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ACST603 Tutorial 2

For each of the questions below:

a) State the formula or formulae you will use to solve the problem. (refer to the list of formulae below)
b) State the inputs to the calculation i.e. state the parameter values you will use to solve the problem.
c) Give the numerical answer to the question.

A sample question and solution are included at the end of this document to assist you.

Q1: How long will it take for $20,000 to grow to $30,000 at 8%p.a. simple interest? (in years correct to two decimal
places)

Q2: If compound interest is charged at 2.0% per month, what is the effective annual rate of interest (as a percentage
correct to two decimal places)?

Q3: How long (in years) does it take for money deposited in a bank account to accumulate to double the initial
amount at the interest rate = 16%.

Q4: $10,000 is invested for 8 years. Calculate the future value if interest is at = 6% for 3 years followed by =
12% for 5 years.

Question 5-7 refer to the note described below:

A 180-days promissory note (this is similar to a bank bill) will mature for $100,000 plus simple interest at 5% p.a.

Sixty days after the issue date, the original owner sold the note to Tom for $100,971.92.

Q5: Calculate the maturity value of the note. (Correct the answer to 2 decimal places.)

Q6 Calculate the rate of simple interest p.a. used by Tom in calculating his purchase price. (The answer should be
expressed as a percentage correct to 2 decimal places.)

Q7: Calculate the rate of simple interest p.a. earned by the original owner of the note over that holding period. (The
answer should be expressed as a percentage correct to 2 decimal places.) The original owner purchased the note for
$100,000, 180 days before maturity.
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Formula Sheet: (for your reference)

P Principal amount or present value

S Future value
T Term of loan / investment
I Interest earned / paid over term
r Rate of simple interest per annum
i Rate of compound interest per year
Simple interest Formula
S  PI , I  S P Total Interest Earned 2.1
I  P  r T Simple interest earned over term 2.2
S  P  1  rT  Future value in terms of present value 2.3
P  S 1  rT  Present value in terms of future value 2.4
r   S P   1 T Rate of return per annum 2.5
r '   S P   1 Rate of return over term of contract 2.6
T   S P   1 r holding period / term of investment 2.7
MD  T 1  rT  Modified duration of bank bill 2.8
Compound interest Formula
S  P 1  i 
T
Future value in terms of present value 2.9
I  S  P  P 1  i   1
T
  Interest earned over term 2.10
P  S 1  i 
T
Present value in terms of future value 2.11
1 T 
i   S P   1 Compound rate of return per annum 2.12
 
i   S P   1
'
Compound rate of return over term of contract 2.13
log e  S P 
T holding period / term of investment 2.14
log e 1  i 
T
MD  Modified Duration of Single Payment due at time T 2.15
1  i 
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Sample question:

Calculate the present value of $10,000 due to be paid 3 years from now. The interest rate to use in the
calculation is i4  10%

Sample Solution:

(a) Use the formula 2.11 Note that I have used the symbol n for the T shown in formula 2.11

S
P  S  1  i 
n

1  i 
n

(b) Input variables S, i, n

The S is $10,000 as stated in the question

The interest rate is . i4  10% This is a rate per year but it compounds 4 times a year.

1 10%
The interest rate per quarter is  i4   2.5%
4 4

The term of the arrangement is n  Term in years  frequency of payments per year = 3  4=12

This is measured in quarters and is consistent with the interest rate.

(c)

S $10, 000.00
The present value is P    $ 7,435.56
1  i  1  0.025 
n 12

This means if we invest $7,435.56 today for 3 years at the rate stated in the question it will accumulate to
$10,000 at the end of that term.