Professional Documents
Culture Documents
Example 1
Sloth Ltd borrows $100,000 for 10 years as an interest only loan. Interest is
payable monthly at the fixed rate of 12% p.a. compounded monthly.
(a)
(b)
Solution
(a) Monthly Interest = 1% $100,000 = $1,000 .
Sloth pays:
10
12
%.
Example 2
A loan of $10,000 is repaid by 5 annual instalments of $2,504.56, interest
being charged at 8% p.a.
Loan
outstanding
Year
at start of
year
1
10,000.00
2
8,295.44
3
6,454.52
4
4,466.32
5
2,319.07
Principal
Interest
repaid
800.00
663.64
516.36
357.31
185.53
1,704.56
1,840.92
1,988.20
2,147.25
2,319.03
Loan
outstanding
at end of
year
8,295.44
6,454.52
4,466.32
2,319.07
0.04
(a)
Verify the numbers for the first two years of the schedule.
(b)
Solution
(a)
(b)
Each customer should see their final balance being exactly zero. The
person (accountant?) specifying the computer programs to generate
individual customers loan records will care.
The person (actuary?) testing the overall profitability of a lenders
loan products probably doesnt care, since errors balance out over
different loans.
Note that over time, the loan outstanding reduces, so the interest reduces,
so the principal repaid each year increases.
Example 3
A loan of $10,000 is repaid by annual instalments, interest being charged at
8% p.a. The first instalment is $2,350 and subsequent instalments increase
at 7% p.a., with a reduced instalment in the final year.
If the instalment varies, it is best to create a column for it in the schedule.
Loan
Loan
outstanding
Principal outstanding
Year
Instalment Interest
at start of
at end of
repaid
year
year
1
10,000.00 2,350.00 800.00 1,550.00
8,450.00
2
8,450.00 2,514.50 676.00 1,838.50
6,611.50
3
6,611.50 2,690.52 528.92 2,161.60
4,449.90
4
4,449.90 2,878.86 355.99 2,522.87
1,927.03
5
1,927.03 2,081.19 154.16 1,927.03
0.00
Copyright 2016. Macquarie University.
5
(a)
Verify the numbers for the first two years of the schedule.
(b)
Solution
(a)
(b)
Extend the schedule to the first time period with a final loan
outstanding that is negative. For that time period, reset:
Final instalment = Loan o/s at start + Interest.
The loan outstanding equals the accumulated value of the loan less
the accumulated value of the repayments made to date. (The
retrospective method.)
3.
1.
2.
L0 = vR1 + v R2 + ... + v Rn = v t Rt
2
Lt = L0 (1 + i ) R1 (1 + i )
t
t 1
= L0 (1 + i ) Rs (1 + i )
t
s =1
3.
t =1
+ R2 (1 + i )
t 2
t s
n t
Lt = vRt +1 + v Rt +2 + ... + v Rn = v s Rt + s
2
n t
s =1
+ ... + Rt
t = 1, 2,3,..., n
t = 0,1, 2,..., n 1
(b)
(c)
Check the above answer using the retrospective method. (If the check
fails, the error could be in (a), (b) or (c).)
Loan o/s after 5 years
= $120,000 (1 + i ) $ x s60 at 1%
60
= $117,195.46
(d)
The answers to (b) and (c) differ slightly (less than $1) due to
rounding. Given they differ, which one is right?
Both retrospective and prospective methods are approximations. The
true answer comes from the loan repayment schedule, which may
match neither of these since it individually rounds each interest
payment. (If it didnt round the interest but used the rounded
instalment, it would match the retrospective method, so perhaps that
method is less wrong.)
(e) If the (prospective) loan outstanding at the end of the 4th year of the
loan is $117,898.38, determine the amount of interest charged during
the 5th year of the loan.
Interest charged in 5th year of loan
= Total instalments paid in 5th year principal repaid over 5th year
= 12 $ x ( Loan o/s after 4 years loan o/s after 5 years )
= 12 $1, 234.34 ( $117,898.38 $117,196.33)
= $14,110.03
(f)
At the end of the 5th year of the loan, the interest rate falls to 11% p.a.
compounded monthly. Determine the new monthly instalment which
will repay the loan in the original term. Use the prospective loan
outstanding. (If a question doesnt specify which loan outstanding to
use, you can use either.)
The new monthly instalment is $ y where
Copyright 2016. Macquarie University.
10
$117,196.33 = $ y a300 at
11
12
% or 0.916%
y = 1,148.66
(Check: Interest rate Instalment .)
(g) If the borrower continues paying the original instalment under the
new interest rate, determine the new term of the loan and the final
smaller instalment. Perform a reasonableness check on the final
instalment.
Assume the loan is exactly repaid by n further instalments of $x.
(Highly unlikely!) Then
$117,196.33 = $1, 234.34 an at 0.916%
1 1.00916 n
= 94.946554
0.00916
1.00916 n = 7.712682
n ln1.00916 = ln 7.712682
n 223.88
That is there will be 223 further full instalments plus a final smaller
instalment of $z where
z = 1,084.34
a223 = 94.832781
224 + 60 = 284 . The new term of the loan is 284 months.
Checks: 0 < z < x .
284 < 360 . Interest rate Fewer Instalments.
Copyright 2016. Macquarie University.
12
(h)
Find the term of the loan and the size of the final instalment. Perform
a reasonableness check on the final instalment.
(b)
Find the loan outstanding after 5 years using both retrospective and
prospective methods.
(We can also do the same types of alterations as done in the previous
question, but this doesnt require any new skills, so well stop here.)
Solution
1
1.02
n
1 ( 1.005
1.02 )
$7,000
= 1.02
1.005
1 1.02
n
1 ( 1.005
1.02 )
= $7,000
1.02
1.005
1.005 n
1.02
+ 1.005
+ (n terms)
1.022
= .357143
n ln 1.005
1.02 = ln.357143
n = 69.50
20
21
7,0001.00568
7,0001.005
2
7,0001.00520
7,000
1
7,0001.00519
300,000
0
69
70
Thus there are 69 instalments following the GP, plus a final smaller
instalment of $x where
69
1 ( 1.005
$x
1.02 )
$300,000 = $7,000
+
70
1.02
1.005
1.02
x = 4,936.65.
Copyright 2016. Macquarie University.
16
Check: 0 < x < 7000 1.00569 = 9875.44 . That is, the 70th instalment must
be smaller than what it would have been had it followed the GP pattern.
(b)
20
19 1 ( 1.02 )
= $300, 000 1.02 $7, 000 1.02
1.005
1 1.02
20
20
1.02
1.005
20
= $300, 000 1.02 $7, 000
1.02
1.005
= $267,960.04
1.005 49
1.005
$x
1 ( 1.02 )
=$7, 000
+
1.005
1.02 1 1.02 1.0250
20
1.005 49
$4,936.65
20 1 ( 1.02 )
= $7, 000 1.005
+
50
1.02
1.005
1.02
= $267,960.04
i
i
(12)
20
1.02
12 x 1 ( 1+i ) i
=
at 6.167781%
1.02
1 + i 1 1+i .06
20
1 ( 1.02
1+i ) i
= 12 x
at 6.167781%
i .02 .06
x = 919.61
at 6.167781%