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ACST152 Introduction to Actuarial Studies

Quiz Questions Set 4 (2014)


Present Values and Fixed Term Annuities
Q1. Sam is now age 65 and wishes to have a retirement
income of $30,000 per annum. He will withdraw
$25,000 at the START of each year for the next 30
years (30 payments in all). If he can earn 5% p.a.
interest, how much does he need to have in his account
on the date of retirement, in order to provide these
payments?

Q1. Sam is now age 65 and wishes to have a retirement income of $30,000 per
annum. He will withdraw $30,000 at the START of each year for the next 30 years
(30 payments in all). If he can earn 4% p.a. interest, how much does he need to
have in his account on the date of retirement, in order to provide these
payments?
Solution: using the formula for payments in advance
PV = 30000 * 1.04 * (1-1.04^-30) / 0.04
= 539,511.44

Q2. (Increasing annuity) Sam's friend has pointed out that he should allow for
the cost of living, which is expected to increase at 3% per annum. Suppose he
withdraws $30,000 at the start of the first year, $30,000*1.03 at the start of the
second year, $30,000 * 1.03^2 at the start of the third year, and so on. If he can
earn 4% p.a. interest, how much does he need to have in his account on the date
of retirement, in order to provide these payments? {You should be able to do this
by summing a GP but you can check your answer using a spreadsheet}
Solution:
The Pv of the first payment is 30000
The PV of the second payment is 30000 * 1.03 / 1.04
The PV of the third payment is 30000 * 1.03^2 / 1.04^2
and so on

This is a GP where the first term is $30000, the constant ratio is 1.03/1.04, and
the number of terms is 30.
Answer = 30000 * [(1.03/1.04)^30-1]/(1.03/1.04-1)
= 785,084.56

Q3. (Deferred annuity) Maryann is now age 50 exactly. She has $Y in her
superannuation account and it is earning 4% per annum interest . Ignore taxes
fees and charges for this question. She does not intend to make any more
contributions. She intends to retire at age 65 exactly. She has calculated that by
the time she retires, the superannuation account will have enough to pay a
retirement income of $10,000 p.a. for 40 years (with the first payment occurring
on the day she retires). What is $Y?
First find the PV at age 65 of the benefit.
PV at age 65 = 10000 * 1.04 * [1-1.04^-40]/0.04
= 205,844.85
If she has $Y now, it must accumulate up to 205,844.85 by the time she
reaches age 65.
S o Y * 1.04^15 = 205844.85
Y = 114,298.34
Q4. (Decreasing annuity). You work for an oil company. The company sells its
output each year on 31 December. In 2013, the output was worth $100 million.
However the oil well is slowly being depleted and you expect that the output will
decrease by 10% p.a. compound each year (i.e. $90 million in 2014, $81 million
in 2015, $72.9 million in the 2016, and so on). If it is now 1 January 2014,
calculate the present value of the future income from the oil well for the next 20
years, using 8% p.a. interest. {You should be able to do this by summing a GP
but you can check your answer using a spreadsheet}
Solution:
The PV of the first payment is 90 * 1.08^-1
The PV of the second payment is 90 * 0.90 * 1.08^-2
The PV of the third payment is 90*0.90^2 * 1.08^-3
and so on.
This is a GP with 20 terms, where the first term is 90/1.08 and the constant ratio
is 0.90/1.08
PV = 90 / 1.08 * [(0.90/1.08)^20-1] /(0.90/1.08-1]
= 486.96 million

Q5. Mr Smith is a benevolent person and he wishes to provide a scholarship for


needy students. He intends to put $X in a bank account on 1 January 2014. The
account will earn interest at 4% p.a. Each year, starting on 1 January 2015 and
every year thereafter for 50 years, the Smith Scholarship will be awarded to one
student. The Scholarship is $1000 in every year. What is the value of $X which is
necessary to meet this requirement?
Solution
PV = 1000 * [1-1.04^-50]/0.04 = 21,482.18

Q6. (Perpetuity) Repeat Q5, but this time assume that Mr Smith wants the prize
to be a perpetuity, i.e. the prize will be awarded every year, forever. What is the
value of $X which is necessary to meet this requirement?
Solution
PV = 1000 / 0.04 = 25,000
Note that the sum of 25000 invested at 4% will produce an income of
$1000 in interest per
year. The scholarship simply pays the interest and the
account balance remains the same at the start of each year.

Q7. (Using Solver). The following is an extract of a spreadsheet which is used


to calculate the present value of a series of unequal payments. The calculations
have been done using an interest rate of 4%. The spreadsheet calculates the
present value of each individual payment and then sums the individual values.
The present value was calculated as $11,211.48
Interest rate
Total present
value

4% p.a
$
11,211.48
Time of
payment
1
2
3
4
5
6
7
8
9
10

Payme
nt
1800
1700
1600
1500
1400
1300
1200
1100
1000
900

PV of payment
$
1,730.77
$
1,571.75
$
1,422.39
$
1,282.21
$
1,150.70
$
1,027.41
$
911.90
$
803.76
$
702.59
$
608.01

One of your colleagues has calculated the present value of these payments using
a different interest rate, which was determined by finding the average interest
rate earned on accounts. His answer was $10,253.53. What interest rate did he
use? Use Solver to find the answer, as a percentage accurate to 2 decimal places
(e.g. 3,76% or 9.88%)
Interest rate
Total present
value

6.08%

p.a

$
10,253.53

Time of
payment
1
2
3
4
5
6
7
8
9
10

Payme
nt
1800
1700
1600
1500
1400
1300
1200
1100
1000
900

$
$
$
$
$
$
$
$
$
$

PV of payment
1,696.83
1,510.71
1,340.35
1,184.56
1,042.22
912.31
793.87
686.00
587.89
498.78

Q8. The following is an extract of a spreadsheet of customers at a mobile phone


company. The company is particularly concerned about losing customers and
they have decided to give discounts to selected customers.
Customers who are under age 30 will get no discount
Customers who are over age 30 and spend less than $50 per month will
get 5% discounts
Customers who are over age 30 and spend more than $50 per month will
get 10% discounts.
Column E shows the level of discount. What Excel command should be in cell E5?
[Note that there might be more than 1 correct answer. This will be a multiple
choice question in the quiz]
A
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
21
22
23
24

B
Custom
er
Id
Numbe
r
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
....
20000

Age

Avera
ge

Discou
nt

Monthl
y
Spend
84
19
62
52
61
59
20
73
86
20
34
52
68
100
80
92
58
80
....
56

0%
0%
10%
10%
10%
10%
0%
10%
10%
0%
5%
0%
10%
10%
10%
0%
0%
10%
...
10%

25
23
52
44
48
44
27
42
45
21
36
29
43
42
40
23
28
54
....
57

ANSWER: IF (c5<30,0,IF(d5<50,5%,10%))

Q9,10,11,12. The Australia Securities and Investment Commission runs a


"shadow shopping" exercise to see whether financial advisors give good financial
advice. Look up ASIC's Media Release MR-55 dated 27 March 2012, and then
decide whether the following statements are True or False. (1/2 mark each)
Q9. More than two-thirds of the clients received excellent advice.
FALSE
Q10. More than two-thirds of the plans included an estimate of how long the
client's retirement savings would last.
FALSE ONLY 56% HAD AN ESTIMATE OF THIS TIMESPAN
Q11. When clients received poor advice, they were usually annoyed because
they felt that they had wasted money paying fees for poor advice.
FALSE - THEY WERE UNAWARE OF THE FACT THAT THEY HAD RECEIVED
POOR ADVICE
Q12. Some financial planners recommended investments which would pay high
commission to the financial planner, even if it was not very good for the client.
TRUE