1. TeaserLoans(4points) Part of the blame following the sub-prime mortgage crisis went to the banks for their policy of teaser

loans which sucked people into buying houses they could not afford. This problem considers this issue:

1. a) Suppose you can afford a monthly payment of $800 for your mortgage. Use the loan formula or an online app to find the selling price of the house (P) that this corresponds to at the teaser rate of 2.0% APR compounded monthly. Assume a 30 year mortgage.

2. b) Now use the house price from part a) to determine the monthly payment at a rate of 4.5% APR, representing the true state of things once the period of enticement is over.

3. c) How much extra are you now paying? Is this likely to be affordable given your choice of monthly amount in part a)?

2. DebtConsolidation(7points)

Credit cards allow people to purchase things that they can almost afford. Things are bought with the feeling that they will soon be paid for. However they also fuel the temptation to buy things that perhaps should have been resisted. This is especially true with the type of credit card that allows a consumer to spend freely for 6 months without being hit by interest. If the account can be zeroed out in that time, the card has given consumer an interest free loan. But it is possible that the consumer has spent up to the limit of the card, say $10,000 and must now pay this off at 24% APR.

1. a) What is the monthly interest rate corresponding to 24% APR? (Simply divide by 12.)

2. b) How much interest is owed after 1 month on the $10,000? (Just multiply by the monthly interest rate.)

3. c) Suppose the consumer is able to make a payment of $200 per month against this $10,000 loan. How long will it take the consumer to pay off the debt? (This just requires some thought.)

Having maxed out one credit card, the consumer is tempted by an offer of a second credit card (from another bank) at 24% APR with a $7500 limit. And then, maybe, after that a similar offer... Resist!!

Debt consolidation services are often the only way out for people who find themselves with a handful of cards and the ability only to pay the minimum required ever month. There is no alternative for such folks than to seek help as they will never be able to get out of the position that they find themselves in.

A service may pay off all the loans say $25,000 worth so that the consumer now only has one debt to pay the one to the consolidation service. The difference is that they may now only pay 12% APR (1% a month) so that instead of paying $500 a month (2% of $25,000) to simply pay the interest, they will be able to pay off the loan.

4. d) How many months will it take to pay off the $25,000 loan at $500 per month at 12% APR compounded monthly?

5. e) When the loan is paid off, how much interest has gone to the Debt Consolidation Service?

6. f) Are Debt Consolidation Services a profit making business or a charitable organization?

3. Consumer Price Index (4 points)

The consumer price index is a useful index of inflation, and may be used to adjust the limits of each tax bracket for the upcoming year. Nevertheless the CPI has its critics. A lot of things are used in the determination of the value of the index at a given time take a look at the latest values for a few of the categories listed under the Consumer Price Index Summary http://www.bls.gov/news.release/cpi.t01.htm - and youll see it is easy to argue against the balance of the categories used.

Note that 100 is the base CPI value from December 1982. The latest CPI is listed under unadjusted All Items for example, in April 2020 this was 256.389; values higher than this number have increased more than average since December 1982; those less than this have increased less than average.

Consider the effects of inflation on retirees. (We painted a pessimistic picture in Section 3B one example showed that $40,000 per year in 40 years time equates to just $12,262 in todays dollars.) It should be clear that some categories used in the CPI calculation are less of an issue for retired folks:

1. a) Look down the Expenditure Category column and identify some categories that might be important for retirees. Then look at the indices for these categories. Are these better (lower) or worse (higher) than the overall number? Write down the indices for All Items as well as for the categories you choose as important for retirees. (Are any of these much higher than expected?)

2. b) Discuss whether the retirement gloom shown in 3B was pessimistic or a reality

4. Retirement(5points)

In Section 3C we considered the problem of a planned retirement income under the assumption that this needs to be financed by investment into a retirement account. However income can have other forms, and we all pay FICA during our working life so we can take out Social Security when we retire.

1. a) Use the Social Security Quick Calculator at https://www.ssa.gov/oact/quickcalc/ to determine the monthly earnings (in todays dollars) of someone born on June 30th 1960 whose income has been $50,000 per year, and who plans on retiring when they reach their full retirement age of 67 - in July 2027.

2. b) However a person may choose to retire before their full retirement age, although there is a penalty for doing so. Use https://www.ssa.gov/planners/retire/1960.html to determine how much this person would receive if they choose to receive Social Security Benefits at the minimum possible age of 62.

3. c) How much will the person have received in benefits when they reach the age of 70 if i) they retire at 67, and ii) they retire at age 62?

4. d) Repeat (c), replacing age 70 with age 80.

5. e) Is it better to claim the benefit at the earliest possible time rather than to wait until full retirement age? Explain your reasoning.