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The Theory of Interest - Solutions Manual
The Theory of Interest - Solutions Manual
Chapter 3
1. The equation of value using a comparison date at time t = 20 is
50,000 = 1000s20 + Xs10 at 7%.
Thus,
50, 000 1000s20 50,000 40,995.49
X= = = $651.72.
s10 13.81645
2. The down payment (D) plus the amount of the loan (L) must equal the total price paid
for the automobile. The monthly rate of interest is j = .18 /12 = .015 and the amount
of the loan (L) is the present value of the payments, i.e.
L = 250a48 .015 = 250 ( 34.04255 ) = 8510.64.
Thus, the down payment needed will be
D = 10,000 8510.64 = $1489.36.
3. The monthly interest rate on the first loan (L1) is j1 = .06 /12 = .005 and
L1 = 500a = ( 500 )( 42.58032 ) = 21, 290.16.
48 .005
The monthly interest rate on the second loan (L2) is j2 = .075 /12 = .00625 and
L2 = 25,000 L1 = 25,000 21, 290.16 = 3709.84.
The payment on the second loan (R) can be determined from
3709.84 = Ra12 .00625
giving
3709.84
R= = $321.86.
11.52639
23
The Theory of Interest - Solutions Manual Chapter 3
1 n +1
n
1 v n
6. We are given an = = x, so that v n = 1 ix. Also, we are given
i
1 v2n
= y, so that v 2 n = 1 iy. But v 2 n = ( v n ) so that 1 iy = (1 ix ) . This
2
a2 n =
2
i
2x y
equation is the quadratic x 2i 2 ( 2 x y ) i = 0 so that i = . Then applying
x2
i 2x y
formula (1.15a), we have d = = 2 .
1 + i x + 2x y
a8 = = = = 5.695.
d d .1
8. The semiannual interest rate is j = .06 / 2 = .03. The present value of the payments is
100 ( a21 + a9 ) = 100 (15.87747 + 8.01969 ) = $2389.72.
9. We will use a comparison date at the point where the interest rate changes. The
equation of value at age 65 is
3000s25 .08 = Ra15 .07
so that
3000 s25 .08 236,863.25
R= = = $24,305
a15 .07 9.74547
to the nearest dollar.
24
The Theory of Interest - Solutions Manual Chapter 3
= (1 + i ) + (1 + i ) + 1 + (1 + i ) 1
n 1 n
+
= sn 1 + (1 + i ) .
n
(c) Each formula can be explained from the above derivations by putting the
annuity-immediate payments on a time diagram and adjusting the beginning and
end of the series of payments to turn each into an annuity-due.
Finally,
1 v p + q 1 1 ivx
a p+q = = 1
i i 1 + iy
(1 + iy ) (1 ivx ) vx + y
= = .
i (1 + iy ) 1 + iy
25
The Theory of Interest - Solutions Manual Chapter 3
1 v10 1 v5
16. We are given 5 a10 = 3 10 a5 or v 5 a10 = 3v10 a5 and v 5 = 3v10 .
i i
Therefore, we have
v 5 v15 = 3v10 3v15 or 2v15 3v10 + v 5 = 0 or 2 3 (1 + i ) + (1 + i ) = 0
5 10
3 ( 3) ( 4 )( 2 )(1) 3 1
2
(1 + i ) = = =2
5
2 2
rejecting the root i = 0.
17. The semiannual interest rate is j = .09 / 2 = .045. The present value of the annuity on
October 1 of the prior year is 2000a10 . Thus, the present value on January 1 is
2000a10 (1.045 )
.5
26
The Theory of Interest - Solutions Manual Chapter 3
so that
1 v 20
R = 1000 = 1000 (1 v 20 ) (1 + i )
30
30
v
= 1000 (1 + i ) (1 + i ) .
30 10
1 i 1
19. We are given i = so that d = = . The equation of value at time t = 0 is
9 1 + i 10
(1 d )n (1 .1)n
6561 = 1000v a or 6.561 =
n
= .
d .1
Therefore, (.9 ) = (.1)( 6.561) = .6561 and n = 4.
n
21. Per dollar of annuity payment, we have PVA = PVD which gives
1
an = v n a or an = 3v n a
3
and 1 v = 3v , so that
n n
4v n = 1 or v n = .25 and (1 + i ) = 4.
n
27
The Theory of Interest - Solutions Manual Chapter 3
Finally,
v n (1 v n )
n
PVB v an
= =
PVD v 3 n a v 3n
1 v n 1 .7 .30 30
= 2n = = = .
v (.7 )2 .49 49
(1 + i ).25 1
23. (a) a5.25 = a5 + v
5.25
at i = .05
i
(1.05 ).25 1
(
= 4.32946 + .77402 ) = 4.5195.
.05
1 v 36 1 v18
4 =5 or
i i
4 (1 v 36 ) = 4 (1 v18 )(1 + v18 ) = 5 (1 v18 ) .
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The Theory of Interest - Solutions Manual Chapter 3
Thus, we have
4 (1 + v18 ) = 5 or v18 = .25.
Finally, we have (1 + i ) = 4, so that (1 + i ) = 2 which gives n = 9.
18 9
27. (a) The monthly rate of interest is j = .12 /12 = .01. The equation of value at time
t = 0 is
6000v k = 100a60 = 4495.5038
ln (.749251)
v k = .749251 so that k = = 29.
ln (1.01)
28.(a) Set: N = 48 PV = 12, 000 PMT = 300 and CPT I to obtain j = .7701%.
The answer is 12 j = 9.24%.
(b) We have 300a48 = 12, 000 or a48 = 40. Applying formula (3.21) with n = 48
and g = 40, we have
2 ( n g ) 2 ( 48 40 )
j = = .8163%.
g ( n + 1) 40 ( 48 + 1)
The answer is 12 j = 9.80%.
29. We have
1 2
a2 = v + v 2 or 1.75 = (1 + i ) + (1 + i ) .
Multiplying through (1 + i ) gives
2
1.75 (1 + i ) = (1 + i ) + 1
2
1.75 (1 + 2i + i 2 ) = 2 + i
and 1.75i 2 + 2.5 .25 or 7i 2 + 10 1 = 0 which is a quadratic. Solving for i
29
The Theory of Interest - Solutions Manual Chapter 3
10 (10 ) ( 4 ) ( 7 ) ( 1) 10 128
2
i= =
( 2) ( 7) 14
4 2 5
= rejecting the negative root.
7
Thus 1538 (1 v10 ) = 1072 (1 v 20 ) = 1072 (1 v10 )(1 + v10 ) , so that 1 + v10 =
1538
or
1072
v10 = .43470.
Solving for i, we obtain
(1 + i ) = .43470
10 .1
and i = (.43470 ) 1 = .0869, or 8.69%.
31. We are given that the following present values are equal
a 7.25% = a50 j = an j 1.
Using the financial calculator
1
a50 j =
= 13.7931
.0725
and solving we obtain j = 7.00%. Since j 1 = 6%, we use the financial calculator
again
an 6% = 13.7931 to obtain n = 30.2.
32. (a) We have j1 = .08 / 2 = .04 and j2 = .07 / 2 = .035. The present value is
6
a6 .04 + a4 .035 (1.04 ) = 5.2421 + ( 3.6731)(.79031)
= 8.145.
(c) Answer (b) is greater than answer (a) since the last four payments are discounted
over the first three years at a lower interest rate.
= 4.1543.
30
The Theory of Interest - Solutions Manual Chapter 3
34. Payments are R at time t = .5 and 2R at time t = 1.5, 2.5,, 9.5. The present value of
these payments is equal to P. Thus, we have
P = R 1 + 2a4 i + 2aa j (1 + i ) (1 + i ) 2
4 1
and
P (1 + i )
1
2
R= .
1 + 2a4 i + 2 (1 + i ) a5 j
4
35. The payments occur at t = 0, 1, 2,, 19 and we need the current value at time t = 2
using the variable effective rate of interest given. The current value is
1 1 1
1 1 1 1 1 1
1 + 1 + + 1 + + 1 + 1 + + 1 + 1 +
9 10 10 11 11 12
1 1 1
1 1 1
+ + 1 + 1 + 1 +
11 12 27
10 11 11 11 11 12 11 12 27
= + + 1 + + + +
9 10 10 12 12 13 12 13 28
11 11 11 11 11 11 28 11
= + + + + + + = .
9 10 11 12 13 28 t =9 t
1 1 t+2
37. We have a ( t ) = = , so that a 1 ( t ) = log 2 .
log 2 ( t + 2 ) log 2 ( t + 1) log t + 2 t +1
t +1
2
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The Theory of Interest - Solutions Manual Chapter 3
Now
n 1 n 1
t+2
an = a 1 ( t ) = log 2
t =0 t =0 t +1
2 3 n +1
= log 2 + log 2 + + log 2
1 2 n
2 3 n +1
= log 2 = log 2 ( n + 1) .
1 2 n
e t
r dr
=e
( )
= eln 20 r ln10 = .
10
Then
10
20 r 19 18 10
s10 = = + + + = 14.5.
r =1 10 10 10 10
1 1 1 1 1
39. A: PVA = + + + + = 4.8553
1.01 1.02 1.03 1.04 1.05
B: AVB = 1.04 + 1.03 + 1.02 + 1.01 + 1.00 = 5.1000
and taking the present value
5.1000
PVB = = 4.8571.
1.05
The answers differ by 4.8571 - 4.8553=.0018.
v =
10
= = .5
( 2 ) ( 90 ) 180
rejecting the negative root. Now v10 = .5 or (1 + i ) = 2 and i = .0718. Finally,
10
or
32
The Theory of Interest - Solutions Manual Chapter 3
(1 + i ) (1 + i )
3n
1
2n
8000 1
+ = 81.6327. =
i i 98
23 1 22 1 10
We are given that (1 + i ) = 2. Therefore, + = = 81.6327 and i = .1225,
n
i i i
or 12.25%.
vn = = = .3
( 2 ) (10 ) 20
rejecting the root v n = 1. Substituting back into (ii)
( ) ( )( )
( 2 ) (.3) 1 .3 = 6, so that i = 2 .3 .7 = .07, or 7%.
i 6
Thus, we have
10, 000 (1.04 ) 1
10
K=
(1.05 )(1.04 )6 + (1.05)(1.04 )5 + (1.04 )4 + (1.04 )3
= $980 to the nearest dollar.
40
1 40 s s 26
sn = (1 + i ) 1 = 41 15
n
45.
n =15 i n =15 i
using formula (3.3) twice and recognizing that there are 26 terms in the summation.
33