Credit Transactions

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
https://www.investopedia.com/terms/f/five-c-credit.asp
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

• Debit cards are plastic cards with electronic information, that

look very similar to credit cards, that you can use to take money
out against your checking account.
• When you swipe your debit card remember that the money is
taken immediately from your checking account.
Risks of Credit
• Interest
• Overspending
• Debt
• Identity Theft
Responsibilities of Credit
• Know the real cost of debt.
• Don’t use credit to live beyond your means.
• It is all about the details…read the fine print!
• Pay as much as you can, as early as you can.
Warning Signs of Credit Abuse

• 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.

 Loans for other durable goods

Consumer loans to finance other kinds of costly durable goods, such as
furniture, home appliances, TVs, home computers, recreational vehicles, and
even small airplanes and mobile homes.
Different Types of Loans
 Education Loans
Loans to finance college education, graduate studies, and special
government-subsidized loan programs.
 Personal Loans
These loans are typically used for nondurable expenditures, such an
expensive European vacation or to cover temporary cash shortfalls.
 Consolidation Loans
This type of loan is used to straighten out an unhealthy credit situation
Different Types of Loans
 Single-Payment Loan
A loan made for a specified period, at the end of which payment is due in full.
 Installment Loan
A loan that is repaid in a series of fixed, scheduled payments rather than in
one lump sum.
 Fixed-rate Loan
The interest rate charged and the monthly payment remain the same over
the life of the obligation.
Different Types of Loans
 Variable-rate Loan
This is made with an increasing frequency, especially on longer-term
installment loan.
END OF MODULE 4
MODULE 5
TOPIC OUTLINE
•Importance of Time
•Types of Interest
•Simple Interest
•Compound Interest
•Future Value / Present Value
•Lump Sum
•Annuities
SIMPLE INTEREST vs COMPOUND
INTEREST
How it works?
•Simple interest is interest on the principal amount.
•Compound interest is when your principal and any
earned interest both earn interest.
 SI = P0(r)(t)
SI: Simple Interest
P0: Deposit today (t=0), Principal
r: Interest Rate per Period
t: Number of Time Periods
• Assume that you deposit ₱1,000 in an account earning 7%
simple interest for 2 years. What is the accumulated
interest at the end of the 2nd year?

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.

After Simple Interest Compound Interest

1 year 110 110

2 years 120 121
3 years 130 133
4 years 140 146
5 years 150 161
10 years 200 259
20 years 300 672
50 years 600 11,739
 Try these:
1. P750 at 6.5% for 5 years compounded annually
2. P25,000 at 8% for 3 years compounded annually
3. P680 at 5.5% for 1.5 years compounded monthly
4. P1500 at 4.5% for 2 years compounded monthly
 Time Lines
0 1 2 3
i%

CF0 CF1 CF2 CF3

• Show the timing of cash flows.

• Tick marks occur at the end of periods, so Time 0 is today; Time 1
is the end of the first period (year, month, etc.) or the beginning
of the second period.
Time line for a P100 lump sum due at the end of
Year 2.

0 1 2 Year
i%

100
Time line for an ordinary annuity of P100
for 3 years

0 1 2 3
I%

100 100 100

Time line for uneven CFs

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.

•The VALUE TODAY!!

 FUTURE VALUE
•is the value at some future time of a present
amount of money, or a series of payments,
evaluated at a given interest rate.

•Principal plus Accumulated Interest

 What is the future value (FV) of an initial P100 after 3
years, if i/yr = 10%?

• Finding the FV of a cash flow or series of cash flows when

compound interest is applied is called compounding.

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%?

• Finding the PV of a cash flow or series of cash flows when

compound interest is applied is called discounting (the reverse of
compounding).
• The PV shows the value of cash flows in terms of today’s
purchasing power.

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

Therefore, you have to deposit P75.13 today to have P100

after 3 years.
 Ordinary Annuity vs.
Annuity Due

Ordinary Annuity
0 1 2 3
I%

P100=PMT P100 P100

Annuity Due
0 1 2 3
I%

P100=PMT P100 P100

67
 Parts of an Annuity

(Ordinary Annuity)
End of End of End of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today
Equal Cash Flows
Each 1 Period Apart
Parts of an Annuity

(Annuity Due)
Beginning of Beginning of Beginning of
Period 1 Period 2 Period 3

0 1 2 3

$100 $100 $100

Today Equal Cash Flows
Each 1 Period Apart
 Overview of an
Ordinary Annuity -- FVA
Cash flows occur at the end of the period
0 1 2 n n+1
i% . . .

R R R
R = Periodic
Cash Flow

FVAn = R(1+i)n-1 + R(1+i)n-2 + ... + FVAn

R(1+i)1 + R(1+i)0
 Example of an
Ordinary Annuity -- FVA
Cash flows occur at the end of the period
0 1 2 3 4
7%
P1,000 P1,000 P1,000
P1,070
P1,145
FVA3 = P1,000(1.07)2 + P1,000(1.07)1
+ P1,000(1.07)0 P3,215 = FVA3
= P1,145 + P1,070 + P1,000 = P3,215
What’s the FV of a 3-year ordinary annuity of P100 at
10%?

0 1 2 3
10%

100 100 100

110
121
FV = 331
72
FV Annuity Formula
The future value of an annuity with N periods and an interest rate of I
can be found with the following formula:

(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%

100 100 100

90.91
82.64
75.13
248.69 = PV 74
PV Annuity Formula

The present value of an annuity with N periods and an interest rate of I

can be found with the following formula:

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

FVADn = R(1+i)n + R(1+i)n-1 + ... + FVADn

R(1+i)2 + R(1+i)1 = FVAn (1+i)
 Example of an
Annuity Due -- FVAD
Cash flows occur at the beginning of the period
0 1 2 3 4
7%
P1,000 P1,000 P1,000 P1,070

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%

100 100 100

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%

100 300 300 -50

90.91
247.93
225.39
-34.15
530.08 = PV 83