Credit & Debt Overview

Podcast

Play an AI-generated podcast conversation about this lesson

Questions and Answers

What distinguishes secured loans from unsecured loans?

Secured loans can be converted into revolving credit, whereas unsecured cannot.

Secured loans are typically short-term, while unsecured loans are long-term.

Secured loans generally have variable interest rates, while unsecured loans always have fixed rates.

Secured loans require collateral, while unsecured loans do not. (correct)

Which of the following statements correctly describes fixed payment loans?

They are only available for home mortgage purposes.

They have the highest interest rates among all loan types.

They include credit cards and overdraft arrangements.

They require repayment in installments over a specific term. (correct)

Why do banks prefer variable interest rates for loans?

They generally generate higher profits due to fixed payment schedules.

They allow the lender to pass the risk associated with changing market conditions onto the borrower. (correct)

They eliminate hidden fees associated with fixed-rate loans.

They attract more borrowers who are looking for a stable repayment plan.

What is a critical factor that can negatively affect the initial attractiveness of credit cards with interest-free periods?

High upfront fees and hidden costs that are not clearly disclosed. Signup and view all the answers

How can debt be utilized in terms of expenditure?

Debt is commonly used for funding short-term lifestyle consumption. Signup and view all the answers

What is a significant advantage of cash management trusts compared to direct bond purchases?

They provide access to a diverse range of money market securities. Signup and view all the answers

How does a zero-coupon bond differ from a traditional coupon-paying bond?

It does not issue periodic interest payments. Signup and view all the answers

Why might a bond's coupon rate not exactly match the market interest rate?

Changes in economic conditions affect coupon pricing. Signup and view all the answers

What is a common type of zero-coupon bond?

Commercial bills. Signup and view all the answers

What risk is associated with corporate bonds compared to government bonds?

Higher default risk. Signup and view all the answers

What is the formula to calculate the interest earned on a zero-coupon bond?

Interest = F - P Signup and view all the answers

Which factor does NOT influence the pricing of cash management trusts?

Economic sanctions on foreign investments. Signup and view all the answers

What contributes to government bonds being considered low default risk?

Governments can always generate revenue through taxes. Signup and view all the answers

What are the two forms of property investment?

Direct and Indirect Signup and view all the answers

What is a key responsibility of financial advisers to meet fiduciary duty?

To objectively assess the client's relevant circumstances Signup and view all the answers

Which factor does NOT contribute to income risk in direct property investment?

Property depreciation Signup and view all the answers

Which of the following is NOT a type of training that advisers must undergo?

Sales techniques and persuasion skills Signup and view all the answers

Negative gearing occurs when an investor's expenses exceed which of the following?

Income from the investment Signup and view all the answers

Which type of risk is associated with high interest rates affecting property loans?

Interest rate risk Signup and view all the answers

What aspect of advisers' conduct emphasizes a commitment to fairness?

Ensuring clients are treated equally without discrimination Signup and view all the answers

What did the Future of Financial Advice (FOFA) reforms primarily aim to address?

Eliminating conflicted remuneration structures Signup and view all the answers

What is implied when an investor engages in negative gearing?

Assumption of future capital growth Signup and view all the answers

What is a characteristic of indirect property investment?

Can involve Real Estate Investment Trusts (REITs) Signup and view all the answers

Which of the following actions would not demonstrate reasonable care by a financial adviser?

Providing advice based on outdated financial practices Signup and view all the answers

In the context of financial advising, efficiency implies what?

Creating a plan and documentation in a timely manner Signup and view all the answers

Which of the following is NOT a direct risk associated with property investment?

Tax rate changes Signup and view all the answers

What primary duty was established for financial advisers under the reforms for consumer protection?

To act in the best interests of their clients Signup and view all the answers

What annual average increase in property value is required for capital gains to offset negative gearing scenarios?

1.38% Signup and view all the answers

What is a requirement for financial advisers regarding the clients they serve?

Carefully recording all relevant aspects of the client Signup and view all the answers

What is a primary characteristic of Bond ETFs compared to traditional mutual funds?

Bond ETFs are structured to track a bond index passively. Signup and view all the answers

Which statement accurately reflects the Efficient Markets Hypothesis?

All available information is reflected in asset prices at all times. Signup and view all the answers

What can be a result of purchasing high-risk investments with a short time horizon?

Increased likelihood of substantial losses due to volatility. Signup and view all the answers

What is one of the advantages of Bond ETFs that contributes to their increased popularity?

They enable trading throughout the day, unlike mutual funds. Signup and view all the answers

Which aspect reflects a flaw in the assumption about expected returns and risk?

Investing without considering time horizon can lead to unexpected outcomes. Signup and view all the answers

Study Notes

Credit & Debt

Credit is an arrangement where a lender approves a request for funds, while debt arises when the transaction is completed and cash changes hands.
Expected return on investments is directly linked to the associated financial risk.
Credit options include fixed payment loans and revolving credit facilities.
Fixed payment loans involve regular installments and include personal loans, car loans, buy now pay later schemes, and home mortgages.
Revolving credit facilities allow borrowers to access funds up to a specific limit, typically with variable interest rates, and include credit cards, overdraft facilities, and lines of credit.
Variable interest rates are used by banks as they allow them to pass on the risk of changing interest rates to borrowers.
Fixed interest rates provide borrowers with certainty and protection against interest rate fluctuations.
Secured loans require collateral, which is an asset used to secure the loan and mitigates risk for the lender in case of default.
Unsecured loans lack collateral and typically carry higher interest rates as they are considered riskier.
Home loans are secured by the acquired property and often require repayment of principal and interest over a 10 to 30 year period.
Credit cards with interest-free periods can be beneficial but rely heavily on discipline in making timely payments. Beware of hidden costs and upfront fees.

Using Debt for Consumption

Debt can be used to finance lifestyle expenditures.
When using debt for short-term consumption, it is crucial to consider the potential impact on future financial planning.

Adviser’s Best Practice

Financial advisers must have reasonable expertise, exercise reasonable care, objectively assess clients’ circumstances, and prioritize their clients' best interests.
Best practice includes efficiency, honesty, and fairness in their dealings with clients.
Efficiency involves timely delivery of plans and documentation.
Honesty encompasses ethical conduct, adherence to fiduciary principles.
Fairness involves non-discriminatory treatment of clients.

Financial Adviser Competencies & Training

There are three key types of training for financial advisers:
- Investment principles, personal advice formulation, and understanding of business operations.
- Ongoing learning to remain updated on economic trends, financial markets, legislative changes, and regulatory environments.
- Product training provided either by the principal or the issuer, depending on the relationship.
Financial advisers must be adequately supervised by their principals, who provide written directions to guide their actions.

Financial Advice Reforms & Fiduciary Duty

Reforms were enacted to protect individuals seeking financial advice and ensure that financial advisers prioritize their clients' best interests.
This includes the introduction of a statutory fiduciary duty, backed by general law and ethical guidelines, obligating financial advisors to act in the best interest of their clients.
The Future of Financial Advice (FOFA) reform program in 2011 introduced a legal duty within the Corporations Law, effective from July 1, 2013.
FOFA incorporates a ban on conflict-of-interest remuneration structures.

Bond Investments

Valuation of coupon-paying bonds requires consideration of coupon timing and amounts.
The coupon rate is typically close to the market interest rate to attract investors based on expected returns and market demand.
The market interest rate, or yield, fluctuates over time due to factors like economic changes, inflation expectations, and shifts in credit supply and demand.
Government bonds are considered low-default risk due to their ability to print money.
Corporate bonds carry higher risk and potentially higher returns, with some bond issues obtaining a credit rating to improve their creditworthiness.
The outstanding value of non-government bonds in Australia is substantial, representing a significant portion of the value of companies listed on the ASX.

Zero-Coupon Bonds / Pure Discount Securities

Zero-coupon bonds do not make interest payments, only offering a lump-sum face value at maturity.
They are issued at a discount to par, with the interest calculated as the difference between the face value (F) and the purchase price (P).
Common types include commercial bills and treasury notes.

Cash Management Trusts (CMTs)

CMTs address the historical challenges of high minimum investment amounts and lack of diversification in bond investments.
They offer a pool of investors' funds to invest in money market securities of various maturities, enhancing diversification.
CMTs have lower entry requirements than direct bond purchases, making them accessible to smaller investors.
They are managed by professional fund managers who make investment decisions based on factors like interest rates, credit quality, and maturities.
CMTs also offer daily interest or dividends, allowing investors to withdraw or reinvest for added flexibility and income.
They provide high liquidity, allowing investors to easily access their funds.

Property Investments

Property investments can be pursued through direct or indirect methods.
Direct property investments include residential, commercial, or land holdings, while indirect investments involve options like property trusts, index funds, and ETFs.
Property investment aims to generate returns through rental income and potential capital gains.
Residential property is also often acquired for personal occupation, serving as a family home.

Direct Property Investment Risks

Income risk exists due to vacancy rates, potential for zero rental income, and the need to repay loan interest and principal.
Property damage necessitates repairs and maintenance costs.
Interest rate risk on borrowed funds could lead to higher loan costs, especially for substantial borrowings.
Market risk arises because capital gains are uncertain and potential losses can occur.
Liquidity risk is prevalent as property is an illiquid asset.
Transaction costs associated with buying and selling properties can be significant.

Negative Gearing

Negative gearing occurs when an investor borrows to acquire an investment property and the deductible costs (interest, rates, fees, maintenance) exceed the rental income generated.
This strategy assumes future capital growth to offset the ongoing losses.
The net return for property investors is calculated by deducting all expenses from the income received, highlighting the concept of net outgoing rather than net tax savings.
It is important to consider the expected capital growth needed to make negative gearing profitable.

Indirect Property Investments

Property companies are listed entities actively involved in property investments.
Property trusts, including Real Estate Investment Trusts (REITs), and property ETFs offer both listed and unlisted options.
Listed Australian REITs (A-REITs) often provide tax-advantaged income, benefiting from capital allowances and tax concessions.
Investors typically have the flexibility to withdraw their funds from property trusts and ETFs.

Bond ETFs

Bond ETFs invest in various fixed-income securities like corporate bonds and Treasuries.
They offer greater flexibility, lower costs, intraday trading, diversified exposure to a wide range of bonds, and lower management fees.
While CMTs are actively managed and aim to outperform the market, ETFs typically track a bond index, offering a more passive investment approach.

The Efficient Markets Hypothesis states that markets are efficient, making it impossible for investors to consistently earn abnormal profits through expert stock selection or market timing.
It suggests that all available information is instantly reflected in asset prices, leaving no room for undervaluation or overvaluation.
The EMH implies that the only way to achieve higher returns is by taking on higher risk.

Flaws in EMH

Market inefficiencies can arise, leading to periods of undervaluation or overvaluation, contradicting the EMH's prediction of fully efficient markets.
The expected return on high-risk assets can be volatile, making them susceptible to significant losses in value.
Investing too quickly without considering the appropriate time horizon, especially for short-term objectives, can lead to suboptimal investment decisions.

Investing with a Short Time Horizon

Investors with short time horizons should prioritize low-risk investments to minimize potential losses.

Studying That Suits You

Use AI to generate personalized quizzes and flashcards to suit your learning preferences.

Description

This quiz explores the concepts of credit and debt, including types of loans, interest rates, and the relationship between investment returns and risk. Learn about fixed payment loans and revolving credit facilities, and the importance of collateral in secured loans.