# Ted has always had difficulty saving money, so on June 1, Ted enrolls in a Christmas savings program at his

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1. Ted has always had difficulty saving money, so on June 1, Ted enrolls in a Christmas savings program at his local bank and deposits \$750. That money is totally locked away until December 1 so that Ted can be certain that he will still have it once the holiday shopping season begins. Suppose that the annual rate of interest is 10 percent on ordinary savings accounts (that allow depositors to withdraw their money at any time). How much interest is Ted giving up by precommitting his money into the Christmas savings account for six months instead of depositing it into an ordinary savings account?

[Hint:If you invest X dollars at an annual interest rate of Y percent, you will receive interest equal to X × Y, where the interest rate Y is expressed as a decimal.]

1. Angela owes \$500 on a credit card and \$2,000 on a student loan. The credit card has a 15 percent annual interest rate and the student loan has a 7 percent annual interest rate. Her sense of loss aversion makes her more anxious about the larger loan. As a result, she plans to pay it off first—despite the fact that professional financial advisors always tell people to pay off their highest-interest-rate loans first. Suppose Angela has only \$500 at the present time to help pay down her loans and that this \$500 will be the only money she will have for making debt payments for at least the next year.

a. If she uses the \$500 to pay off the credit card, how much interest will accrue on the other loan over the coming year? \$

b. On the other hand, if she uses the \$500 to pay off part of the student loan, how much in combined interest will she owe over the next year on the remaining balances on the two loans?  \$ .

c. By how many dollars will she be better off if she uses the \$500 to completely pay off the credit card rather than partly paying down the student loan?

[Hint: If you owe X dollars at an annual interest rate of Y percent, your annual interest payment will be X × Y, where the interest rate Y is expressed as a decimal.]

\$ .

• 9 years ago
Ted has always had difficulty saving money, so on June 1, Ted enrolls in a Christmas savings program at his
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