Problem 1: Borrowing and Saving

In this problem, you can assume it is instant and costless to add or remove money from your

savings account and to borrow or repay credit card debt. Furthermore, assume your risk-free

savings account pays 1% interest annually, your credit card charges 12% interest annually,

and that you have no other assets or debts.

(a) Imagine you have $5,000 in your savings account and a $0 balance on your credit card.

What is the most you would pay today to receive $1,000 in 2 years?

What is the most you would pay today:

(b) Imagine you have $0 in your savings account and a $5,000 balance on your credit card.

What is the most you would pay today to receive $1,000 in 2 years?

What is the most you would pay today:

(c) If you were in the situation in described in part (b) and someone o ered you a guaranteed

$1,000 in 2 years at the cost of $700 today, would you accept? Explain how would you pay

the $700 required today, and provide a calculation showing quantitatively this is a good/bad

deal for you?

(d) Imagine you have $1,000 in your savings account and a $2,000 balance on your credit

card. How much extra money would you have in 2 years by using the $1,000 in your savings

to repay your credit card loan when compared to leaving it in your savings account for the

full two years?