Question 1

Explain the purpose of a convertible loan.

Accepted Answer

A convertible loan has the potential of overcoming the disadvantages (to the borrower) of variable-rate and fixed-rate loans.The borrower can enjoy the lower cost of a variable-rate loan while still being able to lock in the savings of a fixed-rate loan when a low interest rate comes along.

Question 2

A ________ is tied to a market interest rate, such as the prime rate or the six-month Treasury bill rate.

Accepted Answer

A variable-rate loan is tied to a market interest rate, which means that the interest rate can go up or down based on changes in that market interest rate. The other options (A) prime-rate loan, (B) convertible-rate loan, and (C) flexible-rate loan do not necessarily have a direct tie to a market interest rate.

Question 3

What are the risks to the borrower with adjustable-rate loans?

Accepted Answer

The risk of adjustable-rate loans is that the market interest rates may increase during the term of the loan, which will result in higher monthly payments. This can make it harder to budget for loan payments, especially if the increase is significant. While it is possible that during times of inflation your salary may increase, it is not a guaranteed outcome, and therefore not a reliable factor to base your decision on.

Question 4

Variable-rate loans tied to long-term rates expose you to more risk of rate changes than variable-rate loans tied to short-term rates.

Accepted Answer

Variable-rate loans tied to short-term rates are generally more volatile and expose you to more risk of rate changes because short-term interest rates can fluctuate more frequently and sharply than long-term rates.

Question 5

A(n) ________ loan calls for the repayment of both the interest and the principal at regular intervals and is commonly referred to as loan amortization.

Accepted Answer

An installment loan calls for the repayment of both the interest and the principal at regular intervals, typically in equal payments over a set period of time. This repayment schedule is commonly referred to as loan amortization. Term loans also require repayment of both interest and principal, but they may have different repayment structures such as balloon payments. Simple interest loans only require the repayment of the interest that accrues on the principal balance, with the principal typically due in one lump sum at the end of the loan term. Personal loans can be any type of loan (including installment loans), but the term "personal loan" typically refers to unsecured loans used for personal expenses.

Question 6

Unsecured loans are generally less risky to lenders than secured loans. Therefore secured loans typically charge a higher APR than unsecured loans.

Accepted Answer

This statement is incorrect. Since unsecured loans are not backed by collateral, they are riskier for lenders, resulting in higher interest rates and APRs for borrowers. Secured loans, on the other hand, have collateral (such as a car or house) to back them up, making them less risky for lenders and therefore cheaper in terms of interest rates and APRs.

Question 7

Defaulting on a secured loan may lead to the collateral being repossessed.

Accepted Answer

If a borrower defaults on a secured loan, the lender has the right to seize the collateral and sell it to recover their losses. Therefore, defaulting on a secured loan could lead to repossession of the collateral.

Question 8

Bridge loans provide short-term funding until longer-term or additional financing is found.

Accepted Answer

Bridge loans are designed to bridge the gap between the immediate need for financing and the availability of longer-term or additional financing. They are typically short-term loans intended to provide temporary funding for a specific purpose, such as purchasing real estate or funding a business project.

Question 9

A balloon loan calls for repayment of both interest and principal at regular intervals, with the payment levels set so that the loan expires at a preset date.

Accepted Answer

A balloon loan typically involves relatively small payments for a certain period of time followed by a lump sum payment for the remaining amount of the principal at a preset date. Regular payments may only cover interest or a small portion of the principal.

Question 10

An acceleration clause states that if you default on a secured loan, not only can the lender repossess whatever is secured, but if the sale of the asset does not cover what you owe, you can also be billed for the difference.

Accepted Answer

The answer of An acceleration clause states that if you...

Question 11

Which of the following characterize secured loans?

Accepted Answer

All of the above options characterize secured loans.

Question 12

If your before-tax cost of a home equity loan is twelve percent and you are in the thirty percent marginal tax bracket, your after-tax cost of the home equity loan is nine percent.

Accepted Answer

The after-tax cost of a loan is calculated by multiplying the interest rate by (1 - tax rate). In this case, 12% * (1 - 0.30) = 8.4%, not 9%.

Question 13

Variable-rate loans

Accepted Answer

Variable-rate loans typically have rate caps that limit how much the rate can increase or decrease, making them a more stable option than if they constantly adjusted frequently. While variable-rate loans may not always be the best choice compared to fixed-rate loans, they can be beneficial in certain situations.

Question 14

You are considering building a new deck on your home, what factors should you consider when deciding whether to borrow the money or take the money out of your savings account?

Accepted Answer

When deciding whether to borrow the money or take the money out of your savings account, it is important to consider both the after-tax return on your savings and the impact the savings withdrawal will have on your liquidity. Comparing the after-tax APR on the loan with the after-tax return on your savings will help you determine which option is more cost-effective. However, you should also consider the impact of withdrawing money from your savings on your overall financial situation, such as reducing your emergency fund or affecting your ability to pay for other expenses. Therefore, both options A and C are important factors to consider when making this decision.

Question 15

Alice has fallen behind on her signature loan. She recently received a notice from the lender that her wages were going to be garnished to pay off the debt. What is the loan clause that allows the lender to take this action against Alice because she was in default?

Accepted Answer

The answer of Alice has fallen behind on her signature...

Question 16

What is the loan clause stating that if you default on a secured loan, the lender can repossess whatever is secured, as well as bill you for the difference if that repossession does not cover what you owe?

Accepted Answer

The clause being described is the deficiency payments clause, which allows the lender to bill the borrower for the difference if the repossession of the secured item(s) does not cover what is owed on the loan. This clause provides the lender with some protection against the risk of default.

Question 17

A recourse clause defines whatever actions a lender can take to recover money from you in case you default on the loan.

Accepted Answer

A recourse clause does define the actions a lender can take to recover money from a borrower in case of default.

Question 18

A short-term loan that provides funding until a longer-term loan can be secured is called a(n)

Accepted Answer

A bridge loan is specifically designed to provide temporary funding until a longer-term loan can be secured. This type of loan is commonly used by real estate investors who need financing to purchase a property but have not yet secured permanent financing. Bridge loans are typically short-term and have higher interest rates and fees compared to traditional loans.

Question 19

Which of the following is the correct formula to calculate the after-tax cost of a home equity loan?

Accepted Answer

The after-tax cost of a loan is calculated by reducing the before-tax cost by the tax savings, which is achieved by multiplying the before-tax cost by (1 - marginal tax rate).

Question 20

Name the advantages and disadvantages of an unsecured loan.

Accepted Answer

The answer of Name the advantages and disadvantages of an...

Quiz 7: Using Consumer Loans: The Role of Planned Borrowing