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# Actuarial Society of India EXAMINATIONS

5th June 2004 (a.m.) Subject 102– Financial Mathematics
Time allowed: Three Hours INSTRUCTIONS TO THE CANDIDATES 1. Do not write your name anywhere on the answer scripts. You have only to write your Candidate’s Number on each answer script. 2. Mark allocations are shown in brackets. 3. Attempt all questions, beginning your answer to each question on a separate sheet. 4. Fasten your answer sheets together in numerical order of questions. This, you may complete immediately after expiry of the examination time. 5. In addition to this paper you should have available graph paper, Actuarial Tables and an electronic calculator.

AT THE END OF THE EXAMINATION Hand in both your answer scripts and this question paperto the supervisor.

and the annual nominal coupon rate is Page 2 of 5 . the first instalment due now. At the end of 20 years the total of the two funds is Rs 1. During the first year the rate of interest per annum effective will be one of 3%. It is expected that 10 persons will qualify at the end of 1 year from now. At the end of 10 years the amount of fund A is half that of fund B. Determine which provides the higher effective rate of return. [3] 2) A money lender lends small sums and charges interest at the rate of Rs 3 per Rs 100 per month. During the second year.000. when it will remain constant. and so on till the loan is repaid. and so on till the number of qualifiers is 50 per annum.000 will be made to each person who in any year qualifies for membership of a certain profession. After 1 month the loan may be renewed for a further month on payment of a further Rs 3 per Rs 100.3. The rate of interest applicable in any one year is independent of the rate applicable in any other year.7 or 4% with probability 0. What effective rate of interest does he charge per annum? [2] 3) An investor is considering two investments.ASI 102 0604 1) Describe the operation of a motor vehicle insurance policy in the form of a cash flow process. [5] b) If instead of paying a lump sum now it was desired to pay 10 equal half-yearly instalments. [4] 7) On 15 March 1998 the government of a country issued an index-linked bond of term 6 years. Coupons are payable half -yearly in arrears. The second is a 91 day deposit at a rate of interest of 6. payable in advance. calculate the expected accumulated amount in the bank account at the end of two years. The first is a 91 day Treasury Bill discounted at a simple rate of discount of 6% per annum. 20 at the end of 3 years. 4% or 6% with equal probability.000 is invested in a bank account which pays interest at the end of each year. Assuming that interest is always reinvested in the account. Assume that there are 365 days in a year. 15 at the end of 2 years. the rate of interest per annum effective will be either 5% with probability 0. what would the amount of the instalments be? [3] Total [8] 6) Rs 100. [3] 4) Fund A accumulates at a rate of interest of 5% effective per annum and fund B at 7% effective per annum. What is the amount of the combi ned funds after 5 years? [5] 5) a) A prize fund is to be set up out of which a payment of Rs 5. Find at 3% per annum effective what sum must be paid into the fund now so that it may be sufficient to meet the outgo. The rate of interest is fixed randomly at the beginning of each year and remains unchanged until the beginning of the next year.15% per annum convertible daily.

Subsequently. You are given the following values of the inflation index: Date July 1997 March 1998 July 2001 September 2001 Inflation index 110.000 for manager B and on 31 December 2002.000 for manager B.ASI 102 0604 3%. the value of manager A’s fund was Rs 180.000 and of manager B’s fund was Rs 150. effective.000 for manager A and Rs 140.000.7 127. [3] b) Construct a loan schedule showing the capital and interest elements in and the amount of loan outstanding after the 6th and 7th payments. Repayments are calculated using a rate of interest of 8% p. and increases by Rs 10 per annum.1 126.000 for manager A and Rs 145. On 31 December 2003. a) Calculate the initial amount of the loan. [4] b) Calculate the money weighted rate of return earned by manager A over the period 1 January 2001 to 31 December 2003. Interest and capital payments are indexed by reference to the value of an inflation index with a time lag of 8 months. A tax-exempt investor purchased the stock at Rs 111 per Rs 100 nominal on 16 September 2001. with reasons. just after the coupon payment had been made. the shortfall will be treated as an addition to the outstanding loan. [5] c) Find the capital and interest element of the last instalment.5 112. The annuity is paid in arrear for 20 years. Rs 10. [3] c) Without calculating the money weighted rate of return earned by manager B. an investor placed part of his assets with two fund managers. the values were Rs 135.a.000. You should assume that the inflation index will increase continuously from its value in September 2001 at the rate of 4% per annum effective.000 and manager B was given Rs 100. [11] Total [14] 8) A loan is to be repaid by an immediate annuity. a) Calculate the time weighted rates of return earned by manager A and manager B over the period 1 January 2001 to 31 December 2003. The annuity starts at a rate of Rs 100 p. The values of the respecti ve funds on 31 December 2001 were Rs 130.000 invested with each manager on 1 January 2003. whether the money weighted rate of return earned by manager B over Page 3 of 5 .4 a) Calculate the amou nt of the coupon payment per Rs 100 nominal stock on 15 March 2002. [3] b) Calculate the effective real annual yield to the investor on 16 September 2001. [2] Total [10] 9) On 1 January 2001. If any annuity payment falls short of the interest then due. state.a.000 was invested with each manager on 1 January 2002 and a further Rs 10. Manager A was given Rs 120.

[4] b) An investment company has liabilities of Rs 7. the distribution of log-normal with parameters i(t ) . [2] b) Explain why most index-linked securities issued carry some inflation risk.000 payable at the end of each year for the next ten years. The interest rate is 7% per annum effective. Your answer should include reference to how the contract is structured. where i (t ) is the rate of interest earned in year µ and σ 2 .ASI 102 0604 the period 1 January 2001 to 31 December 2003 is higher than. t. [2] d) Comment briefly on the relative performance of the two fund managers. are independently and identically distributed.000. If the interest rate is 7% per annum effecti ve. [2] Total [4] 11) a) Describe how short interest rate futures operate. in which part of an insurance company’s funds is invested.451 at 7% per annum effective. You are given that ∑t t =1 10 2 t v = 228 . [2] Total [4] 13) a) An investment provides income of Rs 1. in practice. [3] Total [12] 10) a) Define the characteristics of a government index-linked bond. [8] Total [12] 14) The annual rates of interest from a particular investment.000. The company holds two investments.946 years. Each year. A and B. [1] Total [4] 12) a) Define arbitrage and describe when an arbitrage opportunity may exist. [2] b) Describe how the principle of “no arbitrage” is used to find the price of complex financial instruments. [3] b) If you think that interest rates are going to rise would you buy or sell the short interest rate future. Investigate whether values of Rs X and n can be found which ensure that the investment company is immunized against small changes in the interest rate. Investment A is the investment described in part a) and Investment B is a zero coupon bond which pays Rs X at the end of n years (where n is not necessarily an integer).000 due in 5 years time and Rs 8.000. is Page 4 of 5 . how the price is stated and what are the cashflows involved. equal to or lower than that earned by manager A. show that the discounted mean term of the investment is 4. There is no capital repayment.000 due in 8 years time.

[5] µ ************************ Page 5 of 5 .00064. Find. Each year the distribution of (1 + i ) is lognormal with parameters = 0. to two decimal places.06748 and a) The insurance company has liabilities of Rs 1.000 will accumulate over 10 years to more than Rs 4.500. = 0. where i is the annual yield on the company’s funds. It currently has assets of Rs 950.000 to meet in one year from now. Assets can either be invested in the risky investment described above or in an i nvestment which has a guaranteed return of 5% per annum effective.07 and standard deviation 0. the probability that the insurance company will be unable to meet its liabilities if: i) All assets are invested in the investment with the guaranteed return. the parameter µ σ 2 = 0.000.0003493. [3] Total [10] 15) The yields on an insurance company’s funds in different years are independently and identically distributed.ASI 102 0604 i (t ) has mean value 0.000. [7] b) Determine the variance of the return from the portfolios in a)i) and a)ii) above. ii) 85% of assets are invested in the investment which does not have the guaranteed return and 15% of assets are invested in the asset with the guaranteed return. Find the probability that a single investment of Rs 2.075 and σ 2 = 0.02.