Faculty of ActuariesInstitute of Actuaries
EXAMINATIONS
7 September 2001 (pm)
Subject 102 — Financial Mathematics
Time allowed: Three hours
INSTRUCTIONS TO THE CANDIDATE
1.
Write your surname in full, the initials of your other names and yourCandidate’s Number on the front of the answer booklet.Mark allocations are shown in brackets.
Attempt all 12 questions, beginning your answer to each question on aseparate sheet.
2.3.
Graph paper is not required for this paper.
AT THE END OF THE EXAMINATION
Hand in BOTH your answer booklet and this question paper.
In addition to this paper you should have availableActuarial Tables and an electronic calculator.
102—S2001 (13.3.01)
? Faculty of Actuaries? Institute of Actuaries
1
A 91-day government bill provides the purchaser with an annual effective rate ofreturn of 5%. Determine the annual simple discount rate at which the bill isdiscounted.[2]
2
A particular share is expected to pay a dividend of d1 in exactly one year.
Dividends are expected to grow by g per annum effective every year thereafter.The share pays annual dividends. Let V0 be the present value of the share and rbe the investor’s required annual effective rate of return.Show that V0 =
d1
.r?g
[3]
3
An asset has a current price of 100p. It will pay an income of 5p in 20 days’ time.Given a risk-free rate of interest of 6% per annum convertible half-yearly andassuming no arbitrage, calculate the forward price to be paid in 40 days.[4]
4
An annuity is paid half-yearly in arrears at a rate of ￡1,000 per annum, for 20years. The rate of interest is 5% per annum effective in the first 12 years and 6%per annum convertible quarterly for the remaining 8 years.Calculate the accumulation of the annuity at the end of 20 years.
[4]
5
An investor purchases a bond, redeemable at par, which pays half-yearly couponsat a rate of 8% per annum. There are 8 days until the next coupon payment andthe bond is ex-dividend. The bond has 7 years to maturity after the next couponpayment.
Calculate the purchase price to provide a yield to maturity of 6% per annumeffective.
[4]
6
(1 + it) follows a log normal distribution where it is the rate of interest over agiven time period beginning at time t. The parameters of the distribution areμ = 0.06 and σ2 = 0.0009.
Calculate the inter-quartile range for the accumulation of 100 units of moneyover the given time period, beginning at time t.[6]
102 S2001—2
7
(i)
The annual effective forward rate applicable over the period from t to t + ris defined as ft,r where t and r are measured in years. If f0,1 = 8%, f1,1 = 7%,f2,1 = 6% and f3,1 = 5%, calculate the gross redemption yield at the issuedate from a 4-year bond, redeemable at par, with a 5% coupon payableannually in arrears.[7]Explain why the gross redemption yield from the 4-year bond is higherthan the 4-year forward rate f3,1.[2]
[Total 9]
(ii)
8
A fast food company is considering opening a new sales outlet. The initial cost ofthe outlet would be ￡1,000,000 incurred at the outset of the project. It isexpected that rents of ￡40,000 per annum would have to be paid quarterly inadvance for 10 years, increasing after ten years to ￡48,000 per annum. The netrevenue (sales minus costs, other than rent) from the venture is expected to be￡100,000 for the first year and ￡200,000 for the second year. Thereafter, the netrevenue is expected to grow at 3% per annum compound so that it is ￡206,000 inthe third year, ￡212,180 in the fourth year and so on. The revenue would be
received continuously throughout each year. Twenty years after the outset of theproject, the revenue and costs stop and the project has no further value.Calculate the internal rate of return from the project.
n?ani
[11]
9
(i)(ii)
Prove that Dan=
.[3]
A bank makes a loan to be repaid by instalments paid annually in arrears.The first instalment is 20, the second is 19 with the payments reducing by1 per annum until the end of the 10th year after which there are no furtherpayments. The rate of interest charged by the lender is 6% per annumeffective.(a) (b) (c)
Calculate the amount of the loan.
Calculate the interest and capital components of the first payment.Calculate the amount of capital repaid in the instalment at the endof the 8th year.
[8]
[Total 11]
102 S2001—3
PLEASE TURN OVER
10
An investor purchased a bond with exactly 20 years to redemption. The bond,redeemable at par, has a gross redemption yield of 6%. It pays annual coupons,in arrears, of 5%. The investor does not pay tax.(i) (ii)
Calculate the purchase price paid for the bond.
[3]
After exactly ten years, immediately after payment of the coupon thendue, this investor sells the bond to another investor. That investor paysincome and capital gains tax at a rate of 30%. The bond is purchased bythe second investor to provide a net rate of return of 6.5% per annum.(a) (b)
Calculate the price paid by the second investor.
Calculate the annual effective rate of return earned by the firstinvestor during the period for which the bond was held.[10]
[Total 13]
11
The force of interest, δ(t), is:
δ(t)= 0.05 for 0 < t ≤ 10, = 0.006t for 10 < t ≤ 20 = 0.003t + 0.0002t2 for 20 < t
(i) (ii) (iii)
Calculate the present value of a unit sum of money due at time t = 25.[7]Calculate the effective rate of interest per unit time from time t = 19 totime t = 20.[3]A continuous payment stream is paid at the rate of e?0.03t per unit timebetween time t = 0 and time t = 5. Calculate the present value of thatpayment stream.[4]
[Total 14]
12
(i)(a)
In the context of a stream of future receipts paid at discrete times,let volatility be defined as the proportionate change in the presentvalue of a payment stream per unit change in the force of interest,for small changes in the force of interest. Prove that thediscounted mean term is equal to the volatility.
If volatility is now defined as the proportionate change in thepresent value of a payment stream per unit change in the annualeffective rate of interest, for small changes in the annual effectiverate of interest, find the relationship between the discounted meanterm and volatility.[5]
(b)
102 S2001—4
(ii)
A life insurance company manages a small annuity fund. Payments areexpected to be made from the fund of ￡1,000,000 per annum at the end ofyears 1 to 10 and ￡1,500,000 at the end of each of the following 10 years.Assets are held in two types of bonds. The first is a zero coupon bond
redeemable in 10 years’ time. The second is a bond which pays an annualcoupon of g% per annum in arrears and is redeemable at par at the end of19 years. ￡10,000,000 nominal of the zero coupon bond have beenpurchased.
Find the nominal amount of the coupon paying bond which must bepurchased and the rate of coupon which is received from the bond if theinsurance company is to equalise the present values and discounted meanterms of its assets and liabilities at an effective rate of interest of 5% perannum.[12]
(iii)
If the present value and discounted mean term of the assets and liabilitiesare equalised, state the third condition which is necessary for the
insurance company to be immunised from small, uniform changes in therate of interest.[2]
[Total 19]
102 S2001—5
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