Purchase of an Automobile, Essay Example

This assignment is based on a scenario that involves the purchasing of an automobile. In this paper, various types of financing options will be explained as to why each of the option is different from the other. There are five questions that will be answered in this assignment. The scenario is that after completing my education, I am considering buying a new automobile. The cost of vehicle is £15,000 and in order to obtain loan, I have contacted three different banks. The loan amount varies with the type of interest and how it is compounded. Bank A, compounds interest on monthly basis, Bank B does it in a quarterly basis and Bank C does the compounding on a daily basis. The auto loan tenure is 4 years with 6% Annual percentage Rate (APR).

The reason why each type of loan has different payments is because of the Effective Annual Rate (EAR). For the calculation of interest, compounding is a powerful tool. When we use the compound interest, the nominal rate of interest in the effective rate of interest is different from the nominal rate. When we talk about bank loan, the interest rate we mean is the EAR i.e. the annual rate on the investment’s return.  The actual rate of interest on compounding is the EAR and that is the reason why the yearly interest rates and payments differ in compounding. In other terms, we can say that the actual rate of interest is EAR because the interest is compounded more than once annually. That is why the results of each bank loan came different because of the different time periods. The Effective Annual rate depends on the compounding frequency and the more the interest is accrued the different the EAR. In this case, we can see that there are three different time periods. One is daily, one is quarterly and one is monthly. So, the EAR differs in relation to the frequency of the compounding of interest. Also, APR is different from EAR because APR is a simple interest whereas EAR involves interest compounded annually.

References

Brooks, R., & Mukherjee, A. K. (2013). Financial management: core concepts. Pearson.

Homer, S., & Leibowitz, M. L. (2013). The Time Value of Money. Inside the Yield Book: The Classic That Created the Science of Bond Analysis, Third Edition, 269-276.