Analyzing Credit. Objective: You will use the Daily average method to determine the balance of a credit card, and will calculate the Effective Annual.

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Presentation transcript:

Analyzing Credit

Objective: You will use the Daily average method to determine the balance of a credit card, and will calculate the Effective Annual Rate, and the Daily Periodic Rate that will be used to help calculate the balance of the credit card. You will use the Daily average method to determine the balance of a credit card, and will calculate the Effective Annual Rate, and the Daily Periodic Rate that will be used to help calculate the balance of the credit card.

Average Daily Balance Method A credit card statement usually contains information like minimum payment, billing period, APR, and a list of transactions, and the last payment. A credit card statement usually contains information like minimum payment, billing period, APR, and a list of transactions, and the last payment. But, how is the new balance calculated each month? How is the minimum payment calculated? How much interest do we really pay? If we make the minimum payment how long will it take to completely pay the credit card? But, how is the new balance calculated each month? How is the minimum payment calculated? How much interest do we really pay? If we make the minimum payment how long will it take to completely pay the credit card?

Example: Given the following credit card statement information; answer the questions. Given the following credit card statement information; answer the questions. Billing cycle: 03/Oct/2014 – 03/Nov/2014 Billing cycle: 03/Oct/2014 – 03/Nov/2014 Previous Balance: $ 4, Previous Balance: $ 4, Last payment: $ Last payment: $ APR 16.5% (compounded monthly) APR 16.5% (compounded monthly)

Transactions: Date: Description: Amount: 05/Oct/2014 Walmart $ /Oct/2014 Gas $ /Oct/2014 Payment $ /Oct/2014 Chocolates $ Find the average daily balance.

To find the average daily balance complete the following table: sum of daily balance Average daily balance = = / 31 = = # days in billing cycle Transaction DateBalance Due $Number of days with same balance Sum Daily Balances 10/ * 2 = / * 6 = / * 6 = / – * 2 = / * 15 =

Find the new balance. Find the new balance. (to find the new balance, find the finance charge first using the daily periodic rate) I = P∙r∙t I = Interest I = Interest P = Principal P = Principal (In this case it means the average daily balance) r = Interest rate r = Interest rate (daily periodic rate) t = is the time t = is the time (Usually one month) I = ( )(r)(1) R =.1781/12 =.0148 I = ( )(.0148)(1) I = 68.66

We can finally find the new balance: We can finally find the new balance: New balance = = Find the minimum payment, assuming the minimum payment is 3.5% of the new balance ∙.035 = Find the EAR. (The actual interest rate you pay is called the EAR) EAR = (1 + (apr/n) n – 1 EAR = (1 + (.165/12) 12 – 1 =.17806

How long would it take to fully pay the credit card is no more charges are added to the card, and paying just the minimum payment?(Hint: use the TVM Solver) 36.54/12 = Approximately three years.