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102_Sol_1104

# 102_Sol_1104

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05/09/2014

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Actuarial Society of India
EXAMINATIONS
November 2004
SUBJECT - 102 : Financial Mathematics
Indicative Solution
Question 1
Convert to amounts at time 0 values:
Loan = 20,000
Interest at
t = 1 : 969.15
t = 2 : 927.68
t = 3 : 875.00
Capital repaid att = 3 : 17500
Equation of Value is
3
3
2
17500
875
68
.
927
15
.
969
20000
v
v
v
v
+
+
+
=
By trial and error the real rate of return is 0.47%
Question 2
Let S be the investment made.
Real value of payments is:
...
)
1
(
)
1
(
)
1
(
)
1
(
)
1
(
3
3
2
2
2
+
+
+
+
++
+
+
=
e
v
g
dS
e
v
g
dS
e
dSv
S
where v is calculated using the real rate of
interesti\u02c6 .
Simplifying we get
)
1
(
)
\u02c6
1
)(
1
(
1
g
i
e
d
+
\u2212
+
+
=
g
d
e
i
+
+
=
+
+
\u2234
1
)
1
)(
\u02c6
1
(
Thus
)
1
(
\u02c6
e
e
g
d
i
+
\u2212
+
=
Question 3
(a) E(i) = 0.3 * 7 + 0.5 * 8 + 0.2 * 10 = 8.1%
Single premium is X such that X *
)
081
.
1
(
25
= 10,000
Hence X = Rs 1,426.78
(b) Expected profit is
= 1,426.78 * [0.3 *
)
07
.
1
(
25
+ 0.5 *
)
08
.
1
(
25
+ 0.2 *
)
1
.
1
(
25] - 10,000
= Rs 300.52
Question 4

a) Earliest redemption date i.e., at the tenth anniversary. Valid reasons should include
remarks about gross redemption yield being less than the coupon and the relative
advantage to the borrower to repay the loan (and reissue at a lower coupon if required).

b) i) The bond is likely to be redeemed later than assumed at the time of issue.
ii) The redemption yield for the buyer of the bond would be higher than that expected
at the time of the issue.
Question 5
a) For the Treasury Stock if the RPI is assumed to grow continuously at a rate of 2.5%
p.a. then if \u201cj\u201d is the real rate of return
9
9
2
/
1
)]
025
.
1
)(
1
[(
100
)]
025
.
1
)(
1
[(
1
...
)]
025
.
1
)(
1
[(
1
)]
025
.
1
)(
1
[(
1
75
.
3
107
j
j
j
j
+
+
\ue00b\ue00a\ue009
\ue005\ue004\ue003
+
+
+
+
+
+
=
i.e.
9
)
2
(
9
100
50
.
7
107
v
a+
=
at i where (1+i) = (1+j)(1.025)
By interpolation (@ 7%, RHS = 104.1 and @ 6%, RHS = 110.96), i = 6.6%
So j = (1.066)/(1.025) -1 = 4%

Alternately, students can evaluate LHS assuming (1+i) = (1.04)(1.025) and prove that RHS is very close to 107. However when such a method is adopted they should prove that they have actually calculated LHS and equated that to RHS.

b) The nominal and real values of the future receipts per Rs 100 nominal may be found
as follows:
Date
Nominal Value
Real value
01/10/04
2
/
1
5
.
69
5
.
158v
2
/
1
2
/
1
)
025
.
1
(
1
5
.
69
5
.
158v