THEORY OF INTEREST - SAMPLE QUESTIONS

1. On July 1, 1984 a person invested 1000 in a fund for which the force of interest at time t is given by t = (3 + 2t ) / 50 where t is the number of years since Jan 1, 1984. Determine the accumulated value of the investment on Jan 1, 1985. 2. A 9% bond with a 1000 par value and coupons payable semi-annually is redeemable at maturity for 1100. At a purchase price of P, the bond yields a nominal annual interest rate of 8% compounded semi-annually, and the present value of the redemption amount is 190. Determine P. 3. On Jan 1, John has the following options for repaying the loan a) Sixty monthly payments of 100 beginning Feb. 1 b) A single payment of 6000 at the end of K months Interest is at 12% compounded monthly. The two options have the same present value. Calculate K. 4. A 1000 par value bond with redemption at par has coupons of 12% payable semiannually, and is priced to yield 10% convertible semiannually. The bond has a term of n years. If the term of the bond is doubled, the price will increase by 50. Calculate the price of the n year bond. 5. An investor purchased a 5 year financial instrument having the following features: - The investor receives payments of 1000 at the end of each year for five years. - These payments earn interest at an effective rate of 4% per year. At the end of the year, this interested is reinvested at the rate of 3% per year. Calculate the purchase price to the investor to yield 4%. 6. A perpetuity pays 1 at the end of every year plus an additional 1 at the end of every second year. The present value of the perpetuity is K. Interest is at 5% annual. Determine K. 7. An investment fund has a value of 1000 at the beginning and the end of the year. A deposit of 200 was made at the end of four months. A withdrawal of 300 was made at the end of seven months. Calculate the dollar weighted rate of interest. 8. A 35 year loan is to be repaid in equal annual installments. The amount of interest paid in the 8th payment is 135. The amount of interest paid in the 22nd payment is 108. Calculate the amount of interest paid in the 29th installment. 9. An investment of 700 is to be used to make payments of 10 at the end of the first year, 20 at the end of the second year, 30 at the end of the third year and so on, every year for as long as possible. A smaller final payment is paid one year after the last regular payment. The fund earns an effective rate of interest of 5%. Calculate the amount of the smaller final payment.

Answers 1. t = 1/ 2 1
1 3 + 2t AV = 1000 exp dt = 1000 exp[ 4 / 50 7 / 200] = 1000e .045 = 1046.03 50 1 / 2

2.

1000v n = 190 = K r = .045 i = .04 C = 1100 1000(.045) = .04099999 1100 g .040999 P = K + (C K ) = 190 + (1100 190) = 1120.68 i .04 g = Fr / C =

3.

i = .01 / month
.01

100 a 60

= 4495.50 = 6000v k

Using logs, K=29.01

4.

F = C =1000 r = g = .06 P = C + C ( g i ) a n
st

.05 .05

P + 50 = C + C ( g i ) a 2 n

Subtract 1 equation from 2nd Solve the quadratic v n = .5 5.

P (1.04) 5 = 5000 + ( IS ) 4 P = 4448.42
.03

50 = 200(v n v 2 n )

Using logs, n=14.21

= 5412.18

6. Payments are 1,2,1,2,1,2,........

i = .05 Set (1 + j ) = (1 + i ) 2 =1.1025 1,1,1,1,1,1,1...... Divide payments into 0,1,0,1,0,1,0,1,......
1st Perpetuity =1 / i =1 / .05 2 nd Perpetuity =1 / j =1 / .1025 1 1 + = 29.756 i j

7.

A = B = 1000 C 4 / 12 = 200 C 7 / 12 = 300 I = B A C = 100 I 100 100 i= = = = 9.9% A + C t (1 t ) 1000 + 200(8 / 12) 300(5 / 12) 1008.33
I t = P (1 v n t +1 )

8.

135 = P (1 v 28 ) 108 = P (1 v 14 ) Want P (1 v 7 ) 135 = P (1 v 14 )(1 + v 14 ) =108(1 + v 14 ) v 14 = .25 P =144 P (1 v 7 ) =144(1 .5) = 72

9.

700 =10( Ia )10

Using Trial and Error

700 = 10( Ia )14 + Rv 15 R = 73.76

@n=14, value = 664.52 @n=15, value=736.80 So there are 14 regular payments and a final payment at 15.