Skip to content

NISM Certifications · NISM-Series-X-A: Investment Adviser (Level 1) · Debt Management and Loans

Rohan Mehta takes a loan of Rs 1,00,000 at 12% p.a. for one year, repayable in 12 equal monthly instalments, with interest charged at a flat rate on the original principal. Interest for the year is Rs 12,000 and the EMI is Rs 9,333.33. Compared with the stated flat rate, the effective annual cost of this loan is:

The effective cost is higher than 12%. Flat-rate interest is calculated on the original principal for the whole tenure, even though the outstanding balance falls with each EMI. The borrower effectively pays interest on money already repaid, so the reducing-balance equivalent rate is considerably above the stated flat rate.

  1. AExactly 12% since interest is charged on the original amount
  2. BLower than 12%, because principal is repaid over the year
  3. CHigher than 12%, because interest is charged on the original principal even as the outstanding balance fallsCorrect
  4. DCannot be compared without knowing the processing fee

Explanation

With flat-rate interest, Rs 12,000 is charged on Rs 1,00,000 for the full year although the outstanding balance declines with each EMI. The average balance is only about half the principal, so the effective rate on the reducing balance is much higher than 12% (roughly 21-22%). Hence the flat rate understates the real cost.

Did you get it right without looking?

One question tells you little. A timed set on Debt Management and Loans shows your real accuracy, how long you take and where you lose marks.

Practise Debt Management and LoansFree diagnostic mock

More Debt Management and Loans questions