CREDIT
CREDIT
OUTLINE
NATURE OF CREDIT
BASES AND SOURCES
CLASSIFICATIONS OF CREDIT
CREDIT
INSTRUMENTS
Credit
•A legal agreement to receive cash,
goods, or services now and pay for them
in the future.
WHY USE CREDIT?
•Avoid paying cash for large outlays
•Meet financial emergency
•Convenience
•Investment Purposes
SOURCE OF CREDIT
Individual Money Lenders
◦ Lend his surplus to those in need so that it will bring
income to him
Retail Stores
Pawnshops
Commercial Banks
◦ Engage in the grant of loans not only to
businessmen, but also to individuals for personal
purposes
SOURCE OF CREDIT
Savings Bank
◦ Financial institution whose primary purpose is accepting
savings deposits and paying interest on those deposits
Rural Bank
◦ Financial institutions that help rationalize the
developing regions or country to finance their needs
specially the projects regarding agricultural progress
SOURCE OF CREDIT
Development banks
◦ Financial institutions dedicated to fund new and upcoming
businesses and economic development projects by providing
equity capital or loan.
Investment Bank
◦ Financial institutions that provide large amounts of long-
term fixed capital, primarily established firms. It generally
takes an equity stake in the borrower firm to exercise some
influence on its direction and operations
SOURCE OF CREDIT
Savings and Loan Associations
◦ Associations that accept savings at interest and lend money to
savers chiefly for home mortgage loans and may other related
services.
Finance Companies
◦ Installment Sales Finance Companies
◦ Consumer Finance Companies
◦ Commercial Finance Companies
SOURCE OF CREDIT
Credit Unions
◦ Corporate organizations which lend savings of members to
some of the members of the group
Insurance Companies
◦ Issues insurance contracts with those who wish to provide for
such contingencies like death or fire. They receive premiums
and pay out money on the occurrence of the particular
contingencies
SOURCE OF CREDIT
•Other Sources
• Social Security System
• Government Service Insurance System
• PAG – IBIG
• Other Government Agencies
C’s of Credit
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https://www.navyfederal.org/resources/articles/small-business/the-5-
cs-of-
credit.html#:~:text=Understanding%20the%20%E2%80%9CFive%20C's
%20of,lenders%20as%20a%20potential%20borrower.
CREDIT POLICIES
• May vary from one business to another
•Credit Terms
• Terms and conditions which credit is granted.
• Credit Periods
• Amount of time within which the customer is expected to
remit payment in part or in full
CREDIT POLICIES
•Credit Limit
• A limit with respect to the amount or value that a
customer can obtain from the source.
https://www.accountingtools.com/articles/2018/1/20/cred
it-policy
How to establish credit
• Bank accounts
• Employment history
• Residence history
• Utilities in borrower’s name
• Department store or gas credit card
How to maintain a good credit rating
• Establish a good credit history.
• Pay monthly balance on time.
• Use credit cards sparingly and stay within the limit.
• Do not move balance to other cards.
• Check credit report regularly.
Credit score: https://www.creditinfo.gov.ph/vision-and-mission
https://www.moneymax.ph/personal-finance/articles/credit-score-
philippines#:~:text=A%20credit%20score%20in%20the,assess%20a%20borro
wer's%20credit%20risk.
https://www.creditinfo.gov.ph/yahoo-news-credit-report-vs-credit-score-
understanding-difference
Types of Credit
• Credit Cards
• Installment Loans
• Service Credit
• Revolving Credit
• Student Loans
• IOU
• Single Payment Credit
https://corporatefinanceinstitute.com/resources/knowled
ge/credit/types-of-credit/
Credit Cards
• Plastic cards with electronic information that can be
used by the holder to make purchases or obtain cash
advances using a line of credit made available by the
card-issuing financial institution.
Installment Loan
• A loan in which the amount of payment and the number of payments
are predetermined, such as an automobile loan.
• Fixed payment
• Set period of time
• Set or varying interest rates
• Examples: Car loans and mortgages
Revolving Credit
• A type of credit that does NOT have a fixed number of payments, such
as a credit card.
• No stated payoff time
• Limit to credit
• Minimum monthly payments
• Finance charges
• Example: credit card
Service Credit
• A member's earned service, prior service, and purchased service.
Student Loans
• Loans offered to students to assist in payment of the costs of
professional education. These loans usually charger lower interest
than other loans, and are also usually issued by the government.
• Allows a person to finance their education and defer payments
until after graduation.
Debit Cards
• Delinquent Payments
• Default Notices
• Repossession
• Collection Agencies
• Judgment Lien
• Garnishment
Financial Consequences of Debt
• Overspending
• Paying high interest rates
• Lowers credit score
• Difficulty getting a loan
Credit Cards and other Types of Open Account
Credit
Open Account Credit
It is a form of credit extended to a consumer in advance of any transactions.
Credit Limit
A specified amount beyond which a customer may not borrow or
purchase on credit.
2 Broadly Defined Sources
1. Financial Institutions
2. Retail stores or merchants
Bank Credit Cards
Credit Statement
A monthly statement summarizing the transactions, interest charges, fees,
and payments in a consumer credit account.
Bank Credit Card
A credit card issued by a bank or other financial institution that allows the
holder to charge purchases at any establishment that accepts it.
Bank Credit Cards
Line of Credit
The maximum amount of credit a customer is allowed to have outstanding at
any point in time.
Cash Advance
A loan that can be obtained by a bank credit cardholder at any participating
bank or financial institution.
Base Rate
The rate of interest a bank uses a base for loans to individuals and small to
midsize businesses.
Grace Period
A short period of time usually 20 to 30 days, during which you can pay your
credit card bill in full and not incur any interest charges.
Bank Credit Cards
Balance Transfer
A program that enables cardholders to readily transfer credit balances from
one card to another.
Advantages of balance transfer
1. The convenience of being able to consolidate credit card payments
2. The potential savings in interest that accompanies the transfer, since such
deals usually come with very low rates (introductory).
Choosing a Credit Card (Factors)
• Spending Habits
• Types of Interest Rate
• Credit Limit
• Fees and Penalties
• Balance Computation Method – Average Daily Balance
• Incentives
Behavioral Biases and Credit Card Use
• Be wary of the minimum payment that appears on your monthly
credit card statement. There is evidence that people focus unduly or
anchor on the stated minimum payment and as result, pay a lower
amount than they would otherwise. And the effect is obvious – they
end up paying more interest.
• Another tendency is to fall victim or “mental accounting,” which
refers to inappropriately viewing interdependent decisions as
independent.
Consumer Loans
Formal, negotiated contracts that specify both the terms for
borrowing and the repayment schedule.
One-shot transactions made for specific purposes
Used mainly to borrow money to pay for big-ticket items.
Loans made for specific purposes using formally negotiated contracts
that specify the borrowing terms and repayment.
Different Types of Loans
Auto Loans
This loan is secured with the auto, meaning that the vehicle serves as
collateral for the loan and can be repossessed by the lender should the buyer
fail to make payments.
Collateral is an item of value used to secure the principal portion of a loan.
SI = P0(r)(t) =
₱1,000 (.07)(2) = ₱140
nt
r
A p 1
n
A— Total amount
p — Principal
r — Interest Rate
n — number of compounding periods
t — time in years
Example: P 100 is invested at 10% interest compounded
yearly for 6 years
You begin with P100 invested at 10% annual interest.
0 1 2 Year
i%
100
Time line for an ordinary annuity of P100
for 3 years
0 1 2 3
I%
0 1 2 3
I%
-50 100 75 50
PRESENT VALUE
•is the current value of a future amount of money, or
a series of payments, evaluated at a given interest
rate.
0 1 2 3
10%
100 FV = ?
Solving for FV:
The arithmetic method
• After 1 year:
• FV1 = PV ( 1 + i ) = P100 (1.10)
= P110.00
• After 2 years:
• FV2 = PV ( 1 + i )2 = P100 (1.10)2
=P121.00
• After 3 years:
• FV3 = PV ( 1 + i )3 = P100 (1.10)3
=P133.10
• After n years (general case):
• FVn = PV ( 1 + i )n
Solving for Future Value
FVn = PV ( 1 + i ) n
Julie wants to know how large her deposit of P10,000 today will become at a
compound annual interest rate of 10% for 5 years.
0 1 2 3 4 5
10%
P10,000
FV5
What is the present value (PV) of P100 due in 3 years, if
i/YR = 10%?
0 1 2 3
10%
PV = ? 100
PV Formula (derived from FV formula)
PV = FVn / ( 1 + i ) n
SOLUTION:
• PV = FVn / ( 1 + i )n
• PV = FV3 / ( 1 + i )3
= P100 / ( 1.10 )3
= P75.13
Ordinary Annuity
0 1 2 3
I%
(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3
0 1 2 3
(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3
0 1 2 3
R R R
R = Periodic
Cash Flow
0 1 2 3
10%
(1+i)n-1
= PMT
i
(1+0.10)3-1
= P100 = P331
0.10
73
What’s the PV of this ordinary annuity?
0 1 2 3
10%
1 1
= PMT −
I I (1+I)N
1 1
= P100 − = P248.69
0.1 0.1(1+0.1)3
75
Overview View of an
Annuity Due -- FVAD
Cash flows occur at the beginning of the period
0 1 2 3 n-1 n
. . .
i%
R R R R R
P1,145
P1,225
FVAD3 = P1,000(1.07)3 + P1,000(1.07)2
+ P1,000(1.07)1
P3,440 = FVAD3
= P1,225 + P1,145 + P1,070 = P3,440
Find the FV and PV if the
annuity were an annuity due.
0 1 2 3
10%
78
PV and FV of Annuity Due
vs. Ordinary Annuity
PV of annuity due:
= (PV of ordinary annuity) (1+i)
= (P248.69) (1+ 0.10) = P273.56
79
PV and FV of Annuity Due
vs. Ordinary Annuity
FV of annuity due:
= (FV of ordinary annuity) (1+i)
= (P331.00) (1+ 0.10) = P364.10
80
EXAMPLE:
Scenario Solution
• Want to retire in 35 years
• Deposit (invest) P2,500 year into a
fund (which returns 12.1% annually) Pmt = P2,500
• How much will you have to retire on N= 35
in 35 years? i = 12.1%
• How much cash did you have to FV = ? = P1,104,853
outlay in total to accumulate that
much?
P2500/yr x 35 yrs = P87,500 total
cash outlay
EXAMPLE
Scenario Solution
• Want to retire with you in 35 years,
but is ski bum & fails to save his 1st Pmt = P2500
15 years N= 20
• Deposit (invest) $2500 year into an i = 12.1%
S&P 500 Index fund (which returns FV = ? = P182,231
12.1% annually)
• How much will you have to retire on P2500/yr x 20 yrs = P50,000 total
in 35 years? cash outlay
• How much cash did you have to P1,104,853 vs. P182,231
outlay in total to accumulate that
much?
What is the PV of this
uneven cash flow stream?
0 1 2 3 4
10%