Solutions 2 BS4a Actuarial Science Oxford MT 2012

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2.2

Yields, pthly payments, annuities and loans

4, 000(1 + i)4 = 4, 400 i = (4400/4000)1/4 1 0.024 = 2.4%

1. The second investment gives a rate of interest i given by

For the rst investment, we cannot calculate the rate of interest explicitly, but we can see that if it was i = 2.4%, wed have 4, 000(1 + i)7 + 2, 000(1 + i)5 + 3, 000 = 529.43 > 0 so the actual rate must be higher to break even. Therefore, the rst investment gives the higher rate of interest. 2. (a) We need to solve X (1+ y )s + Y (1+ y )t = 0. This gives y = (Y /X )1/(ts) 1. As you would expect, the yield increases as Y increases or X decreases. If Y > X the yield is positive, and then it decreases with the length of the term t s; if Y < X then the yield is negative and it increases towards zero as t s increases. (b) The income stream corresponds to interest at eective rate X/P paid on the investment P at the end of each time unit, with the capital P repaid at time n. So the yield is simply X/P . This can be veried formally from the yield equation. 3. (a) m|an| = am+n| am| = v m an| (b) From above a n| = v 1 an| = (1 + i)an| . For part (ii), simply add on another payment at time 0 to the cash-ow for an1| , to give a n| = 1 + an1| . (c) The values of the increasing annuity at time 0 and 1 are given by (Ia)n| =
n k=1 n1 j =0

kv

and

(1 + i)(Ia)n| =

(j + 1)v j .

Subtracting the two, we obtain i(Ia)n| = a n| nv n (d) Let c be the security; then V al0 (c) = N v n + jN an|i
(p)

(Ia)n| =

a n| nv n . i
(p)

and

V aln (c) = N + jN sn|i ,

N the amount of nominal units (and so also the sum received at redemption since the security is redeemed at par). 4. (i) Present value of quarterly payments in arrears, of 0.25 each for 67 years:
(4) a67|

Notice also a67| =

(4)

67 4 r =1

1 1 1 (1 + i)67 (1 + i)r/4 = (1 + i)1/4 = 23.5391. 4 4 1 (1 + i)1/4

i a , i(4) 67|

by Question 6.

Solutions 2 BS4a Actuarial Science Oxford MT 2012

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(ii) Terminal accumulated value of monthly payments in arrears, of 1/12 each for 18 years: s18| = (1 + i)18 a18| = (1 + i)18
(12) (12)

1 1 (1 + i)18 (1 + i)1/12 = 26.1122. 12 1 (1 + i)1/12

(iii) Present value of quarterly payments in advance, of 0.25 each for 16.5 years (198 months):
(4) a 16.5|

16. 5 4 1 r =0

1 1 1 (1 + i)16.5 (1 + i)r/4 = = 12.2078. 4 4 1 (1 + i)1/4

(iv) Accumulated value of monthly payments in advance, of 1/12 each for 15.25 years (61 quarters): s 15.25| = (1 + i)15.25 a 15.25| = (1 + i)15.25
(12) (12)

1 1 (1 + i)15.25 = 20.9079. 12 1 (1 + i)1/12

(v) Present value of quarterly payments in arrears of 0.25 each for 3.75 years deferred by 4.25 years, i.e. rst payment in 4.5 years, last payment in 8 years:
(4) 4.25|a3.75|

= (1 + i)4.25 a3.75| = 2.9374.

(4)

(vi) (Is)4| is the accumulated value of an increasing annuity after four years. We have (Is)4| = (1.04)3 + 2(1.04)2 + 3(1.04) + 4 = 10.4081. 5. Let C be the advertised price. Then the equation of discounted values at time 0 is 0.95C = or 0.95 1 (1 + i)1.25 15 = 1.05 (1 + i)1/12 1 f (i) := 1 (1 + i)1.25 13.5714 = 0. (1 + i)1/12 1 f (20%) = 0.2595 C (12) (1.05)12a1.25|i 15

or

The function f (i) is decreasing in i and gives f (10%) = 0.5134, and by linear interpolation i

We quote this as an approximate answer (or check f (16.6%) 0.0137, which is pretty good compared to f (10%) and f (20%), indeed it can be shown that 16.5% is correct to 1 d.p.)

20%f (10%) 10%f (20%) 16.6% f (10%) f (20%)

Solutions 2 BS4a Actuarial Science Oxford MT 2012 6. We calculate Val1 (c ) =

1

21

c (s)e

(1s)

ds =

eu du = e 1 = 1 + i 1 = i.

Now let p N. Then we get the same answer: Val1 (cp ) = i(p) s1| = i(p) 7. First note that 30, 000 = Xa25|i = X
(12) (p)

(1 + i) 1 = i. i(p)

1 (1/(1 + i))25 = 8.2657X 12((1 + i)1/12 1)

so that X = 3629.46 nominal, per annum, so X/12 = 302.46 per month. (a) Retrospective formula L10 = 30, 000(1 + i)10 s10|i 3629.46 = 26051.60 (b) Set up a loan of amount L10 for a term of 20 years L10 = Y a20|i Y = 3340.96 Y /4 = 835.24 (c) Similarly, for annual repayment rst L10 = Za10|i Z = 4610.72 ) if A payment of ((2n 1, Z ), (2n, Z )) is equivalent to (2n, Z = Z (1 + (1 + i)) = 9774.73 Z 8. (a) The total payments per year are 10,000, hence X = 10, 000/12 = 833.33 per month. The nominal interest rate is i(12) = 12((1 + i)1/12 1) = 9.569%. The initial outstanding loan is L = 10, 000a25| = 94, 859.12, and the retrospective method yields after 5 years L5 = v 5 L 10, 000s5|
(12) (12) (4) (12)

= 88, 970.54

and the interest part in the next monthly payment is one months interest on L5 I = L5 i(12) = 709.47. 12

(b) The total capital repayment in the rst ve years is L L5 = 5888.58, the total payments made are 49999.80, therefore the total interest is the dierence: 44111.22.

Solutions 2 BS4a Actuarial Science Oxford MT 2012

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9. To calculate the amount X of the rst 3 payments, we work on the basis of a 10-year loan with an interest rate of 5% throughout. We get Xa10|5% = 10, 000, giving X = 10000/7.72173 = 1295.05. We then wish to calculate the outstanding debt L3 after the rst 3 payments. Using the retrospective formula, we get L3 = Val3 (0, 10000), (1, X ), (2, X ), (3, X ) = (10000)1.053 Xs3|5% = 7493.61, since s3|5% = 3.1525. Then we reschedule the remaining debt L3 for the remaining term of 7 years on the basis of a rate of 8%, giving payments of Y at the end of each year where Y = L3 /a7|8% = 7493.61/5.20637 = 1439.31. In summary we have a cash-ow c = (0, 10000), (1, X ), (2, X ), (3, X ), (4, Y ), (5, Y ), . . . , (10, Y ) . The yield is y satisfying 0 = y -Val0 (c) = 10000 + X 1 (1 + y )3 (1 + y )3 (1 + y )10 +Y . y y

To show that the APR is 6.4%, we just check the value of the RHS at y = 6.4% and y = 6.5%. [Remember that the APR is the yield rounded down to the next lower 0.1%. This value is positive (-12.8) in the rst case and negative (-35.1) in the second. 10. (a) Let a n|i denote the value of this annuity at an annual rate of interest i. We have k n1 n1 1+r a n|i = = (1 + j )k = a n|j . 1+i k=0 k=0 since 1+j =1+ ir 1+i = . 1+r 1+r

Solutions 2 BS4a Actuarial Science Oxford MT 2012

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(b) Let a n|i denote the value of this annuity at an annual rate of interest i. We have a n|i =
n (1 + r)k1 k=1

(1 + i)k

1 1 = (1 + j )k = an|j . 1 + r k=1 1+r

Hence, the present value of this annuity is not equal to an|j (unless r = 0). (c) Let the rst annuity payment be X . The equation of value is 10, 000 = X (1.05)1 a20|j where 1+j = 1.09 1.05 j = 0.03810.

Now a20|j = 13.822455 so that 10, 000 = X (1.05)1 a20|j X = 759.63.