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ACTUARIAL SOCIETY OF INDIA

9, Jeevan Udyog, 278, Dr. D N Road, Fort, Mumbai – 400 001

Examinations – May 2002

Subject 102 - Mathematics of Finance

Time allowed: 3 Hours Maximum marks 100

Instruction to the Candidates

1. Write your Candidates number in the space provided.

2. Do not write your name anywhere in the answer sheets.
3. Mark allocations are shown in brackets.
4. Attempt all questions. Begin your answer to each question on a new page.
5. Actuarial Tables and graph paper will be available on request.
6. You may use simple electronic calculators, but not programmable ones or those
capable of storing prior data.
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Prove by General reasoning:
Q. 1
.. ( p)
a 1−υn
= ( p)
n d [5]

Q.2
(i) Calculate the equivalent effective rate of interest per annum for
(a) Interest rote of 5% pa payable quarterly
(b) Annual discount rate of 7% pa
{c) Force of interest of 5.4% [6]

(ii) A sum of Rs.1000 will be paid as monthly salary for a contract from 1 Jan
2000 to 31 Dec 2009 to Mr. Anuj . If interest rates were 10% pa convertible
half yearly for the first 3 years, 9% pa convertible monthly for the next 3
years and 8% pa effective thereafter, find the present value of the payments
on 1 Jan 2000. Salaries are paid at the end of each month. [8]

Q.3 Explain briefly the three theories of the term structure of interest rates. [6]

Q.4 (i) Give two examples to sho w why using accumulated values to assess the
suitability of an investment project can cause problems. [4]

(ii) List the other factors besides the NPV, IRR and payback period, which you
will generally consider before choosing a project. [4]
(iii) Vijay is looking to invest in one of the below projects.
Cash flows for Project A are:
Initial cost - Rs. 100,000 as at 1 Jan 2000
Annual income - Rs. 7500 at the end of 1st year, increasing at 5% pa till 31
Dec 2010
Residual Value - Rs. 150,000 as at 31 Dec 2010

Cash flows for Project B are:

Initial cost - Rs. 100,000 as at 1 Jan 2000
Annual income - NIL
Residual value - Rs. 300,000 as at 31 Dec 2010

(a) Calculate the NPV for each project as at 1 Jan 2000, at an interest rate [5]
of 10% p.a.

(b) Advice Vijay in choosing one project based on the findings in (a). [1]
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A loan of Rs.100, 000 is repayable in ten annual installments, starting in one year's
Q.5 time, with interest payable at 12.5% p.a. Each of the first five installments is one-
third of each of the installments in the sixth to the tenth years. Calculate the loan
outstanding one year before the loan is completely repaid? [8]

Q.6 (i) Describe the investment characteristic of convertible bonds. [6]

(ii) A government bond has an outstanding term of 6.5 years and a coupon of
6%pa. The bond is redeemable at 105. Calculate the yield obtained by the
investor, if he purchased the bond at 93 immediately after the coupon
payment.
Ignore tax. (Govt. bond coupons are paid half- yearly) [6]

Q.7 An index linked zero coupon bond was issued on 1 Jan 2000 for redemption at par
on 31 Dec 2004. The redemption payment was linked to the price inflation index
with 6 months time lag. Calculate the average nominal and real rates of return
obtained by an investor who purchased Rs.25,000 nominal of the stock on 1 Jan
2002 for Rs. 25,625 and held it until redemption. You are given the following
values for price index: [6]

Date Index Date Index

1 Jan 1999 144 1 Jul 2002 177

1 Jul1999 148 1 Jan 2003 181
1 Jan 2000 155 1 Jul 2003 182
1 Jul 2000 160 1 Jan 2004 188
1 Jan 2001 162 1 Jul 2004 193
1 Jul2001 168 1 Jan 2005 201
1 Jan 2002 175 1 Jul 2005 225

Q.8
(i) A fixed interest stock is redeemable at 105% in 15 years time and pays
interest at 9% per annum payable half- yearly in arrears. An investor decides
to agree a forward contract to buy the security in six years time immediately
after the coupon payment then due, instead of purchasing the stock. Calculate
the forward price based on a risk free rate of return of 5% pa effective and no
arbitrage. The current price of the stock is Rs 103%. [4]

(ii) Three years later, the price of the security is such that the gross redemption
yield is still 9%. Calculate the value of the forward contract if the risk free
yield has not changed. [8]
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Q.9 In any year the yield on funds invested with a given insurance company has mean
value j and standard deviation s and is independent of the yields in all previous
years. Money is invested only at the beginning of a year. Derive formulae for the
mean value and variance of the accumulated value after n years of a single [12]
investment of 1 unit at time 0.

An investor who has a sum of Rs.l00,000 wishes to purchase an annuity certain

Q.10 with a term of 15 years. Calculate the amount of the payments that can be provided
if the annuity takes each of the following forms:

(i) A level annuity payable monthly in arrears.

[3]
(ii) A level annuity due payable half- yearly for 15 years , commencing in 4 years
time.
[3]
(iii) An annuity payable weekly such that the level of payment during the first 5
years is half the level during the next 10 years.
Interest is at 8% pa convertible quarterly.

[5]