II-19

PRACTICE MULTIPLE CHOICE TEST 5

1. You are given 8t = t ~ 1 for 2:::; t ~ 10. For anyone year interval between nand n + 1,
with 2 :::; n :::;9, calculate the equivalent d(2).

(B) ln (C) n n- 1 _n_

(D) n-1

2. The accumulated value of 1 at time t, for 0:::; t :::;1, is given by a second degree
,,'
polynomial in t. You are given (i) the nominal rate of interest convertible semiannually for
the first half of the year is 5% per year, and (ii) the effective rate of interest for the year is
4% per year. Find the value of 8.75,

(A) .021 (B) .023 (C) .025 (D) .027 (E) .029

Two funds, A and B, start with the same amount. Fund A grows at an annual interest rate of
i > 0 for n years, and at an annual interest rate of j > 0 for the next n years. Fund B grows
at an annual interest rate of k > 0 for 2n years. Fund A equals 1.5 times Fund B after n
years. The amounts in the two funds are equal after~71:years. Which of the following are
true?

I.j<k<i II. k < :i (i + j)

I;

(A) 1& II (B) I & ID (C) II & ID (D) All (E) None of A, B, C, D ~'

You
The
300
18
~ 700 11
0a600
t200
360
areend
X
240
Y
given+
0Xof
X year
100
(C)
(D)
(B)
(E)
the 18
102
107
(B)following
.80
.82
111
.84.78time
99 Accumulated
t data valueseries aof-Ipayments.
on three
~.force of interest at is 1~O. Calculate
Payment at end of year
(3).

Y. (A) 93
(A) .76
 IT-20
~
••
6. A corporation borrows 10,000 for 25 years, at an effective annual interest rate of 5%. A ••
sinking fund is used to accumulate the principal by means of 25 annual deposits earning an ••
effective annual interest rate of 4%. Calculate the sum of the net amount of interest paid in
the 13th installment and the increment in the sinking fund for the ninth year. ••
••
(A) 664 (B) 674 (C) 684 (D) 694 (E) 704
••
.-
7. The force of interest at time t is kt3. R is the present value of a four-year continuously ••
increasing annuity which has a rate of payment at time t of mt3. Calculate R .
••
=(C)
Given that i(4) (D)
(E) 1118
1127
(B).04,
1109
1136
I
calculate (Da)68/'
ge-4k
••
(A) 1100
(A) k - Te-4k (E) m( lee (B) (C) k
-64k) - ke-64k
••
•••
•••
•••
~

9. On a loan, payments of 1 are made at the end of each one-half of an interest conversion
period for a total of five interest conversion periods. What is the amount of principal
included in the eighth payment?

(E) vl.5

10. An annuity provides for 30 annual payments. The first payment of 100 is made immediately
and the remaining payments increase by 8% per year. Interest is calculated at 13.4% per
year. Calculate the present value of the annuity.

CA) 1423 (B) 1614 (C) 1753 (D) 1866 (E) 1944
/
/

11. John took out a 2,000,000 construction loan, disbursed to him in three installments. The
first installment of 1,000,000 is disbursed immediately, and this is followed by two 500,000
installments at six month intervals. The interest on the loan is calculated at a rate of 15%
convertible semiannually and accumulated to the end of the second year. At that time the
loan and accumulated interest will be replaced by a 30-year mortgage at 12% convertible
monthly. The amount of the monthly mortgage payment for the first five years will be one-
half of the payment for the sixth and later years. The first monthly mortgage payment is due
exactly two years after the initial disbursement of the construction loan. Calculate the
amount of the 12th mortgage payment.
"
(A) 13,225 (B) 13,357 (C) 16,787 (E) 25,811
r/16,955
 IT-21

12. A 700 par value five-year 10% bond with semiannual coupons is purchased for 670.60.
The present value of the redemption value is 372.05. Calculate the redemption value.

/ /1\) 500 (B) 599 (C) 606 (D) 700 (E) 1000

13. Wendel sells short 5,000 shares of stock Y on January 1, 1993. The margin requirement
during 1993 is 45%. The margin account earns 6% effective during 1993. Stock Y pays a
dividend of 1 per share per year on December 31, 1993. Wendel covers his short position
on January 1, 1994. Stock Y sold for 12 per share on January 1, 1993 and X per share on
January 1,1994. WendeI's yield rate on the transaction was 9% effective. Calculate X.

Simplify (E)
(B)
(D)
(E) v(B)
11.50
(C)
v3 10.57
1expression:
- V (iv 6) (1i d).
(A) 10.19the following
(D) 10.96
CY/IO.84

(A) - v3

I
15. Plastic trays last 8 years and cost 20. Metal trays last 24 years and cost x. Trays are needed
for 48 years, and inflation will increase the cost of the trays 5% per year. At 10.25% I,
interest, determine x so that the buyer is indifferent to purchasing plastic or metal trays.

(A) 36.90 (B) 38.70 (C) 40.70 (D) 42.70 (E) 44.80

16. Brian buys a 10-year decreasing annuity-immediate with annual payments of 10, 9, 8.... 1.
On the same date, Jenny buys a perpetuity-immediate with annual payments. For the first
11 years, payments are 1, 2, 3, ... 11. Thereafter, payments remain constant at 11. At an
annual effective interest rate of i, both annuities have a present value of X. Calculate X.

(A) 26.6 (B) 27.6 (C) 28.6 (D) 29.6 (E) 30.6
I
i
,
I
17. A bank offers the following certificates of deposit:
Term (in years) 7%
5%
6%
8% Rate, compounded semiannually
Nominal Annual Interest
1

The bank requires that interest accumulate at the certificate's interest rate, and does not
permit early withdrawal. The certificates mature at the end of the term. During the next six
years the bank will continue to offer these certificates of deposit. Jeff invests 1000 in the
bank. Calculate the maximum amount he can withdraw at the end of six years.

(A) 1480 (B) 1510 (D) 1570

~9) 1540 (E) 1600
 ill-23

SOLUTIONS TO PR.\.CTICE MULTIPLE CHOICE TEST 5

1. For a unit of money at time t = 2, the accumulated value at time n is

a(n) = exp[lnbtdt] = exp[2·ln(t-1)1;] = (n-1)2. The annual rate of discount

between nand n2 + 1 is d = --a-(n-+~l)~-
a(n+1)-a(n) = -~n~2
n2-(n_1)2~-, so that 1 - d = ( n; 1)2 .
The equivalent d(2) is given by

d(2) = 2 [1 - (I-d)l/'] ~ 2 [1 - ( (n;;:l rt2] = 2 [1 - n;;:l] = ~, ANSWER B.

2. Let aCt) = a + bt + ct2, where a(O) = a = 1. We are given a(i) = a + ib +!c = 1.025,
and a(l) = a + b+ c = 1.04. The second two equations give us ib + !c = ,025 and
b+ c = .04, which solve for b = .06 and c = - .02. Then aCt) = 1 + .06t - .02t2, and

bt -- D[a~)]
aCt -- 1 + .06
.06t- _.04t
.02t2 ' so b.75 -- .06 - (.04)(.75)
1 + (.06)(.75) - (.02)(.75)2 -- .,02902 ANSWER E .

3. Since A exceeds B after n years, clearly i> k; but since B catches up to A after 2n years, then
clearly k > j, so we have j < k < i, and I is true. Note again that (1 +i)n(1 +jt = (1 +k )2n,
so (1+i)(1+J) = (1+k)2. Then 1 + k = [(1+i)(1+J)]1/2 is the geometric mean of 1 +i and
1 + j. Recall that the geometric mean is less than the arithmetic mean, which is

i[(1+i) + (1+j)] = 1 + iij,sok < iij, and II is true.

Again using (1+i)n(1+j)n = (1+kin, recall that (1+i)n = (1.5)(1+k)n. Substituting we

have (1.5)(1+k)n(1+J)n = (1+k)2n, so (~)(1+j)n = (1+k)n, and (1+j) = (~y/n(1+k).

Then j ~ k (~) l/n + (~) l/n _ 1 i= k (~) l/n, so ill isfalse. Only I and II are true,
ANSWERA.

4. We are given 300 + 200(1+i) 6 + 240(1+i)12 = X

700 + 360(1+i)6 = X + 100
600(1+i)6 + Y(1+i)12 = X

The second equation tells us that (1 +i)6 = X 36800 . Substituting this into the first equation
gives us 300 ' 200 (X-600) + ~(X-600)2 = X or
-r 3bO (360)2 ,
300 + ~(X -600) + s.!o(X2-1200X +360,000) = X, or X2 - 1440X + 342,000 = 0, so
1440 ± vi (1440)2 - 4(342 000) .
X = ".' = 1140 or 300. By the meanmg of X, the root must be
X = 1140, which gives us (1+i)6 = 1.5. Finally, (600)(1.5) + Y(1.5)2 = 1140, so Y = 106.67,
ANSWERD.
 ID-24

_ c--
5. ___ ." _~- ' &,J.

= e-·2025 .81669, ANSWERD.

.~

- 10 ]

6. (AlgebraIc. so 1')
utlOn Th e S:'.::K:::g
... - ....aeposIt IS 10, 000
~.l.'1C s- 25/.04
= 240 ..12 Th e b a 1ance In
. th e SIn
. ki ng

fund after t years is SF B: = :;":,:1,125;-,04'so the increment for the ninth year is
SFB9 - SFBs = 240.: ~ :,}~)~ = 328.62. The direct interest to the lender is constant at
(10,000)(.05) = 500. T."le l:lterest earned in the sinking fund in year 13 is

(.04)SFB12 = (.04)(2-+0,:2)512!04 = 144.32,sothenetinterestpaidis

500 - 144.32 = 355.68. Finally the sum of the two values is 684.30, ANSWER C.

(Calculator solution) The BA-35 calculator's keys can be used to speed up some of the
computations. To find the sinking fund deposit, hit lAC/aNI, enter 25, hit [M, enter 4, hit I%il,

enter 10,000, hit 1+/-1 !FV/ , and then hit ICPTIIPMTI to obtain 240.12 as the sinking fund
deposit. In order to calculate SF B9 - SF Bs, enter 8, hit lli), and then hit ICPTIIFVIISTO! to

compute and store - SFBs = - 2212.52. Now enter 9, hit !R],and hit ICPTIIFVII+/-Iw
IRCLIIMEMII = Ito compute SF B9 as well as the final result SF B9 - SF Bs = 328.62.

7.
R= 14mt3.exp[-ltkr3dr]dt = 14mt3.e-kt4/4dt = _T·e-kt4/41:= T(1-e-64k), \
ANSWERE.

68 - a6S/'
8.
(Algebraic solution) Recall (Da)68/ = where i = (1.01)4 - 1. Theni ',
1 - (l+i)-6S 1 - (1.01)-272, .
a68/,
, = .
'/, = (1.01) 4' - 1 By dIrect calculatIOn, a681,' = 22.98367,
so (Da)- = 68 - 22.98367 = 1108.67 ANSWER B
6S/ (1.01)4 - l' .
(Calculator solution) Use the calculator to obtain i from i(4) = .04: enter 4, hit 12ndll [> EFFI,
enter 4, hit I = Ito obtain i = 4.0604%. Now hit lAC/aNI, hit 4.06041%il, enter 68, hit [Nj, enter

1, hit IPMTI, and then hit ICPTI!PVj to obtain a6si = 22.9837. Then
68 - a68/
(Da)68/ = : = 1108.67.

O·
9. The prospective outstanding balance after seven payments is the present value of the remaining
three payments, so ° B7 = vl/2 + v + v3/2. The interest due in the eighth payment is
Is = [(l+i)1/2 - 1]OB7andtheprincipa1isP-Is = v3/2, ANSWERE.
 ID-25

10. The present value is PV = 100 [1 + ( {?3~) + C\03~ f + ... + ({103~ f9]
= 100
(1
~_I.l~o~
1.134
(1.08)30)
= 1614.11. Note also that

11.'1~84 = .95238 = rk, so .95238 is the value of vat i = .05. Thus we have
PV = 100 ( \_!~O) = 100· a301.05 = (100)(1.05)(15.3725) = 1614.11, ANSWERB.

(Calculator comment: To compute 100a30!.05 hit IACIONI12ndIlBGNI, enter 30, hit lli], enter 5,
hit I%il, enter 100, hitlPMTI, and then hit/CPTIIPVI to obtain 1614.11.)

11. After 2 years the accumulated value of the loan is

1,000,000(1.075)4 + 500,000(1.075)3 + 500,000(1.075)2 = 2,534,430.10, and this is the present
value ofthe mortgage payments. Therefore 2,534,430.10 = p. a60j.Ol+ 2P . a3001.01.v6~1' and
P -_ 2,534,430.10 60
I
(1.01)a601.01+ 2(1.01)v.01 . a3001.01
2,534,430.10 ANSWERC.
16,787.12,
= (1.01)(44.95514) + 2(1.01)(.55044)(94.94656)

(Calculator comment: To obtain the debt at time 2, hit IAClONl12ndllBGNlenter 3, hit lli], enter

7.5, hit~, enter 500,000, hit IPVI,enter 500,000, hit 1+/-IIPMTI, and then hit ICPTIIFV!
00, enter 1.075, hit' = Ito obtain 2,534,430.10 as the value of the debt at time 2.

The factor a60I.01 + 2a3001.01 . v~1 can be calculated as follows: hit IAClONI12nd IIBGNI, enter
300, hit lli], enter 1, hit I%il, enter 1, hit IPMT1, and then hit ICPTIIPVI[][J, enter 2, hit I = IIFVI

to compute 2a3oo1and store it in IFVI. Now enter 60, lli], and then hit ICPTI!PVI to obtain

a60I.01+ 2a3001.01. v~l = 150.9764.)

1I

L
 ID-26

12. (Algebraic solution) Since the present value of redemption is given, Makeham's Formula is
suggested. We have P = K + 1(C-K), where P = 670.60, K = 372.05, and
gC = Fr = 35. Thus we have 670.60 - 372.05 = 298.55 =~ (C-372.05). Using the basic

formula P = K + Fr· anTi' we have 670.60 - 372.05 = 298.55 = 35aiOji' so alOji = 8.53.
Using the BA-35 calculator we find i = .03. Therefore (298.55)(.03C) = 35(C-372.05), so
8.9565C = 35C - 13,021.75, and C = 500.00, ANSWER A.

(Calculator solution) The difference between the price and present value of the redemption
value, 670.60 - 372.05 = 298.55, is the present value, at the yield rate, of the coupons. Thus

we have 298.55 = 35alOji' where j is the effective yield rate per six-month period. Hit
IACIONI,enter 10, hit lli], enter 35, hit IPMTI, enter 298.55, hit IPVI,and then hit ICPTI~to
obtain j = 3%. Then the redemption value is (372.05)(1 + j)lO = 500.00.

13. Per share we have -

Profit = 12 - X
Margin Deposit = (.45)(12) = 5.40
Interest on Margin = (5.40)(.06) = .324
Dividend to Stockowner = 1

09 -
. -
. Id - Profit
Yle -
+ Interest
Ni,' -
argzn
Dividends _ (12- X)
- 5+
.40
.324 - 1

=? X = 10.84. ANSWERC

14. S·
mce
d t
= -1 -,Tt-, , t h en d d
-d'
t = (1 +i) -
(1 + i) 1
i= 2
V . Since v= e-6, then (j = -In v, and

d~ b =- i· Their product is therefore -v, ANSWERB

15. For the 48 year period, six purchases of plastic will be needed, costing
20,20(1.05)8,20(1.05)16, ... ,20(1.05)40. The present value of these purchases is
20 [I + (1.05)8(1.1025)-8 + ... + (1.05)4°(1.1025)-40]. Note that (1.1025) = (1.05)2, so we

have PV = 20[1 + v8 + ... + v40] at i= .05, so PV = 20 [11-- (1.05)-

(1.05)-:8] = 55.93861.
Similarly, only two purchases of metal will be needed, costing x and x(1.05)24. The present
value is x[1 + (1.05)24(1.1025)-24] = x[l + (1.05)-24] = 1.31OIx. Then

x = 51:~f~yI = 42.70, ANSWER D

 ill-27

10 - a-·
16. The present value ofBrian's anr.u:ty :5 1':;'Cm:i
i
= i 1011
..
= X. The present value of Jenny's

II
" 1"

Perpetuity is (la"L-,
) 1111 + t .vl: , t.' + ~ t
= :;::--11 = ~t = X.

Equating the two present values ',l;efind

from which we find a'iOii = 4.5, and i = .17963. Finally, X = ll79tj5 = 30.61849,
ANSWERE

17. Will Jeffmaximize his investment by purchasing a 4-year CD rolled over into a 2-year CD (or in
the opposite order), or by purchasing a 3-year CD rolled over into a second 3-year CD? Under
the first option he has 1000(1.04)8(1.03t = 1540.34. Under the second option he has
1000(1.035)6(1.035)6 = 1511.07. Thus the best option is the 4,2 combination for 1540.34,
ANSVlERC

(Note that a series of three 2-year CD's would produce only 1000(1.03)12 = 1425.76.)