QM 2009 Exam

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SECTION B
Attempt EITHER Question 1 OR Question 2

Question 1
A local business is to purchase a warehouse for $3 000 000. They find a bank that is willing to
lend the amount at an interest rate of j 12 = 8.1% p.a., with the business agreeing to pay back the
loan by making equal monthly repayments (at the end of each month, beginning in a month's
time) for 5 years.

a Represent the cash flows as a fully labelled time line diagram.


[2 marks]

b Determine the size of the monthly repayment.


[4 marks]

c Construct an amortization table for the last 3 repayments


[8 marks]

d After two years, due to tight monetary policy, the interest rate applicable to the loan rises to
j12 = 9.6% p.a. Determine the new monthly repayments are required (i.e. for payments 25 to
60) in order to pay the loan off in a total of 5 years.
[7 marks]

e If the business does not change the size of its monthly repayments, determine how many
more repayments it will take to pay off the loan.
[4 marks]

[Total : 25 marks]
a) Time line diagram :

$3 000 000 $0
(PV) (FV)
R R R R R R
|_____|_____|_____|____....... _____|_____|_____|
0 1 2 3 58 59 60

b) Determine the size of the monthly repayment.

Given PV = $ 3 000 000, i = 8.1%/12 = 0.00675 per month, n=60

$3 000 000 = R [1 - 1.00675-60]


0.00675
$3 000 000 = 49.202219 R
R = $ 60972.86
Thus the monthly repayment must be $60 972.86 per month.

c)
PV(of debt with 3 payments to go) = $60 972.86 [1 - 1.00675-3]
2

0.00675
= $ 180476.68

Amortisation table :
Month Monthly Interest on Decrease in Outstanding
Payment OP OP Principle
57 $60,972.86 $180,476.68
58 $60,972.86 $1,218.22 $59,754.64 $120,722.04
59 $60,972.86 $814.87 $60,157.99 $60,564.05
60 $60,972.86 $408.81 $60,564.05 $0.00

Example calculations:

interest = OP * i = 180,476.68 * 0.00675 = 1,218.22


OP = prev OP – payment + int = 180,476.68 – 60,972.86 + 1,218.22 =
120,722.04

d)
OP = PV(of debt with 60-24=36 payments to go) = $60 972.86 [1 -
1.00675-36]
0.00675
= $1 942 892.54

Use this as the PV for the new rate part:


Given PV = $1 942 892.54, i = 9.6%/12 = 0.008 per month, n=36

$1 942 892.54 = R [1 - 1.008-36]


0.008

 R = $62 327.44
Thus the new monthly repayment must be $62 327.44 per month.

e) If payment size is not changed:

PV = $1 942 892.54, R = $60 972.86 , i = 0.008

n = -ln(1-PVi/R)/ln(1+i) = -ln(1 - 1 942 892.54 * 0.008 / 60 972.86) /


ln(1.008) = 36.9297

That is, 36 more full payments and a partial payment will be required.
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Question 2
Jane is living in rented accommodation but is thinking about buying a house. She is paying $320
per week in rent, and can afford to commit up to $400 per week on accommodation. Buying a
house will cost her $170,000. If she can save a deposit of at least $10,000 she will be able to
borrow from the XYZ bank at an interest rate of j52 = 10.40% p.a. Savings at the XYZ bank
earns interest at j52 = 4.68% p.a.

Jane decides to deposit $80 every week into a savings account until she has saved at least
$10,000. (The first deposit will be made in one week’s time, and interest be earned at j52 = 4.68%
p.a.) As soon as she has saved at least $10,000, she will borrow enough money to make up the
$170,000 required to buy the house. The following week she will commence repayments of $400
a week, with interest charged at j52 = 10.40% p.a.

NB Assume that there is no inflation with respect to housing prices. That is, the price of the
house will be $170,000 regardless of when it is purchased.

a Illustrate this scenario as a fully labelled time line diagram.

[3 marks]

b Determine how many weeks it takes until Jane has saved at least $10,000.

[5 marks]

c Determine how much Jane will have saved by then. [NB Assume that Jane’s last deposit is
NOT a partial deposit – that her savings will not be exactly $10,000, but rather a little more
than $10,000.]

[6 marks]

d Thus determine how much she needs to borrow in order to have the $170,000 required to buy
a house.

[2 marks]

e Determine how many repayments it will take to pay back this loan.

[5 marks]
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f If you have no deposit, the XYZ bank charges interest at a rate of j52 = 10.92% p.a. Briefly
explain (one or two sentences) why a borrower with no deposit might be subjected to a
higher interest rate.

[4 marks]
[Total : 25 marks]
a) FV*≈ 10000

80 80 80 80

|_______|_______|___..___|_______|

0 1 2 n-1 n weeks

PV=170000-FV*

400 400 400


400 X

|_______|_______|____..__|
_______|_______|

0 1 2 N-1
N N+1 weeks

NB Savings in red and repayments in green. (Other layouts are


acceptable)

b) Savings interest: i = j52/52 = 0.0468/52 = 0.0009 per week.

For a simple annuity, n = ln(1 + FVi/R) / ln(1+i) = ln(1 +


10000*0.0009/80) / ln(1.0009)

= 118.5085 => 119 weeks of saving required.

c)

For a simple annuity, FV = R((1+i)119 – 1)/i = 80(1.0009119 - 1)/0.0009 =


$ 10043.73 accumulated.
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d) Need to borrow 170000 – 10043.73 = $ 159956.27

e)

i = jm/m = j52/52 = 0.1040/52 = 0.002 per week

For a simple annuity n = -(ln(1-PVi/R)/(ln(1+i)

= - ln(1-159956.27*0.002/400) / ln(1.002)

= 804.976535

That is, 804 weekly repayments of $400, followed by a partial payment


in week 805.

f) Generally in any financial market, the higher the perceived risk


the higher the return that investors/lenders will require to
compensate for that risk. If a borrower has not been able to save a
deposit they are perceived as more risky than a borrower who has been
able to save a deposit, and are thus subjected to a higher interest
rate.

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