Question

Saul and Pepper have been friends since kindergarten. Both Saul and Pepper have good part-time jobs. Pepper deposits a portion of the money she earns in the bank each week. Saul, on the other hand, spends most of the money he earns on building his baseball card collection.
Recently, a rare 1975 Topps Mini George Brett rookie card has recently gone on sale for $100. This card would greatly enhance the value of Saul’s current collection. However, he does not have money to buy the card. He asks Pepper to loan him $100. He also agrees to sign an IOU to pay Pepper back her $100 plus 7% interest in one month; the time it will take him to have enough to pay her back.
Saul and Pepper’s friend, John, works at a supermarket. He has recently become good friends with Jackson, who works at the same supermarket. John likes Jackson because he is reliable and willing to cover work shifts for him. One day, Jackson asks John to loan him $100. He promises to pay John back in three months with 7% interest. He signs an IOU agreeing to this.
Required:
1. Which IOU pays the most money? Saul’s or Jackson’s? Why?
2. Which IOU seems less risky? Why?
3. Do you think Pepper should lend Saul the money? Should John lend money to Jackson? Why?

Answer 1

Answer:

1.  Both IOUs pay out the same amount of money ($107)

2. Saul’s loan from Pepper is less risky

3. Yes, Pepper should lend Saul the money. Yes, John should lend Jackson the money

Explanation:

1. Let calculate the amount of money to be paid on each IOU:

At the end of one month, Saul's IOU = $ (100 + 100 * 0.07) = $107

Saul pays back $107 to Pepper at the end of one month

At the end of three months, Jackson's IOU = $ (100 + 100 * 0.07) = $107

Jackson pays back $107 to John at the end of three months

Hence, both Saul and Jackson pay the same amount on their IOUs

Whilst both IOU of Saul and Jackson pay out the same amount, they do so under different time durations. Saul’s IOU to Pepper pays out the amount of money in a shorter duration of time (one month) as compared to that of Jackson which takes three months.

2. Saul's loan from Pepper is less risky. This is because Saul and Pepper have been friends for a verl long time (since kindergarten); that's ample time to have known one another. There is little to no surprise to be displayed between them as they pretty much know all there is to know about one another. This stands in contrast with Jackson with whom John recently became friends; although he has a reputation of being reliable but there is still a greater decree of uncertainty about him since its a new friendship. For example, Jackson could default on his IOU agreement.

On the other hand, while Saul's loan from Pepper is to be payed back in one month, Jackson's loan from John is to be returned over a time span of three months. This gives Jackson more time to spread out repayment much more conveniently than Saul but then again, that's what Saul spends most of his income on.

Saul is taking the loan to advance his investment in his baseball collection which could yield more income for Saul

Hence, overall, Saul's IOU seems less risky

3. Yes, Pepper should lend Saul the money. Asides the fact that they have been friends for over a decade (at the least), Saul already spends his income on building his baseball card collection anyway. It's a win-win for both party; Saul gets the satisfaction of adding an extra valuable card to his collection while Pepper gets the satisfaction of getting an extra $7 from her loan to Saul which she can add to her savings.

Yes, John should John lend the money to Jackson. Jackson already has a strong work and office etiquette which is evident by his reliability. Furthermore, if all goes as agreed, John and Jackson's new friendship could be further deepened and strengthened.