FIGUERRA, SHANE MARIEL R.

RECINAN | M3 HOMEWORK1
DOC. PINKY ASIS-CASTRO

Answer the following questions.

1. What are the factors that influence the reason why interest rates go up and down; and
explain what are these factors and how they influence interest rates.

An interest rate is the percentage of principal a lender charges for using its funds.
The principal is the amount of cash granted. Borrowers pay interest as compensation for
using a lender’s money. Consequently, banks also pay interest rates as a reward for saving
money. While interest rates affect investment returns or loan repayment costs, it is also
influenced by factors such as the economy's strength, inflation, supply and demand,
government policy, credit risk, and loan period. A strong economy with low
unemployment increases demand for goods and services, which can increase rates as
businesses attempt to borrow more money to meet this demand. On the other hand, a
weak economy results in lower interest rates as lenders are less confident about lending
their money due to the increased risk of default and decreased need for borrowing. The
second factor is inflation wherein when inflation rises, so too do interest rates. This is
because lenders require a higher rate of return on their investment to make sure they do
not lose out on purchasing power due to rising costs of goods and services over time. In
such a scenario, borrowers must pay back more than the principal amount due to the
currency's depreciation. The government also plays an important role in determining
interest rates, as it uses these to influence economic policy. Moreover, interest rates are
ultimately determined by supply and demand. When there is high demand for credit,
lenders can increase their rates as they have more opportunities to lend out money at
higher returns. On the other hand, when there is a low demand for borrowing, lenders will
lower their rates to make their services attractive to potential borrowers.
2. How do interest rates affect the economy?

Interest rates play a crucial role in shaping the overall health and performance of
an economy. They are set and controlled by a country's central bank or monetary
authority and have far-reaching effects on various economic aspects. To begin with,
interest rates determine the cost of borrowing money. When interest rates are low, it
becomes cheaper for businesses and individuals to take out loans, such as mortgages, car
loans, or business loans. Lower borrowing costs encourage spending and investment,
which can stimulate economic growth. Low interest rates also can boost consumer
spending in several ways. As mentioned earlier, they make borrowing less expensive,
encouraging people to finance big-ticket purchases like homes and cars. Lower interest
rates on existing variable-rate loans (like credit card debt) reduce monthly payments,
leaving consumers with more disposable income to spend. In addition, low-interest rates
also incentivize businesses to invest in new projects, expand operations, and purchase
capital equipment. Lower financing costs make it more financially attractive for
businesses to undertake these activities, which can lead to increased productivity and
economic growth. Investors often shift their money between stocks and bonds based on
interest rate expectations. When interest rates are low, bonds become less attractive due
to their lower yields. As a result, investors may allocate more funds to the stock market,
potentially driving up stock prices. Lastly, interest rates can influence exchange rates.
Higher interest rates in one country can attract foreign capital seeking better returns,
causing the currency to appreciate. A stronger currency can impact exports negatively by
making them more expensive for foreign buyers thus totally leveraging the whole growth
of the economy.

3. How are banks classified? Explain the difference between each bank classification.

Banks in the Philippines are classified into universal banks, commercial banks,
thrift banks, rural banks, cooperative banks, Islamic banks, government-owned banks,
and banks classified by the Bangko Sentral ng Pilipinas (BSP). The BSP, which is the
Philippine central bank, acting through its Monetary Board, is mandated by law to ensure
that the control of 60 percent of the resources or assets of the banking system is held by
domestic banks that are at least majority-owned by Philippine nationals.

The universal and commercial banks represent the largest single group,
resource-wise, of financial institutions in the country. They offer the widest variety of
banking services among financial institutions. In addition to the function of an ordinary
commercial bank, universal banks are also authorized to engage in underwriting and
other functions of investment houses and to invest in equities of non-allied undertakings.
On the other hand, the thrift banking system is composed of savings and mortgage banks,
private development banks, stock savings and loan associations, and microfinance thrift
banks. Thrift banks are engaged in accumulating the savings of depositors and investing
them. They also provide short-term working capital and medium- and long-term
financing to businesses engaged in agriculture, services, industry, and housing,
diversified financial and allied services, and to their chosen markets and constituencies,
especially small and medium-sized enterprises and individuals. Moreover, the rural and
cooperative banks are the more popular types of banks in rural communities. Their role is
to promote and expand the rural economy in an orderly and effective manner by
providing people in rural communities with basic financial services. Rural and
cooperative banks help farmers through the stages of production, from buying seedlings
to marketing their produce. Rural banks and cooperative banks are differentiated from
each other by ownership. While rural banks are privately owned and managed,
cooperative banks are organized or owned by cooperatives or federations of cooperatives.
Lastly, the Act Providing for the Regulation and Organisation of Islamic Banks (the
Islamic Banking Law) (Republic Act No. 11439) authorized the establishment of Islamic
banks and Islamic banking units within conventional banks and the government-owned
banks in this category are the Development Bank of the Philippines and the Land Bank of
the Philippines.
4. What is amortization?

Amortization is a financial accounting and budgeting process used to gradually

reduce the value of an intangible asset or the balance of a loan or debt over time. It
involves the systematic allocation of the initial cost or value of the asset or debt into
smaller, periodic expenses or reductions. The purpose of amortization is to match the
expense or reduction in value with the revenue or benefits generated by the asset or the
repayment of the debt. The amortization concept is widely used in lending, where an
amortization schedule itemizes the beginning balance of a loan, less the interest and
principal due for payment in each period, and the ending loan balance. The amortization
schedule shows that a larger proportion of loan payments go toward paying off interest
early in the term of the loan, with this proportion declining over time as more and more
of the loan's principal balance is paid off. This schedule is quite useful for properly
recording the interest and principal components of a loan payment.

5. What is negative amortization?

Negative amortization, also known as "deferred interest," occurs when the

payments made on a loan are insufficient to cover the interest charges, let alone reduce
the loan's principal balance. This results in the outstanding balance of the loan increasing
over time rather than decreasing as it would in a typical amortizing loan. Negative
amortization commonly occurs in certain types of loans, such as Adjustable-Rate
Mortgages, Interest-Only Loans, and Deferred Students Loans.
Adjustable-rate mortgages offer borrowers the option to make minimum monthly
payments that may not cover the full amount of interest due. If the interest rate on the
loan increases or the payment cap is reached, the unpaid interest is added to the loan's
principal balance, leading to negative amortization. While in interest-only loans,
borrowers are required to make payments that cover only the interest charges for a
specified period, typically the first few years of the loan term. During this period, the
principal balance remains unchanged, and any portion of the payment that would have
 gone toward the principal is deferred, leading to negative amortization. In addition, some
student loans, particularly federal loans, offer income-driven repayment plans that allow
borrowers to make payments based on their income. If the calculated monthly payment is
less than the accruing interest, the unpaid interest may be added to the loan's principal
balance, resulting in negative amortization. Thus, negative amortization can be risky for
borrowers because it increases the overall cost of the loan and can lead to a situation
where the borrower owes more than the original loan amount. This is often referred to as
"payment shock" when borrowers eventually have to start making fully amortizing
payments or when they reach a predetermined point in their loan term.

6. Name other payments not included in the amortization that a borrower pays.

When borrowers make loan payments, they typically consist of more than just the
amortization of the principal loan amount. Several other components may be included in
a borrower's payment. These can vary depending on the type of loan, the lender's policies,
and the terms of the loan agreement. Here are some common components that may be
included in loan payments but are not part of the amortization:

● Interest: This is the cost of borrowing money and is usually the largest component
of a loan payment, especially in the early years of the loan. The interest amount is
calculated based on the outstanding loan balance and the interest rate.

● Principal: This is the portion of the loan payment that goes towards reducing the
actual loan amount. Over time, as you make payments, the principal portion
increases, and the interest portion decreases.

● Taxes: In some cases, property taxes may be included in the loan payment.
Lenders may collect taxes on behalf of borrowers and pay them to the appropriate
authorities.
● Insurance: Lenders often require borrowers to have homeowner's insurance (for
mortgages) or insurance on the collateral (e.g., auto insurance for car loans).
Insurance premiums may be included in the loan payment.

● Escrow Accounts: Lenders often maintain escrow accounts to collect and manage
taxes and insurance payments on behalf of borrowers. A portion of your monthly
payment may go into this account, which is then used to pay taxes and insurance
when they are due.