Improving one’s financial situation

Question 1
Dominic is in his 40s and lives in a two bedroom flat in Blackburn. He works at the local council. When he bought the flat in April 2019 the mortgage broker talked him through repayment and interest-only mortgages. He decided to use his savings as a deposit and chose a repayment mortgage, which by April 2021 was standing at £83,000. The market value of his flat had fallen by 2% over this time period on the original purchasing price of £95,000.

In April 2021 Dominic earns a net monthly income of £1,600 and his expenditure has averaged £1,500 a month over the last two years. In April 2021 a personal loan to conduct initial refurbishment on the flat is down from £1,500 to £800, but his current account balance has dropped to zero and he has an overdraft on his current account of £1,300. Meanwhile his savings account holds just £50. He now owes £1,800 on a credit card. His cash holdings have dropped to £30. The rest of his balance sheet has not changed since April 2019.

Dominic is now reviewing his finances.

Table 1 shows his balance sheet and financial ratios in April 2019.

Table 1 Dominic’s household balance sheet – April 2019
April 2019
Assets (Total) 96,400
Liquid assets 1,400
Cash 100
Current account 1,000
Instant access savings account(s) 300
Other liquid assets 0
Other assets 95,000
Home 95,000

Liabilities (Total) 86,750
Short-term liabilities 250
Overdraft 0
Credit card 250
Other short-term liabilities 0
Other liabilities 86,500
Personal loans 1,500
Mortgage 85,000

Ratios
Net worth / wealth 9,650
Current asset ratio 5.60
Leverage ratio 89.99
1.1 Using the information provided in Table 1, complete Dominic’s balance sheet for April 2021. (4 marks)

1.2 Explain the factors Dominic might have considered in choosing a repayment mortgage over an interest-only mortgage in 2019. (3 marks)

1.3 Using the financial ratios and other relevant information, compare Dominic’s financial situation in April 2019 and April 2021. (4 marks)

1.4 Briefly explain two other possible actions Dominic could take to improve his financial situation. (4 marks)

Question 2
Anita is living at home with her mother. But Anita has now found a job and is planning to move into her own flat. She wants to buy a flat four years from now, knowing that she will need a deposit of at least £9,000 in order to do so. Anita has £1,500 in a savings account.

2.1 If Anita uses all of her savings and saves £110 per month, what rate of return will Anita need to reach her target of £9,000 after four years? (3 marks)

2.2 Anita has seen that shares (equities) in a particular internet start-up company have given an 18 per cent return over the past two years. She is considering using all of her savings into buying this company’s shares. Give two reasons why putting all her savings into this one company’s shares might not generate anything close to the 18% return they’ve achieved over the past two years.(4 marks)

2.3 Briefly explain another way that Anita could save the amount of her deposit if she is risk-averse or doesn’t have much risk capacity. (4 marks)

2.4 How will Anita’s efforts to save for a deposit be affected if there is a fall in interest rates which causes a rise in house prices? (4 marks)

Question 3
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 March 2020 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 March 2020
Region Burglary Violence against the person
Cheshire 4.3 per thousand of population 36.2 per thousand of population
Durham 0.65% 4.16%
Hampshire 1 in 179 of population 1 in 33 of population
South Wales 0.0046 0.0293
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 marks)

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 Cheshire? (3 marks)

3.3 Give two reasons why a particular household in South Wales may in fact be at a lower risk of burglary than the probability shown in the table. (4 marks)

3.4 Briefly explain in your own words the meaning of moral hazard, and identify two ways in which an insurer can design a policy covering burglary to reduce the risk of moral hazard. (5 marks)

(Total marks available for Question 3: 15 marks)

Sample Solution

ACED ESSAYS