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ACTSC 231 Winter 2020 Practice Quiz A

Signature:

IMPORTANT NOTES:

• Do not open the booklet until instructed to do so.

• Keep at least 5 decimal places in all calculations. Unless otherwise stated, you may
round your final answers to 2 decimal places.

• This practice quiz is open book and you are permitted (and encouraged) to work with
others.

• You will earn full marks on this practice quiz if you put forth a reasonable effort.

• Be sure to show your work so that you may compare it with the solutions to be posted.
1. Given d(12) = 5.5%, find the following equivalent rates: (answer to the nearest 0.01%)

(a) d
(b) d(3)
(c) i
1
(d) i( 2 )
(e) δ

Solution:

(a)
12
d(12)

1−d= 1−
12
 12
0.055
⇒1−d= 1−
12
⇒ d = 5.36%

(b)
3 12
d(3) d(12)
 
1− = 1−
3 12
3 12
d(3)
  
0.005
⇒ 1− = 1−
3 12
⇒ d(3) = 5.46%

(c)
12
d(12)

−1
(1 + i) = 1−
12
 12
−1 0.005
⇒ (1 + i) = 1−
12
⇒ i = 5.67%

(d)
1
!−1 12(2)
i( 2 ) d(12)

1+ 1 = 1−
2
12
1
!−1
i( 2 )
 24
0.055
⇒ 1+ 1 = 1−
2
12
1
⇒ i( 2 ) = 5.83%
1
Note that i( 2 ) is the nominal interest rate compounded every 2 years.
(e)
12
d(12)

−δ
e = 1−
12
 12
−δ 0.005
⇒e = 1−
12
⇒ δ = 5.51%
2. Suppose that a(t) = (1 − 0.05t)−2 for t ≥ 0.

(a) Which of the following two cash flows has the higher present value?
Cash Flow #1: $3000 at time 2 and $1000 at time 5
Cash Flow #2: $4000 at time 4
(b) Determine the effective interest rate for the period between time 2 and time 5
(answer to the nearest 0.01%).
(c) Determine the effective discount rate for the seventh year (answer to the nearest
0.01%).
(d) Ethan makes a deposit now to accumulate $7,500 after 15 years. Determine the
value in his account after 10 years.

Solution:

(a) Under Cash Flow #1,

PV = 3000v(2) + 1000v(5)
= 3000[1 − 0.05(2)]2 + 1000[1 − 0.05(5)]2
= 2992.50

Under Cash Flow #2,

PV = 4000v(4)
= 4000(1 − 0.05(4))2
= 2560.00

Thus, Cash Flow #1 has the higher present value.


(b) The effective interest rate for the period between time 2 and time 5 is given by
a(5) − a(2)
i[2,5] =
a(2)
[1 − 0.05(5)]−2 − [1 − 0.05(2)]−2
=
[1 − 0.05(2)]−2
= 44.00%.

(c) The effective discount rate for the seventh year is given by
a(7) − a(6)
d[6,7] = d7 =
a(7)
[1 − 0.05(7)]−2 − [1 − 0.05(6)]−2
=
[1 − 0.05(7)]−2
= 13.78%.
(d) To accumulate $7,500 after 15 years, he must deposit the following amount now

P = 7500v(15)
= 7500[1 − 0.05(15)]2
= 468.75.

Thus, the value in his account after 10 years is

P a(10) = 468.75[1 − 0.05(10)]−2


= 1875.00.
3. Jennifer borrows $10,000 from a bank on April 10, 2018 at a simple interest rate of
7.5% per year.

(a) What’s the effective rate of interest earned in: (answer to the nearest 0.01%)
i. the first year
ii. the second year
iii. the fifth year
(b) Jennifer agrees to repay her loan on January 13, 2020. What is the amount of
Jennifer’s required payment if the loan period was measured using the:
i. exact simple interest method
ii. ordinary simple interest method
iii. 30/360 rule

Solution:

(a) We are given a(t) = 1 + 0.075t. We have:


i.
a(1) − a(0)
i1 =
a(0)
[1 + 0.075(1)] − 1
=
1
= 7.50%.

ii.
a(2) − a(1)
i2 =
a(1)
[1 + 0.075(2)] − [1 + 0.075(1)]
=
[1 + 0.075(1)]
= 6.98%.

iii.
a(5) − a(4)
i5 =
a(4)
[1 + 0.075(5)] − [1 + 0.075(4)]
=
[1 + 0.075(4)]
= 5.77%.

Note the decreasing pattern in in as n increases which confirms what we found


in lecture for simple interest.
(b) i. We count the actual number of days between April 10, 2018 and January 13,
2020 to obtain

(30 − 10) + 31 + 30 + 31 + 31 + 30 + 31 + 30 + 31 + 365 + 13 = 643.

Using the exact simple interest method:


 
643
10, 000 1 + 0.075 · = 11, 321.23
365

ii. Using the ordinary simple interest method:


 
643
10, 000 1 + 0.075 · = 11, 339.58
360

iii. Using the 30/360 rule:


We find

D = 360(2020 − 2018) + 30(1 − 4) + (13 − 10) = 633,

and
 
633
10, 000 1 + 0.075 · = 11, 318.75
360
4. A fund grows at a force of interest given by

0.06, 0 < t ≤ 4,
δt =
0.005(t2 − t), t > 4.

Calculate the present value of $500 that is payable at time 12.


Solution:

We want 500v(12). First, we find


 Z 12 
v(12) = exp − δt dt
0
 Z 4 Z 12 
= exp − δt dt + δt dt
0 4
 Z 4 Z 12 
2
= exp − 0.06dt + 0.005(t − t)dt
0 4
(  3  t=12 !)
t t2
= exp − 0.06(4 − 0) + 0.005 −
3 2 t=4
 3
122
 3
42
   
12 4
= exp − 0.06(4) + 0.005 − − 0.005 −
3 2 3 2
= 0.0677.

Thus, we have

500v(12) = 500(0.0677)
= 33.83.