Faculty of Actuaries
Institute of Actuaries
EXAMINATIONS
April 2001
Subject 102 Financial Mathematics
EXAMINERS REPORT
Faculty of Actuaries
Institute of Actuaries
Subject 102 (Financial Mathematics) April 2001 Examiners Report
A certificate of deposit is a certificate stating that some money has been
deposited. They are issued by banks and building societies. Terms to maturity
are usually in the range 28 days to 6 months. Interest is payable on maturity.
The degree of security and marketability will depend on the issuing bank. There
is an active secondary market in certificates of deposit.
460
500
650
X
400 460 + 50 500 + 40 650 + 60
(1.11)3 =
= (1.11)3 710
400 510 540
460 500 650
= 715.50
(i)
0.08
= 1
2
4
i(2)
1 +
1
1 2 = 0.08247
i(2) =
4
(0.98)
8.247% p.a. convertible half-yearly
12
(ii)
d(12)
1
12
(12)
0.08
= 1
4
12
= 1 (0.98) 12
= 0.080539
8.0539% p.a. convertible monthly
(i)
A forward contract is an agreement made between two parties under
which one agrees to buy from the other a specified amount of an asset at a
specified price on a specified future date.
The investor agreeing to sell the asset is said to hold a short forward
position in the asset, and the buyer is said to hold a long forward
position.
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Subject 102 (Financial Mathematics) April 2001 Examiners Report
(ii)
Forward price =
3
(0.050.03)
12
150e
1
0.05
12
30e
= 120.63
(i)
d1
(1 +
4
i )12
d1 (1 +
(1 +
1
g )2
10
i )12
d1 (1 + g )
(1 +
16
i )12
d1 (1 +
3
g )2
22
(1 + i )12
= d1
4
v12
= d1
4
12
v
1 + g 2
1
1+i
d1
4
12
v
(1 +
1
i)2
(ii)
1
3
1
2
2
g
g
g
1
+
1
+
1
+
1 +
+
+
+ ...
1+i
i
i
1
1
+
+
(1 +
6
12
i)
(1 +
d1 (1 +
1
g )2
2
12
i)
1
(1 + i ) 2 (1 + g ) 2
We need to modify the above to:
4
Price =
d1 (1 + i )12
1
(1 + i ) 2 (1 + g ) 2
Hence
18
0.5 (1 +
(1 +
1
i) 2
4
12
i)
1
(1.04) 2
i = 10%, RHS = 17.79
i = 9%, RHS = 21.24
i = 10% p.a. to the nearest 1%
Page 3
Subject 102 (Financial Mathematics) April 2001 Examiners Report
(i)
A(t) = exp
t
0
For 0 t < 8,
(r )dr
t
0
(r )dr =
t
0
(0.04 + 0.01r ) dr
= [0.04r + 0.005r 2 ]t0
= 0.04t + 0.005t2
for 0 t < 8, A(t) = exp(0.04t + 0.005t2)
For t 8,
A(t) = A(8) . exp
t
8
0.07dr
= A(8) . exp(0.07 (t 8))
= exp(0.64) . exp(0.07t 0.56)
= exp(0.07t + 0.08)
(ii)
Present values =
100
A(10)
100
exp(0.78)
= 45.84
First calculate the effective annual interest rate:
1 + i = (1.03)2 = 1.0609
i = 6.09% p.a.
PV of initial investments (working in millions):
2 + 1.5
Page 4
7
12
v
6.09%
= 3.4492m
Subject 102 (Financial Mathematics) April 2001 Examiners Report
PV of net income:
v 0.2a10 + 0.1( Ia )10
10v10
a
v 0.2a10 + 0.1 10
1 v10
1 v10
10v10
v 0.2
+
0.1
@ 6.09%
ln1.0609
d . ln1.0609 ln1.0609
v[0.2 7.5498 + 0.1 (131.5197 93.6567)]
4.9922m
PV of Sale proceeds = 3v11 @ 6.09%
= 1.5657m
NPV of project = 4.9922 + 1.5657 3.4492
= 3.1087m
(i)
We can find forward rates f1,1 and f2,1 using the spot rates y1 , y2 and y3 :
(1 + y2)2 = (1 + y1) (1 + f1,1) and
(1 + y3)3 = (1 + y2)2 (1 + f2,1)
(ii)
1.0422 = (1.041) (1 + f1,1)
f1,1 = 4.30%
and
(1.043)3 = (1.042)2 (1 + f2,1)
f2,1 = 4.50%
(a)
Price per 100 nominal
2
3
3
3 v4.1% + v4.2%
+ v4.3%
+ 110v4.3%
3(0.96061 + 0.92101 + 0.88135) + 110 0.88135
105.24
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Subject 102 (Financial Mathematics) April 2001 Examiners Report
(b)
Let yc2 = 2-year par yield
2
2
+ v4.2%
1 = yc2 v4.1% + v4.2%
(i)
1 = yc2 (0.96061 + 0.92101) + 0.92101
yc2 = 0.04198
i.e. 4.198% p.a.
Let j denote the mean yield, then
2
1 + j = exp +
= 1.0757305
2
j = 0.0757305
We require
20,000 E(X10) + 150,000 E(S10)
=
20,000s10 + 150,000 (1 + j )10 at rate j%
1.075730510 1
10
20,000
+ 150,000 (1.0757305)
0.0757305
20,000 14.1961 + 311,261.98
595,183.99
where X10 represents the accumulation after 10 years of 1 p.a. paid in
arrears for 10 years
and S10 represents the accumulation after 10 years of 1 paid now.
(ii)
We require Pr(Z . S10 600,000) = 0.99
where Z = single amount paid now
Now
Page 6
600,000
Pr S10
= 0.99
Z
log S10 10
10
~ N (0,1)
Subject 102 (Financial Mathematics) April 2001 Examiners Report
600,000
10
log
= 0.01
So we want
10
600,000
log
10
Z
So, from tables,
= 2.326
10
So
600,000
= exp 2.326 10 + 10
Z
= 1.139112
10
(i)
DMT =
= 526,726.25
1.v + 2v2 + ... + 10v10
v + v2 + ... + v10
( Ia )10
a10
a10 10v10
i
a10
7.0236 1.07 10 0.50835
0.07 7.0236
= 4.946 as required
(ii)
We will consider three conditions necessary for immunisation
(1)
VA = VL
VA = a10 + Xvn at 7%
= 7.0236 + Xvn
VL = 7v5 + 8v8 at 7%
= 9.64698
Xvn = 2.62338
(a)
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Subject 102 (Financial Mathematics) April 2001 Examiners Report
(2)
VA = VL where VA =
dVA
dVL
and VL =
d
d
VA = ( Ia )10 + n . Xvn = 4.946 7.0236 + n . Xvn
= 34.7393 + n . Xvn
VL = 5 7v5 + 8 8v8
= 62.20310
n . Xvn = 27.46380
(b)
(a) and (b) n = 10.46886
X = 2.62338 (1.07)10.46886
= 5.32692
(3)
VA > VL
VA =
10
. vt + n2 . Xvn
t =1
= 228.451 + (10.46886)2 5.32692 v10.46886
= 515.966
VL = 52 7v5 + 82 8v8
= 422.761
Condition (3) satisfied
Thus, X = 5.32692m and n = 10.46886 years will achieve
immunisation.
11
(i)
(a)
Let R = total annual repayment
R =
80,000
at 8%
(12)
a25
80,000
= 7,232.77 p.a.
1.036157 10.6748
Monthly instalment = 602.73 per month
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Subject 102 (Financial Mathematics) April 2001 Examiners Report
1
Interest in 1st instalment = 80,000 1.0812 1
= 514.72
Capital in 1st instalment
= 602.73 514.72
= 88.01
(b)
Capital outstanding after 19 years = 7,232.77 a6(12) at 8%
= 7,232.77 1.036157 4.6229
= 34,645.33
Total amount of instalments paid in last 6 years
= 6 7232.77 = 43,396.62
Hence, total interest paid in last 6 years =
43,396.62 34,645.33 = 8,751.29
1
(c)
Capital outstanding = 602.73v12 = 598.88
Interest = 602.73 598.88 = 3.85
(ii)
If repayments are made less frequently than monthly, the total annual
repayment increases since the borrower makes interest payments less
frequently.
The amount of capital outstanding after 19 years will be unaltered.
Therefore, the total interest repaid during the last 6 years (being the
difference between the total payments and total capital repaid in the last
6 years) will increase.
12
(i)
The coupon will be:
0.03 100 Index July 1999
Index July 1995
2
1.5
126.7
= 1.72 per 100 nominal
110.5
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Subject 102 (Financial Mathematics) April 2001 Examiners Report
(ii)
There are many ways candidates may layout their solution.
Measure time, t, in half years from 16 September 1999 and let i be the
real yield per half year.
Set (1 + r) = (1.04) and month 0 = September 1999
Then Q(t) = Q(0) (1 + r)t is the estimated value of the index at time t,
where
Q(0) = 127.4
The first interest payment at time 1 is 1.72 and the value of the index will
be
Q(1) = Q(0) . (1 + r)
For t 2, the investors tth interest payment will be received in month 6t,
and will be of amount
(6t 8)
(1 + r ) 6
1.5
110.5
1.5 Q(0)
Q(0)
4
t 3
(1 + r )
110.5
This payment will be received at time t, when the value of the index will
be Q(t).
Redemption proceeds will be paid at time 5 with the final coupon
payment.
The redemption proceeds will be
100Q(0) (1 + r )
110.5
5 3
and the value of the index will be Q(0) (1 + r)5
Page 10
Subject 102 (Financial Mathematics) April 2001 Examiners Report
Thus the real yield equation is:
111.0 =
1.72
.v +
(1 + r )
i.e.
111.0 =
t =2
4
t 3
1.5Q(0) (1 + r )
110.5 (1 + r )t
4
5 3
100Q(0) (1 + r )
110.5 (1 + r )5
vt
v5
(*)
4 5
1.72
127.4
(1 + r ) 3
. v + 1.5
(1 + r )
110.5
t =2
+ 100
127.4
(1 + r ) 3 v5
110.5
111.0 = 1.6866v + 1.6848 ( a5 v)
+ 112.3186v5
111.0 = 0.0018v + 1.6848 a5 + 112.3186v5
At 2%, RHS = 109.67
At 1%, RHS = 112.32
111 109.67
0.005
Linear interpolation: i ; 0.020
112.32 109.67
= 0.01749
(iii)
yield for year is 3.53% p.a.
From equation (*), if the retail price index had been greater than 110.5,
the right hand side would be less than 111.0 with i = 1.749% per half year.
Hence, the real yield, i, would need to be less than 1.749% per half year
for the right hand side to equal 111.0.
Real yield decreases
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