FM1 Solutions

2007 The Infinite Actuary, LLC 1 J oint Exam2/FM (Sample Exam)
1. Which of the following is not a way to create a 40-45-50 butterfly?

(A) buy 40-strike call, write two 45-strike calls, buy 50-strike call
(B) buy 40-strike put, write two 45-strike puts, buy 50-strike put
(C) buy 40-strike put, write 45-strike call, write 45-strike put, buy 50-strike call
(D) buy 40-strike call, write 45-strike call, write 45-strike put, buy 50-strike put
(E) all of the above will create a 40-45-50 butterfly


2. Let
1
, 0 15
4
t
t
t
o = s s
+

What is the first year for which the effective rate of discount is less than 12.5?
(A) 3
(B) 4
(C) 5
(D) 6
(E) 7


3. A bond will pay a coupon of 100 at the end of each of the next three years and will
pay the face value of 1000 at the end of the three-year period. The bonds modified
duration when valued using an annual effective interest rate of 20% is X.

Calculate X.

(A) 2.25
(B) 2.61
(C) 2.70
(D) 2.77
(E) 2.89


4. You are given the following table of interest rates:
Calendar
Year of
Original
Investment
Portfolio
Rates
(in %)
y
1992 8.25 8.25 8.40 8.50 8.50 8.35
1993 8.50 8.70 8.75 8.90 9.00 8.60
1994 9.00 9.00 9.10 9.10 9.20 8.85
1995 9.00 9.10 9.20 9.30 9.40 9.10
1996 9.25 9.35 9.50 9.55 9.60 9.35
1997 9.50 9.50 9.60 9.70 9.70
1998 10.00 10.00 9.90 9.80
1999 10.00 9.80 9.70
2000 9.50 9.50
2001 9.00
Investment Year Rates (in %)
1
y
i
2
y
i
3
y
i
4
y
i
5
y
i
5 y
i
+

A person deposits 1000 on J anuary 1, 1997. Let the following be the accumulated
value of the 1000 on J anuary 1, 2000.
P: under the investment year method
Q: under the portfolio yield method

Calculate P +Q.
(A) 2575
(B) 2595
(C) 2610
(D) 2655
(E) 2700


5. A loan is repaid with 10 annual payments. The first payment occurs one year after
the loan. The first payment is 100 and each subsequent payment increases by 10.
The annual effective rate of interest is 5%. The amount of principal repaid in the 4
th

payment is X.

Determine X.

(A) 71
(B) 76
(C) 80
(D) 84
(E) 91


6. A 1000 par value 10-year bond that pays 9% coupons semiannually is purchased for
X. The coupons are reinvested at a nominal rate of 7% convertible semiannually.

The bond investors nominal annual yield rate convertible semiannually over the 10-
year period is 9.2%.

Determine X.

(A) 924
(B) 987
(C) 1024
(D) 1386
(E) 1442


7. Bill writes a $100-strike call option on stock XYZ with 6 months to expiration for a
premium of $7.24. The risk-free rate is 5% convertible semiannually. For what rage
of prices at expiration does Bill make a profit?

(A) 0 to 92.58
(B) 92.58 to
(C) 0 to 107.42
(D) 107.42 to
(E) 0 to 107.60


8. 10 deposits of $2000 are made every other year with the first deposit made
immediately. The resulting fund is used to buy a perpetuity with payments made
once every 3 years following the pattern X, 4X, 7X, 10X, . The first perpetuity
payment is made 3 years after the last deposit of $2000. The annual effective rate of
interest is 6%.

Determine X.

(A) 408
(B) 458
(C) 471
(D) 512
(E) 603


9. J ohn buys a perpetuity-due with annual payments that are adjusted each year for
inflation. The first payment is 100. Inflation is 3% for years 1-5 and 2% thereafter.

Calculate the price of the perpetuity if the yield rate is an effective 6% per annum.

(A) 2750
(B) 2760
(C) 2770
(D) 2780
(E) 2790

2007 The Infinite Actuary, LLC 10 J oint Exam 2/FM (Sample Exam)

10. Given the following information about the treasury market:
Term Coupon Price
1 0% 96.62
2 0% X
3 0% 88.9

It is known that the 2-year forward rate is 4.5%.

Calculate X.

(A) 87.65
(B) 89.70
(C) 92.90
(D) 93.45
(E) 95.50

11. A 20-year bond is priced at par and pays R% coupons semiannually. The bonds
duration is 13.95 years.

Determine R.

(A) 2
(B) 3
(C) 4
(D) 5
(E) 6


12. Which of the following is not true?

(A) An asset insured with a floor is equivalent to investing in a zero-coupon bond and
buying a call option on the asset.
(B) A short position insured with a cap is equivalent to writing a zero-coupon bond
and buying a put option on the asset.
(C) A covered written call is equivalent to investing in a zero-coupon bond and
writing a put option on the asset.
(D) A covered written put is equivalent to writing a zero-coupon bond and writing a
call option on the asset.
(E) All of the above are true.


13. A fairly smart actuary (also know as an FSA) is offered the following rates on a loan:
I. X% nominal annual rate of interest compounded monthly
II. X% nominal annual rate of discount compounded monthly
III. X% annual effective rate of interest
IV. X% annual effective rate of discount
V. X% constant force of interest

Which rate does the FSA take?

(A) I
(B) II
(C) III
(D) IV
(E) V

14. An annuity pays 1 at the beginning of each year for n years. Using an annual
effective interest rate of i, the present value of the annuity at time 0 is 8.55948. It is
also known that ( ) 1 3.172169
n
i + = .

Find the accumulated value of the annuity immediately after the last payment.

(A) 27.152
(B) 28.456
(C) 29.513
(D) 30.765
(E) 31.973


15. Deposits are made at the beginning of every month into a fund earning a nominal
annual rate of 6% convertible monthly. The first deposit is 100 and deposit increase
2% every year. In other words, deposits 1-12 are 100, deposits 13-24
are100 1.02 102 = , deposits 25-36 are
2
100 1.02 104.04 = , and so on.

Calculate the fund balance at the end of 10 years.

(A) 16,569
(B) 16,893
(C) 17,257
(D) 17,770
(E) 17,859


16. On J anuary 1 a fund has a balance of $100. Sometime during the year a withdrawal
of $20 is made. Immediately before the withdrawal the fund balance is $110. At
year-end the balance is $95.

If the time weighted and dollar weighted rates for the year are equal, then in what
month was the $20 withdrawal made?

(A) J une
(B) J uly
(C) August
(D) September
(E) October

17. A common stock pays annual dividends at the end of each year. The earnings per
share in the year just ended were J . Earnings are assumed to grow 10% per year in
the future. The percentage of earnings paid out as a dividend will be 0% for the next
5 years and 50% thereafter.

Calculate the theoretical price of the stock to yield the investor 21%.

(A)
( )
4
5
1.1
J

(B)
( )
5
5
1.1
J

(C)
( )
6
5
1.1
J

(D)
( )
5
10
1.1
J

(E)
( )
6
10
1.1
J


18. You are the CFO of Infinite Life. Infinite Life only has one liability of $5000 due in
8 years. Infinite Life uses a nominal rate of 6% convertible semiannual to discount
all liability cash flows.

You call up your favorite bond broker and ask him what bonds he has for sale today.
Your broker says he has 5-year and 10-year bonds. Both bonds are priced to yield
6% convertible semiannually. The 5-year bond pays 6% coupons semiannually and
the 10-year bond is a zero-coupon bond. The bonds can be bought in any face
amount.

What face amount of the 5-year bond should you buy in order to meet the first two
conditions of immunization?

(A) 777
(B) 888
(C) 999
(D) 1111
(E) 2222


19. You are given the following prices for $100 zero-coupon bonds:
Term Price
1 95.24
2 89.00
3 81.63

R is the swap rate in a 3-year swap contract.

Determine R.

(A) 5.7%
(B) 6.1%
(C) 6.5%
(D) 6.9%
(E) 7.2%


20. A fund earns simple interest of i. Which of the following are true?
I. The effective rate of interest is constant for each period.
II. The amount of interest is constant for each period.
III. The equivalent force of interest is ( ) ln 1 i + .

(A) I only
(B) II only
(C) III only
(D) II, III only
(E) The correct answer is not given by (A), (B), (C) or (D).


21. If
( )
2
, 0 and 13.03567.
1
t
n
t
t Ia
t
o = > =
+

Determine n.

(A) 10
(B) 11
(C) 12
(D) 13
(E) 14

22. You are given the following information about 3 funds:
Fund
Effective Rate
per Year
Interest Payments
A j % paid directly to investor
B 5% paid directly to investor
C 4% automatically reinvested

An investor deposits $10,000 into fund A. He reinvests fund As interest payments
into fund B. He reinvests fund Bs interest payments into fund C. The total value of
all three funds after 10 years is $20,000.

Determine j.

(A) 6
(B) 7
(C) 8
(D) 9
(E) 10


23. Which of the following are true?
I. Modified duration is greater for bonds with higher par values.
II. Modified duration is greater for yields compound more frequently.
III. The modified duration of a single cash flow is the time remaining until the cash
flow.

(A) I only
(B) II only
(C) III only
(D) II, III only

24. An annuity-immediate has the following payments:
10, 20, 30, 40, 50, 40, 30, 20, 10

Which of the following expressions represents the present value of the annuity?

(A)
5 5
10a a
(B)
5 5
10a a
(C)
5 4
10a a
(D)
5 4
10a a
(E) ( ) ( )
5 4
10 10 Ia Da +

25. You are given the following term structure of interest rates.
Term
(in years) Spot Rate
1 5.00%
2 5.75%
3 6.25%
4 6.50%

Calculate ( )
4
1000 Da rounded to the nearest 100.

(A) 8700
(B) 8800
(C) 8900
(D) 9000
(E) 9100


26. Suppose you desire to short-sale 200 shares of ABC stock, which has a bid price of
$24.82 and an ask price of $25.01. You cover the short position three months later
when the bid price is $21.45 and the ask price is $21.64.

Your broker charges a 0.3% commission to engage in the short-sale and a 0.3%
commission to close the position. He also requires a 50% haircut on the net proceeds
of the short-sale. The market rate of interest is 6% convertible continuously and the
short-rebate on the haircut is 4% convertible continuously. No dividends were paid
on the stock during the three months.

Calculate the profit on the short-sale.

(A) 595.60
(B) 608.13
(C) 652.33
(D) 671.50
(E) 684.12


27. Which of the following are true?
I. The payoff on a short forward is the spot price at expiration minus forward price.
II. Zero coupon bonds can be used to shift profit diagrams.
III. For forward contacts, cash settlements often reduce transaction costs.
(A) I only
(B) II only
(C) III only
(D) II, III only


28. A $10,000 loan is repaid with level annual payments. The first payment is made one
year after taking out the loan.

The outstanding balance just after the 8
th
payment is $7,112.10. The outstanding
balance just after the 16
th
payment is $2,845.36.

Calculate the outstanding balance just after the 17
th
payment.

(A) 1185
(B) 1485
(C) 1885
(D) 1985
(E) 2185


29. A 10-year 1000 par value bond pays 4% coupons semiannually and is redeemable at
1200. The bond is priced to yield an annual nominal rate of 6% convertible
semiannually.

Calculate the adjustment to the book value during the 6
th
year.

(A) 12.26 write up
(B) 24.17 write down
(C) 24.17 write up
(E) 35.73 write down
(E) 35.73 write up


30. The present value of a 25-year annuity-immediate with a first payment of $2500 and
decreasing by X each year thereafter is $15,923. The annual effective rate of interest
is 10%.

Determine X.

(A) 70
(B) 80
(C) 90
(D) 100
(E) 110

31. Which of the following expression does not represent a definition for
| m
n
a ?

(A)
m
n
v a
(B)
m n m
a a
+

(C)
m n
n
v s
+

(D)
1 m m m n
v v v
+ +
+ + +
(E) All of the above represent a definition for
| m
n
a .

FM Sample Exam #1 Solutions
Last updated December 7, 2009
32.
(1 + i)
x
= 5
2(1 + i)
y
= 8
(1 + i)
y
= 4
3(1 + i)
z
= 20
(1 + i)
z
=
20
3
12(1 + i)
3x2y+z
=
12 [(1 + i)
x
]
3
(1 + i)
z
[(1 + i)
y
]
2
=
12(5)
3

20
3
(4)
2
= 625
33. After the 3 years of interest only payments the balance is still 100,000 so we
solve
100,000 = 1500a
n 0.01
Using the calculator we get 111 payments plus the 3 years of interest only payments
equals 111 + 3(12) = 147 payments.
34. The sinking fund payment is
Rs
25 0.04
= 10,000
R = 240.12
The interest payment is
10,000 0.05 = 500
The sinking fund balance at time 11 is
240.12s
11 0.04
= 3238.34
c 2008 The Innite Actuary, LLC FM Sample Exam #1 Solutions
So the interest earned on the sinking fund during the 12th year is
3238.34 0.04 = 129.53
And the net interest paid is
500 129.53 = 370.47
The increment in the sinking fund for the 8th year is
240.12s
8 0.04
240.12s
7 0.04
= 315.98
Finally the sum of these two items are
370.47 + 315.98 = 686.45
35. Using Put-Call Parity
Call(K, T) Put(K, T) = PV(F
0,T
K)
93.809 74.201 =
F
0,0.5
1000
1.02
F
0,0.5
= 1020
c 2008 The Innite Actuary, LLC FM Sample Exam #1 Solutions

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2007 The Infinite Actuary, LLC 1 J oint Exam2/FM (Sample Exam)

1. Which of the following is not a way to create a 40-45-50 butterfly?

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