In this problem, you are being asked to calculate the effective borrowing cost (rate) of an adjustable rate mortgage assuming you live in the house till the loan matures under the following eight (8) scenarios:

1. Index rises 1/4% every year

2. Index rises 1/2% every year

3. Index rises 3/4% every year

4. Index rises 1% every year

5. Index rises 2% every year

6. Index falls 1/4% every year

7. Index falls 1/2% every year

8. No change in index

A description of the 1-year ARM with monthly payments is as follows:

Amount: $100,000

Maturity: 15 years

Points: 2

Closing Costs: 4%

Initial Contract Rate (teaser): 6.75%

Margin: 125 bps (1basis point = 0.01%)

Current Index Yield: 4%

Caps and Floors: Annually: 1%, Lifetime: 5%

Here is what I have so far, I'm getting stuck on how to work out the pay rate adjustment year over year.