Core Principles for High Credit Card Interest Rates (Chapter 1)

Drawing from the “Five Core Principles of Money and Banking” (pages 4-8), here are some reasons why credit card issuers charge high-interest rates:

• Time Value of Money: People generally prefer to receive money now rather than later. Credit card companies are essentially loaning you money upfront, so they charge a premium (high-interest rate) for this immediate access to funds.
• Risk Requires Compensation: Credit card debt carries a higher risk of default compared to other loans (e.g., mortgages). Issuers compensate for this risk by charging higher interest rates.
• Information Asymmetry: Credit card companies might have limited information about your financial situation, making it harder to assess your creditworthiness. This uncertainty can lead to higher interest rates to cover potential defaults.

Money vs. Assets (Chapter 2)

The statement “Money is an asset, but not all assets are money” is true because (pages 23-25):

• Money: Functions as a medium of exchange, a unit of account, and a store of value. It’s readily accepted for goods and services and maintains its value over time (ideally).
• Assets: Encompass a broader range of things you own that have economic value. This can include real estate, stocks, bonds, or even a valuable car. Not all assets are as liquid (easily convertible to cash) as money. For example, selling a car might take time and effort compared to using cash for a purchase.

Four Characteristics of Financial Instrument Value (Chapter 3)

The four fundamental characteristics that determine the value of a financial instrument (pages 50-51) are:

1. Expected Cash Flow: The amount of cash you expect to receive from the investment over time. Higher expected cash flow generally leads to a higher value.
2. Timing of Cash Flow: When you receive the cash flow matters. Generally, cash received sooner is worth more than the same amount received later (due to the time value of money).
3. Risk of Default: The chance that the issuer of the financial instrument might not be able to fulfill their obligations (e.g., repay a loan or pay promised interest). Higher risk corresponds to lower value.
4. Marketability: How easily you can sell the financial instrument in the market. Greater marketability (liquidity) typically increases the value.

Impact of Inflation on Long-Term Loan (Chapter 6)

If a borrower and lender agree on a long-term loan with a fixed nominal interest rate, unexpected inflation can impact the parties in the following ways (pages 151-152):

• Borrower: Benefits from inflation. The fixed loan payment becomes less burdensome over time as the value of money decreases. In essence, the borrower is repaying the loan with “cheaper” dollars.
• Lender: Loses purchasing power due to inflation. The fixed interest rate earned provides a lower return on investment in real terms (after adjusting for inflation).

Example:

• Loan amount: $10,000
• Fixed interest rate: 5%
• Unexpected inflation: 3%

The borrower repays the loan with a fixed payment amount based on the original loan amount and interest rate. However, if inflation is 3%, the real value of the repaid money decreases each year. For the lender, the 5% interest rate might not keep pace with inflation, resulting in a net loss of purchasing power.