Family Name

ID. No.

Given Name

DEPARTMENT OF MATHEMATICS AND STATISTICS

Theory of Interest 62-392 Test 1
M. Hlynka
Thursday, February 9, 2012. Time allowed: 75 minutes.
Directions: You must show your work! You will be graded on your completeness as well as your correctness.
Choose the closest answer. Calculators encouraged. #1 is 10 pts. Others are 5 pts each.
1. (MH) 1. Given i(3) = .06, find each of the following equivalents:
(a) i(2) (b) i (c) d(3) (d)
i(3) 3
SOLUTION: (b) 1 + i = (1 +
) = 1.023 = 1.061208 so i = 0.061208 .
3
i(2) 2
) = 1 + i = 1.061208 so i(2) = (1.061208.5 1) 2 = 0.06029901
(a) (1 +
2
1
1
1
(c) 1 + i =
so d(3) = 3 (1
) = 3 (1
= .06/1.02 = 0.05882353
(1 d(3)/3)3
(1 + i)1/3
1.02
(d) = ln(1 + i) = ln(1.061208) = 0.0594
2. (SOA Nov.2005.25) The parents of three children, ages 1, 3, and 6, wish to set up a trust fund that will
pay X to each child upon attainment of age 18, and Y to each child upon attainment of age 21. They
will establish the trust fund with a single investment now of Z. Find Z in terms of X, Y, v. Explain.
X
Y
(A) 17
+ 20
(B) 3[Xv18 + Y v21 ]
15
12
v +v +v
v + v18 + v15
v20 + v18 + v15
(C) 3Xv3 + Y (v20 + v18 + v15 ) (D) (X + Y )
v3
(E) X(v17 + v15 + v12 ) + Y (v20 + v18 + v15 )
SOLUTION:
Child age 6 needs X in 18 6 = 12 years. PV is Xv12 . Child age 6 needs Y in 21 6 = 15 years. PV
is Y v15 .
Similarly for child age 3 in 15 and 18 years.
Similarly for child age 1 in 17 and 20 years.
Thus Z = P V = Xv12 + Y v15 + Xv15 + Y v18 + Xv17 + Y v20 .
Answer is E.
3. (MH) If sn| = 5 and s2n| = 15 find s3n| .
(1 + i)n 1
SOLUTION: Given 5 =
and
i
(1 + i)2n 1
(1 + i)n 1
15 =
=
((1 + i)n + 1) = sn|((1 + i)n + 1) = 5((1 + i)n + 1)
i
i
we find (1 + i)n + 1 = 3 so (1 + i)n = 2.
(1 + i)3n 1
(1 + i)n 1
So s3n| =
=
((1 + i)2n + (1 + i)n + 1) = 5(22 + 2 + 1) = 35.
i
i
SOLUTION2:
15 = s2n| = sn| + (1 + i)n sn| = 5 + (1 + i)n (5) so (1 + i)n = 2. Thus
s3n| = sn| + (1 + i)n s2n| = 5 + 2(15) = 35.
4. (John Carroll University, modified) A bank account credits interest using a force of interest
t =

3t2
t3 + 2

(a) Find the accumulation function of the account, a(t).

(b) A deposit of 100 is made in the account at time t = 0. Find the interest earned by the account

from the end

until the end of the 8th year.
R t of the 4th year
3
t
3
3
(a) a(t) = e 0 r dr = eln(r +2)|0 = eln(t +2)ln(2) = eln(1+.5t ) = 1 + .5t3 .
(b) Int = 100 (a(8) a(4)) = 100 (1 + .5 83 (1 + .5 43 )) = 100 .5 (83 43 ) = 22400.
5. (John Carroll University, modified) The force of interest, (t), is a function of time and, at any time t,
measured
in years, is given by the formula:
0 < t < 10
.05
(t) =
0.006t
10 < t < 20

0.00003t2
20 < t.
Calculate the present value of $100 to be received at time t = 30 years.
SOLUTION:
R 30
R 10
R 20
R 30
2
100e 0 r dr = 100e 0 .05dt 10 .006tdt 20 .00003t dt = 100e.5.9.19 = 100e1.59 = 20.392
6. (SOA FM Practice #25) A perpetuity immediate pays X per year. Brian receives the first n payments,
Colleen receives the next n payments, and Jeff receives the remaining payments. Brians share of the
present value is 40% and Jeffs share is K%. Find K.
SOLUTION:
X(1 vn )
.4X
= .4P V = .4Xa| =
. Thus vn = .6.
Brians share = Xan| =
i
i
Jeffs share = v2n Xa| = .36P V = (36/100)P V = (K/100)P V So K = 36.
7. (SUNY-Albany) Jeff and John share equally in an inheritance. Using his inheritance, John immediately
bought a 10year annuity due with annual payments of 2500 each. Jeff put his inheritance in an
investment fund earning an annual effective interest rate of 9%. Two years later, Jeff bought a 15 year
annuity immediate with annual payments of Z. The present value of both annuities were determined
using an annual effective interest rate of 8%. Calculate Z.
SOLUTION: P V (John) = 2500
a10|i=.08 = P V (Jeff) so
2
2500
a10|i=.08 (1.09) = Za15|i=.08 so
1 v15
1 v10
2500
(1 + i)(1.09)2 = Z
so
i
i
10
1 1.08
1 1.0815
1 1.0810
2500
(1.08)(1.092) = Z
so Z = 2500
(1.08)(1.09)2 = 2514.76
.08
.08
1 1.0815
8. (SOA May.2003.33) At an annual effective interest rate of i, i > 0, both of the following annuities have
a present value of X:
1. a 20-year annuity-immediate with annual payments of 55
2. a 30-year annuity-immediate with annual payments that pays 30 per year for the first 10 years, 60
per year for the second 10 years, and 90 per year for the final 10 years.
Calculate X.
(A) 575 (B) 585 (C) 595 (D) 605 (E) 615
SOLUTION: X = 55a20| = 55(a10| + v10 a10| ).(*)
X = 30a10| + 60a10|v10 + 90a10|v20 (**)
Using () = () gives 55(1 + y) = 30(1 + 2y + 3y2 ) where y = v10 . This gives a quadratic
0 = 90y2 +5y 25. By the quadratic formula, we get
5 + 25 + 9000
y=
= .5 = v10 so 2 = (1 + i)10 so i = 2.1 1 = .07177
180
1 v20
1 .25
Thus X = 55a20| = 55
= 55
= 574.72
i
.07177