05 Jun Question IRM 3090 Principles of Risk and Insurance
Question
IRM 3090 Principles of Risk and Insurance
Problem Set #4
Ichabod Kazels is 45 years old and makes $55,000 per year. He plans on working until age 70. At that point he wants to retire and move to St. Lucia in the Caribbean; see
http://en.wikipedia.org/wiki/Saint_Lucia
In fact, he wants to be able to afford a house like the one featured in the following link:
http://www.slucia.com/terra/stlucia/residential_property267.html
That is, he will want to buy a house for $2,200,000.00. (Ignore inflation.)
Since the cost of living is fairly low (although nice housing is relatively expensive) in St. Lucia, he thinks that he will need only approximately $4000 per month to cover living expenses (food, taxes, gas, entertainment, etc…) in excess of the cost of the house.
When he dies, he wants to bequest the whole house to his twin children Ingrid and Ingmar free and clear. Thus, he does not want to have to borrow against the house to fund living expenses.
Unfortunately, he has not been saving very much up to this point; he only has $50,000 in savings now. Since he is risk averse, he has in invested in low-risk securities that he expects to earn an effective annual rate of 3 percent per year.
He intends to work until he is 70. Both of his parents and their parents lived well into their mid 90s. So, he expects to live until 95. He expects to be very risk averse in retirement and will seek safe investments that generate only an effective annual rate of 2%.
How much does he need to save per month in order to afford the house and living expenses in retirement? Can he afford such a dream? What if he goes for a more reasonable house such as that in the link below (for $290,000).
http://www.slucia.com/terra/stlucia/search_property251.html
How much does he need to save per month in order to afford the first house if he invests in riskier securities that earn an expected effective annual rate of 9 percent? Can he afford it then?
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