Level 2:
Revision
guidebook
Grade 6-8
NFO
TM
Contents
Chapter 1: Money . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 02
Chapter 2: Banking . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 07
Chapter 3: Financial Planning & Insurance . . . . . . . . . . . . . . . . . 13
Chapter 4: Investing . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Chapter 5: Loans and Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28
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Chapter 1: Money
Evolution of money and forms of money
The journey of money shows how society has grown. It began with bartering,
where people swapped goods like grain for tools. This system wasn’t easy, so
valuable items like gold and salt became money. Coins and paper money made
trade simpler and more reliable. Later, representative money, backed by gold,
added trust, and fiat money, supported by governments, became common. Today,
fiat money is commonly used and digital money, like cryptocurrencies and CBDCs
are offering new ways to trade.
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Understanding currency
Local, foreign, and exchange rates
Currency is the backbone of trade, representing a country’s official medium of
exchange. Local currency refers to the money used within a country. For example,
the Indian Rupee (INR) is India’s local currency, while the US Dollar (USD) is the
United States’ local currency. When people or businesses trade internationally,
they often deal in foreign currency, meaning money from other countries. If an
Indian company imports goods from the USA, they would need USD to pay for
them.
To exchange currencies, we use exchange rates, which show how much one
currency is worth in terms of another. For instance, if 1 USD = 83 INR, converting
100 USD into INR involves simple multiplication: 100 USD × 83 INR = 8,300 INR.
Conversely, dividing INR by the exchange rate converts it to USD.
Exchange rates are influenced by supply and demand. High demand for a
currency increases its value, while inflation can reduce a currency’s purchasing
power, leading to a weaker exchange rate. For example, if a country exports
valuable goods, its currency is in higher demand and appreciates.
Understanding currencies and exchange rates is essential for travel, international
trade, and economic stability, making them a vital part of global commerce.
Importance of money
● Medium of exchange: Money simplifies trade by eliminating the need for
direct bartering, making transactions efficient and convenient.
● Unit of account: It provides a standard measure to compare the value of
goods and services, aiding informed decisions.
● Store of value: Money retains value over time, allowing people to save and
use it in the future.
● Standard of deferred payment: It enables agreements to pay for goods or
services at a later date, facilitating credit systems and long-term
transactions.
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Money plays a vital role in shaping society by enabling access to goods, services,
and opportunities, fostering economic growth and social stability. However, its
unequal distribution often highlights disparities, influencing social structures and
individual well-being.
Understanding the demand and supply of money
Money is essential for the smooth functioning of an economy, and its demand and
supply play a pivotal role in maintaining financial stability.
People demand money for three key reasons: transactional, precautionary, and
speculative motives.
Demand for money
People demand money for three primary reasons: transactional, precautionary,
and speculative motives.
1. Transactional motive: This refers to the need for money to carry out
everyday transactions. For instance, you need money to buy groceries, pay
rent, or cover utility bills. This demand is influenced by income levels and
the frequency of transactions.
2. Precautionary motive: This is the need to hold money for unforeseen
events or emergencies. For example, people save money for unexpected
medical expenses, sudden repairs, or job loss. This motive highlights
money's role as a safety net.
3. Speculative motive: This involves holding money to take advantage of
future investment opportunities. For example, investors might wait for stock
prices to drop or real estate markets to stabilise before using their funds.
This motive reflects money's role in wealth-building strategies.
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Supply of money
Central banks, like the Reserve Bank of India (RBI) or the Federal Reserve,
regulate the supply of money to maintain economic balance. They use several
tools for this purpose:
1. Interest rates: By adjusting interest rates, central banks influence
borrowing and spending. Lower interest rates make borrowing cheaper,
increasing the money supply, while higher rates do the opposite.
2. Open Market Operations (OMO): Central banks buy or sell government
securities to inject or absorb liquidity. For example, buying securities puts
more money into the economy, while selling them reduces money
circulation.
3. Reserves: Central banks require commercial banks to hold a portion of
deposits as reserves. Adjusting these reserve requirements can either
restrict or expand the money available for lending.
By balancing the demand and supply of money, central banks stabilise inflation,
control economic growth, and ensure financial stability, making these dynamics a
cornerstone of modern economies.
MCQs
1. What is an exchange rate?
A. The value of goods and services compared to each other.
B. The price difference between two countries' economies.
C. The value of one country’s currency compared to another country’s
currency.
D. The cost of exchanging goods within a country.
2. What is the primary role of a central bank in managing the supply of
money?
A. To print unlimited amounts of money to avoid inflation.
B. To provide loans to the public at fixed interest rates.
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C. To ensure that there is the right amount of money in the
economy—neither too much nor too little.
D. To issue digital currencies to all citizens.
3. Which of the following is a tool the central bank uses to control the supply
of money?
A. Controlling bank reserves to influence lending.
B. Setting prices for goods and services.
C. Regulating the stock market.
D. Restricting the use of mobile payment apps.
Correct answers and explanations:
1. C. An exchange rate shows how much one country’s currency is worth in
terms of another country's currency. It indicates the value of one currency
expressed in another.
2. C. The central bank's main job is to regulate the money supply to maintain
economic stability. Too much money can cause inflation, while too little can
slow down economic growth.
3. A. The central bank can change how much money banks must keep in
reserve. By adjusting this requirement, it affects how much banks can lend,
which in turn influences the overall money supply in the economy.
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Chapter 2: Banking
Understanding the working of banks
Banks are vital institutions that drive economic growth by managing money and
providing financial services. Their basic functions can be grouped into three main
areas:
1. Accepting deposits: Banks provide a safe place for individuals and
businesses to deposit their money, offering accounts like savings, current,
and fixed deposits.
2. Providing loans: They lend money to individuals, businesses, and
governments for various purposes, such as buying a home, funding
businesses, or supporting public projects.
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3. Facilitating transactions: Banks enable cashless payments through
cheques, digital transfers, credit cards, and mobile banking services.
Central vs. commercial banks
Banks are classified into two main types: central and commercial.
● Central banks (e.g., Reserve Bank of India or Federal Reserve) are
regulatory bodies that oversee and regulate the banking system and all the
banks operating in it. They issue currency, manage monetary policy, and
regulate inflation by controlling the money supply and interest rates. Central
banks also act as lenders of last resort for commercial banks.
● Commercial banks, on the other hand, interact directly with the public.
They focus on day-to-day banking services like deposits, loans, and money
transfers. Examples include HDFC Bank, Axis Bank, State Bank of India, etc.
Together, central and commercial banks ensure the smooth functioning of the
economy by managing money, supporting businesses, and facilitating financial
stability.
Types of money transfers: exploring online and electronic
methods
Money transfers have evolved significantly with the rise of electronic and online
methods, making transactions faster, easier, and more convenient. While
traditional methods like cash deposits and cheques are still in use, electronic and
online systems now dominate personal and business transactions.
1. NEFT (National Electronic Funds Transfer)
NEFT is a widely-used system for transferring funds between bank
accounts in India. It operates in batches, processing transactions at fixed
intervals throughout the day. It’s ideal for non-urgent transfers and is
accessible via bank branches and online banking.
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2. RTGS (Real-Time Gross Settlement)
RTGS is used for high-value transactions that need immediate clearance.
Unlike NEFT, RTGS processes transactions in real-time and individually,
although it requires a minimum transfer of Rs. 2 lakh. This makes it suitable
for transferring large sums quickly, such as property payments or corporate
deals.
3. IMPS (Immediate Payment Service)
IMPS enables 24/7 instant money transfers across banks. Banks charge a
small fee to process IMPS transactions. It’s perfect for small, urgent
transfers, offering convenience through mobile apps and internet banking.
4. UPI (Unified Payments Interface)
UPI has revolutionised money transfers by allowing seamless transactions
through mobile apps like Google Pay, PhonePe, and Paytm. Users can link
their bank accounts to the app, generate a UPI ID, and transfer funds
instantly using mobile numbers or QR codes. UPI’s simplicity and speed
make it a preferred choice for individuals and businesses alike.
How banks raise money: banking methods explained
Banks play a critical role in the economy by managing funds and providing
financial services. One of their primary tasks is to raise money, which they achieve
through deposits and various banking methods.
1. Demand deposits
Demand deposits are funds that customers can withdraw anytime without
prior notice. Banks raise money through:
● Savings accounts: These are the most common accounts, where
individuals deposit their money to earn interest while maintaining
easy access to their funds. They encourage saving while allowing
liquidity.
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● Current accounts: Designed for businesses and professionals,
current accounts enable frequent transactions without restrictions on
withdrawals. They typically don’t earn interest, but they provide
essential liquidity for daily operations.
2. Term deposits
Term deposits require customers to lock their money for a fixed period,
offering higher interest rates. Examples include:
● Fixed Deposits (FDs): Customers deposit a lump sum for a set term,
earning guaranteed returns.
● Recurring Deposits (RDs): Customers deposit a fixed amount
regularly, building savings with interest over time.
By pooling funds from these deposits, banks create a stable capital base to
provide loans, invest in government securities, and support the economy.
Ombudsman
An ombudsman is an independent official appointed to address complaints and
disputes between customers and banks. In the banking sector, the ombudsman
ensures that customers' concerns are heard and resolved fairly, offering an
alternative to lengthy legal processes.
How it works
When a customer faces an issue with a bank—such as wrongful charges, delays
in services, or loan-related concerns—they can file a complaint with the bank’s
ombudsman if the bank fails to resolve the issue within a specified time (usually
30 days).
The ombudsman investigates the matter, mediates between the customer and the
bank, and, if necessary, gives a decision that the bank must follow. The process is
free, simple, and designed to protect customers' rights.
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Key features
● Eligibility: Any banking customer can approach the ombudsman for
unresolved complaints related to deposits, loans, credit cards, or online
banking.
● Time-bound: Complaints are usually resolved within 30 days.
● Accessible: The service is free of cost and available online or through
written applications.
The banking ombudsman promotes accountability and trust in the financial system
by providing customers with a reliable avenue for grievance redressal. It ensures
transparency, fairness, and quick resolution, making banking safer and more
customer-friendly.
MCQs
1. How do central banks differ from commercial banks?
A. Central banks offer loans to the public, while commercial banks only
monitor currency.
B. Central banks are only involved in small loans, while commercial
banks manage the government budget.
C. Commercial banks set interest rates for the economy, while central
banks handle personal accounts.
D. Central banks function as regulators, overseeing and enforcing the
rules, while commercial banks operate as service providers, offering
financial products and services to the public.
2. Which of the following is an example of an electronic method of money
transfer?
A. Money Order
B. Cheque
C. Real Time-Gross Settlement (RTGS)
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D. Cash
3. Which of the following best describes a Fixed Deposit (FD)?
A. A deposit you can withdraw anytime without penalty.
B. A type of account that allows unlimited transactions.
C. A deposit where you contribute money monthly for a set period.
D. A one-time deposit left with the bank for a fixed period that earns
higher interest.
Correct answers and explanations:
1. D. Central banks, such as the RBI, manage monetary policy and set rules for
the financial system. In contrast, commercial banks provide services like
loans and deposits directly to the public.
2. C. RTGS is a digital way to move money electronically between bank
accounts, offering a faster and more secure alternative to traditional
methods like cheques and money orders.
3. D. A Fixed Deposit is a lump sum deposited with the bank for a specified
term, earning higher interest. The funds are locked in until the end of the
term, providing higher returns compared to regular savings accounts.
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Chapter 3: Financial Planning &
Insurance
Savings and goal setting
Savings are a foundational element of financial planning. They involve setting
aside a portion of your income for future use rather than spending it immediately.
These funds cater to emergencies, planned expenditures, or investments that can
grow over time. Goal setting complements savings by giving them direction,
ensuring that financial efforts are structured and aligned with achieving long-term
stability.
Importance of savings
Savings serve three primary purposes1. Building wealth: Consistently saving enables investment in assets such as
stocks, mutual funds, or real estate. These investments grow over time,
often bolstered by compound interest. For instance, a well-planned
retirement fund can significantly increase in value with regular
contributions.
2. Financial security: Savings act as a safety net for unexpected events like
medical emergencies or job loss. This cushion reduces reliance on loans,
preventing debt accumulation and ensuring financial stability.
3. Achieving goals: Savings facilitate goal-oriented planning, whether it's
buying a home, funding higher education, or retiring comfortably.
SMART goals
SMART goals create a structured and actionable framework for setting financial
goals. By focusing on clarity and feasibility, they ensure goals are effective and
achievable:
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● Specific: Define your objective clearly. For example, “Save ₹40,000 for a
new laptop” is more focused than a vague aim to “save money.”
● Measurable: Establish quantifiable targets to track progress, such as saving
₹20,000 per month for two months.
● Achievable: Ensure the goal is realistic based on your income and
expenses. For instance, saving ₹10,000 monthly on a ₹30,000 income is
achievable if your expenses are ₹20,000.
● Relevant: Align goals with broader priorities. Saving for a laptop, for
example, supports professional productivity.
● Time-bound: Set a timeframe to stay motivated and focused, like achieving
the savings target within two months.
Example: If you earn ₹60,000 per month and have expenses of ₹40,000, you can
save ₹20,000 monthly and achieve a ₹40,000 goal in two months.
Insurance
Insurance is a vital tool in financial planning, offering protection against the
financial consequences of unexpected events. Regular premium payments ensure
financial coverage during emergencies, safeguarding both individuals and their
families.
Purpose of insurance
Insurance serves multiple purposes:
1. Risk mitigation: Minimises financial loss from unforeseen events like
accidents, illness, or property damage.
2. Financial security: Covers large expenses that would otherwise deplete
savings or investments, providing peace of mind.
3. Long-term planning: By transferring risks to insurance providers,
individuals can focus on achieving their financial goals without fear of
sudden setbacks.
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Types of Insurance
1. Life insurance: Ensures financial security for dependents in case of the
policyholder's death.
● Term life insurance: Covers the individual for a specified period.
● Whole life insurance: Offers lifelong coverage.
● Example: A ₹1 crore policy supports a family financially if the primary
income earner passes away.
2. Health insurance: Covers medical expenses such as hospital stays,
surgeries, and medications.
● Deductibles: The amount a policyholder must pay before insurance
coverage begins. For instance, with a ₹30,000 hospital bill and a
₹10,000 deductible, the insurer covers the remaining ₹20,000.
3. Auto insurance: Protects against vehicle-related financial losses.
● Third-party insurance: Covers damages caused to others,
mandatory by law.
● Comprehensive insurance: Extends coverage to include your
vehicle, theft, and natural disasters.
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● Example: Auto insurance pays for repairs after a car accident.
4. Home insurance: Protects property and belongings from damage, theft, or
liability risks.
● Example: If a fire damages your home, the policy covers repair costs
and replaces lost items.
5. Disability insurance: Provides income replacement if an individual is unable
to work due to illness or injury.
● Example: If an injury prevents work for six months, disability
insurance can replace 70% of your income.
Simple and compound interest
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Simple interest
P = Principal amount (initial loan or investment)
R = Annual interest rate (in %)
T = Time period (in years)
Simple interest is calculated only on the original amount invested or borrowed,
known as the principal. This method offers steady, predictable returns over time,
making it suitable for short-term investments or loans.
Example: Imagine you invest ₹10,000 at a fixed annual interest rate of 5% for
three years. At the end of the three years, you earn ₹1,500 in interest. This
straightforward approach ensures consistent returns, but it doesn’t take
advantage of growth on previously earned interest.
Compound Interest
P = Principal amount
R = Annual interest rate (in %)
T = Time period (in years)
A = Total amount after interest is compounded
Compound interest builds on the initial principal and any interest accumulated
over time. This compounding effect leads to exponential growth, making it
especially advantageous for long-term investments.
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Example: If you invest the same ₹10,000 at 5% annual compound interest for three
years, the total interest earned would be ₹1,576. The extra ₹76 arises because the
interest earned in earlier years is reinvested and earns additional interest in
subsequent years.
Simple Interest (SI)
Given:
Substitute the values:
● Principal (P) = ₹10,000
● Annual Interest Rate (R) =
5%
● Time (T) = 3 years
At the end of 3 years, the total interest earned
is ₹1,500.
Compound Interest (CI)
If the same ₹10,000 is invested
at an annual compound interest
rate of 5% for 3 years:
Given:
Substitute the values:
● Principal (P) = ₹10,000
● Annual Interest Rate (R) =
5%
● Time (T) = 3 years
At the end of 3 years, the total interest earned
is ₹11,576.25
Simple Interest (SI): ₹1,500
Compound Interest (CI): ₹11,576.25
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Inflation vs. deflation
Economic conditions like inflation and deflation influence purchasing power and
financial planning.
1. Inflation
A general increase in prices reduces money’s purchasing power. For
example, ₹100 may buy 10 packs of chips today but only 8 next year.
Types of inflation:
● Hyperinflation: Extremely rapid price increases, often exceeding
50% per month, as seen in Zimbabwe during the 2000s.
● Stagflation: High inflation accompanied by stagnant economic
growth and high unemployment, as in the 1970s oil crisis.
2. Deflation
A general decline in prices increases purchasing power but can harm the
economy by reducing business profits and leading to layoffs.
Causes of deflation:
● Overproduction: Excess supply forces businesses to lower prices.
● Decreased demand: Reduced consumer spending results in price
drops and slowed economic growth.
MCQs
1. How does life insurance benefit your family?
A. It provides a lump sum of money to your family if you pass away.
B. It covers routine medical expenses.
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C. It helps you save money for retirement.
D. It pays for your household bills while you are alive.
2. Which type of insurance primarily helps cover medical expenses like
surgeries and hospital stays?
A. Auto insurance
B. Home insurance
C. Health insurance
D. Disability insurance
3. You invested ₹3,000 at a compound interest rate of 7% per annum for 3
years. Calculate the interest earned.
A. ₹3,675
B. ₹630
C. ₹3,630
D. ₹675
Correct answers and explanations:
1. A. Life insurance provides a lump sum to your family if you pass away.
2. C. Health insurance covers medical expenses like surgeries and hospital
stays.
3. D) Compound interest = P x (1+R/100)^N - PCI = 3,000 x (1+7/100)^3 3,000
CI = 3,000 x (107/100)^3 -3,000
CI = 3,000 x (1.07)^3 - 3,000
CI = 3,000 x (1.225043) - 3,000
CI = 3,675 - 3,000
CI = ₹675
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Chapter 4: Investing
Investing involves allocating money to assets like stocks, bonds, or real estate to
grow wealth, achieve financial goals, and secure financial independence.
Investment options
1. Fixed Deposit (FD)
An FD is a secure investment where you deposit a lump sum with a bank for
a fixed period at a predetermined interest rate, ensuring stable returns.
● Features: Fixed interest rates, tenures from 7 days to 10 years, early
withdrawals with penalties, minimum deposit ₹1,000, insured up to ₹5
lakh by DICGC.
● Benefits: Stable, predictable returns; low risk; interest payout
flexibility (periodic or end-of-tenure).
● Limitations: Lower returns compared to inflation-beating options like
stocks; penalties for premature withdrawals; funds are locked.
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2. Recurring Deposit (RD)
An RD allows small monthly deposits for a fixed period with guaranteed
returns.
● Features: Monthly fixed deposits, tenures from 6 months to 10 years,
interest rates similar to FDs (5–7%), early withdrawals with penalties.
● Benefits: Encourages disciplined savings; low-risk, fixed returns;
ideal for salaried individuals.
● Limitations: Slightly lower returns than FDs due to incremental
deposits; penalties for early withdrawal.
Stocks
Stocks, also known as shares or equities, represent partial ownership in a
company. When you buy a stock, you become a shareholder, which entitles you to
a portion of the company’s profits, typically distributed as dividends, and the
potential for capital gains as the company grows.
Types of stocks
1. Common or equity stocks
● Definition: Common stocks are the most widely traded type of
stocks, granting shareholders voting rights in the company’s key
decisions, such as electing the board of directors.
● Key features:
● Voting rights: Shareholders have a say in corporate decisions,
typically one vote per share.
● Returns: Common stocks offer the potential for high returns
through capital appreciation (an increase in the stock's price)
and dividends (a portion of the company’s profits paid to
shareholders).
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● Risk: Returns depend on the company’s performance, making
common stocks riskier than preference stocks, as dividends
are not guaranteed, and capital gains can fluctuate.
● Ideal for: Investors seeking long-term growth and willing to accept
higher risks for potentially higher rewards.
2. Preference stocks
● Definition: Preference stocks, or preferred shares, provide a fixed
dividend and priority over common stocks in the event of company
liquidation or asset distribution. However, they typically do not carry
voting rights.
● Key features:
● Fixed dividends: Preferred shareholders receive a
predetermined dividend, making it a more predictable income
source.
● Priority: In the event of bankruptcy, preferred shareholders are
paid before common shareholders, reducing risk.
● Limited growth: Preference stocks usually do not benefit from
capital appreciation like common stocks do, and their returns
are more stable but less lucrative in a growing company.
● Risk: Lower risk compared to common stocks but with limited upside
potential.
● Ideal for: Conservative investors looking for steady income with
lower risk.
Features of stocks
Stocks are highly liquid and traded on stock exchanges like the NSE and BSE. To
invest in stocks, you need a DEMAT account to store shares and a trading account
for transactions.
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Benefits
Stocks offer high growth potential, with opportunities for significant capital
appreciation and dividends. They also act as a hedge against inflation, preserving
purchasing power over time.
Limitations
Investing in stocks involves high risk due to market volatility. Success requires
substantial research and an understanding of market dynamics.
Bonds
Bonds are debt instruments where you lend money to companies or governments
in exchange for fixed interest payments and the return of principal upon maturity.
Types of bonds
● Corporate bonds: Issued by companies; higher risk but higher returns.
● Government bonds: Issued by governments; lower risk with lower but
stable returns.
Features
Bonds have a fixed tenure and interest rate (coupon rate) and can be traded on
stock exchanges.
Benefits
Bonds provide stable returns and steady income, making them a safer option than
stocks for conservative investors. They also help diversify investment portfolios.
Limitations
Bonds generally offer lower returns than stocks or mutual funds. Corporate bonds
carry a default risk if the issuer fails to repay.
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Mutual funds
Mutual funds pool money from multiple investors to create a diversified portfolio
managed by professional fund managers.
Types of mutual funds
● Equity funds: Invest in stocks; high risk but high returns.
● Debt funds: Focus on fixed-income securities; lower risk with stable
returns.
● Hybrid funds: Combine stocks and bonds for balanced risk and return.
● Sector funds: Target specific industries like technology or healthcare.
Features
Mutual funds offer diversification, reducing risk by spreading investments across
various assets. They are managed by professionals and provide liquidity, allowing
investors to buy and sell units easily.
Benefits
Investors gain access to a diversified portfolio with minimal effort. Mutual funds
cater to both short- and long-term financial goals.
Limitations
Management fees (expense ratios) reduce net returns. Mutual funds are subject to
market risk, and returns can fluctuate during economic downturns.
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Commodities
Commodities include raw materials like gold, oil, and agricultural products that
play a significant role in the global economy.
Types of commodities:
● Metals: Gold, silver, copper.
● Energy: Oil, natural gas, coal.
● Agriculture: Wheat, coffee, sugar.
Features
Commodities can be traded physically or through financial instruments like ETFs
and futures. Prices are influenced by supply-demand dynamics and global events.
Benefits
Commodities, especially gold, act as a hedge against inflation. They add stability
to portfolios during market volatility and provide diversification.
Limitations
Commodities are highly volatile, with prices sensitive to geopolitical and economic
factors. Unlike stocks or bonds, they do not generate regular income.
MCQs
1. What are the two main types of stocks that investors can buy?
A. Bonds and Commodities
B. Savings and Debt
C. Equity and Preference
D. Hybrid and Equity Funds
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2. What is the main advantage of balancing risk and return in your
investments?
A. To maximise short-term gains.
B. To reduce the chance of losses while still aiming for growth.
C. To invest in only one type of asset.
D. To guarantee that your money will always grow.
3. Which of the following is typically considered a long-term investment?
A. Real estate
B. Savings account
C. Short-term bond
D. Commercial paper
Correct answers and explanations:
1. C. The two main types of stock are Equity Stock and Preference Stock.
2. B. Balancing risk and return helps reduce potential losses while still allowing
for the possibility of growth by diversifying across different assets.
3. A. Real estate is typically considered a long-term investment, where value
appreciation happens over many years.
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Chapter 5: Loans and Credit
Introduction to loans and credit
Loans and credit play a crucial role in helping individuals and businesses meet
financial goals that might not be possible with immediate funds. Whether it’s
purchasing a home, starting a business, or dealing with an emergency, loans and
credit provide the necessary resources. However, they come with obligations like
repayment and interest, which must be carefully managed to avoid financial
stress.
Important terms in loans
1. Interest: Interest is the cost of borrowing money, expressed as a
percentage of the loan amount. Lenders charge this as a fee for providing
funds. For example, a loan of ₹1,00,000 at an interest rate of 10% per year
would mean paying ₹10,000 annually as interest.
2. Tenure: Tenure is the time given to repay the loan. Shorter tenures result in
higher monthly payments (EMIs) but lower overall interest costs.
Conversely, longer tenures reduce monthly EMIs but increase the total
interest paid over time.
Secured vs. unsecured loans
● Secured loans: Require collateral, such as a house or vehicle, to back the
loan. This reduces the lender’s risk, resulting in lower interest rates.
● Unsecured loans: Do not require collateral. Instead, the loan is granted
based on the borrower’s creditworthiness, often leading to higher interest
rates due to the increased risk for the lender.
Types of loans
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1. Personal loans
● Features:
● Unsecured loans, meaning no collateral is required.
● Used for various purposes like medical emergencies, travel, or home
repairs.
● Short-to-medium repayment tenure, typically 1 to 5 years.
● Benefits:
● Quick approval and disbursal process.
● Flexible usage without restrictions.
● Limitations
● Higher interest rates compared to secured loans.
● Loan amounts are limited by income and credit score.
2. Home loans
● Features
● Secured loans where the property being purchased serves as
collateral.
● Long repayment tenure, ranging from 10 to 30 years.
● Lower interest rates due to the secured nature of the loan.
● Benefits
● Enables home ownership by spreading the cost over time.
● Tax benefits on both principal and interest payments under Indian
laws.
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● Limitations
● Risk of losing the property if repayments are not made.
● Long-term financial commitment, limiting flexibility.
3. Auto loans
● Features
● Secured loans with the purchased vehicle acting as collateral.
● Shorter tenure, typically 3 to 7 years.
● Interest rates depend on factors like the vehicle’s age, borrower’s
credit score, and market conditions.
● Benefits
● Makes vehicle ownership more accessible.
● Fixed monthly payments simplify budgeting.
● Limitations
● Depreciating asset: Vehicles lose value over time.
● Higher interest rates for used vehicles.
Credit score and history
A good credit score and history are essential for accessing loans with favourable
terms.
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Credit score
A credit score is a three-digit number ranging from 300 to 900 that reflects your
creditworthiness. It’s based on your credit history, which includes past loans,
credit card usage, and repayment behaviour.
Factors affecting credit score
1. Payment history: Missed or delayed payments negatively impact your
score.
2. Credit utilisation: Using a high percentage of your available credit lowers
your score.
3. Length of credit history: A longer history demonstrates reliability.
4. Credit mix: A balanced mix of secured and unsecured loans is ideal.
5. Credit inquiries: Frequent loan applications can lower your score.
Benefits of a high credit score
● Easier loan approvals.
● Lower interest rates.
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● Higher borrowing limits.
How to Improve Your Credit Score
● Pay bills on time.
● Avoid opening too many credit accounts at once.
● Regularly monitor your credit report for errors.
Equated Monthly Instalments (EMI)
Equated Monthly Instalments (EMI) represent a fixed monthly payment made
toward repaying a loan. Each EMI consists of two key components: the principal,
which is the original loan amount, and the interest, which is the fee charged by the
lender for borrowing money.
Several factors influence the size of an EMI. The loan amount plays a significant
role—larger loans naturally lead to higher EMIs. Similarly, the interest rate impacts
monthly payments, with higher rates increasing the EMI amount. The tenure, or
repayment period, also affects EMIs; longer tenures lower the monthly payments
but increase the total interest paid over the life of the loan.
EMIs come with distinct advantages and limitations. On the positive side, they
provide predictable payments that simplify financial planning and offer flexible
tenure options to accommodate individual affordability. However, longer tenures,
while reducing the monthly burden, lead to higher overall interest costs.
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Additionally, missing EMI payments can harm your credit score, affecting future
borrowing potential. To manage EMIs effectively, it is crucial to choose a tenure
that aligns with your repayment capacity, prioritise paying off high-interest loans
first to minimise costs, and consider prepaying loans whenever possible to reduce
the outstanding balance and interest burden.
Debt management
Debt management is crucial for maintaining financial stability and avoiding the risk
of being overburdened by obligations. To manage debt effectively, it is essential to
prioritise high-interest debt, such as credit card balances, as these tend to
accumulate quickly and increase the overall repayment burden.
Creating and adhering to a well-structured budget is equally important, as it helps
track income and expenses, ensuring that loan repayments are made on time
without compromising other financial commitments. Additionally, avoiding
overborrowing is key; only take loans that you can comfortably repay to prevent
financial stress and maintain a healthy financial position.
Government schemes for loans
Governments often introduce schemes to make credit accessible, especially for
small businesses, students, and low-income groups.
Example: Mudra Yojana
● Purpose: To support small businesses and entrepreneurs.
● Features
● No collateral required.
● Categorised into Shishu (up to ₹50,000), Kishore (₹50,000–₹5 lakh),
and Tarun (₹5 lakh–₹10 lakh) loans.
● Lower interest rates and flexible repayment terms.
Other Examples
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● MSME loans: Designed for micro, small, and medium enterprises with
benefits like low-interest rates and no collateral.
● Educational loans: Schemes like CSIS provide interest subsidies for
economically weaker sections.
MCQs
1. What does EMI stand for?
A. Equal Monetary Instalments.
B. Equated Monthly Instalment.
C. Equal Money Investment.
D. Equitable Monthly Interest.
2. What does your credit score represent?
A. How much money you have saved.
B. The amount of your debt.
C. Your likelihood to repay a loan.
D. Your total income.
3. Which type of loan is typically used to buy a house?
A. Personal loan
B. Home loan
C. Auto loan
D. Business loan
Correct answers and explanations:
1. B. EMI stands for Equated Monthly Installment, which is a fixed payment
amount made by a borrower to a lender at a specified date each calendar
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month.
2. C. Your credit score represents your likelihood to repay a loan, which is
based on your credit history, including how reliably you've paid back past
loans and managed debt.
3. B. A home loan is typically used to buy a house. It is specifically designed
for the purchase of real estate, where the property itself serves as
collateral.
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NFO
TM