Chapter 4, Problem 29AA

a.

To determine

To discuss: The reason due to which one should avoid using credit card for cash advances.

Explanation of Solution

Cash advances can be done either through credit card or through borrowings from financial institutions. If the amount is huge and the borrower needs to raise capital for only one time purpose, then financial institute is the better option. Credit card should be used only if the short-term and more frequent cash requirement possess. There are various charges on credit card such as interest rate, membership fee, finance charges and transfer charges which makes this option more costly as compared to the amount borrowed from financial institutions.

Therefore, one should avoid using either of the credit cards as they are more expensive means of borrowing.

b.

To determine

To discuss: The reasons for charging 0% APR for six months.

Explanation of Solution

There are banks that provide relief for six months from the period of borrowing but later they charge higher interest rate. This can be one of its promotional strategies to attract borrowers to lend money. Banks by doing so also tries to take competitive advantage among other competitor banks.

c.

To determine

To compute: The annual and monthly cost of both credit cards and suggest which incurs higher cost.

Explanation of Solution

Given Information:

Particular	Credit card A	Credit card B
APRs for purchase	0% for 6 months then 14.99%	9.99%
Other APRs:
Cash advances	19.99%	19.99%
Balance transfers	9.99%	9.99%
Annual fee	$50	None
Monthly fees	0	$10.95
Cash advance fees	3% of amount	None
Late payment fees	$25	$30
Over limit fee	$25	$50

Assumption for both cases: Borrower has borrowed $1000 and repaid the amount in 6 months. In both credit cards balance transfer amount and cash advances will nullify each other. So, only annual charges, APR and cash advance fee is considered to compute annual cost of credit. Late payment and over limit fees are not considered as borrower will make all the payments timely to ensure credibility.

In credit card A, the borrower may borrow money for 6 months without any interest rates. If amount is not repaid within 6 months then 14.99% will be charged on annual basis. Annual cost of credit card A and B is as follows:

  $\begin{array}{c}\text{Credit card A}=\text{\$50+}\left(\text{3\%}\times \text{1000}\right)\\ =\$80\end{array}$

  $\begin{array}{c}\text{Credit card B}=\left(\text{\$10}\text{.95}\times 12\right)+\$1000\times \frac{9.99\%}{12}\times 6\text{ months}\end{array}$

         $\begin{array}{c}=\$131.4+\$49.95\end{array}$

         $\begin{array}{c}=\$181.35\end{array}$

In case, if borrower has issued a credit card but not borrowed any amount then credit card A will charge $50 annually whereas $131.4 will be charged on credit card B annually.

d.

To determine

To suggest: Better offer among the both credit card.

Explanation of Solution

Annual charges of credit card A are lower as compared to the charges of credit card B. But if long term credit for say more than a year is required then other financial sources as that would be cheaper than using credit card.