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Theory of Interest Chapter 4 Solutions
Theory of Interest Chapter 4 Solutions
Chapter 4
1. The nominal rate of interest convertible once every two years is j, so that
.07
1 + j = 1 +
The accumulated value is taken 4 years after the last payment is made, so that
(1 + j )
i (12 )
4
(12 )
1 +
= (1.02524 ) and i = .100, or 10.0%.
12
2000
s32 .035
s4 .035
(1.035 )8
57.33450 (
= ( 2000 )
1.31681) = $35,824 to the nearest dollar.
4.21494
34
Chapter 4
6. (a) We use the technique developed in Section 3.4 that puts in imaginary payments
and then subtracts them out, together with adapting formula (4.1), to obtain
200
( a176 a32 ) .
s4
Note that the number of payments is
176 32
= 36, which checks.
4
(b) Similar to part (a), but adapting formula (4.3) rather than (4.1), we obtain
200
( a a36 ) .
a4 180
Again we have the check that
180 36
= 36.
4
(
d 12 .09
7. The monthly rate of discount is d j =
=
= .0075 and the monthly discount
12
12
factor is v j = 1 d j = .9925. From first principles, the present value is
1 (.9925 )
300 1 + (.9925 ) + (.9925 ) + + (.9925 ) = 300
6
1 (.9925 )
upon summing the geometric progression.
120
12
114
v3
1
125
v + v + v + =
=
=
3
3
1 v
(1 + i ) 1 91
3
and
(1 + i )3 1 = 91 or (1 + i )3 = 216
125
125
1
3
6
216
and 1 + i =
= = 1.2 which gives i = .20, or 20%.
5
125
9. Using first principles with formula (1.31), we have the present value
100
1 e .4
.
1 e .02
35
+ e .38 ]
Chapter 4
10. This is an unusual situation in which each payment does not contain an integral
number of interest conversion periods. However, we again use first principles
8
140
4
measuring time in 3-month periods to obtain 1 + v 3 + v 3 + + v 3 and summing the
geometric progression, we have
1 v 48
4 .
1 v 3
11. Adapting formula (4.9) we have
( )
( )
1
d ( 4)
( 4)
4
1
= 1 + i = 1.12 and d = 4 1 (1.12 ) = .11174.
4
The answer is
10
1 (1.12 )
2400
.11174
12. (a)
(b)
1 (1.12 )
800
.11174
m
1 m tm
1 1m
1 vn 1 v 1 vn
( m)
( )
v
a
=
a
v
=
a
a
=
( m ) = ( m ) = anm .
n
n
n 1
m t =1
d
i
i
t =1 m
The first term in the summation is the present value of the payments at times
1 ,1 + 1 ,, n 1 + 1 . The second term is the present value of the
m
m
m
2
,1 + 2 ,, n 1 + 2 . This continues until the last term
payments at times
m
m
m
is the present value of the payments at times 1, 2,, n. The sum of all these
( )
payments is anm .
13. The equation of value is
( )
1000 n a2 = 10,000 or
( )
a2 = 10,
vn
( 2)
n
.
n
( 2 ) = 10 or v = 10d
d
Now expressing the interest functions in terms of d, we see that
( )
( )
a2 = v n a2 =
v = 1 d and d
( 2)
= 2 1 (1 d ) 2 .
36
Chapter 4
We now have
(1 d )n = 20 1 (1 d ).5
.5
n ln (1 d ) = ln 20 1 (1 d )
and
n=
.5
ln 20 1 (1 d )
.
ln (1 d )
14. We have
( )
( )
( )
1 vn
1 v2n
i
or 3 ( 2 ) = 2 ( 2 ) = 45 ( 2 ) .
i
i
3 (1 v n ) = 2 (1 v 2 n ) or 2v 2 n 3v n + 1 = 0
which can be factored ( 2v n 1)( v n 1) = 0 or v n = 1 , rejecting the root v = 1. Now
2
using the first and third, we have
3 (1 v ) = 45i or i =
n
3 1 1
2 = 1.
45
30
1+ v 4 + v 4 +
3
+v
141
1 v 36
3 .
1 v 4
( )
( )
2400an = 40,000 or an = 50 .
3
Thus
an =
1 e .04 n 50
=
.04
3
or
37
Chapter 4
1 e .04 n =
and
2
3
e .04 n =
1
3
18. We have
an =
1 vn
= 4 or v n = 1 4
and
(1 + i )n 1
n
sn =
= 12 or (1 + i ) = 1 + 12 .
Thus, 1 + 12 =
1
8 1
leading to the quadratic 1 + 8 48 2 = 1, so that =
= .
1 4
48 6
an = v dt =
t
n
0
n (1+ r )
r dr
e 0 = e 0
dr
dt
Now
t
(1+ r )
e 0
dr
= e ln 1+t = (1 + t ) .
(
Thus,
1
an = (1 + t ) dt = ln (1 + t )]0 = ln ( n + 1) .
n
1 v
iv
. Thus, t ln v = ln v + ln
( Da )n =
n an
i
and t = 1
( Ia )n =
. Thus,
( Ia )n + ( Da )n = 1 ( an nv n + n an )
i
1 vn
1
= ( an + 1 v n nv n + n an ) = ( n + 1)
= ( n + 1) an .
i
i
38
i
ln .
an nv n
i
and
Chapter 4
Diagrammatically,
Time:
( Ia )n :
( Da )n :
1
1
2
2
3
3
n 1
n 1
n
n
n
n +1
n 1
n +1
n2
n +1
2
n +1
1
n +1
Total:
Pan + Q
an nv n
i
= 6a20 +
a20 20v 20
i
v4
1
10 a10 ) = (10v 4 a14 + a4 )
(
i
i
1
= 10 (1 ia4 ) a14 + a4
i
1
= 10 a14 + a4 (1 10i ) .
i
v 4 ( Da )10 =
24. Method 1:
Method 2:
1
an nv n + nv n )
(
i
(1 + i ) an an
a
= n =
= .
i
i
d
1 1
PV = ( Ia ) v n ( Ia ) = (1 v n ) + 2
i i
n
n
a
1 v 1 1 v
=
= n.
1 + =
id
d
i i
PV = ( Ia )n + v n na =
25. We are given that 11v 6 = 13v 7 from which we can determine the rate of interest. We
have 11(1 + i ) = 13, so that i = 2 /11. Next, apply formula (4.27) to obtain
2
P Q 1 2 11
11
+ 2 = + 2 = + 2 = 66.
i i
i i
2
2
26. We are given:
v
v2
2
(
)
X = va =
and 20 X = v Ia = .
i
id
39
Chapter 4
Therefore,
v
v2
X= =
i 20id
27. The semiannual rate of interest j = .16 / 2 = .08 and the present value can be expressed
as
10 a10
300a10 .08 + 50 ( Da )10 .08 = 300a10 .08 + 50
.08
10 A
= 300 A + 50
= 6250 325 A.
.08
28. We can apply formula (4.30) to obtain
2
1.05 1.05
+
PV = 600 1 +
+
1.1025 1.1025
19
1.05
+
1.1025
i =
i k .1025 .05
=
= .05, or 5%,
1+ k
1 + .05
5
+ (1.05 ) (1.08 )
1 (1.05 /1.08 )5
= 1000 (1.05 )(1.08 )
= 7297.16.
1 1.05 /1.08
5
The total accumulated value is 9309.57 + 7297.16 = $16, 607 to the nearest dollar.
40
Chapter 4
or
1/ (1.25 )
1
=
4
1 (1 + .01k ) /1.25 (1.25 ) (.25 .01k )
5
4.096 =
10 =
1
.25 .01k
and k = 15%.
32. The first contribution is ( 40,000 ) (.04 ) = 1600. These contributions increase by 3%
each year thereafter. The accumulated value of all contributions 25 years later can be
obtained similarly to the approach used above in Exercise 30. Alternatively, formula
(4.34) can be adapted to an annuity-due which gives
9
The 11th payment is 100 (1.05 ) (.95 ) = 147.38 . Then the present value of the second
1 (.95 /1.07 )10
10
10 payments is 147.38
(1.07 )(1.07 ) = 464.71 . The present value
.07 .05
of all the payments is 919.95 + 464.71 = $1385 to the nearest dollar.
34. We have
PV =
2
1 m1
v + 2v m +
2
m
+ nmv m
nm
1
1
n 1
1 + 2v m + + nmv m
2
m
1
nm
1
1
n 1
PV (1 + i ) m 1 = 2 1 + v m + + v m nmv m
m
1 ( )
= anm nv n .
m
PV (1 + i ) m =
1
41
Chapter 4
Therefore
( )
PV =
35. (a)
(b)
( )
anm nv n
m (1 + i ) m 1
1
anm nv n
( )
im
36. We have
+ 12 ) + (13 + 14 +
+ 24 )] =
( 24 ) ( 25 ) 25
= .
( 2 )(144 ) 12
PV = [ v 5 + v 6 + 2v 7 + 2v8 + 3v 9 + 3v10 +
v5 1
5
7
9
(
)
= v +v +v +
a =
2
1 v
v
v
1
=
.
2
1 v iv i vd
37. The payments are 1,6,11,16,. This can be decomposed into a level perpetuity of 1
starting at time t = 4 and on increasing perpetuity of 1, 2,3, starting at time t = 8 .
Let i4 and d 4 be effective rates of interest and discount over a 4-year period. The
present value of the annuity is
1
1
4
1
where i4 = (1 + i ) 1.
+ 5 (1 + i4 )
i4
i4 d 4
We know that
1
(1 + i )4 = (.75 )1 = 4 / 3, or i4 = 4 1 = 1 and d 4 = 3 = 1 .
3
3
1 + 13 4
3 1
3 + ( 5 ) 1 1 = 3 + 45 = 48.
4 3 4
38. Let j be the semiannual rate of interest. We know that (1 + j ) = 1.08, so that
j = .03923 . The present value of the annuity is
2
1.03
1.03
1+
+
+
1.03923 1.03923
1
= 112.59
1 1.03 /1.03923
42
Chapter 4
10
5
5
0
tdt
tdt
] 75 / 2
=
= 3.
25
/
2
]
t
10
1 2
5
2
5
2
1
0
2
( Ia ) =
(.08 )2
= 156.25.
t
1+ k
t
1+ k
t
1+ i
(
)
f
t
v
dt
dt
=
=
0
0 1+ i
1+ k
ln
1 + i 0
1
1
1
.
=
=
=
1 + k ln (1 + i ) ln (1 + k ) i k
ln
1+ i
(b)
n
0
( n t )v t dt = nan ( Ia )n
n (1 v n )
an nv n
n an
14
1
( t 2 1)e
t
0
(1+ r )1 dr
dt.
1
The discounting function was seen to be equal to (1 + t ) in Exercise 19. Thus, the
answer is
14
1
14 ( t 1)( t + 1)
14
t2 1
dt =
dt = ( t 1) dt
1
1
t +1
t +1
14
1
= t 2 t = ( 98 14 ) 1 = 84.5.
2
1
2
43
Chapter 4
1
= 20
1 v.5
so that 1 v.5 = .05 and v.5 = .95.
1 + v.5 + v + v1.5 +
X [1 + v 2 + v 4 +
] = X 1 2 = 20
1 v
4
so that X = 20 (1 v ) = 20 1 (.95 ) = 3.71.
2
45. We have
n
0
at dt =
n
0
n an
(1 vt ) dt =
n ( n 4)
= 40.
.1
46. For each year of college the present value of the payments for the year evaluated at the
beginning of the year is
(
1200a912/12 .
The total present value for the payments for all four years of college is
( )
( )
1200a912/12 (1 + v + v 2 + v 3 ) = 1200a4 a912/12 .
P
.
i
1 1
For annuity #2, we have PV2 = q + 2 .
i i
Denote the difference in present values by D.
D = PV1 PV2 =
(a) If D = 0 , then
pq q
2.
i
i
pq q
q
q
or i =
.
2 = 0 or p q =
i
i
i
pq
dD d
= ( p q ) i 1 qi 2
di di
= ( p q ) i 2 + 2qi 3 = 0.
Multiply through by i 3 to obtain
44
Chapter 4
( p q ) i + 2q = 0 or i =
2q
.
pq
48. We must set soil (S) posts at times 0,9,18,27. We must set concrete posts (C) at times
0,15,30. Applying formula (4.3) twice we have
PVS = 2
a36
a9
and PVC = ( 2 + X )
a45
a15
a36
a9
= (2 + X )
a45
so that
a15
a a
a
a a
X = 2 36 45 45 = 2 36 15 1 .
a9 a15 a15
a9 a45
49. We know an =
1 vn
= a, so that v = 1 a . Similarly, a2 n =
n
1 v2n
= b, so that
2
v 2 n = 1 b . Therefore, 1 b = (1 a ) = 1 2a + a 2 2 , or a 2 2 = ( 2a b ) so
2a b
. Also we see that n ln v = ln (1 a ) n = ln (1 a ) so that
that =
a2
an nv n
ln (1 a )
. We now
n=
. From formula (4.42) we know that ( Ia )n =
substitute the identities derived above for an , n, v n , and . After several steps of
tedious, but routine, algebra we obtain the answer
a3
a
2a b ( b a ) ln
.
2
( 2a b )
b a
n
n
d
d n
d n
t
t 1
an = v t = (1 + i ) = t (1 + i ) = v tv t = v ( Ia )n .
di
di t =1
di t =1
t =1
t =1
d
a
di n
i =0
= v ( Ia )n
i =0
= t =
t =1
n ( n + 1)
.
2
n
n
d
d n
d n
t
t 1
an = v t dt = (1 + i ) dt = t (1 + i ) dt = v tv t dt = v ( Ia )n .
0
0
di
di 0
di 0
d
a
di n
i =0
= v ( Ia )n
t =0
= tdt =
0
45
n2
.
2