In$-$class Assignment $4$

The Situation

Quentin is the human resources manager for Lightning Wholesale. Recently, he was approached by Katherine, who is one of the employees in the sporting goods department. Katherine indicated that she was having some financial problems, did not have a very good credit rating, and was considering a payday loan. Quentin wants to show her the true costs of using a payday loan company and alternatives for short$-$term financing.

The Data

Canadian payday loan companies generally operate under one of three structures:

$1.$ The Traditional Model. These companies incur all operating costs, provide their own capital for any loan, and collect interest and charges or fees for their services. These companies assume all the risk.

$2.$ The Broker Model. These companies incur all operating costs but do not provide the capital for the loan. A third$-$party partner provides the capital, and the payday loan company charges a brokerage fee for its services. The third$-$party partner collects all interest and assumes all risk.

$3.$ The Insurance Model. These companies incur all operating costs and recover these costs through fees and insurance premiums on the loan. An insurance company $($usually owned by the payday loan company$)$ provides all capital and assumes all risk.

The table below summarizes a sample of charges that could be imposed under each model.

Traditional Model Broker Model Insurance Model

Effective interest rate $59\%21\%48\%$

Per Transaction Fee $$9\mathrm{.}99$ $$10\mathrm{.}00$ N$/$A

Check Cashing Fee $7\mathrm{.}99\%$ of principal and interest

combined $$8\mathrm{.}00$ N$/$A

Insurance Fee N$/$A N$/$A $19\%$ of principal and interest

combined

Brokerage Fee N$/$A $29\mathrm{.}5\%$ of principal and interest

combined N$/$A

$$ As an alternative to using a payday loan company, Katherine could use a finance company that targets people with poor credit ratings or those in quick need of money. These companies typically charge $28\%$ compounded monthly on loans.

$$ A second alternative is to take a cash advance on her credit card. Most credit card companies charge around $19\%$ compounded daily.

$$

Important Information

$$ Like most people who borrow money from payday loan companies, Katherine needs to borrow a small sum of money for a short period of time. Her requirements are to borrow $$300$ for a period of seven days, or one week.

$$ Assume exactly $52$ weeks in a year.

Your Tasks

$1.$ Determine and rank the weekly periodic rate and annual effective rates for $(5)$:

a$.$ the Traditional Model

b$.$ the Broker Model

c$.$ the Insurance Model

d$.$ a finance company

e$.$ a credit card.

Show your work.

Note that under Section $347$ of the Criminal Code of Canada, any charges related to the borrowing of money are considered interest. This includes any types of fees and charges, although in name they may not be called interest.

$2.$ Explain why consumers might use products and options that are not the lowest economic cost. What would you do in Katherine$$s place? $(2)$