# Actuarial Society of India EXAMINATIONS

31st May 2003 (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 14 questions, beginning your answer to each question on a separate sheet. 4. 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 paper

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Q.1

Prove, by general reasoning, 1 1 = +i an Sn

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Q.2

The force of interest is given by, δ (t ) = 0.05 + 0.001t + 0.0001t 2 a) 0 ≤ t ≤ 10

Calculate the total at time 10 of the accumulated proceeds of an investment of Rs100 at time 0 plus an investment of Rs 100 at time 5. Calculate the equivalent constant force of interest earned on the transaction. A policyholder has obtained a quotation for purchasing an index- linked annuity certain from a life office. In return for the purchase price of Rs 10,00,000, the policyholder will receive 10 annual payments starting one year from now. The first payment will be Rs 1,25,000 and future payments will be increased in line with price inflation. If the life office assumes a constant nominal rate of interest of 8% per annum in the calculation, find the constant rate of inflation assumed. A salaried person aged exactly 35 now wishes to make 15 annual payments starting today into a pension plan. His aim is to provide for the expenses to be incurred, towards his daughter’s education, when he is aged 55. The expenses to be incurred are an initial lump sum of Rs 50,000 payable at age 55, and an annuity certain of Rs 20,000 per annum payable half- yearly in arrear during the next 6 years. In calculating how much annual payment to invest each year, the person has assumed that • • an effective rate of interest of 7% per annum will be achieved during the 20- year period, and that, the annuity certain can be purchased at a price that will yield a nominal rate of interest of 6% per annum convertible halfyearly.

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b) Q.3

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Q.4

a)

Assuming that the amount of each payment during any period of 5 years is half the amount of each payment in the subsequent 5 years, calculate the amount of the first annual payment.

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b)

Under the pension plan, • • the rate of interest actually earned over the 20- year period is 6% per annum effective, and the annuity certain is purchased at age 55 at a nominal rate of 5% per annum convertible half- yearly. [5]

Assuming that the person makes the payments as in a) above, calculate the revised amount of the initial lump sum that will be available. Q.5 A film producer has spent an amount of Rs 1,00,000 on making a film. The film generates revenues for a year at the rate of Rs 1,20,000 per annum during the first month, Rs 1,10,000 per annum during the second month and so on till Rs 10,000 in the twelfth month. Assume that the revenues are received continuously during each month. Assuming an interest rate of 6% per annum convertible half- yearly, calculate at the end of the year the net gain or loss made by the film producer. Assume that all months are of equal length. Q.6 A borrower is repaying one debt of Rs.4000 by 30 equal half- yearly instalments of principal and interest calculated at 5% per annum convertible half- yearly of which the 12th payment has just been paid, and another debt of Rs.1500 by 20 equal half- yearly instalments of principal and interest calculated at 4% per annum convertible half- yearly of which the 8th instalment has just been paid. If the remaining instalments of the two debts are to be replaced by an annuity-certain of 20 half- yearly payments, what rate of interest should be paid on the combined loan so that the total sum to be paid in future by the borrower will not be altered. Assume that all annuities are payable in arrear. Q.7 An investment manager of a life insurance company purchased a 10-year Government of India fixed interest bond with 7% interest per annum payable half- yearly in arrear with a gross redemption yield of 7%. There is an excellent secondary market for this bond. List the reasons why the net real actual yield that will be achieved can be less than what is expected.

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Q.8

a)

Describe the practical difficulties in estimating future cashflows to investors in equity shares. List reasons why the running yield from property investment is expected to be higher than that for ordinary shares. A mutual fund sells units to unit holders. It retains any income earned on its investments within the fund. Unit holders can redeem units available in their account based on the unit price on 1st April each year. The Unit price on 1st April in each year is: Year 1996 1997 1998 1999 2000 2001 2002 Unit price on 1.86 2.11 2.55 2.49 2.88 3.18 3.52 1st April For an initial investme nt of Re.1 on 1st April 1996, find the time weighted rate of return and linked internal rate of return for the fund over the period 1st April 1996 to 1 st April 2002 (ignore expenses of transaction). In order to allow for expenses, the mutual fund sells units at a price that is 2% more than the above-mentioned unit price and buys back units at a price that is 2% below the above- mentioned price.

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b)

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Q.9

a)

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b)

Write down the equation of value to find the yield obtained by an investor who purchased 200 units on 1st April in each year, from 1996 to 2001 inclusive, and who sold back his holding to mutual fund on 1st April 2002. Write down the equation of value to find the yield obtained by an investor who invested Rs.500 in the fund on 1st April in each year, from 1996 to 2001 inclusive, and who sold back his holding to mutual fund on 1st April 2002. List the disadvantages of using time weighted rate of return and money weighted rate of return in assessing the performance of an investment fund manager.

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c)

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d)

[3] Q.10 Q.11 Explain the difference between a future contract and forward contract. A 3-month forward contract is issued on 1st February 2003 on a stock with a price of Rs 500 per share. Dividends are received continuously and the dividend yield is 3% per annum. In addition, it is anticipated that a special dividend of Rs 100 per share will be paid on 1st April 2003. Assuming a risk free force of interest of 5% per annum and no arbitrage, calculate the forward price per share of the contract. [3] Q.12 A company is liable to make four payments at five-yearly intervals, the first payment being due five years from now. The amount of the tth payment is Rs (1000+100t). The company values these liabilities at an effective rate of
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interest of 5% per annum. a) b) Find the present value and the discounted mean term of these liabilities. An amount equal to the total value of the liabilities (on the basis of an effective annual interest rate of 5%) is immediately invested in two newly issued loans, one redeemable at the end of ten years and the other at the end of 30 years. Each loan bears interest at 5% per annum payable annually in arrear. Both the loans are issued and redeemable at par. Given that, on the basis of an effective annual interest rate of 5%, the discounted mean term of the asset-proceeds is the same as the discounted mean term of the liability – outgo, determine how much is invested in each of the loans. Q.13 a) A certain irredeemable stock pays interest at 5.5% per annum payable quarterly on 31st March, 30th June, 30th September and 31st December. On 31st August 2001 this stock was quoted at a price of Rs 49.50 per Rs 100 nominal. Find the gross nominal yield per annum, convertible halfyearly. An investor bought Rs 20,000 nominal of this stock on 31 August 2001 at the price quote in a) above. Exactly one year later he sold this holding at a price such that the purchaser’s gross nominal yield per annum, convertible half- yearly was 10%. Find the net annual yield obtained by the investor on the entire transaction, given that he pays tax on income at 40% and on capital gains at 30%. The yields i t , t = 1, 2,..., n on a company’s fund in different years are independently and identically distributed. Each year the distribution of (1 + i t ) is log-normal with parameters µ and σ 2 . Let Vn be the random variable denoting the present va lue of Re 1 due at the end of n years. a) Show that Vn has a log–normal distribution and find the parameters of the distribution. Assuming further that each year the yield, i t , has mean value 0.08 and standard deviation 0.05; find the expected value and the standard deviation of the present value of Rs 1000 due at the end of 10 years. [10]
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b)

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Q.14

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b)