THE UNIVERSITY OF MELBOURNE

CENTRE FOR ACTUARIAL STUDIES

DEPARTMENT OF ECONOMICS
ACTL20001 FINANCIAL MATHEMATICS I
SEMESTER 1 ASSESSMENT
18 June 2015, 4 pm

Reading time: 15 minutes

Writing time: 2 hours
Total number of pages: 4
This exam contributes 70 % to the total assessment in this subject.

Instructions to invigilators
This is a closed book exam. No books, lecture notes or dictionaries are allowed in the
examination room.
Calculators are permitted.
Candidates must write the make and model number of their calculator(s) below.
This paper is to remain in the examination room and should be inserted in
the script book at the end of the examination.

Instructions to candidates
There are FIFTEEN questions. The number of marks allocated is shown at the end
of each question. The total number of marks is 70.
The only calculators permitted are the following:
Casio FX82 (with or without any suffix)
Casio FX83 (with or without any suffix)
Casio FX85 (with or without any suffix)
Sharp EL531 (with or without any suffix)
Texas Instruments BA II (with or without any suffix)
Texas Instruments TI-30 (with or without any suffix).
Please fill in the form below (include all calculators).

Student number
Calculator make (e.g. Casio)
Calculator model (e.g. FX82)

This paper will be held by the Baillieu Library.

Page 1 of 4
 Justify all your answers unless otherwise instructed.

True or false
For each of questions 1 to 3 say whether the claim is true or false AND give a short
justification.
1. An equation of value EQV (i) = 0 always has EQV (i) tend to infinity as i tends to
−1, and EQV (i) tend to 0 as i tends to infinity. [3 marks]
2. Convex functions are those that increase more rapidly than f (x) = x, because their
second derivative is positive. [3 marks]
3. Shares and commercial property are highly liquid investments. [3 marks]

4. Briefly describe the similarities and differences between forward contracts and futures
contracts. [3 marks]

5. The equation of value

1
EQV (i) = 101.604 − 198.128v + Cv 2 = 0, v = ,
1+i

has two solutions i = 0.10 and −0.15. Calculate C to two decimal places. [3 marks]

6. In lectures we saw five criteria for evaluating and comparing financial projects. State
three (3) of them. [3 marks]

7. For a rate of interest of 9% per annum convertible monthly, calculate, to four decimal
places, the equivalent rate of discount per annum convertible quarterly. [4 marks]

8. Express the force of interest δ as an infinite Taylor series of powers of i(2) . Disregard
whether the series converges or not. [4 marks]

9. In a consistent market, a bank deposit earns simple interest from time 0. Between
time 1 and time 2 the deposit has grown by 10%. Calculate the force of interest at
time 2, to four decimal places. [5 marks]

Page 2 of 4
10. Payments of $100 are made quarterly for five years. Calculate, to the nearest cent,
their present value seven months before the first payment is made, if the force of
interest is δ = 0.08 per annum. [5 marks]

11. An ordinary share pays annual dividends. It is expected that dividends will grow at
3% per annum compound. The next dividend, due 6 months from now, will be $1.00,
and the present value (now) of all future dividends (in perpetuity) is $100. Calculate,
to four decimal places, the effective rate of interest used to discount future dividends.
[6 marks]

12. A loan of $100,000 has monthly repayments of $1,000. The interest rate is 8.4% per
annum convertible monthly.
Calculate how many months it will take to repay the loan and the amount of the final
payment (to the nearest dollar). [6 marks]

13. A continuous cash flow is defined as

( 400, 0 ≤ t ≤ 1
K(t) = 100, 1 < t ≤ 3
500, 3 < t < 5.

(a) Let S(t) be the accumulated value of the cash flow up to time t; the force of
interest δ is constant. State a differential equation satisfied by S(t), for t between 3
and 5.
(b) Calculate, to the nearest cent, the accumulated value at time 5 of the payments
made between time 0 and time 1, if the effective rate of interest per time unit is
i = 0.10.
[2 + 4 = 6 marks]

14. The force of interest during the period [0, 10] is


0.10 − 0.01t, 0≤t≤5
δ(t) =
0.04, 5 < t ≤ 10.

(a) A deposit of $100 is made at time 3. Calculate the accumulated value at time 9,
to the nearest cent.
(b) Calculate the effective rate of interest for the the period from t = 3.5 to t = 4.5,
to four decimal places.
[3 + 3 = 6 marks]

Page 3 of 4
 n − an
15. (a) Show that (Da) n = .
i
For parts (b) and (c) use an effective rate of interest of i = 5% effective.
(b) A loan is repaid by payments of $10 at time 1, $9 at time 2, and so on, decreasing
by $1 per year until the last payment of $1 at time 10. Calculate the loan outstanding
at time 6, just after the repayment then due has been made, to the nearest cent.
(c) Calculate the amount of capital in the repayment made at time 7, to the nearest
cent.
[3 + 4 + 3 = 10 marks]

END OF EXAMINATION

Page 4 of 4
 SOLUTIONS
These are short solutions, some details may be missing

1. First part is false in general, true when the coefficient of v n of the highest degree is
positive. Second part is false if there is a constant term in EQV (i).
2. False, by definition a convex has all its chords above it, may well be decreasing; if a
convex function has a second derivative then it is non-negative.
3. False, shares are liquid because they sell on exchanges and usually come in small
parcels, but property takes time to sell and has high unit prices so is illiquid.

4. Forward and futures contracts are similar because they are both promises to buy or
sell some asset at a specific date; their main differences are that futures are stan-
dardised and traded on exchanges, while forward contracts are customised for both
parties and privately traded.

1
5. Insert one of the roots into to the equation and solve. Alternatively, if y1 = 1.10 , y2 =
1
0.85 then the equation of value has to be a multiple of the polynomial (v−y 1 )(v−y 2) =
2
v − (y1 + y2 )v + y1 y2 . This implies C = 95.

6. (i) Is the net present value (NPV) of the cash flow positive?
(ii) What return will we make on our capital? Internal rate of return solution to
NPV(i) = 0.
(iii) Payback period (without interest).
(iv) Discounted payback period.
(v) Accumulated profit at end of project.

12 −4 "

(12) −3
 #
i(12) d(4)
  
i
7. 1+ = 1− ⇒ d(4) = 4 1 − 1 + = 0.0886667.
12 4 12

∞
i(2) (−1)n−1  (2) n
  X
8. δ = log(1 + i) = 2 log 1 + = i .
2 n=1
n2n−1

1 d i i 1
9. 1 + 2i = 1.1(1 + i) ⇒ i = ; δ(t) = log(1 + it) = ⇒ δ(2) = = .
9 dt 1 + it 1 + 2i 11

7 (4) 7δ 1 − e−5δ
10. 400(1 + i)− 12 ä 5 = 400e− 12 δ = 1 589.03.
4(1 − e− 4 )
 1
1
2 2 − 12 1 (1 + i) 2
11. 100 = v [1 + v(1.03) + v (1.03) + · · ·] = (1 + i)
2
1.03 = (1 + i) − 1.03 or,
1 − 1+i
1
if x = (1 + i)− 2 ,

100x2 − 103 − x = 0 ⇒ x = 1.01989 ⇒ i = 0.040199.

12. If we solve a n = 100 000/1 000 = 100 we get

1 1
v n = 1 − 100i, n = − log(1 − 100i) = − log(1 − 0.7) = 172.597.
δ log 1.007

It will take 173 months to repay the loan, and the final payment X173 is found from

100 000 = 1 000a 172 +X173 v 173 ⇒ X173 = (1+i)173 (100 000−1 000a 172 ) = 598.24.

13. (a) S 0 (t) = δS(t) + 500.

i
(b) 400s̄ 1 (1 + i)4 = 400 (1 + i)4 = 614.46.
δ
Z 9
14. (a) exp δ(t) dt = e0.28 = 1.32313.
3
Z 4.5
(b) exp δ(t) dt − 1 = e0.05 − 1 = 0.06184.
3.5

1 1
15. (a) a n + · · · + a 1 =(1 − v n + · · · + 1 − v) = (n − a n ).
i i
4 − a4
(b) a 4 = 3.54595, = 9.08099.
i
(c) X7 = 4 = L6 −L7 +iL6 ⇒ capital = 4−iL6 = 4−(4−a 4 ) = a 4 = 3.54595.