Word limit: 800 words
Donna and Dan live in Dewsbury. Donna is a police officer and Dan works part-time in a warehouse. When they bought a three-bedroom house in September 2018 the mortgage broker talked them through repayment and interest-only mortgages. They decided to use their savings as a deposit and chose a repayment mortgage, which by September 2020 was standing at £110,000. The market value of their house had increased by 2% over this time period on the original purchasing price of £144,000.
Together, in September 2020 the couple earn a net monthly income of £3,000 and their expenditure has averaged £3,300 a month over the last two years. In September 2020 a loan to conduct initial refurbishment (putting up new fences) is down from £2,000 to £1,000, their current account balance has dropped to zero and they have an overdraft on their current account of £1,800. Meanwhile their savings account holds just £100. They also owe £2,500 on a credit card. The rest of their balance sheet has not changed since September 2018.
They are reviewing their finances as they consider further home improvements.
Table 1 shows their balance sheet and financial ratios in September 2018.
Table 1 Donna and Dan’s household balance sheet – September 2018
Assets (Total) 146,080
Liquid assets 2,080
Current account 1,500
Instant access savings account(s) 500
Other liquid assets 0
Other assets 144,000
Liabilities (Total) 118,500
Short-term liabilities 1,500
Credit card 1,500
Other short-term liabilities 0
Other liabilities 117,000
Personal loans 2,000
Net worth / wealth 27,580
Current asset ratio 1.39
Leverage ratio 81.12
1.1 Using the information provided in Table 1, complete the couple’s balance sheet for September 2020.
1.2 Explain the factors Donna and Dan might have considered in choosing a repayment mortgage over an interest-only mortgage in 2018.
1.3 Using the financial ratios and other relevant information, compare the couple’s financial situation in September 2018 and September 2020, and explain whether you lean towards their home improvement idea.
1.4 Briefly explain two other possible actions they could take to improve their financial situation.
After not being able to save before, Ari calculates that his new job will enable him to start putting aside some money. He wants to buy a flat five years from now, knowing that he will need a deposit of at least £15,000 in order to do so. He has just received £2500 in his late grandmother’s will.
2.1 If he saves the £2500 lump sum plus £150 per month, what rate of return will Ari need to reach his target of £15,000 after 5 years?
2.2 Ari has seen that shares (equities) in a particular company have given a 9 per cent return over the past five years. Give two reasons why, to get a similar return over the next 5 years, it might not be a good idea to put all his savings for the deposit into buying this company’s shares.
2.3 Ari can get a higher rate of return on his savings, enough to reach his target deposit, if he commits to a savings plan that runs for 10 years (rather than 5) with no scope for early withdrawals. Identify two financial disadvantages of waiting an extra 5 years before offering the deposit to buy a first home.
2.4 How will Ari’s efforts to save for a deposit be affected if there is a sharp rise in interest rates which causes a fall in house prices?
Table 2 shows some data related to crime in different areas of England. When answering the questions that follow, assume that the rates of offences in each area in the year ending September 2019 are valid indicators of the current annual risks of these offences.
Table 2 Rates of police recorded crime for burglary and violence against the person for selected areas of England and Wales, year ending September 2019
Region Burglary Violence against the person
Cleveland 9.4 per thousand of population 41.4 per thousand of population
Gwent 0.63% 3.47%
London 1 in 109 of population 1 in 41 of population
Norfolk 0.0038 0.0268
Source: adapted from Office for National Statistics (2020)
3.1 Transform the figures in Table 2 into one comparable measure of risk by expressing each probability as a decimal, rounded to four decimal places.
3.2 If crimes categorised as burglary and violence against the person are mutually exclusive, what is the chance (expressed in percentage) of being victim of either crime next year in the area with the highest combined crime rate?
3.3 Give two reasons why a particular household in Norfolk may in fact be at a higher risk of burglary than the probability shown in the table.
3.4 Briefly explain in your own words the extent to which adverse selection could be reduced if mutual insurance pricing models were adopted for contents insurance (eg in case of burglary) in these four police areas rather than individual risk-based pricing.