DEFINITIONS

EARLY DEFINITIONS

                                                                            P

L = loan size,   P = total annual payment,     P% =  ---- x 100%. 

                                                                            L

NOTE: P% is not an interest rate. It is the amount of the annual payment expressed as a percentage of the loan, L. It is a key part of the mathematics.

L₁ = first year initial value of ‘L’ and ‘P_1’ likewise. ‘L_2’ and ‘P_2’ are second year initial values, and so forth.

AEG = Average Earnings / Incomes Growth, and

AEG% p.a. is the rate of Average Earnings / Incomes Growth.

r% p.a. = the traditional figure that is quoted as the interest rate.

e% p.a. is the annual percentage escalation rate of the annual payment P. In practice payments are made monthly but the mathematics is done on a yearly basis.

                                                   r

‘R’  =  Interest rate factor = 1 +  ------ ,   so for example 5% interest gives a factor 1.05.

                                                 100

‘E’  =  escalation rate factor, so an escalation rate of 2% p.a. has a factor of 1.02.

By definition, 
True Interest, I% p.a. =  r% p.a.  -  AEG% p.a.

LATER   DEFINITIONS

                                                              C

C = True Capital Payment            C% =  ------  x 100% and is needed to repay the loan on

                                                                                  L

schedule.

BSM% = Basic Stability Margin, has been superceded by a better understanding, following tests of the maths using past data and spreadsheets.

Originally BSM% was defined as an addition to the value of P% in year one to take account of the volatility of economic conditions, specifically to allow for variations in the true rate of interest and the variability in the rate of increase of incomes between individuals. 

Later it was seen that the entry cost (the cost of the initial monthly / annual payment) has to be determined by an assessment of the variability of the true rate of interest and the initial value of D% which has to be enough to cope with the variability of the true interest rate.

Unemployment risk is not included, but may be included as an insurance premium by the risk manager at his/her discretion.

P_SEC% = The Safe Entry Cost. This is the estimated minimum safe initial annual payment expressed as a percentage of the amount borrowed.

STANDING   LOANS - explained in more detail in LESSON 1

A standing loan is defined as one where: -

                                                                                                    P

P₁% = P₂% = P₃%  … = P_n% for all values of n. Remember P% =  ----- x 100%

                                                                                                    L

                                             L_n             L_n+1

This also applies to the ratios:  -----     =   -----    =  constant for all values of n.

                                             P_n            P_n+1