AMS 318

Prepared by Mu Tian October 17, 2014

Homework #6
Due: Wednesday, October 15, at the end of class
* Please submit your solution with detailed steps

1. Copy and complete the following amortization table. Be careful to note that there is no
payment at t=2.

BALANCE
TIME(years INTEREST IN PRINCIPAL IN
PAYMENT AFTER
since loan) PAYMENT PAYMENT
PAYMENT
0 − − −
1 8000 22342
3 1916.14 9908
4 0

Solution: Below is the correct tabular

BALANCE
TIME(years INTEREST IN PRINCIPAL IN
PAYMENT AFTER
since loan) PAYMENT PAYMENT
PAYMENT
0 − − − 29119.00
1 8000 1223 6777 22342
3 14350.14 1916.14 12434 9908
4 10324.14 416.14 9908 0
To complete the table, we first need to find i, the effective interest rate for one interest
period. Since the interest on 22342, the balance after payment for the 1st year, is 1916.14,
which is on the 3rd year. So we have 22342(1 + i)2 − 22342 = 1916.14. Therefore i =
(1 + 1916.14
22342
)1/2 − 1 ≈ 0.042. The initial loan balance L must satisfy L(1 + i) − 8000 = 22342.
Therefore, L ≈ 29119.00. Now we can complete line 1 of the table, the interest in the
payment on the 1st year should be 29119 × i ≈ 1223, so the principal is 8000 − 1223 = 6777.
On year 3, the principal should de the difference between the previous balance 22342 and
the current balance 9908. Therefore the principal is 22342 − 9908 = 12434. The payment
amount at year 3 should be the sum of interest and principal: 1916.14 + 12434 = 14350.14.
For the last year, since the balance is 0 after payment, the amount of principal must be the
previous balance, 9908. The interest should be 9908 × i = 416.14. The payment amount is
the sum of these two: 416.14 + 9908 = 10324.14.

1
2. Ellen has a thirty-year mortgage with level monthly payments. The amount of principal
in her 82nd payment is $259.34, and the amount of principal in her 56th payment is
$230.19. Find the amount of interest in her 133rd payment.

a. 559.63
b. 708.90
c. 604.59
d. 455.92
e. 533.15

Solution: Let Q be the monthly level payment and i be the effective monthly interest rate,
1
v = 1+i . The total number of payment/interest period is n = 12×30 = 360. We are adopting
the table on textbook pp.214 and in this question we assume the last payment R == Q.
The principal for the k-th month is Qv n−k − Qiv n−k+1 = Qv n−k+1 . Therefore we have the
following equations:
Qv 360−82+1 = 259.34 (1)
Qv 360−56+1 = 230.19 (2)
We take the ratio of the above two equations and obtained v 26 = 230.19
259.34
and therefore we
obtain v ≈ 0.995425. Plug this value into any of the above equations we can get Q =
932.26956. According the table in the textbook, the interest in her 133rd payment should be
Q(1−v 360−133 )+Qiv 360−133+1 and since i = (1/v −1) this comes down to Q−Qv 228 ≈ 604.59.

IF THE STUDENTS USE 889 AS THE ENTRY (2, 2) IN THE TABLE

PLEASE USE THIS SOLUTION BELOW:

3. A $14000 loan is to be repaid by the sinking fund method, with irregular payments into
the sinking fund. The table below is a partially completed sinking fund table for this
situation. Find the missing entries, noting that there was no payment at then end of the
3rd year.

SINKING S.F. BAL. NET

TIME IN INTEREST ON INTEREST ON
FUND AFTER BALANCE ON
YEARS LOAN S.F.
DEPOSIT DEPOSIT LOAN
0 0 0 0.00 0 14000
1 889 0.00 5200
2 3000 218.40
4 0

Solution: below is the correct tabular:

2
 SINKING S.F. BAL. NET
TIME IN INTEREST ON INTEREST ON
FUND AFTER BALANCE ON
YEARS LOAN S.F.
DEPOSIT DEPOSIT LOAN
0 0 0 0.00 0 14000
1 889 5200 0.00 5200 8800
2 889 3000 218.40 8418.40 5581.60
4 1834.45 4859.60 722.00 14000 0
889
We first compute the effective annual interest rate i = 14000 = 0.0635. Since the gap between
the second payment and the third payment is 2 years, the interest on loan for the 4th year
should be 14000(1 + i)2 − 14000 = 1834.45.
Next, we need to find out the effective interest rate j earned by the sinking fund account.
Note that the sinking fund account has an interest amount 218.40 at the 2nd year, also the
balance of the SF account on the 1st year is 5200, so we immediately have j = 218.40
5200
= 0.042.
Now we complete the rest of the entries. The SF DEPOSIT for year 1 should be 5200 since
the SF BAL is always obtained by summing the previous sinking fund balance, the current
sinking fund deposit and the current interest on the sinking fund; in this case the previous
SF BAL is 0, hence the current SF INT must be zero. The net balance is the difference
14000 − 5200 = 8800, the difference between the loan amount and the current sinking fund
balance.
For the second year, we know the 3000 as the sinking fund deposit and 218.40 as the SF
interest. Also note that the previous line’s sinking fund balance was 5200. The sinking fund
balance for year 2 should be 5200 + 218.40 + 3000 = 8418.40. So the net balance should be
14000 − 8418.40 = 5581.60.
For year 4, two years have elapsed since year 2. Therefore the interest on sinking fund should
be 8418.40[(1 + j)2 − 1] = 722. Moreover since the net balance should be zero, the SF BAL
must equal to the loan amount 14000. So the sinking fund deposit is 14000−8418.40−722 =
4859.60
IF THE STUDENTS USE 899 AS THE ENTRY (2, 2) IN THE TABLE
PLEASE USE THIS SOLUTION BELOW:

4. A $14000 loan is to be repaid by the sinking fund method, with irregular payments into
the sinking fund. The table below is a partially completed sinking fund table for this
situation. Find the missing entries, noting that there was no payment at then end of the
3rd year.

SINKING S.F. BAL. NET

TIME IN INTEREST ON INTEREST ON
FUND AFTER BALANCE ON
YEARS LOAN S.F.
DEPOSIT DEPOSIT LOAN
0 0 0 0.00 0 14000
1 889 0.00 5200
2 3000 218.40
4 0

Solution: below is the correct tabular:

3
 SINKING S.F. BAL. NET
TIME IN INTEREST ON INTEREST ON
FUND AFTER BALANCE ON
YEARS LOAN S.F.
DEPOSIT DEPOSIT LOAN
0 0 0 0.00 0 14000
1 899 5200 0.00 5200 8800
2 899 3000 218.40 8418.40 5581.60
4 1855.73 4859.60 722.00 14000 0
899
We first compute the effective annual interest rate i = 14000 = 0.0642. Since the gap between
the second payment and the third payment is 2 years, the interest on loan for the 4th year
should be 14000(1 + i)2 − 14000 = 1855.73.
Next, we need to find out the effective interest rate j earned by the sinking fund account.
Note that the sinking fund account has an interest amount 218.40 at the 2nd year, also the
balance of the SF account on the 1st year is 5200, so we immediately have j = 218.40
5200
= 0.042.
Now we complete the rest of the entries. The SF DEPOSIT for year 1 should be 5200 since
the SF BAL is always obtained by summing the previous sinking fund balance, the current
sinking fund deposit and the current interest on the sinking fund; in this case the previous
SF BAL is 0, hence the current SF INT must be zero. The net balance is the difference
14000 − 5200 = 8800, the difference between the loan amount and the current sinking fund
balance.

For the second year, we know the 3000 as the sinking fund deposit and 218.40 as the SF
interest. Also note that the previous line’s sinking fund balance was 5200. The sinking fund
balance for year 2 should be 5200 + 218.40 + 3000 = 8418.40. So the net balance should be
14000 − 8418.40 = 5581.60.
For year 4, two years have elapsed since year 2. Therefore the interest on sinking fund should
be 8418.40[(1 + j)2 − 1] = 722. Moreover since the net balance should be zero, the SF BAL
must equal to the loan amount 14000. So the sinking fund deposit is 14000−8418.40−722 =
4859.60