Credit Cards, Excess Debt, and the Time Value of Money: the Parable of the Debt Banan

In: Business and Management

Submitted By yassinealaoui
Words 8853
Pages 36
Credit Cards, Excess Debt, and the Time Value of Money: The Parable of the Debt Banana
Timothy Falcon Crack and Helen Roberts
University of Otago, New Zealand

The parable of the debt banana is an analogy between the accumulation of excess personal debt and the accumulation of excess body weight. We created this parable to grab student attention and to then serve as a springboard for discussion of personal debt, time value of money mathematics, the mechanics of credit cards, personal bankruptcy, moral hazard, ethics, and credit card reform. A follow-up survey in a large class
(453 students; 84% response rate) showed that 92% of students seeing the parable alongside the underlying finance principles said that it grabbed their attention more than if the underlying finance principles alone were presented, and 87% of students said it made an impression upon them that will make them more careful in their future credit card spending habits.
We provide worked examples of credit card use as well as a spreadsheet that lets readers explore these examples and perform sensitivity analysis.

The parable of the debt banana is an analogy between the accumulation of excess personal debt and the accumulation of excess body weight. We created and presented our parable in a compulsory Finance 101 course taken by all business majors. Most students had little or no exposure to the world of finance and many had poor mathematical skills. Both their lack of financial sophistication and their natural body consciousness meant that our simple parable was very well received
(see survey responses in Appendix 1).
In theory, young peoples’ use of credit cards should be part of a plan to gain financial independence and to build a good credit score. The reality, however, is that there are altogether too many stories of young people getting into financial…...

Similar Documents

Time Value for Money

...four years if interest is compounded semiannually? After four years in the savings account with 2% interest on $5000 compounded annually I would have $5412.16 Compounded semiannually $5414.28 You have $10,000 in credit card debt, at a 14% interest rate. When is it beneficial to pay off the debt vs. putting money in a savings account? Explain the pros and cons of either option. By using the site calculater I was able to find that if I had $10,000 in credit card debt with a 14% interest rate it would take me over 27 years to pay off this debt only paying the minimum balance. Also I would pay $11,166.66 in interest charges. If I paid on this debt with a fixed monthly amount ,such as $217, I can have this credit card debt paid off in about 5 and a half years. Paying only $4432.09 in interest charges. Depending on my income I might be able to save alittle and py on my debt. I think that in the end it will be better to pay off my debt. I know that if I have a little extra one week I can put it in my savings account. Also by paying off my debt I will be more creditworthly and be able to get a loan for something I might need such as; a house, a car or repairs on a house or car. Reference:

Words: 428 - Pages: 2

Time Value of Money

...rate. How much will you have at the end of four years if interest is compounded annually at a rate of 2%? How much would you have at the end of four years if interest is compounded semiannually? If you used a lower rate of 2% and compounded annually you would have $ 5,412.16. If you compounded the interest semiannually with the same rate you would have $ 5,414.28. 4. You have $10,000 in credit card debt, at a 14% interest rate. When is it beneficial to pay off the debt vs. putting money in a savings account? Explain the pros and cons of either option. A benefit of paying off the debt is that you will not have to keep paying finance charges. For example a $ 10,000 debt with a 14% interest rate will cost you $ 6,889.60 in interest over the course of a four year term. One benefit to paying these charges if you pay them on time it will help your credit score stay higher. One benefit to putting your money in a savings account is that it is safer there in the account. I would have to say that one of the cons of a savings account is that your money does not build a lot of interest over time....

Words: 385 - Pages: 2

Credit Card Debt

...Proposing a solution to Credit Card Debt Credit cards have become a very familiar feature to our life style that it is difficult to imagine a world functioning without them. Credit cards are the most convenient type of payments. The craze of the credit card industry has affected everyone in the world. That could be why Credit card debt is the cause of over one million bankruptcies each year. The reason is that many people get a credit card without reading the fine print before signing for them. By the time annual fees are added on, along with spending needlessly, payments are missed; your balance has already reached its maximum limit. Also in some cases a Lack of knowledge is likely due to a lack of education about personal finances. Almost all students on college campuses report that they are likely to ask their parents questions about finances. However, 30 percent also say that their parents have not discussed such issues as setting financial goals or the importance of savings with them. Students also aren't learning about money in school. Although 62 percent of students reported that they had been offered a personal finance class, only a third of those offered a class actually took it (Norvilitis p 356). Although we all like to place the blame on the credit cards and the credit card companies we need to keep in mind that the real cause of our financial mess is us. It is usually a pattern of unneeded......

Words: 779 - Pages: 4

An Introduction to Debt Policy and Value

...problem 2, we calculated the total value per share when firm borrows money to repurchase shares. From the calculation below, we can see that total market value of equity declined from 10,000 to 6,700, while total value per share rose from $10 to $11.70. Therefore, as the firm borrows and repurchases shares, the total value of equity declined, but the price per share rose. Assume that all the new debt is used to repurchase shares. Share price = (Total market value of equity + Cash paid out)/ Number of original shares Based on this assumption change, we will go through all the calculations one more time and estimate the impact of this change across the board. The table 5.1 contains various cost of debts based on various capital structures. In this table we estimate value of operations, value of debt, value of equity, stock price, net income and earnings per share of the firm for various capital structures. Our objective here is to identify the optimum capital structure for the firm. {draw:frame} Table 5.1 – Cost of Debt for various Capital Structures We used the Hamada equation to estimate the impact of the financial leverage on beta. This calculation is done in the table 5.2. The leveraged beta is utilized to estimate the true weighted average cost of capital (WACC) for various capital structures. Table 5.2 estimated the cost of equity, leveraged beta, weighted average cost of capital, free cash flow and the value of the assets for......

Words: 545 - Pages: 3

Debt Value

... _______ Case Study corporate finance Case 28 – An Introduction to Debt Policy and Value Case 30 – MCI Communications, Corp.: Capital Structure Theory ____________________________________________________________ _______ Table of Contents Case 28 - An Introduction to Debt Policy and Value 3 Effects of Debt on the Value of the Firm 3 Split of Value between Creditors and Shareholders 4 Source of Value Creation 4 Effects on Value per Share 5 The Benefits of Leveraging for the Shareholders 6 The Macroeconomic Benefit of Debts 7 Koppers Company, Inc. 7 Case 30 – MCI Communications, Corp.: Capital Structure Theory 9 Introduction 9 Cost of Capital 9 Costs of Equity 9 Cost of Debt 10 WACC 10 Scenario Analysis 11 Leverage and Risk – Coverage Ratio 11 Leverage and Earnings – Earnings per Share 12 The Creditor’s Reaction 14 Impact on Financial Flexibility 15 Summary and Concluding Remarks 16 Literature 17 Case 28 - An Introduction to Debt Policy and Value The following case is about the management of the corporate capital structure. In this context, we deal particularly with the questions on debt policy and value. Effects of Debt on the Value of the Firm Borrowing for itself does not create any value. However, borrowing might influence the capital structure of a firm in a way that changes the weighted average costs of capital (WACC) which consequently has effects to the value of the firm, too. However, in reality whether this statement is true......

Words: 5494 - Pages: 22

Time Value of Money

...The Pakistan Credit Rating Agency Limited STRUCTURED FINANCE RATING KARACHI ELECTRIC SUPPLY COMPANY LIMITED APRIL 2012 The Pakistan Credit Rating Agency Limited STRUCTURED FINANCE KARACHI ELECTRIC SUPPLY COMPANY LIMITED REPORT CONTENTS Summary Report Detailed Report:     PAGE 1 2 2 4 7 Rating Profile Instrument Structure Assessment ANNEXURES BoD Profile Standard Rating Scale I II April 2012 STRUCTURED FINANCE The Pakistan Credit Rating Agency Limited RATINGS (APRIL 2012) KARACHI ELECTRIC SUPPLY COMPANY LIMITED [KESC] RATING RATIONALE & KEY DRIVERS  SECURED, RATED, LISTED TFC (I) OF PKR 300MLN TFC (II) OF PKR 1,200MLN TFC (III) OF PKR 500MLN PRELIMINARY AA AA AA TFC (I) Tenor Issue size (PKR mln) Greenshoe option Profit Rate Profit payment Principal repayment TFC (II) TFC (III) 13 months 36 months 60 months 300 13.00% Monthly Bullet 1,200 700 14.75% Quarterly Bullet 500 300 15.50% Quarterly Bullet ANALYSTS Samiya Mukhtar +92 42 35869504 Rana Muhammad Nadeem +92 42 35869504 The rating primarily draws its strength from the security structure of the instrument. This includes, inter alia, first parri passu charge with 1.2x minimum throughput of receivables from specific 250 corporate consumers and first pari passu charge with 1.2x minimum throughput of excess proceeds (after meeting certain pre-agreed financial obligations) entitled to KESC relating...

Words: 9816 - Pages: 40

Money as Debt

...Money as Debt Assignment There are two great mysteries in the world that our lives are dominated by. Love and Money. We have explored and known much about Love and not so much about Money. The belief was that the banks lent out money they were entrusted with by their depositors and that the vast majority of money came from depositors and banks' earnings. However, in fact, money is created everyday by banks, known as private corporations, in the form of mortgages and loans directly from borrowers' promise to repay, that is known as debt. Money is now Debt. In Fractional Reserve System, money is initially created as debt, thus anyone taking a loan from a bank, new money is created. In fact, 95% of all money was created by our pledge of indebtedness. This system dictates the use of 9:1 ratio, in which for every dollar borrowed, nine more times that dollar is lent again, in other words, each new deposit contains a slightly new loan in a decreasing series. "One thing to realize about our fractional reserve banking system is that, like a child's game of musical chairs, as long as the music is playing, there are no losers."- Andrew Gause, Monetary Historian. The overall banking system is a closed loop controlled by Central Bank and supported by active cooperation of the government. The nations became totally dependent on banks as everything and everyone including government signed the pledge voluntarily giving the power to the banker to decide. "Permit me to issue and control the...

Words: 400 - Pages: 2

Credit Card Usage and Debts Among Teenagers

...Credit card usage and debts among teenagers Cummins, Haskell and Jenkins’s research study, “Financial Attitudes and Spending Habits of University Freshmen” published in 2011 in the journal Journal of Economics and Economic Education Research, examines two factors that are associated with college students’ credit card indebtedness. The author states that college students’ buying patterns and financial values affect their credit card indebtedness. Specifically, students with a tendency towards compulsive buying are more likely and those with effective financial management are less likely to hold credit card debts. Depth interview data further illustrate the contexts and causes of overusing credit cards as well as solutions for their debt problem. It sheds light on reasons why college students fall into credit card debt and suggests strategies for helping them use credit cards wisely. In the 2012 SCMP news article entitled, “Students responsible with dollars and Cents”, the writer gives statistical data collected from the survey which is conducted by the Tung Wah Group of Hospitals and the University of Hong Kong. A total of 802 undergraduate students respond to the survey. It indicates that majority of students possess one or more credit cards and one-third accumulate debt. Half of the respondents in this survey know little about credit knowledge which is significantly related to debt levels. The findings suggest that credit education is needed for students to help them......

Words: 476 - Pages: 2

How to Negotiate with Credit Card Companies to Settle Debt

...How to negotiate with credit card companies to settle debt You have done it all to pay off your debt and you are still drowning financially, beside bankruptcy there is still an option. Informing your creditors about your situation and telling them that you have no other option left beside bankruptcy but you want to avoid at all costs. You can ask for a revised payment plan, lower interest rate. You will have to appeal to their desire of getting paid, as faced with the prospect of total loss in case of you declaring bankruptcy they will try to avoid it as much as you do. This sounds like solid good news but it is not a bed of roses, it is painstaking hard work. You will have to make long frequent calls to the bank for them to understand your position. You will need to be consistent and determined with your efforts if you want your bank to make a settlement. Negotiations isn’t easy, but if you follow these steps on how to negotiate with credit card companies to settle debt you will finally get the settlement of your loan that you wanted. 1. The first step is to decide what type of settlement do you want, there are four main types of settlement plans and you can decide which one suit you best depending on your needs. They are described briefly here for your convenience. i) Lump sum settlement: In this plan you can negotiate to pay some amount of the money owed. Usually the payment can be divided into three installments. ii) Workout arrangement: The......

Words: 666 - Pages: 3

Credit Card Debt

...111 December 11, 2014 Final Paper Introduction Credit Card debt and college student debt are problems that must be addressed now. We are seeing to many people suffer from both since they are misinformed and not educated about either. I got my first credit card when I was 18 years old. My parents taught me to be careful with my card and if I wasn’t they would cut me off immediately. Unfortunately people are now getting credit cards earlier and parents are not teaching kids how to use credit cards correctly. According to a study, “50.9% of students had debt before college” (Jones 2005). This means over half of the people entering college already are in some type of debt. Students must be educated before college so we can alleviate the amount of students in debt. Graduating students are “leaving college with $20,402 in education and credit debt” (Robb and Sharpe 2009). This results in people trying to dig themselves out of debt for their whole life. The average student also has “4.25 cards in their name” (Davidson, 2004). This is part of the reason why students are accumulating so much debt since they don’t know how to properly manage credit cards. This is because students have a low degree of financial literacy. This means that students don’t know the true value of money and as a result spend more than they have. We can see this by the amount students are using their credit cards. Not only are students getting in debt, but it is also having social impacts. The social......

Words: 1804 - Pages: 8

Analysis of Credit Card Debt

...Analysis of credit card debt By: Corrine Owens M3A2 9/15/15 Analysis of credit card debt pg.1 Based upon a balance of 5,270.00 on an APR of 15.53% the calculation is as follows per US BANK: $256.85 per month will pay off your credit card in 24 months. To pay off your credit card balance of $5,270 in 24 months you need to pay $256.85 per month. This includes your additional monthly purchases of $0 and your major purchases. This assumes no additional charges such as late fees. If you keep your monthly payment at $25 it will take more than 360 months(US BANK,2015). Results Summary | Current balance | $5,270 | Current monthly payment | $25 | Monthly charges | $0 | Major purchase 1 | $0 in 0 month(s) | Major purchase 2 | $0 in 0 month(s) | Annual fee | $0 | Interest rate (APR) | 15.53% Pg.2 | Payment required to meet goal of 24 months is $256.85. | Keeping your monthly payment at $25 will take more than 360 months. | | | Because most credit card companies require individuals to pay at least 2% of their balance due, on a balance of...

Words: 1116 - Pages: 5

Credit Card Debt

...Credit Card Company's Marketing to College Students Credit Card Company's Marketing to College Students The credit card companies marketing their products to college students on campus leads to debt, money management, and unnecessary stress. Ultimately, when they first obtain a credit card they feel some sense of empowerment. Most young adults have typically never had the responsibility of paying bills and managing money compared to an older mature adult. College students should be focused more on receiving their education than dodging creditors on campus looking to inflate their sign up numbers. Getting a credit card too soon can lead to problems down the road. Credit “is no longer considered an earned privilege. It’s now considered a social entitlement and the screening criterion for applicants is weak” (Manning, 2001, p. 157). So a student just signed up for a shiny new piece of plastic with a low to fair credit limit and a very high interest rate because they are considered high risk. If they do not work or have any others sources of income, they can find the trap of debt before they know it. Once the debt piles up, it becomes very hard to recover with no job and no plan in hand. Manning (2001) explains “Credit card companies encourage fantasies of easy money because students are so profitable. Teens have financial naiveté, high material expectations and responsiveness to relatively low-cost marketing campaigns, high potential earnings, and future demand for......

Words: 818 - Pages: 4

Lasa 1 Credit Card Debt

...Analysis of Credit Card Debt Darlene Rivas Argosy University MAT 109 Professor Morris October 21, 2015 Abstract Our best intentions are to provide and ensure that potential credit card consumers are taking a double look and thinking twice before signing a contract from a banker. There are fine prints in contracts, in which inexperienced consumers miss nearly all the time. In this report, consumers will learn how to formulate the annual percentage rate, determine their monthly payment and principal, interest fees that will be applied their monthly payment. There are useful tips to ensure they will be educated in making the right decisions, and determining which plan works out best for them to prevent further debt. Analysis of Credit Card Debt If a consumer has a credit card with a balance of $5,270.00 with an annual interest rate of 15.53%, they will have to pay a minimum of 2% to the entire balance. Their monthly fee will be $105.40 towards the credit card. Furthermore, $68.20 would go towards the interest, and $37.20 towards the principal. This means that it will take a consumer over 11 years to pay off the principal off to the credit card balance. Assuming that the interest is on a fixed rate, and will not fluctuate throughout the course of time, a consumer would have to contribute an additional $100 towards the principal for the next 5 years, in order to cut the time in half towards paying off the balance. Darlene currently has a Capital One credit......

Words: 1080 - Pages: 5

Using a Credit Card Leads Most Americans Into Debt.

...My thesis will be covering why I think that American’s should not use credit cards and the consequences that come along with being in such an industry. It will be covering the regulation’s benefits many companies have and the don’ts on having them and what will come along with accepting them. I will talk about hidden fees along with annual fees and all the fine print that everyone seems to not read. I will also touch basis on how one can stay out of debt in the paying process even though everyone wants a credit card some should not have one due to mismanaging of their incoming funds period. Writing on how my views on the credit card industry and why it is targeting the venerable and the young college students and people they know need credit and give it to them at a APR that is out of this world keeping them bound and in debt to them. My views on the credit card industry is that if they know that a person has more outgo then income then they should not extend the credit. Some people are so desperate and they know it that they will give them the credit but it will cost them just as much for the credit than the credit itself. My view from my stand point of view because I been there is that as long as you pay on time regardless if it’s the minimum they will keep extending credit to you so you can stay in debt to them and by the time you have paid one thing off you could have bought three of the same thing. In my thesis I want you expect that the information that I...

Words: 312 - Pages: 2

A Research on Identifying Effective Solutions to Decrease Credit Card Debts in Turkey

...Abstract The abusive and excessive use of credit cards are a major economical issue in Turkey for a decade, which poses threats to the core structure of our society and the individuals’ self-esteem. News regarding the problems arising due to the inappropriate use of credit cards increases on a daily-basis, which signifies the fact that the problem shows a continually expanding trend, which is worth carrying an investigation upon. In order to overcome this problem, eight solutions were proposed. These solutions were banning the installments in shopping, copying the American model by providing collateral to the banks while getting a new credit card, requesting a guarantor per person while giving a credit card, giving maximum one credit card per person who has already debt, increasing the commission rate of the point on sale machines, educating people about the usage of credit cards and tell them its advantages and disadvantages, preparing therapy meetings by government for shopaholics and limiting cash advance credit from credit cards. The underlying research methodology of these solutions includes student surveys, internet based researching, discussions with credit card users, and discussions with personnel of banks. These proposed solutions were evaluated according to their effectiveness, feasibility, acceptability, sustainability and legality. Among these solutions three of them passed the criteria and suitable to apply. The chosen solutions can be regarded as the......

Words: 3338 - Pages: 14