Academic year 2016 – 2017

Mathematics of Finance (Bilingual Bachelor 3)

Lecturer: Selim MANKAÏ
Continuous Assessment 2
5 April February 2017
Time allowed: 1 hour

Instructions to the students:

All books, notes and other aids are not permitted during the examination

Exercise 1 (6 points)

- What are the most common amortization methods of loan repayment?

Interest-only loan
Amortized method (Straight-Line and Mortgage-Style)
Sinking fund method
- Define the “Internal return rate” and explain how does it work?

- What are the limits of the “Net present value” criterion?

NPV is sensitive to changes in estimates for future cash flows, salvage value and
the cost of capital.
Net present value does not take into account the size of the project.
Exercise 2 (3 points)

An investor makes an investment which will provide $2000 at the end of one the first and
$5000 at the end of fourth year. The investor pays $1000 now (t=0) and agrees to pay X at the
end of the third year. If the investor uses an interest rate of 7% compounded annually.

1. Present for each period the inflows and outflows.

t Inflow Outflow
0 (1000)
1 2000
2
3 (X)
4 5000

2. Find the maximum value of X so that the investment is profitable?

1
Exercise 3 (4 points)

Anchor Gaming Inc. is investigating a project with the following cash flows:

t
0 1 2 3
Cash-flows
-$15,000 +$6,800 +$5,200 +$4,900

Anchor Gaming has a weighted average cost of capital of 14%.

1. What is the payback period for this project? (1pt)

t Cash-flows Cumulated
Cash-flows
0
1 6,800 6,800
2 5,200 12,000
3 4,900 16,900
The payback period is 2 years and 7,34 months

2. What is the net present value (NPV) of this project? How to interpret the result?

(2pt)
3. What is the profitability index (PI) of the project? How to interpret the result?

1pt)

Exercise 4 (7 points)
A woman borrows $18,000 to buy a new car. The loan is to be repaid by fixed instalments
payable monthly for 5 years. The repayments are calculated at nominal interest rate of 5.4%
compounded monthly.

2
 1. What is the size of her monthly payment? (2 pts)
Her monthly payment will be $342.99 (rounded to the nearest penny).
2. How much interest will she pay? (1.5 pt)
Based on the formula, the total interest paid will be $2,579.40.
3. Find the annual percentage rate. (1 pt)
The effective annual rate is 5.536% (rounded to the nearest 3 decimal places).
4. Construct the amortization table (2 first and 2 last periods). (2.5 pts)
Remember that the balance reduction is the periodic payment minus the periodic interest. The
balance reduction in the last row is set equal to the initial balance which may make the last
payment a little bigger or smaller than the rest.