You are on page 1of 4

AY2011-12 Sem1 QF2101 Tut 2

NG Wee Seng
Email: matnws@nus.edu.sg
Tel: 65164673

1
QF2101 Basic Financial Mathematics
Tutorial 2

Basic Problems


1 Calculate the present value (at time t = 0) of a 5-year annuity that pays $100 yearly,
with the first payment made at end of the tenth year. Take the effective annual
interest rate to be 10%. Give your answer to the nearest dollar.
[161]

2 Calculate the future value, at the end of the tenth year, of a 10-year annuity
immediate of $100 per month when the effective annual interest rate is 8.5%. Give
your answer to the nearest dollar
[18485]

3 A man wants to accumulate $10, 000 by the end of two years by making a deposit of
$300 at the end of each month during the first year and $(300 + x) at the end of each
month of the following year. Given that the account pays 12% compounded monthly,
find the value of x.
[150.44]

4 A 20-year annuity is such that the first payment of $x is made at the end of the first
year, and that subsequently, payments increase in such a way that each payment is
104% of the preceding one. If the present value of this annuity is $7229.50, find the
value of x to the nearest integer. Take the effective annual rate of interest to be 7%.
[500]


5 A perpetual annuity that pays $1 for the first 5 years, with the first payment made t =
1, and pays $A thereafter, has present value P. If the effective annual rate of interest
is 10%, express A in terms of P.
[ 1 1 . 1 1 . 1
10
5 5
+
|
.
|

\
|
=
P
A ]


AY2011-12 Sem1 QF2101 Tut 2


NG Wee Seng
Email: matnws@nus.edu.sg
Tel: 65164673

2
6 A man takes out a loan of $35000 to be repaid by annual installments over 20 years.
The first payment will be made at the end of the first year. Take the interest rate to be
7% per annum.
(i) Calculate the annual installment.
(ii) Suppose the man asks for the term of the loan to be extended by 5 years after
making the 13
th
payment. Find the outstanding loan after the 13
th
payment
and hence, calculate the new installment to the nearest dollar.
[(i) $3303.7524 (ii) $17804.878; $2242]


7 I take out a $50,000 mortgage on a home at 12.5% interest convertible semi-annually.
I will pay off the mortgage with monthly instalments for 20 years. Suppose that after
making the 60
th
payment, I decide to renegotiate the loan so that I will repay the
outstanding amount by making a lump sum payment of $10000, and clearing the
balance by means of monthly instalments of $x for 10 years at 11% interest
convertible semi-annually. Find x to 2 decimal places.
[490.32]



8 A loan of $ 8,000 is to be repaid by annual instalments of $600. The effective annual
interest rate is 6% . Determine the total number of payments to be made and the
amount of the last payment.
[ 28 payments; 376.627 ]


AY2011-12 Sem1 QF2101 Tut 2


NG Wee Seng
Email: matnws@nus.edu.sg
Tel: 65164673

3
9 A 30-year loan of $10,000 is to be repaid by annual repayments. The interest rate is
guaranteed at 8% for the first 5 years of the loan. Prevailing interest rates apply
thereafter.
(i) Calculate the annual repayment for the first five years based on a 8% interest
rate for a 30-year term. (That is, find A such that $10000 can be fully repaid
with 30 annual repayments of $A at 8%)
(ii ) Calculate the loan balance immediately after the fifth payment has been
made.
The interest rate is increased to 9% between year 6 and year 30 inclusive.
(iii) Calculate the new annual repayment if the outstanding loan is to be fully
paid at the end of year 30.
(iv) If instead, the same annual repayment (i.e. your answer to (i)) is made
throughout the term of the loan, how many years does it take to fully repay
the loan? How much is the last payment?
[ (i) $888.27 (ii) 9482.13 (iii) 965.34 (iv) Further 37.565 years total of 5 + 38
= 43 years. Full repayment for 42 years; last payment= 511.53 ]


10 (a) It is given that the force of interest over the time interval [1, 3] is given by
1
) (

+ = t t | o o . If $100 invested at t = 1 grows to $120.74 at time t = 2 and $100
invested at t = 2 accumulates to $114.00 at t = 3. find o and | .
(b) A bank account credits interests using a force of interest
2
3
) (
3
2
+
=
t
t
t o . A deposit of
$1000 is placed in the account at time 0 = t . Calculate the amount of interest the
account earns from the end of the forth year to the end of the eighth year.
[ ; 2 / 1 ) (
3
t t a + = interest = 1000( a(8) a(4)) = 224,000]

AY2011-12 Sem1 QF2101 Tut 2


NG Wee Seng
Email: matnws@nus.edu.sg
Tel: 65164673

4
Discussion Problems

1 Consider projects A and B with cash flows ( ) ,..., , ,
0
a a a a and ( ) ,..., , ,
0
b b b b
respectively, both having the same length. The numbers b a b a , , ,
0 0
are positive and
such that
b
b
a
a
0 0
> .
Prove that IRR
A
< IRR
B
.


2 Consider two projects A and B with cash flows ( ) ,..., , ,
0
a a a a and
( ) ,..., , ,
0
b b b b both having the same length. The numbers b a b a , , ,
0 0
are positive.
It is given that
0 0
b a >
b
b
a
a
0 0
> and 0 ) (
0 0
< + a b n b a . We have shown in
Question 1 that IRR
A
< IRR
B
.

Let NPV
A
(d) and NPV
B
(d) be the present values of the cash flows of project A and
project B respectively, where
r
d
+
=
1
1
. We assume that r > 0.
(i) Show that the difference, PV
A
(d) - PV
B
(d) has different signs at 0 = d and 1 = d .
(ii) Deduce that there is an unique interest rate r* for which the two projects have equal
NPV. We call r* the crossover rate of the two projects.
(iii) Show further that NPV
A
< NPV
B
if and only if r > r*.
(iv) Sketch the graphs of NPV
A
and NPV
B
as a function of the rate of interest r, indicating
r
*
and the IRR of each project on your graphs.

You might also like