUCTION Because most students that use Understanding Healthcare Financial Management will be conducting time value analyses on spreadsheets, most of the text discussion focuses

### PowerPoint. to accompany. Chapter 5. Interest Rates

PowerPoint to accompany Chapter 5 Interest Rates 5.1 Interest Rate Quotes and Adjustments To understand interest rates, it s important to think of interest rates as a price the price of using money. When

### Personal Finance Unit 1 Chapter 3 2007 Glencoe/McGraw-Hill

0 Chapter 3 Money Management Strategy What You ll Learn Section 3.1 Discuss the relationship between opportunity costs and money management. Explain the benefits of keeping financial records and documents.

### The Basics of Interest Theory

Contents Preface 3 The Basics of Interest Theory 9 1 The Meaning of Interest................................... 10 2 Accumulation and Amount Functions............................ 14 3 Effective Interest

### The Time Value of Money

The following is a review of the Quantitative Methods: Basic Concepts principles designed to address the learning outcome statements set forth by CFA Institute. This topic is also covered in: The Time

### Statistical Models for Forecasting and Planning

Part 5 Statistical Models for Forecasting and Planning Chapter 16 Financial Calculations: Interest, Annuities and NPV chapter 16 Financial Calculations: Interest, Annuities and NPV Outcomes Financial information

### Account a service provided by a bank allowing a customer s money to be handled and tracks money coming in and going out of the account.

Account a service provided by a bank allowing a customer s money to be handled and tracks money coming in and going out of the account. Account fee the amount charged by a financial institution for the

### Accounts payable Money which you owe to an individual or business for goods or services that have been received but not yet paid for.

A Account A record of a business transaction. A contract arrangement, written or unwritten, to purchase and take delivery with payment to be made later as arranged. Accounts payable Money which you owe

### Simple Interest. and Simple Discount

CHAPTER 1 Simple Interest and Simple Discount Learning Objectives Money is invested or borrowed in thousands of transactions every day. When an investment is cashed in or when borrowed money is repaid,

### 13. If Y = AK 0.5 L 0.5 and A, K, and L are all 100, the marginal product of capital is: A) 50. B) 100. C) 200. D) 1,000.

Name: Date: 1. In the long run, the level of national income in an economy is determined by its: A) factors of production and production function. B) real and nominal interest rate. C) government budget

### CARDMEMBER AGREEMENT RATES AND FEES TABLE INTEREST RATES AND INTEREST CHARGES FEES

Purchase Annual Percentage Rate (APR) Balance Transfer APR Cash Advance APR Penalty APR and When It Applies Paying Interest Minimum Interest Charge Credit Card Tips from the Federal Reserve Board CARDMEMBER

### CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY

CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY Answers to Concepts Review and Critical Thinking Questions 1. The four parts are the present value (PV), the future value (FV), the discount

### CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY

CHAPTER 5 INTRODUCTION TO VALUATION: THE TIME VALUE OF MONEY 1. The simple interest per year is: \$5,000.08 = \$400 So after 10 years you will have: \$400 10 = \$4,000 in interest. The total balance will be

### Formulating Models of Simple Systems using. Vensim PLE. version 3.0B

Formulating Models of Simple Systems using Vensim PLE version 3.0B Professor Nelson Repenning System Dynamics Group MIT Sloan School of Management Cambridge, MA O2142 Edited by Laura Black, Farzana S.

### Looking at statistics one might easily say that the United States is a nation of credit

Personal Finance Program TOPIC 4 CREDIT CARDS Credit Cards LESSON 11 Comparing costs and benefits of buying on credit is key to making a good purchase decision. Spending and Credit Standards, Jump\$tart

### International Money and Banking: 12. The Term Structure of Interest Rates

International Money and Banking: 12. The Term Structure of Interest Rates Karl Whelan School of Economics, UCD Spring 2015 Karl Whelan (UCD) Term Structure of Interest Rates Spring 2015 1 / 35 Beyond Interbank

### Module 5: Interest concepts of future and present value

Page 1 of 23 Module 5: Interest concepts of future and present value Overview In this module, you learn about the fundamental concepts of interest and present and future values, as well as ordinary annuities

### Current liabilities - Obligations that are due within one year. Obligations due beyond that period of time are classified as long-term liabilities.

Accounting Fundamentals Lesson 8 8.0 Liabilities Current liabilities - Obligations that are due within one year. Obligations due beyond that period of time are classified as long-term liabilities. Current

FIN 534 Week 4 Quiz 3 (Str) Click Here to Buy the Tutorial http://www.tutorialoutlet.com/fin-534/fin-534-week-4-quiz-3- str/ For more course tutorials visit www.tutorialoutlet.com Which of the following

### CHAPTER 6 DISCOUNTED CASH FLOW VALUATION

CHAPTER 6 DISCOUNTED CASH FLOW VALUATION Answers to Concepts Review and Critical Thinking Questions 1. The four pieces are the present value (PV), the periodic cash flow (C), the discount rate (r), and

### Graphical Integration Exercises Part Four: Reverse Graphical Integration

D-4603 1 Graphical Integration Exercises Part Four: Reverse Graphical Integration Prepared for the MIT System Dynamics in Education Project Under the Supervision of Dr. Jay W. Forrester by Laughton Stanley

### CASH FLOWS, PROFITS AND

1 CASH FLOWS, PROFITS AND FINANCIAL STATEMENTS 1.1 INTRODUCTION Strategic cost management requires an understanding of not only profits and financial statements, but also of engineering economics and the

### Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS. Peter N. Ireland Department of Economics Boston College. irelandp@bc.edu

Lecture Notes on MONEY, BANKING, AND FINANCIAL MARKETS Peter N. Ireland Department of Economics Boston College irelandp@bc.edu http://www2.bc.edu/~irelandp/ec261.html Chapter 9: Banking and the Management

### Compound Interest Formula

Mathematics of Finance Interest is the rental fee charged by a lender to a business or individual for the use of money. charged is determined by Principle, rate and time Interest Formula I = Prt \$100 At

### Finance 350: Problem Set 6 Alternative Solutions

Finance 350: Problem Set 6 Alternative Solutions Note: Where appropriate, the final answer for each problem is given in bold italics for those not interested in the discussion of the solution. I. Formulas

### Introduction to Real Estate Investment Appraisal

Introduction to Real Estate Investment Appraisal Maths of Finance Present and Future Values Pat McAllister INVESTMENT APPRAISAL: INTEREST Interest is a reward or rent paid to a lender or investor who has

### CHAPTER 7: NPV AND CAPITAL BUDGETING

CHAPTER 7: NPV AND CAPITAL BUDGETING I. Introduction Assigned problems are 3, 7, 34, 36, and 41. Read Appendix A. The key to analyzing a new project is to think incrementally. We calculate the incremental

### Present Value Concepts

Present Value Concepts Present value concepts are widely used by accountants in the preparation of financial statements. In fact, under International Financial Reporting Standards (IFRS), these concepts

### SOCIETY OF ACTUARIES FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS

SOCIETY OF ACTUARIES EXAM FM FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS This page indicates changes made to Study Note FM-09-05. April 28, 2014: Question and solutions 61 were added. January 14, 2014:

### The following is an article from a Marlboro, Massachusetts newspaper.

319 CHAPTER 4 Personal Finance The following is an article from a Marlboro, Massachusetts newspaper. NEWSPAPER ARTICLE 4.1: LET S TEACH FINANCIAL LITERACY STEPHEN LEDUC WED JAN 16, 2008 Boston - Last week

### 2. How would (a) a decrease in the interest rate or (b) an increase in the holding period of a deposit affect its future value? Why?

CHAPTER 3 CONCEPT REVIEW QUESTIONS 1. Will a deposit made into an account paying compound interest (assuming compounding occurs once per year) yield a higher future value after one period than an equal-sized

### Time Value of Money. 15.511 Corporate Accounting Summer 2004. Professor S. P. Kothari Sloan School of Management Massachusetts Institute of Technology

Time Value of Money 15.511 Corporate Accounting Summer 2004 Professor S. P. Kothari Sloan School of Management Massachusetts Institute of Technology July 2, 2004 1 LIABILITIES: Current Liabilities Obligations

### Finance CHAPTER OUTLINE. 5.1 Interest 5.2 Compound Interest 5.3 Annuities; Sinking Funds 5.4 Present Value of an Annuity; Amortization

CHAPTER 5 Finance OUTLINE Even though you re in college now, at some time, probably not too far in the future, you will be thinking of buying a house. And, unless you ve won the lottery, you will need

### FNCE 301, Financial Management H Guy Williams, 2006

REVIEW We ve used the DCF method to find present value. We also know shortcut methods to solve these problems such as perpetuity present value = C/r. These tools allow us to value any cash flow including

### Chapter 7 SOLUTIONS TO END-OF-CHAPTER PROBLEMS

Chapter 7 SOLUTIONS TO END-OF-CHAPTER PROBLEMS 7-1 0 1 2 3 4 5 10% PV 10,000 FV 5? FV 5 \$10,000(1.10) 5 \$10,000(FVIF 10%, 5 ) \$10,000(1.6105) \$16,105. Alternatively, with a financial calculator enter the

### Ing. Tomáš Rábek, PhD Department of finance

Ing. Tomáš Rábek, PhD Department of finance For financial managers to have a clear understanding of the time value of money and its impact on stock prices. These concepts are discussed in this lesson,

### Understanding A Firm s Financial Statements

CHAPTER OUTLINE Spotlight: J&S Construction Company (http://www.jsconstruction.com) 1 The Lemonade Kids Financial statement (accounting statements) reports of a firm s financial performance and resources,

### MAT116 Project 2 Chapters 8 & 9

MAT116 Project 2 Chapters 8 & 9 1 8-1: The Project In Project 1 we made a loan workout decision based only on data from three banks that had merged into one. We did not consider issues like: What was the

### SOCIETY OF ACTUARIES FINANCIAL MATHEMATICS. EXAM FM SAMPLE QUESTIONS Interest Theory

SOCIETY OF ACTUARIES EXAM FM FINANCIAL MATHEMATICS EXAM FM SAMPLE QUESTIONS Interest Theory This page indicates changes made to Study Note FM-09-05. January 14, 2014: Questions and solutions 58 60 were

### Practice Problems on Money and Monetary Policy

Practice Problems on Money and Monetary Policy 1- Define money. How does the economist s use of this term differ from its everyday meaning? Money is the economist s term for assets that can be used in

### Paying off a debt. Ethan D. Bolker Maura B. Mast. December 4, 2007

Paying off a debt Ethan D. Bolker Maura B. Mast December 4, 2007 Plan Lecture notes Can you afford a mortgage? There s a \$250,000 condominium you want to buy. You ve managed to scrape together \$50,000

### MATHEMATICS OF FINANCE AND INVESTMENT

MATHEMATICS OF FINANCE AND INVESTMENT G. I. FALIN Department of Probability Theory Faculty of Mechanics & Mathematics Moscow State Lomonosov University Moscow 119992 g.falin@mail.ru 2 G.I.Falin. Mathematics

### Present Value (PV) Tutorial

EYK 15-1 Present Value (PV) Tutorial The concepts of present value are described and applied in Chapter 15. This supplement provides added explanations, illustrations, calculations, present value tables,

### CHAPTER 4 DISCOUNTED CASH FLOW VALUATION

CHAPTER 4 DISCOUNTED CASH FLOW VALUATION Solutions to Questions and Problems NOTE: All-end-of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due to space and readability

### Vilnius University. Faculty of Mathematics and Informatics. Gintautas Bareikis

Vilnius University Faculty of Mathematics and Informatics Gintautas Bareikis CONTENT Chapter 1. SIMPLE AND COMPOUND INTEREST 1.1 Simple interest......................................................................

### This week its Accounting and Beyond

This week its Accounting and Beyond Monday Morning Session Introduction/Accounting Cycle Afternoon Session Tuesday The Balance Sheet Wednesday The Income Statement The Cash Flow Statement Thursday Tools

### If P = principal, r = annual interest rate, and t = time (in years), then the simple interest I is given by I = P rt.

13 Consumer Mathematics 13.1 The Time Value of Money Start with some Definitions: Definition 1. The amount of a loan or a deposit is called the principal. Definition 2. The amount a loan or a deposit increases

### What three main functions do they have? Reducing transaction costs, reducing financial risk, providing liquidity

Unit 4 Test Review KEY Savings, Investment and the Financial System 1. What is a financial intermediary? Explain how each of the following fulfills that role: Financial Intermediary: Transforms funds into

### Finance 197. Simple One-time Interest

Finance 197 Finance We have to work with money every day. While balancing your checkbook or calculating your monthly expenditures on espresso requires only arithmetic, when we start saving, planning for

### Bond valuation. Present value of a bond = present value of interest payments + present value of maturity value

Bond valuation A reading prepared by Pamela Peterson Drake O U T L I N E 1. Valuation of long-term debt securities 2. Issues 3. Summary 1. Valuation of long-term debt securities Debt securities are obligations

### Understand the relationship between financial plans and statements.

#2 Budget Development Your Financial Statements and Plans Learning Goals Understand the relationship between financial plans and statements. Prepare a personal balance sheet. Generate a personal income

### Practice Problems Mods 25, 28, 29

Practice Problems Mods 25, 28, 29 Multiple Choice Identify the choice that best completes the statement or answers the question. Scenario 25-1 First National Bank First National Bank has \$80 million in

### Synthesis of Financial Planning

P 7A R T Synthesis of Financial Planning 1. Tools for Financial Planning Budgeting (Chapter 2) Planned Savings (Chapter 3) Tax Planning (Chapter 4) 2. Managing Your Liquidity Bank Services (Chapter 5)

### Chapter 6 APPENDIX B. The Yield Curve and the Law of One Price. Valuing a Coupon Bond with Zero-Coupon Prices

196 Part Interest Rates and Valuing Cash Flows Chapter 6 APPENDIX B The Yield Curve and the Law of One Price Thus far, we have focused on the relationship between the price of an individual bond and its

### CHAPTER 6. Accounting and the Time Value of Money. 2. Use of tables. 13, 14 8 1. a. Unknown future amount. 7, 19 1, 5, 13 2, 3, 4, 6

CHAPTER 6 Accounting and the Time Value of Money ASSIGNMENT CLASSIFICATION TABLE (BY TOPIC) Topics Questions Brief Exercises Exercises Problems 1. Present value concepts. 1, 2, 3, 4, 5, 9, 17, 19 2. Use

1.0 ALTERNATIVE SOURCES OF FINANCE Module 1: Corporate Finance and the Role of Venture Capital Financing Alternative Sources of Finance TABLE OF CONTENTS 1.1 Short-Term Debt (Short-Term Loans, Line of

### VISA. Classic. Credit Card. Agreement and Disclosure Statement. Classic. Federally insured by NCUA

Classic The Partnership FCU MAILING ADDRESS For ALL correspondence, deposits & loan payments PO Box 18539 Washington DC 20036-8539 VISA Classic Credit Card Member Services & Loans Audio Response ADVANTAGE

### USING FINANCIAL CALCULATORS

lwww.wiley.com/col APPEDIX C USIG FIACIAL CALCULATORS OBJECTIVE 1 Use a financial calculator to solve time value of money problems. Illustration C-1 Financial Calculator Keys Business professionals, once

### CHAPTER 3 THE LOANABLE FUNDS MODEL

CHAPTER 3 THE LOANABLE FUNDS MODEL The next model in our series is called the Loanable Funds Model. This is a model of interest rate determination. It allows us to explore the causes of rising and falling

### Credit Cards, Loans, and Debt

Credit Cards, Loans, and Debt 1 CREDIT CARDS, LOANS, AND DEBT PRE-READING QUESTIONS 1. Do you have any credit cards? Which ones? 2. How often do you use your credit cards? What do you buy with them? 3.

### Purpose EL-773A HP-10B BA-II PLUS Clear memory 0 n registers

D-How to Use a Financial Calculator* Most personal finance decisions involve calculations of the time value of money. Three methods are used to compute this value: time value of money tables (such as those

### Inflation. Chapter 8. 8.1 Money Supply and Demand

Chapter 8 Inflation This chapter examines the causes and consequences of inflation. Sections 8.1 and 8.2 relate inflation to money supply and demand. Although the presentation differs somewhat from that

### Economics of Traditional Planning Methods

Economics of Traditional Planning Methods 1.0 Introduction These notes are partly adaptations of information from four sources in the bibliography [1], [2], [3, ch. 5], with some information obtained from

### Practice Problems on Current Account

Practice Problems on Current Account 1- List de categories of credit items and debit items that appear in a country s current account. What is the current account balance? What is the relationship between

### Chapter 6. Discounted Cash Flow Valuation. Key Concepts and Skills. Multiple Cash Flows Future Value Example 6.1. Answer 6.1

Chapter 6 Key Concepts and Skills Be able to compute: the future value of multiple cash flows the present value of multiple cash flows the future and present value of annuities Discounted Cash Flow Valuation

### Basic Financial Tools: A Review. 3 n 1 n. PV FV 1 FV 2 FV 3 FV n 1 FV n 1 (1 i)

Chapter 28 Basic Financial Tools: A Review The building blocks of finance include the time value of money, risk and its relationship with rates of return, and stock and bond valuation models. These topics

### Remember the Interest

STUDENT MODULE 7.1 BORROWING MONEY PAGE 1 Standard 7: The student will identify the procedures and analyze the responsibilities of borrowing money. Remember the Interest Mom, it is not fair. If Bill can

### Chapter 18. Web Extension: Percentage Cost Analysis, Leasing Feedback, and Leveraged Leases

Chapter 18 Web Extension: Percentage Cost Analysis, Leasing Feedback, and Leveraged Leases Percentage Cost Analysis Anderson s lease-versus-purchase decision from Chapter 18 could also be analyzed using

### Module 5: Interest concepts of future and present value

file:///f /Courses/2010-11/CGA/FA2/06course/m05intro.htm Module 5: Interest concepts of future and present value Overview In this module, you learn about the fundamental concepts of interest and present

### CHAPTER 26. Working Capital Management. Chapter Synopsis

CHAPTER 26 Working Capital Management Chapter Synopsis 26.1 Overview of Working Capital Any reduction in working capital requirements generates a positive free cash flow that the firm can distribute immediately

Chapter 6 Interest rates and Bond Valuation 2012 Pearson Prentice Hall. All rights reserved. 4-1 Interest Rates and Required Returns: Interest Rate Fundamentals The interest rate is usually applied to

### Solutions to Practice Questions (Bonds)

Fuqua Business School Duke University FIN 350 Global Financial Management Solutions to Practice Questions (Bonds). These practice questions are a suplement to the problem sets, and are intended for those

Answers to Review Questions 1. The real rate of interest is the rate that creates an equilibrium between the supply of savings and demand for investment funds. The nominal rate of interest is the actual

### The Time Value of Money (contd.)

The Time Value of Money (contd.) February 11, 2004 Time Value Equivalence Factors (Discrete compounding, discrete payments) Factor Name Factor Notation Formula Cash Flow Diagram Future worth factor (compound

### Chapter 4 Time Value of Money ANSWERS TO END-OF-CHAPTER QUESTIONS

Chapter 4 Time Value of Money ANSWERS TO END-OF-CHAPTER QUESTIONS 4-1 a. PV (present value) is the value today of a future payment, or stream of payments, discounted at the appropriate rate of interest.

### Interest Cost of Money Test - MoneyPower

Interest Cost of Money Test - MoneyPower Multiple Choice Identify the choice that best completes the statement or answers the question. 1. To determine the time value of depositing \$100 in a savings account,

### TVM Applications Chapter

Chapter 6 Time of Money UPS, Walgreens, Costco, American Air, Dreamworks Intel (note 10 page 28) TVM Applications Accounting issue Chapter Notes receivable (long-term receivables) 7 Long-term assets 10

### Present Value and Annuities. Chapter 3 Cont d

Present Value and Annuities Chapter 3 Cont d Present Value Helps us answer the question: What s the value in today s dollars of a sum of money to be received in the future? It lets us strip away the effects

### 1 Interest rates, and risk-free investments

Interest rates, and risk-free investments Copyright c 2005 by Karl Sigman. Interest and compounded interest Suppose that you place x 0 (\$) in an account that offers a fixed (never to change over time)

### Module 8: Current and long-term liabilities

Module 8: Current and long-term liabilities Module 8: Current and long-term liabilities Overview In previous modules, you learned how to account for assets. Assets are what a business uses or sells to

### Time Value of Money. Nature of Interest. appendix. study objectives

2918T_appC_C01-C20.qxd 8/28/08 9:57 PM Page C-1 appendix C Time Value of Money study objectives After studying this appendix, you should be able to: 1 Distinguish between simple and compound interest.

### Cash Flow: Know Its Value Today When Buying, Selling, or Expanding

The Business Library Resource Report #26 Cash Flow: Know Its Value Today When Buying, Selling, or Expanding! Rate of Return Components! Risk and Present Value Analysis! You as Seller, You as Buyer! Today

Sample Examination Questions CHAPTER 6 ACCOUNTING AND THE TIME VALUE OF MONEY MULTIPLE CHOICE Conceptual Answer No. Description d 1. Definition of present value. c 2. Understanding compound interest tables.

### WORKING CAPITAL MANAGEMENT

CHAPTER 9 WORKING CAPITAL MANAGEMENT Working capital is the long term fund required to run the day to day operations of the business. The company starts with cash. It buys raw materials, employs staff

### 13.75% VISA CLASSIC 12.75% VISA GOLD

Account Opening Disclosure Notice regarding the terms of your West Suburban Bank Visa Credit Card account. Interest Rates and Interest Charges Annual Percentage Rate (APR) for Purchases 13.75% VISA CLASSIC