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Exam FM Formula Summary: A Few Notes
Exam FM Formula Summary: A Few Notes
01
no driver 11/14/2006
Introduction
Since ASM does not have a formula summary, I decided to compile one to use as I started working on old test questions. In the interest of other actuarial students, I thought I would share the results.
A few notes:
1. This set of formulas is mostly derived from the 3rd edition of the ASM manual for Exam FM/2. As a reference, it does not attempt to recreate the methods presented in the ASM manual and skips many of the necessary techniques for using these formulas to solve certain types of problems. In particular you will notice that there are no formulas from chapters 2 and 8, and very little from chapter 5. 2. Since the syllabus for the exam will change after the November 2006 sitting, this compilation will not be complete for exams given in 2007 and beyond, but it can probably be used as a starting point for future exam takers. 3. I may have misstated some of the explanations of the formulas either through lack of understanding or inadequate keyboard/TEX skills. Please let me know if you nd errors in this document and I will attempt to correct them. Also note that some formulas have no explanation, and are intended to show identities and useful relationships between terms that have been dened previously. 4. This summary is meant as a reference. You dont need to memorize all of these formulas to do well on the exam. In fact, most of them can be easily derived from one another. As you work problems, some of these formulas will become second nature. For some of the problems where these formulas may work, you may prefer working from rst principles or an intermediate derivation. Mykenk has suggested that you only need to know ve formulas for the 2006 exam: Arithmetically increasing & decreasing annuity, geometrically increasing annuity, principle repaid at time t, and the price of a bond. As you learn the material you will gure out what works for you.
Chapter 1
Basics:
a (t) : accumulation function. Measures the amount in a fund with an investment of 1 at time 0 at the end of year t. a (t) a (t 1) : amount of growth in year t. it =
a(t)a(t1) a(t1)
: rate of growth in year t, also known as the eective rate of interest in year t.
A (t) = ka (t) : any accumulation function can be multiplied by a constant (usually the principal amount invested) to obtain a result specic to the amount invested.
a (t) =
j =1
(1 + ij ) : variable interest.
t
1 (1+i)t
= (1 + i)
a(t)a(t1) a(t)
= iv
i(m) = m (1 + i) m 1 1d= 1
d(m) m m
d(m) = m 1 (1 d) m
Force of Interest:
t =
1 d a(t) dt a (t) Rt
0
d dt lna (t)
a (t) = e
r dr
Chapter 3:
Annuities:
an = a n =
1v n i 1v n d
= v + v 2 + + v n : PV of an annuity-immediate. = 1 + v + v 2 + + v n1 : PV of an annuity-due.
a n = (1 + i) a n = 1 + a n1 sn =
(1+i)n 1 i
= (1 + i)
n1
+ (1 + i)
n2
s n = (1 + i) s n = s n+1 1 a mn = a n + v n a n + v 2n a n + + v (m1)n a n
Perpetuities:
1 vn 1 = = v + v 2 + = a : PV of a perpetuity-immediate. n n i i 1 1 vn lim a n = lim = = 1 + v + v2 + = a : PV of a perpetuity-due. n n d d lim a n = lim a a =
1 d
1 i
=1
Chapter 4:
m-thly Annuities & Perpetuities:
an
(m) i v = 1i a n : PV of an n-year annuity-immediate of 1 per year payable in m-thly (m) = i(m) a n = s 1 installments. v =1 = d(m) ments.
n n
(m)
a n
(m)
i a d(m) n
(m)
sn s n
(m)
= =
: AV of an n-year annuity-immediate of 1 per year payable in m-thly installments. : AV of an n-year annuity-due of 1 per year payable in m-thly installments.
(m)
1 vn 1 (m) (m) lim a n = lim (m) = (m) = a : PV of a perpetuity-immediate of 1 per year payable in m-thly n n i i installments. 1 vn 1 (m) (m) lim a n = lim (m) = (m) = a : PV of a perpetuity-due of 1 per year payable in m-thly installn n d d ments. a a =
(m) (m) 1 d(m)
1 i(m)
1 m
Continuous Annuities:
Since lim i(m) = lim d(m) = ,
m m
1 vn 1 vn i (m) lim a n = lim (m) = = a n = a n : PV of an annuity (immediate or due) of 1 per year m m i paid continuously.
Similarly:
nv n = Pa A n + Q an d n S = P sn + Q sn i : AV of a series of n payments, where the rst payment is P and each additional payment increases by Q. n = Ps S n + Q s nd n nv (Ia) n = a : PV of an annuity-immediate with rst payment 1 and each additional payment ini creasing by 1; substitute d for i in denominator to get due form. n n (Is) n = s : AV of an annuity-immediate with rst payment 1 and each additional payment increasing i by 1; substitute d for i in denominator to get due form.
n
(Da) n = nia n : PV of an annuity-immediate with rst payment n and each additional payment decreasing by 1; substitute d for i in denominator to get due form.
s n (Ds) n = n(1+i) : AV of an annuity-immediate with rst payment n and each additional payment i decreasing by 1; substitute d for i in denominator to get due form. 1 1 =1 (Ia) = id i + i2 : PV of a perpetuity-immediate with rst payment 1 and each additional payment increasing by 1.
n
(I a ) = 1.
1 d2
(Ia) n + (Da) n = (n + 1) a n
Q i2
(Ia) n
(m)
n nv 1 =a : PV of an annuity-immediate with m-thly payments of m in the rst year and each i(m) n additional year increasing until there are m-thly payments of m in the nth year.
nv n
Ia
nv = an : PV of an annuity with continuous payments that are continuously increasing. Annual rate of payment is t at time t.
f (t) v t dt : PV of an annuity with a continuously variable rate of payments and a constant interest
0 n
rate. f (t) e
Rt
0
r dr
: PV of an annuity-immediate with an initial payment of 1 and each additional payment increasing by a factor of (1 + k ).
Chapter 5:
Denitions:
Rt : payment at time t. A negative value is an investment and a positive value is a return. P (i) = v t Rt : PV of a cash ow at interest rate i.
Chapter 6:
General Denitions:
Rt = It + Pt : payment made at the end of year t, split into the interest It and the principle repaid Pt . It = iBt1 : interest paid at the end of year t. Pt = Rt It = (1 + i) Pt1 + (Rt Rt1 ) : principle repaid at the end of year t. Bt = Bt1 Pt : balance remaining at the end of year t, just after payment is made.
L an
Sinking Funds:
L P M T = Li + s n : total yearly payment with the sinking fund method, where Li is the interest paid j L to the lender and s n is the deposit into the sinking fund that will accumulate to L in n years. i j is the interest rate for the loan and j is the interest rate that the sinking fund earns.
L = (P M T Li) s n j
Chapter 7:
Denitions:
P : Price paid for a bond. F : Par/face value of a bond. C : Redemption value of a bond. r : coupon rate for a bond. g=
Fr C
F r = Cg
Bond Amortization:
When a bond is purchased at a premium or discount the dierence between the price paid and the redemption value can be amortized over the remaining term of the bond. Using the terms from chapter 6: Rt : coupon payment. It = iBt1 : interest earned from the coupon payment. Pt = Rt It = (F r Ci) v nt+1 = (Cg Ci) v nt+1 : adjustment amount for amortization of premium (write down) or Pt = It Rt = (Ci F r) v nt+1 = (Ci Cg ) v nt+1 : adjustment amount for accumulation of discount (write up). Bt = Bt1 Pt : book value of bond after adjustment from the most recent coupon paid.
: theoretical price of a stock that is expected to return a dividend of D with each subsequent dividend increasing by (1 + k ), k < i.
Chapter 9:
Recognition of Ination:
i =
ir 1+r
: real rate of interest, where i is the eective rate of interest and r is the rate of ination.
tRt t=
t=1 n
t=1 n
tv t Rt d=
t=1 n
: (Macauley) duration. v Rt
t
t=1
: volatility/modied duration.
: convexity